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                UNITED STATES SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

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                                    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, 1998     Commission file nos.: 1-13573-01
                                                                      1-13573

                       U.S. TIMBERLANDS KLAMATH FALLS, LLC
                         U.S. TIMBERLANDS FINANCE CORP.
             (Exact name of registrant as specified in its charter)

                   DELAWARE                                   93-1217136
                   DELAWARE                                   91-1851612
         (State or other jurisdiction                      (I.R.S. Employer
      of incorporation or organization)                   Identification No.)

 625 Madison Avenue, Suite 10-B, New York, NY                    10022
   (Address of principal executive offices)                    (Zip code)

        Registrant's telephone number, including area code: 212-755-1100

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           Securities registered pursuant to Section 12(b) of the Act:

                                      None

           Securities registered pursuant to Section 12(g) of the Act:

           Title of Each Class:       Name of Each Exchange on Which Registered:
           9-5/8% Senior Notes                 New York Stock Exchange

      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 then 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 requirement for the past 90 days.

       Yes |X|    No |_| 

      Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to be
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to the Form 10-K.

      The co-Registrants have not issued any common equity held by
non-affiliates of the co-Registrants.

      Documents incorporated by reference: None

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                       U.S. TIMBERLANDS KLAMATH FALLS, LLC
                         U.S. TIMBERLANDS FINANCE CORP.

                                TABLE OF CONTENTS

                                                                            Page
                                                                             No.
PART I
    Item 1.   Business ..................................................    1
    Item 2.   Properties ................................................   10
    Item 3.   Legal Proceedings .........................................   10
    Item 4.   Submission of Matters to a Vote of Security Holders .......   10

PART II
    Item 5.   Market for Registrant's Common Units and Related Security
              Holder Matters ............................................   11
    Item 6.   Selected Financial Data ...................................   12
    Item 7.   Management's Discussion and Analysis of Financial
              Condition and Results of Operations .......................   13
    Item 7A.  Quantitative and Qualitative Disclosures About Market Risk    23
    Item 8.   Financial Statements ......................................   23
    Item 9.   Changes in and Disagreements with Accountants on Accounting
              and Financial Disclosure ..................................   23

PART III
    Item 10.  Directors, Executive Officers, Promoters and Control
              Persons of the Registrant .................................   24
    Item 11.  Executive Compensation ....................................   27
    Item 12.  Security Ownership of Certain Beneficial Owners and
              Management ................................................   31
    Item 13.  Certain Relationships and Related Transactions ............   31

PART IV
    Item 14.  Exhibits, Financial Statements, and Reports on Form 8-K ...   33


                                        i
<PAGE>

                                     PART I

Item 1. Business.

General

      The business of U.S. Timberlands Klamath Falls, LLC, a Delaware limited
liability company formed in 1996 (the "Company"), consists of the growing of
trees and the sale of logs and standing timber. The Company owns approximately
615,000 fee acres of timberland and cutting rights on approximately 3,000 acres
of timberland (collectively the "Timberlands") containing total merchantable
timber volume estimated as of January 1, 1999 to be approximately 2.1 billion
board feet ("BBF") in Oregon east of the Cascade Range (the "Timberlands"). Logs
harvested from the Timberlands are sold to unaffiliated domestic conversion
facilities. These logs are processed for sale as lumber, plywood and other wood
products, primarily for use in new residential home construction, home
remodeling and repair and general industrial applications. The Company also owns
and operates its own seed orchard and produces approximately five million
conifer seedlings annually from its nursery, approximately half of which are
used for its own internal reforestation programs, with the balance sold to other
forest products companies. Except as the context otherwise requires, references
herein to, or descriptions of, assets and operations of the Company include the
assets and operations of U.S. Timberlands Company, L.P. (the "Master
Partnership") and the predecessors of the Company and the Master Partnership.

      The Timberlands' merchantable timber consists of Ponderosa Pine
(approximately 45%) and Douglas fir (approximately 14%), species which have
historically commanded premium prices over other softwood species, with the
balance consisting of Lodgepole Pine, White Fir and other softwood species. The
Timberlands have stands of varying ages and are unique in the forests east of
the Cascade Range in Oregon in that approximately 178,000 acres are actively
managed tree farms (the "Plantations"). The Plantations were first established
by Weyerhaeuser Company ("Weyerhaeuser") in the early 1960s and acreage has been
planted each year since then. Currently, the Plantations contain age classes
ranging generally from one to 37 years old. Initial thinning or harvesting of
the Plantation stands is expected to begin within the next five years. Because
the timber on the Plantations is generally not yet considered merchantable,
volumes of timber on the Plantations are not included in the Company's estimated
merchantable timber volume. The balance of the Timberlands are composed of
natural stands. For a more complete description of the Company's properties, see
"Properties."

      In August 1996, the Company and U.S. Timberlands Management Company,
L.L.C., formerly known as U.S. Timberlands Services Company, L.L.C. ("Old
Services"), acquired approximately 604,000 fee acres of timberland (the "Klamath
Falls Timberlands"), containing an estimated merchantable timber volume of
approximately 1.9 BBF and related assets from Weyerhaeuser (the "Weyerhaeuser
Acquisition"). In July 1997, the Company, which is now the Master Partnership's
subsidiary operating company acquired approximately 42,000 fee acres of
timberland and cutting rights on approximately 3,000 acres of timberland (the
"Ochoco Timberlands"), containing an estimated merchantable timber volume of
approximately 280 million board feet ("MMBF") from Ochoco Lumber Company
("Ochoco") (the "Ochoco Acquisition"). Over 40% of the merchantable timber on
the Ochoco Timberlands is at least 80 years old. The Company believes that the
age classes and species mix of the Ochoco Timberlands fit well with the Klamath
Falls Timberlands and provide the Company flexibility in developing its harvest
plans. In October 1997 and May 1998, the Company sold approximately 13,000 and
15,300 acres from the Klamath Falls Timberlands respectively.

      During the period from January 1, 1994 through the acquisition of the
Klamath Falls Timberlands by the Company, approximately 58% of the logs
harvested from the Klamath Falls Timberlands were delivered to a plywood mill
owned by Weyerhaeuser at Klamath Falls, Oregon. Similarly, prior to the Ochoco
Acquisition, substantially all of the timber harvested from the Ochoco
Timberlands was delivered to Ochoco's mills. The Company does not currently own
any conversion facilities nor does it presently intend to own any such
facilities on a long-term basis; consequently all of the Company's sales are
made to unaffiliated third parties. Concurrent with the Company's acquisition of
the Klamath Falls Timberlands, the Company arranged for Collins Products LLC
("Collins"), a privately
<PAGE>

owned forest products company located within the Klamath Falls Timberlands area,
to purchase Weyerhaeuser's Klamath Falls mill facilities. The Company entered
into a 10-year log supply agreement with Collins (the "Collins Supply
Agreement") providing for the purchase by the plywood mill and delivery by the
Company of a minimum of 34 million board feet ("MMBF") of logs each year at
market prices. The Collins Supply Agreement is extendable by Collins for two
additional five-year terms. In addition to its sales under the Collins Supply
Agreement, the Company sells logs to conversion facilities located in the area
surrounding the Timberlands. There are currently more than 50 primary conversion
facilities located within a 150 mile radius of the Company's Timberlands.

Formation of the Company

      On November 19, 1997, the Master Partnership acquired substantially all of
the equity interests in the Company and the business and assets of Old Services
(the "Acquisition") and completed its initial public offering (the "MLP
Offering") of common units representing limited partner interests ("Common
Units"). Upon the closing of the Acquisition, Old Services contributed all of
its assets, including its timber operations, to U.S. Timberlands Services
Company, L.L.C., a newly formed Delaware limited liability company and the
Company's manager (the "Manager" or "New Services"), in exchange for interests
therein. Immediately thereafter, the Company assumed certain indebtedness (the
"Holdings Debt") of U.S. Timberlands Holdings, L.L.C., an affiliate of the
Company ("Holdings"), and the Manager contributed its timber operations to the
Company in exchange for a member interest in the Company. Then the Manager
contributed all but a 1% member interest in the Company to the Master
Partnership in exchange for a general partner interest in the Master
Partnership, the right to receive Incentive Distributions (as defined in the
Glossary of Certain Terms) and 1,387,963 subordinated units representing limited
partner interests in the Master Partnership ("Subordinated Units"), and Holdings
contributed all of its interest in the Company to the Master Partnership in
exchange for 2,894,157 Subordinated Units. The Manager then distributed the
Subordinated Units to Old Services. Approximately 143,398 Subordinated Units
were used by Old Services to redeem interests in Old Services held by certain
founding directors of the Manager (the "Founding Directors"). As a result of
such transactions, the Company became the operating company and the Manager owns
an aggregate 2% interest in the Master Partnership and the Company on a combined
basis, and the right to receive Incentive Distributions; Old Services owns
1,244,565 Subordinated Units; Holdings owns 2,894,157 Subordinated Units; and
the Founding Directors own an aggregate of 143,398 Subordinated Units. The
4,282,120 Subordinated Units owned by Old Services, Holdings and the Founding
Directors represent an aggregate 32.6% interest in the Master Partnership. The
Common Units and the Subordinated Units are referred to herein collectively as
"Units" and the holders of Units are referred to herein as "Unitholders."
Concurrent with the closing of the Master Partnership's MLP Offering, the
Company and its wholly-owned subsidiary, U.S. Timberlands Finance Corp.
("Finance Corp."), consummated the public offering (the "Public Note Offering")
of $225.0 million aggregate principal amount of unsecured senior notes (the
"Notes") and obtained a $25.0 million revolving credit facility to be used for
working capital purposes (the "Working Capital Facility") and a $75.0 million
revolving credit facility to be used for acquisitions and capital improvements
(the "Acquisition Facility" and, together with the Working Capital Facility, the
"Bank Credit Facility"). See "Management's Discussion and Analysis - Liquidity
and Capital Resources."

      Finance Corp., a Delaware corporation, was formed on August 18, 1997, and
is a wholly-owned subsidiary of the Company. Finance Corp. serves or co-obligor
for the Notes. It has nominal assets and does not conduct any operations.
Accordingly, a discussion of the results of operations, liquidity and capital
resources of Finance Corp. is not presented.

Company Structure and Management

      The operations of the Master Partnership are conducted through, and the
operating assets are owned by, the Company, as the Master Partnership's
operating subsidiary. The Master Partnership owns a 98.9899% member interest in
the Company and the Manager owns a 1% general partner interest in the Master
Partnership and a 1.0101% managing member interest in the Company. The Manager
therefore owns an aggregate 2% interest in the Master Partnership and the
Company on a combined basis.


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      The Company's business is managed by the Manager. The Manager does not
receive any management fee or other compensation in connection with its
management of the Company, but is reimbursed for all direct and indirect
expenses incurred on behalf of the Company (including wages and salaries of
employees, officers and directors of the Manager) and all other necessary or
appropriate expenses allocable to the Company or otherwise reasonably incurred
by the Manager in connection with the operation of the Company's business.

      Conflicts of interest may arise between the Manager and its affiliates, on
the one hand, and the Master Partnership, the Company and the Unitholders, on
the other, including conflicts relating to the compensation of the directors,
officers and employees of the Manager and the determination of fees and expenses
that are allocable to the Company. The Manager has a conflicts committee (the
"Conflicts Committee"), consisting of two independent members of its Board of
Directors, that is available at the Manager's discretion to review matters
involving conflicts of interest.

      The principal executive offices of the Company and Finance Corp. are
located at 625 Madison Avenue, Suite 10-B, New York, New York 10022. The
telephone number at such offices is (212) 755-1100.

The Timberlands

Timber Growth

      Timber growth rates reflect timberland productivity and the rate of return
on a timber investment. Growth rate is an important factor in determining when
to harvest timber and the harvest potential of timberlands over the long term.
Merchantable timber is economically mature for harvesting when its current
growth rate falls below the desired rate of return on the investment in the
standing trees. The average growth rate from regeneration to economic maturity
measures the capacity of the land for timber production. The Company's older and
natural stands on the Timberlands that are expected to provide the near term
harvest have a current average growth rate of approximately 160 board feet per
acre per annum. The younger Plantations are growing at a rate that is expected
to average at least 315 board feet per acre per annum to economic maturity in 50
to 60 years. This growth rate is based on calculated volumes at the time of
maturity. The Company has achieved higher growth rates on the Plantations by
planting seedlings which are able to begin growing immediately (as compared to
the slower natural regeneration process) by eliminating competing non-timber
growth from the Timberlands and by applying modern forestry practices to assist
the growth of the timber. Management does take action to enhance the growth rate
in the natural stands as well. For example, selective harvesting in the slower
growing natural stands opens up the timber stand allowing for more vigorous
growth of the remaining trees. When it is no longer possible to maintain
acceptable growth rates in these stands they will be harvested entirely and
converted to faster growing plantations.

Harvest Plans

      The Company strives to manage all of its Timberlands, including the
Plantations, in an economically prudent and environmentally sensitive manner in
order to maximize their value over time. Integral to this management process are
the Company's long-term harvest plans. The Company prepares its harvest plans
annually based on analyses of the size and age class distribution of the
Timberlands and the economic maturity of each harvest tract. The factors the
Company considers in determining its long-term harvest plans include, among
other things, current and expected market conditions, competition, customer
requirements, the age, size and species distribution of the Company's timber,
assumptions about timber growth rates which are improving over time as a result
of technological, biological and genetic advances that improve forest management
practices, expected acquisitions and dispositions, access to the Timberlands,
availability of contractors, sales contracts and environmental and regulatory
constraints. The Company's harvest plans reflect the Company's expectations for
each year's harvest, including the sites to be harvested, the manner of
harvesting such sites, the volume of each species to be harvested, the prices
expected to be received for the Company's timber, the amount of stumpage sales,
logging and other costs, thinning operations and other relevant information. The
Company has the flexibility to update its harvest plans during the year to take
into consideration changes in these factors. The Company harvested from log,
stumpage and timber deed sales 139 MMBF in 1997 and 145 MMBF in 1998 and plans


                                       3
<PAGE>

to harvest, or commit to harvest, approximately 202 MMBF in 1999. The Company
also sold through property sales, 42 MMBF in 1997 and 27 MMBF in 1998 and
intends to sell approximately 12 MMBF in 1999. Under the current harvest plans,
the Company intends to harvest its current Timberlands aggressively over
approximately the next ten years after which time the harvest level is expected
to decline to a level which the Company considers to be more sustainable over
the long term. The Company believes these harvest plans can be achieved;
however, since harvest plans are based on certain assumptions, many of which are
beyond the Company's control, there can be no assurance that the Company will be
able to harvest the volumes projected in its harvest plans. While the Company's
debt obligations place certain limitations on the harvest plans, the Company
believes that it has sufficient flexibility to permit modifications in response
to fluctuations in the market for logs and lumber and the other factors
described above. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations." If the Company's current harvest plans are
pursued unaltered for the next ten years, if it consummates the land sales
contemplated by its strategic plan and if its other strategic assumptions prove
to be accurate, the Company expects that its timber inventory would decline by
the end of 2009 and that its more valuable species of timber would decline as a
percentage of its total timber inventory by such date. The Company expects that
its inventory would remain relatively stable thereafter. Long term harvest
plans, growth rates and forest inventory levels will be reviewed during 1999 and
2000. Such harvest plans, land sales and other strategic assumptions do not take
into account any acquisition that the Company may consummate during such period.

Access

      The Timberlands are accessible by a system of approximately 5,000 miles of
Company-owned and established roadways or low-maintenance roads. The Company
uses third-party road crews to conduct construction and maintenance on the
Timberlands. The Company regularly enters into reciprocal road-use agreements
with the United States Department of Agriculture - Forest Service ("USFS") and
the United States Department of Interior Bureau of Land Management ("BLM") and
cooperates with such agencies in numerous cost-sharing arrangements regarding
jointly used roads.

Sales and Markets

      Once a block of timberland is ready to be harvested, the Company solicits
offers from its customers for delivery of logs. After a price and volume have
been agreed to among the parties, the Company either (i) contracts a third party
to harvest the acreage and deliver to a roadside site on the Timberlands, where
a contracted trucking company picks up the logs and delivers them to the
customer, or (ii) sells the timber on a stumpage basis where the customer
arranges to harvest and deliver the logs. When the Company sells timber on a
stumpage basis, depending on the length of the contract, it may either receive
payment in full upon the execution of the contract, or may receive a portion of
the payment upon execution of the contract and the balance of payment when the
timber is cut. In a stumpage sale, the Company generally retains the risk of
loss on the timber until such time as it has been harvested by the buyer. The
Company also sells timber to customers pursuant to timber deeds. In a timber
deed sale, the Company receives a portion of the payment for the timber at the
time of execution of the contract and the balance of payment at various
intervals throughout the duration of the contract, and the risk of loss on the
timber covered by the contract passes immediately to the buyer, regardless of
when the buyer harvests the timber. The Company currently sells its sawlogs or
stumpage directly to unaffiliated wood products manufacturers and sells its
chips to unaffiliated pulp mills or hardboard plants. The percentage of logs
which are sold as sawlogs/stumpage or pulp logs is dependent upon, among other
things, the species mix and quality of the inventory harvested and the market
dynamics affecting the region. Most of the timber on the Timberlands is softwood
which, due to its long fiber, strength, flexibility and other characteristics,
is generally preferred over hardwood for construction lumber and plywood. Once
processed, sawlogs are suitable for use as structural grade lumber, appearance
grade boards, plywood and laminated veneer and can also be manufactured for such
end uses as window trim, molding and door jambs. Sawlogs and stumpage sales
accounted for approximately 78.0% and 89.2% of the Company's revenues in 1997
and 1998, respectively. Timber deeds and timber and timberland sales accounted
for approximately 19.8% and 8.8% the Company's revenues for 1997 and 1998.


                                       4
<PAGE>

      Chips, which can be used to make hardboard or pulp, accounted for
approximately 1.9% and 1.7% of the Company's revenues in 1997 and 1998,
respectively. The market price of chips has historically been volatile, rising
and falling with the price of pulp. Sales of seedlings accounted for the
remaining 0.3% of the Company's revenues in 1997 and 1998.

      The Company's customers include numerous unaffiliated operators of
conversion facilities. Since its acquisition of the Klamath Falls Timberlands in
August 1996, the Company has sold logs and chips from such timberlands to 24
different customers. Concurrent with the Weyerhaeuser Acquisition, the Company
arranged for Collins, a privately owned forest products company located within
the Klamath Falls Timberlands, to purchase Weyerhaeuser's Klamath Falls mill
facilities. At such time, the Company entered into the Collins Supply Agreement,
a 10-year log supply agreement with Collins providing for purchase by the
plywood mill and delivery by the Company of a minimum of 34 MMBF of logs each
year at market prices. The Collins Supply Agreement is extendable by Collins for
two additional five-year terms. In 1997, timber sales to Collins, Crown Pacific
Partners and Boise Cascade Corporation accounted for approximately 23%, 21% and
15%, and in 1998, Crown Pacific Partners, Boise Cascade Corporation, Collins and
Thomas Lumber Company accounted for approximately 27%, 18%, 17% and 16%
respectively, of the Company's revenue. Collins made its purchases pursuant to
the Collins Supply Agreement, while the other purchases were made pursuant to
short-term arrangements. Although the loss of one or more of such customers or
other significant customers could have a material adverse effect on the
Company's results of operations, the Company believes that the capacity for
processing wood fiber in the Company's markets currently exceeds the supply and
that, therefore, such customers could readily be replaced. Prior to the
Company's acquisition of the Ochoco Timberlands, virtually all of the logs sold
from such timberlands were sold to Ochoco's own facilities. Since the Ochoco
Acquisition in July 1997, all of the sales from the Ochoco Timberlands have been
and will be made to unaffiliated customers. There are currently more than 50
primary conversion facilities located within a 150-mile radius of the Company's
Timberlands.

Seasonality

      Log and stumpage sales volumes are generally at their lowest levels in the
first and second quarters of each year. Heavy snowfalls in higher elevations
prevent access to many areas of the Company's timberlands in the first quarter.
This limited access, along with spring break-up conditions in March or April
(when warming weather thaws and softens roadbeds), restricts logging operations
to lower elevations and areas with rockier soil types. The result of these
constraints is that sales volumes are typically at their lowest in the first
quarter, improving in the second quarter and at their high during the third and
fourth quarters. Most customers in the region react to this seasonality by
carrying high log inventories at the end of the calendar year at a level that
provides sufficient inventory to carry them to the second quarter of the
following year.

      Contributing to this seasonality of log volumes is the market demand for
lumber and related products which is typically lower in the first or winter
quarter when activity in the construction industry is slow, but increasing
during the spring, summer and fall quarters. Log and stumpage prices generally
increase in the spring with this build up of construction activity matching the
timing of re-entry to all forested areas and increased logging activity.


                                       5
<PAGE>

Competition

      Due to transportation costs, domestic conversion facilities in the Pacific
Northwest tend to purchase raw materials within relatively confined geographic
areas, generally within a 200-mile radius. It is generally recognized that log
suppliers such as the Company provide their market with a commodity product. The
Company and its competitors all benefit from the same competitive advantages in
the region--namely, excess of demand, close proximity to numerous mills, and
positive demographic trends of the Pacific Northwest and the West Coast.
Therefore, the Company and its competitors are currently able to sell all the
logs they are able to produce. Additional competitive factors within a market
area generally will include species and grade, quality, ability to supply logs
which consistently meet the customers' specifications and ability to meet
delivery requirements. The Company believes that it has a reputation as a stable
and consistent supplier of well merchandised, high-quality logs. The Company has
no conversion facilities and therefore does not compete with its customers for
logs. The Company believes that this gives it an advantage over certain of its
competitors that also own conversion facilities.

      The Company competes with numerous private land and timber owners in the
northwestern United States and the state agencies of Oregon, as well as
immaterial amounts of foreign imports, primarily from Canada and New Zealand. In
addition, the Company competes with the USFS, the BLM and the Bureau of Indian
Affairs. Certain of the Company's competitors have significantly greater
financial resources than the Company.

      The Company believes that it competes successfully in the timber business
for the following reasons: (i) the Company has substantial holdings of timber
properties which include approximately 2.1 BBF of merchantable, good quality
timber, approximately 178,000 acres of plantation timberland and a full-scale
seed orchard and nursery operation located in a region where conversion
facilities have been experiencing shortages in the supply of wood fiber; (ii)
the Company focuses on owning timberlands rather than operating conversion
facilities, which minimizes the Company's cost structure and capital
expenditures, allows the Company to seek the most favorable markets for its
timber rather than being committed to supply its own facilities, and ensures
that the Company will not compete with its customers; (iii) the Company's lean
operating structure allows it to efficiently manage its Timberlands, and should
enable it to acquire additional timberlands without commensurate increases in
overhead; and (iv) the Company's computerized geographic information system
("GIS") enables the Company to evaluate the optimal timing and patterns of the
harvest of its Timberlands and evaluate and integrate acquisitions of additional
timberlands.

Resource Management

Timber Resource Management

      All of the silvicultural activities on the Timberlands and the harvesting
and delivery of logs are conducted by independent contractors who are not
employees of the Company. The Company's operations involve intensive timber
management and harvesting operations, which include road construction and
reforestation, as well as wildlife and watershed management, all of which are
carefully monitored using the Company's GIS. See "Geographic Information
System." The Company employs a number of traditional and recently developed
harvesting techniques on its lands based on site-specific characteristics and
other considerations. Due to the topography of the Timberlands, over 95% of the
Timberlands can be harvested using lower-cost mechanical methods as opposed to
higher-cost cable systems.

      Harvesting on the Timberlands is conducted using both selective and
regeneration harvesting. In selective harvesting, a partial harvest provides
merchantable timber and opens up the stand for supplemental growth on the
remaining stand. Harvest entries are separated by approximately 10 to 15 years
and each entry is prescribed for volume to be removed, spacing to be provided,
and diameter limits to be harvested. In regeneration harvesting, which is used
to harvest approximately 30% of the Company's timber, all merchantable volume is
removed in a single harvest. After an area has been regeneration harvested, the
Company employs a reforestation contractor to plant two-year-old seedlings at a
density of approximately 350 trees per acre. The Company also attempts to
protect and maintain the ecosystem within the Timberlands while providing for a
reasonable harvest. For example, the Company typically leaves a mix of


                                       6
<PAGE>

green and dead trees at the harvest site, including some large trees, snags and
downed logs to provide habitats for a variety of wildlife species and enrich and
protect the soil for successive generations of trees.

      Particular forestry practices vary by geographic region and depend upon
factors such as soil productivity, weather, terrain, tree size, age and
stocking. The rain, site and soil conditions on the east side of the Cascade
Range, for example, permit management to harvest on an optimal rotation, or
harvest cycle, of 50 to 60 years. Forest stands are thinned periodically to
improve growth and stand quality until harvested. The Company actively utilizes
commercial thinning as a timber management practice. Pre-commercial thinning,
which occurs only in the Plantation stands, is utilized when the timber
harvested is not merchantable. The Company believes that such thinning improves
the overall productivity of the Timberlands by enhancing the growth of the
remaining trees. Occasionally, revenues are generated from pre-merchantable
thinning due to strong markets for wood chips.

      The Company's policy is to ensure that every acre harvested is reforested
in order to enhance the long-term value of its timberlands. Based on the
geographic and climatic conditions of a given harvest site, harvested areas may
be regenerated naturally, by leaving mature trees to reseed the area, or
replanted with seedlings. Natural regeneration methods are widely used on
approximately 70% of the Company's harvested land. Approximately 28% of the
Timberlands acreage currently consist of Plantations. The Company expects to
convert approximately 3,000 to 6,000 acres of natural stands to Plantations
annually. During 1998, the Company planted approximately 2.2 million seedlings.
The Company uses genetically improved seedlings (representing approximately 90%
to 95% of seedlings planted) to grow trees with desirable traits such as
superior growth characteristics, good form and disease resistance, resulting in
greater wood volume over a rotation than that generated by naturally regenerated
seedlings. The seedlings are grown in the Company's nursery, which uses seeds
from the Company's seed orchard, which was established by Weyerhauser in 1973.
Such seeds are generated by trees that are created by grafting selected superior
genetic stock to mature root stock.

Geographic Information System

      The GIS is a computer software program that the Company acquired from
Weyerhaeuser as part of the Klamath Falls Acquisition. The GIS data, which has
been compiled over a period of at least five years, includes detailed
topographical field maps for every stand within the Timberlands including data
for the Ochoco Timberlands, setting forth the characteristics, including age,
species, size and other characteristics for the timber growing on each such
stand. Using the data in the GIS, the Company can use a computer model to "grow"
the timber over time, enabling it to generate long-term harvest plans and to
update its inventory annually. To maintain the integrity of the data in the GIS,
the Company performs a detailed ground survey of the remaining timber inventory
on a tract after each harvest and updates the data in the GIS for that tract.
With the aid of the GIS, the Company is able to actively manage the Timberlands,
track its inventory and develop site-specific harvest plans on multiple scales,
adding additional layers of detail, such as the location of roadways or wildlife
nesting areas, as required. The GIS also permits the Company to analyze the
impact that new legislation may have on its timberlands by inputting the
proposed constraints imposed by such legislation in light of the particular
field characteristics of its Timberlands. The GIS will also be used to evaluate
potential acquisition opportunities.

      Although GIS systems are generally available for purchase, many of the
Company's competitors do not utilize GIS systems, mainly due to the relatively
high initial cost and to the length of time necessary to collect sufficient data
to optimize the use of the GIS. Thus, the Company believes the GIS gives it an
advantage over its competitors.

Land Sales

      In 1998, the Company sold approximately 15,300 acres from the Klamath
Falls Timberlands. The Company expects to sell additional timberland parcels in
the future.


                                       7
<PAGE>

Federal and State Regulation

Endangered Species

      The federal Endangered Species Act and counterpart state legislation
protect species threatened with possible extinction. Protection of endangered
species may include restrictions on timber harvesting, road building and other
silvicultural activities in areas containing the affected species. A number of
species indigenous to the Pacific Northwest have been protected under the
Endangered Species Act, including the northern spotted owl, marbled murrelet,
Columbian white-tail deer, mountain caribou, grizzly bear, bald eagle, northern
goshawk and various anadromous fish species. Currently, the Company has
identified several spotted owl, bald eagle and northern goshawk nesting areas
affecting the Timberlands and the presence of bull trout in certain of its
streams, which may affect harvesting on approximately 26,000 acres.

      In 1990, the United States Fish and Wildlife Service (the "USFWS") listed
the northern spotted owl as a threatened species throughout its range in
Washington, Oregon and California. The Oregon Forest Practices Act and related
regulations also protect endangered species and has specific provisions
governing habitat protection for the spotted owl, the bald eagle and other
threatened species.

      Based on the latest survey available to the Company, there were
approximately 80 bald eagle sites on the Klamath Falls Timberlands. The Company
observes harvesting restrictions around the eagle sites.

      In addition, the Company conducts surveys to determine the presence of
northern spotted owls. The surveys have been conducted every year in order to
(i) meet the regulatory requirements for timber harvest and other management
activities, (ii) monitor existing sites and determine the current status of such
sites, (iii) determine if areas identified as containing suitable habitat are
supporting owls and (iv) investigate other spotted owl or other species
sightings. The most recent of such surveys was completed in July 1997, and
identified approximately 27 northern spotted owl sites affecting the Klamath
Falls Timberlands, three of which are located on the Klamath Falls Timberlands.

      The Company believes that it is managing its harvesting operations in the
areas affected by protected species in substantial compliance with applicable
federal and state regulations. Based on certain consultants' reports, and on
management's knowledge of the Timberlands, the Company does not believe that
there are any species protected under the Endangered Species Act or similar
state laws that, under current regulations and Court interpretation, would
materially adversely affect the Company's ability to harvest the Timberlands in
accordance with current harvest plans. There can be no assurance, however, that
species within the Timberlands may not subsequently receive protected status
under the Endangered Species Act or that currently protected species may not be
discovered in significant numbers within the Timberlands. Additionally, there
can be no assurance that future legislative, administrative or judicial
activities related to protected species will not adversely affect the Company or
its ability to continue its activities and operations as currently conducted.

Timberlands

      The operation of the Timberlands is subject to specialized statutes and
regulations in the State of Oregon, which has enacted laws which regulate
forestry operations, including the Forest Practices Act, which addresses many
growing, harvesting and processing activities on forest lands. Among other
requirements, these laws restrict the size and spacing of harvest units, and
impose certain reforestation obligations on the owners of forest lands. The
State of Oregon requires a company to provide prior notification before
beginning harvesting activity. The Forest Practices Act and other state laws and
regulations control timber slash burning, operations during fire hazard periods,
logging activities affecting or utilizing water courses or in proximity to
certain ocean and inland shore lines, water anti-degradation and certain grading
and road construction activities. The Company believes it is in substantial
compliance with these regulations.


                                       8
<PAGE>

Environmental Laws and Superfund

      The Company's operations are subject to federal, state and local
environmental laws and regulations relating to the protection of the
environment. Although the Company believes that it is in material compliance
with these requirements, there can be no assurance that significant costs, civil
and criminal penalties, and liabilities will not be incurred, including those
relating to claims for damages to property or natural resources resulting from
the Company's operations.

      Environmental laws and regulations have changed substantially and rapidly
over the last 20 years, and the Company anticipates there will be continuing
changes. The trend in environmental regulations is to place more restrictions
and limitations on activities that may affect the environment, such as emissions
of pollutants and the generation and disposal of wastes. Increasingly strict
environmental restrictions and limitations have resulted in increased operating
costs for the Company and it is possible that the costs of compliance with
environmental laws and regulations will continue to increase.

Access to Timberlands May be Limited by Federal Regulation

      A substantial portion of the Timberlands consists of sections of land that
are intermingled with or adjacent to sections of federal land managed by the
USFS and the BLM. Removal of trees from those portions of the Timberlands
requires transportation of the logs by truck across logging and general purpose
roads. In many cases, access is only, or most economically, achieved through a
road or roads built across adjacent federal land pursuant to a reciprocal
right-of-way ("RROW"). Removal of federal timber often requires similar access
across the Timberlands. Recent litigation (not involving the Company) before the
United States Court of Appeals for the Ninth Circuit held that the BLM was not
required to consult with the USFWS, which administers the Endangered Species
Act, prior to approving a private landowner's proposal to build an access road
across federal land pursuant to an existing RROW entered into prior to the
enactment of the Endangered Species Act wherein the BLM did not have discretion
to disapprove a road segment due to endangered species concerns. A reversal on
appeal or a rehearing of that case, or future federal law or regulation
requiring the BLM to consult with the USFWS in connection with an RROW, could
materially adversely affect the Company's ability to harvest the affected
portion of the Timberlands. Certain of the Company's RROW agreements contain
provisions that require compliance with state and federal environmental laws and
regulations. To the extent that the Company acquires new Timberlands that
require access through federal lands, the Company may enter into new RROW
agreements with the BLM or other federal agencies which would require
consultation with the USFWS. In addition, the BLM has published advance notice
of its intent to revise regulations governing RROW agreements entered into the
future to, among other things, expand the BLM's consideration of environmental
and cultural factors in granting, issuing or renewing rights-of-way, provide the
BLM with regulatory authority to object to the location of roads because of
potential effects on threatened or endangered species and allow for the
abandonment of rights-of-way under certain circumstances.

Safety and Health

      The operations of the Timberlands are subject to the requirements of the
Federal Occupational Safety and Health Act ("OSHA") and comparable state
statutes relating to the health and safety of employees. The Company believes
that it is in compliance with OSHA regulations, including general industry
standards, permissible exposure levels for toxic chemicals and record-keeping
requirements.

Employees

      As of March 15, 1999, the Company had 30 salaried employees, including
employees of the General Partner that manage the business of the Company. The
employees of the Timberlands are not unionized, and the Company believes that
its employee relations are good. All of the silvicultural activities on the
Timberlands and the harvesting and delivery of logs are conducted by independent
contractors who are not employees of the Company.


                                       9
<PAGE>

Item 2. Properties

Timber Inventory

      The Company currently owns and manages approximately 615,000 fee acres of
timberland and cutting rights on approximately 3,000 acres of timberland
containing total merchantable timber volume estimated as of January 1, 1999 to
be approximately 2.1 BBF in Oregon east of the Cascade Range. The Timberlands
include substantial holdings of merchantable, good-quality timber. A
merchantable tree is a tree of sufficient size that will produce a sound log 16
feet in length and at least 4.6 inches in diameter, inside bark, at the small
end. The Company's merchantable timber inventory consists of premium species of
softwood, consisting of Ponderosa Pine and Douglas fir, species which have
historically commanded premium prices over other softwood species, as well as
Lodgepole Pine, White Fir and other species. The Company believes that the
Timberlands are suitable and adequate for current operations.

      The Timberlands have stands of varying sizes and ages and are unique in
the forests east of the Cascade Range in Oregon in that approximately 178,000
acres of the 615,000 acre total consist of actively managed pine Plantations
with stands ranging in age from one to 37 years. The Plantations are stocked
with high quality Ponderosa Pine (approximately 77%) and Lodgepole Pine
(approximately 23%). Because the timber on the Plantations is generally not yet
considered merchantable, volumes of timber on the Plantations are not included
in the Company's estimated merchantable timber volume. However, initial thinning
of the Plantation stands, including the thinning of commercial quantities of
merchantable timber, is expected to begin within the next five years. See "The
Timberlands--Harvest Plans."

Merchantable Timber Inventory by Species

      The Company maintains data regarding the estimated merchantable timber
inventory by species within the Timberlands. All volumes are based on
information developed by Company personnel. As of January 1, 1999, the total
timber inventory amounted to 2.1 BBF. The Company's combined timber inventory by
MMBF and percentage is Ponderosa Pine (931.3 (45%)), Lodgepole Pine (399.6
(19%)), White Fir (409.6 (20%)), Douglas fir (282.3 (14%)) and other species
(65.5 (2%)). Other species include Cedar, Sugar Pine, Western Larch and Grand
Fir.

Size and Species Distribution of Merchantable Timber

      The Company's Timberlands are well diversified, not only by species mix
but also by size distribution. Timber on the Timberlands generally reaches
merchantable size between 40 and 50 years in natural stands and between 25 and
35 years in the Plantations. The Company maintains data as to the estimated
volume distribution of merchantable timber on the Timberlands by species and by
diameter at breast-height ("DBH"). As of January 1, 1999, approximately 562
MMBF, or 27%, of the merchantable timber had a DBH of 16 or more inches.

Acreage Distribution by Age Class on Plantations

      The Company also maintains data as to the acreage distribution of timber
on the Plantations by age class. As of January 1, 1999, the Plantations totaled
178,000 acres. Of the total acreage, 63,300 acres range from 1 to 15 years of
age, 109,800 acres range from 16 to 25 years of age, and 4,900 acres are 26
years of age or older.

Item 3. Legal Proceedings

      There is no pending litigation and, to the knowledge of the Company, there
is no threatened litigation, the unfavorable resolution of which could have a
material adverse effect on the business or financial condition of Company.

Item 4. Submission of Matters to a Vote of Security Holders

      There were no matters submitted to a vote of the Company's Unitholders
during the fourth quarter of 1998.


                                       10
<PAGE>

                                     PART II

Item 5. Market for Registrant's Common Units and Related Security Holder Matters

      In connection with the consummation of the Transactions, a 98.9899% member
interest in the Company was issued to the Master Partnership and a 1.0101%
member interest was issued to the Manager. There is no public trading market for
the Company's equity securities. The Company distributes all of its Available
Cash on a quarterly basis.

      The Company made its first cash distribution to the Master Partnership for
distribution to holders of the Common Units and the Subordinated Units on May
15, 1998, of $0.73, representing the sum of $0.50, the Minimum Quarterly
Distribution (as defined in the Master Partnership Agreement) for the first
quarter of 1998, plus $0.23, the pro rata portion of the Minimum Quarterly
Distribution for the period from November 19, 1997 through December 31, 1997.
The Company made distributions to the Master Partnership for the Minimum
Quarterly Distributions of $0.50 per Unit for the second, third and fourth
quarters of 1998 on August 14, 1998, November 13, 1998 and February 12, 1999,
respectively.


                                       11
<PAGE>

Item 6. Selected Financial Data

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------   ------------------------------------
                                                                U.S. Timberlands (1)                       Predecessor (1)
---------------------------------------------------------------------------------------------   ------------------------------------
                                                                                  August 30,    January 1,
                                                                                1996 through     through
                                                                                 December 31,   August 29,

                                                        1998          1997          1996          1996          1995          1994
------------------------------------------------------------------------------------------------------------------------------------
<S>              <C>                                  <C>           <C>           <C>           <C>           <C>           <C>    
CASH FLOWS AND OTHER DATA
   (IN MILLIONS):
Modified EBITDDA (6) ...........................      $  44.2       $  53.3       $  (1.4)      $   3.6       $  12.5       $  11.5
Additions to timber, timberlands and
   logging roads (3) ...........................          0.3         111.4         283.5           0.0           0.2           0.0
Cash flow from (used in) operating
activities .....................................         17.5          28.5          (3.0)          5.5          11.8          13.2
Cash flow from (used in) investing
 activities ....................................          0.4        (103.8)       (291.5)         (0.5)         (1.9)         (2.0)
Cash flow from (used in) financing
 activities ....................................        (23.7)         69.3         311.0          (5.1)        (10.0)        (11.2)

OPERATING STATEMENT DATA
 (IN MILLIONS)
Revenues (2)(3) ................................         71.3          77.3          14.0          15.6          31.7          32.3
Depreciation, depletion and road
amortization (2)(3) ............................         21.9          17.3           3.3           0.9           1.5           1.5
Cost of timber and property sales
   (2)(3) ......................................          5.9           8.7            --            --            --            -- 
Operating income (loss) (2)(3) .................         16.3          27.3          (4.8)          2.7          11.1          10.1
Income (loss) before extraordinary
   items (4) ...................................         (6.4)         (1.4)        (13.0)          2.7          11.6           9.9
Extraordinary items, losses on
   extinguishment of debt (5) ..................           --           9.3            --            --            --            -- 
Net Income (loss) ..............................         (6.4)        (10.7)        (13.0)          2.7          11.6           9.9

BALANCE SHEET DATA (AT
    PERIOD END, IN MILLIONS):
Working capital ................................          1.4           1.8          21.5           0.5           1.3           0.2
Total assets (3) ...............................        350.7         385.2         310.2          27.8          30.9          29.8
Long-term debt (7) .............................        225.0         225.0         305.0            --            --            -- 
Equity (deficit) (8) ...........................        116.9         145.6          (2.9)         27.8          29.2          27.7

OPERATING DATA
(UNAUDITED):
Log, stumpage and timber deed sales
   volumes (MMBF) (2)(3) .......................        144.5         138.9          30.2          32.8          63.8          68.3
Property sale volume (MMBF) (2) ................         26.6          41.5            --            --            --            --
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1)   Due to the Weyerhaeuser Acquisition on August 30, 1996, the financial and
      operating data after August 30, 1996 are not comparable to financial and
      operating data of the Predecessor. See discussion of the Company and the
      Predecessor's basis of presentation in Note A of the Notes to Financial
      Statements. Also, See "Management's Discussion and Analysis of Financial
      Condition and Results of Operations."
(2)   Revenues in 1998 consist of $63.6 million of log and stumpage sales, $6.3
      million of timber and property sales and $1.4 million of by-products and
      other sales. Revenues in 1997 consist of $60.4 million of log and stumpage
      sales, $15.2 million of timber and property sales and $1.7 million of
      by-products and other sales. Revenues prior to 1997 consist primarily of
      log sales. See "Management's Discussion and Analysis of Financial
      Condition and Results of Operations."
(3)   See August 1996 acquisition of the Klamath Falls Timberlands and July 1997
      acquisition of the Ochoco Timberlands in Note C of the Notes to Financial
      Statements. 
(4)   See effect of interest expense and amortization of deferred financing fees
      and debt guarantee fees in "Management's Discussion and Analysis of
      Financial Condition and Results of Operations."


                                       12
<PAGE>

(5)   See effect of debt extinguishment in Note E of the Notes to Financial
      Statements.
(6)   Modified EBITDDA is defined as operating income plus depreciation,
      depletion, and road amortization and cost of timber and property sales.
      Modified EBITDA should not be considered as an alternative to net income,
      operating income, cash flows from operating activities or any other
      measure of financial performance presented in accordance with generally
      accepted accounting principles. Modified EBITDDA is not intended to
      represent cash flow and does not represent the measure of cash available
      for distribution, but provides additional information for evaluating the
      Company's ability to make the Minimum Quarterly Distribution. In addition,
      Modified EBITDDA does not necessarily represent funds available for
      management's discretionary use as it is calculated prior to debt service
      obligations and capital expenditures. See "Management's Discussion and
      Analysis of Financial Condition and Results of Operations."
(7)   See discussion of long-term debt at Note E of the Notes to Financial
      Statements.
(8)   See discussion of the Company and the Predecessor's equity (deficit) in
      Note A of the Notes to Financial Statements.

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations

Forward-Looking Statements

      Certain information contained in this report may constitute
forward-looking statements within the meaning of the federal securities laws.
Although the Company believes that expectations reflected in such
forward-looking statements are based upon reasonable assumptions, it can give no
assurance that its expectations will be achieved. Forward-looking information is
subject to certain risks, trends and uncertainties that could cause actual
result s to differ materially from those projected. Such risks, trends and
uncertainties include the highly cyclical nature of the forest products
industry, general economic conditions, competition, price conditions or trends
for the Company's products, the possibility that timber supply could increase if
governmental, environmental or endangered species policies change, and
limitations on the Company's ability to harvest its timber due to adverse
natural conditions or increased governmental restrictions. The results of the
Company's operations depend upon a number of factors, many of which are beyond
its control. These factors include general economic and industry conditions,
domestic and export prices, supply and demand for logs, seasonality, government
regulations affecting the manner in which timber may be harvested, and
competition from other supplying regions and substitute products. These and
other risks are described in the Company's other reports and registration
statements, which are available from the United States Securities and Exchange
Commission.

General

      The basis of presentation of the Company's financial statements is
described in Note A to the consolidated financial statements. The comparability
of the financial results of the Company and the Predecessor is primarily
affected by (i) increased revenues resulting from increased harvest levels on
the Klamath Falls Timberlands, (ii) revenues realized from harvesting on the
Ochoco Timberlands acquired by the Company in July 1997, (iii) increased
depletion charges resulting from the step-up in asset values of the Timberlands,
(iv) reduced per MBF logging and hauling costs resulting from the use of
independent contractors rather than Company employees to conduct silvicultural
activities and the harvesting and delivery of logs due to lower hourly wage
rates, the elimination of compensation payments during seasonal down time and
the reduction in associated capital costs and (v) a different customer base, as
a majority of the Predecessor's sales were to an affiliated customer at
internally established transfer prices whereas all of the Company's sales are to
unaffiliated conversion facilities at market based prices (although whether the
transfer prices or market-based prices were higher changed from time to time).

Supply and Demand Factors

      The Company's results of operations are affected by various factors, many
of which are beyond its control, including general industry conditions, domestic
and international prices and supply and demand for logs, lumber and other wood
products, seasonality and competition from other domestic and international
supplying regions and substitute products.


                                       13
<PAGE>

Supply

      The supply of logs available for purchase has been most affected in recent
years by significant reductions in timber harvested from public timberlands,
principally as a result of efforts to preserve the habitat of certain endangered
species, as well as a change in the emphasis of government policy toward habitat
preservation, conservation and recreation and away from timber management. Since
the early 1970s, environmental and other similar concerns and governmental
policies have substantially reduced the volume of timber under contract to be
harvested from public lands. The pace of regulatory activity accelerated in the
late 1980s. The resulting supply decrease caused prices for logs to increase
significantly, reaching peak levels during 1993. Although prices have declined
from these record levels, current prices still exceed pre-1993 levels. The low
supply of timber from public lands, which is expected to continue for the
foreseeable future, has benefitted private timber holders such as the Company
through higher stumpage and log prices.

      Industry participants do not expect environmental restrictions to ease
materially within any reasonable planning horizon. Consequently, many producers
of lumber and wood products are attempting to adapt to the new supply
environment by increasing their emphasis on raw material yields, entering into
long term timber supply arrangements and value added manufacturing, and
accessing previously untapped supplies (such as private wood lot owners, timber
with difficult access, alternative species and imports). These factors have
tended to restrict prices from even greater increases. While raw material supply
is expected to be an ongoing challenge for the lumber and wood products
industry, such conditions are likely to cause the favorable operating
environment for timber owners such as the Company to continue for the
foreseeable future.

      In response to an increase in timber prices in the early 1990s, imports of
logs and lumber from abroad (from countries such as Canada and New Zealand)
increased. These imports, however, only partially offset the lost volume of
timber from public timberlands and did not replace the mature, high-quality
timber found in greater quantities on public timberlands. Since 1993, imports
have decreased and their current impact on timber prices is minimal.

Demand

      Changes in general economic and demographic factors, including the
strength of the economy and interest rates for home mortgages and construction
loans, have historically caused fluctuations in housing starts and, in turn,
demand and prices for lumber and commodity wood products. With the growth of the
home center distribution business, the repair and remodeling markets have become
a significant factor in terms of the demand for lumber and commodity wood
products and have dampened the wide fluctuations that occurred when new housing
starts were the primary factor. A large portion of the Company's property
consists of Pine species, which are used in the finishing market, for molding
trim, doors and windows. This market is more affected by repair and remodeling
than new housing construction. Prices for these species, primarily Ponderosa
Pine, reached a peak in the spring of 1993 and as a result attracted imports of
Radiata Pine from New Zealand and Chile. The market absorbed these relatively
small quantities with little impact on prices. The demand for logs in the United
States is also affected by the level of lumber imports. In response to
increasing lumber imports from Canada, the United States and Canada signed an
agreement in 1996 which restricts the availability of Canadian softwood lumber
in the United States. The Company believes that this agreement has not had a
material impact on the price or demand for logs in the United States although
its long-term effect is uncertain.

      Due to transportation costs, domestic conversion facilities in the Pacific
Northwest tend to purchase raw materials within relatively confined geographic
areas, generally within a 200-mile radius. The conversion facilities in the
vicinity of the Timberlands need more wood supply to run at capacity than can be
produced by nearby timberlands. As a result, the demand from this region is
relatively steady, although prices fluctuate with market conditions.

Current Market Conditions

      Low mortgage interest rates have created favorable conditions for new home
construction, home repair and remodeling, and industrial and other construction,
which has strengthened the demand for the Company's logs and


                                       14
<PAGE>

timber. However, as the result of weak log markets in Asia, the supply of logs
has increased on the West Coast. Combined with the continued heavy importing of
lumber from Canada, this has put downward pressure on prices for the Company's
logs and timber during most of 1998.

      The key lumber price indicators for Ponderosa Pine dropped 26% from
mid-1997 to the end of 1997. Ponderosa Pine indicators for 1998 remained at
historically low levels and continued to decline throughout the year for a 7%
reduction. Lodgepole Pine prices experienced a decline of 5% in 1998. Douglas
Fir prices were consistently lower in 1998 from 1997 levels, with an average
year-to-year reduction of 16%. In contrast, prices for White Fir were generally
higher in 1998 than in 1997 by 14%, with significant increases in the second
half of 1998. Strong demand for panel products manufactured from this species
persisted through the second half and the Company benefitted from the demand by
shifting more production to White Fir logs to improve the overall mix.

Results of Operations

Year Ended December 31, 1998 Compared to Year Ended December 31, 1997

      The following table sets forth sales volume for each of 1997 and 1998 from
the sale of logs, stumpage and timber deeds by thousand board feet and price per
thousand board feet and the sales of property.

<TABLE>
<CAPTION>
                                    Sales Volume (MBF)                    Price Realization (MBF)
                                    ------------------                    -----------------------
                                                       Timber                                      Timber       Property  
Period                   Logs          Stumpage         Deeds         Logs         Stumpage         Deeds     Sales (000s)
------                   ----          --------         -----         ----         --------         -----     ------------
<S>                      <C>            <C>            <C>           <C>            <C>            <C>            <C>    
    1998
Year ended 12/31         93,557         50,894             --        $   420        $   479             --        $ 6,276
4th Quarter ....         24,299         23,787             --            396            441             --             --
3rd Quarter ....         29,017         22,617             --            431            511             --             --
2nd Quarter ....         23,832          2,506             --            432            570             --          6,276
1st Quarter ....         16,409          1,984             --            418            447             --             --

    1997
Year ended 12/31         97,749         30,189         11,045        $   446        $   556        $   315        $11,760
4th Quarter ....         27,415         17,830             --            487            576             --         11,760
3rd Quarter ....         25,867         10,056             --            436            569             --             --
2nd Quarter ....         23,094          2,303             --            441            350             --             --
1st Quarter ....         21,373             --         11,045            413             --            315             --
</TABLE>

      Revenues. Revenues were $71.3 million in 1998, a decrease of $6.0 million
or 8% from revenues of $77.3 million in 1997. This decrease was primarily
attributable to a $9.0 million reduction in timber and property sales, a $4.3
million reduction in log sales and a $0.2 million reduction in by-products and
other revenues, partially offset by a $7.6 million increase in revenues from
stumpage sales. To meet its working capital requirements, the Company harvested
and sold logs and stumpage in 1998 at rates in excess of both 1997 levels and
the Manager's estimate of the long-term sustainable annual harvest level for its
current timberlands of approximately 110,000 MBF per year.

      Revenue from planned timber and property sales decreased to $6.2 million
in 1998 from $15.2 million during 1997, representing a $9.0 million or 59%
reduction. The significant reduction was due to a decrease in the volume
contained in the 1998 timber and property sales of 26,600 MBF as compared to
52,600 MBF in 1997.

      Log sales for 1998 were $39.3 million on volumes of 93,600 MBF, compared
to log sales of $43.6 million on volumes of 97,700 MBF in 1997. The average log
sales price per MBF for 1998 was $420 compared to an average log sales price per
MBF of $446 for 1997, a 6% reduction, reflecting weaker markets, primarily for
Ponderosa Pine logs.

      Stumpage sales for 1998 were $24.4 million on volumes of 50,900 MBF,
compared with stumpage sales of $16.8 million on volumes of 30,200 MBF in 1997.
The average stumpage sales price per MBF for 1998 was $479


                                       15
<PAGE>

compared to an average stumpage sales price per MBF of $556 for 1997, a 14%
reduction. The decrease in average stumpage sales prices from 1997 to 1998 was
primarily due to a reduction in the grade of timber harvested from the Ochoco
Timberlands.

      In addition, the Company entered into six stumpage contracts in 1998 for
an aggregate estimated revenue of $5.5 million and 16,700 MBF. It is expected
that such timber will be removed, and revenue recognized, during 1999, under
such contracts.

      Operating Costs. Results for 1998 reflect a full year's ownership of the
Ochoco Timberlands whereas 1997 results include such ownership from the date of
acquisition on July 15, 1997. Operating costs were $55.0 million in 1998, an
increase of $4.9 million or 10% over operating costs of $50.1 million in 1997.
This increase was the result of a $4.6 million increase in Depletion,
Depreciation and Road Amortization ("DD&A") expense and a $4.2 million increase
in selling, general and administrative expenses partially offset by a $2.8
million decrease in cost of timber and property sales and a $1.1 million
decrease in cost of products sold.

      DD&A expense was $21.9 million in 1998, a $4.6 million or 27% increase
over DD&A expense of $17.3 million in 1997. This increase was primarily
attributable to a net increase in log and stumpage sales volumes and an increase
in the Company's depletion rate per MBF, which resulted from the Ochoco
Timberlands acquisition in July 1997.

      Selling, general and administrative expenses were $10.5 million for 1998,
an increase of $4.2 million or 67% over comparable expenses of $6.3 million in
1997. The increase in selling, general and administrative expenses was primarily
attributable to one-time expenses of $1.7 million related to severance costs and
the repurchase of member interests in the Manager that were incurred in the
first and fourth quarters of 1998, combined with increased costs associated with
operating as a publicly traded company, and implementing the Company's strategy
to pursue accretive acquisitions of timberland.

      The reduction in the cost basis of the timber and property sales between
1998 and 1997 is due to the reduced volume contained in the 1998 sale as
compared to the 1997 sales, as previously mentioned.

      Cost of products sold was $16.7 million for 1998 as compared to $17.8
million for 1997, a $1.1 million or 6% reduction. The decrease in cost of
products sold was the result of a $0.6 million decrease in logging costs, a $0.3
million decrease in wood fiber processing costs and a $0.2 million decrease in
silviculture expenses.

      Interest Expense. Interest expense for 1998 was $22.2 million as compared
to $25.3 million for 1997, representing a $3.1 million or 12% reduction. 1998
interest expense was incurred primarily on the $225.0 million of Notes issued in
the November 1997 Public Note Offering. 1997 interest expense related primarily
to $215.0 million of term debt and $90.0 million of revolving debt incurred in
connection with the Weyerhaeuser Acquisition on August 30, 1996 and $110.0
million of incremental debt incurred in connection with the Ochoco Acquisition
on July 15, 1997. The reduction in interest expense is primarily attributable to
the use of a substantial portion of the proceeds from the Company's Initial
Offering completed on November 19, 1997, to retire outstanding debt.

      Amortization of Deferred Financing Fees and Debt Guarantee Fees. The
Company deferred $6.7 million of fees incurred in connection with the issuance
of the Notes. These fees will be amortized over the term of the Notes, which are
due in November 2007. The amortization of these fees during 1998 was $0.7
million. During 1997 the Company recognized $4.2 million of expense related to
debt guarantee fees and amortization of deferred financing fees.

      Interest Income. Interest income for 1998 was $0.5 million, a decrease of
$1.0 million or 67% from interest income for 1997 of $1.5 million. The reduction
in interest income is primarily attributable to the reduction in the cash and
cash equivalents available in 1998 compared to 1997.


                                       16
<PAGE>

      Other expense, net. Other expense, net was $0.3 million for 1998 compared
to $0.6 million for 1997, representing a reduction of $0.3 million or 50%.

      Extraordinary Items. During 1997 the Company refinanced certain long-term
borrowings resulting in extraordinary losses on extinguishment of debt of $9.3
million due to the write-off of existing unamortized deferred financing fees and
other related fees.

      Cash Flow From Operations. During 1998, cash flow from operations
decreased $11.0 million or 39% primarily as a result of decreased proceeds from
timber and property sales, an increase in selling, general and administrative
expenses and a decrease of advance payments on stumpage sales contracts.

Year Ended December 31, 1997 Compared to Year Ended December 31, 1996

      The results of operations for the year ended December 31, 1996 are based
on combining the periods of January 1, 1996 through August 29, 1996 (the period
prior to the Weyerhaeuser Acquisition) and August 30, 1996 through December 31,
1996 both as shown in the historical financial statements appearing elsewhere in
this Annual Report. The principal effect of the Weyerhaeuser Acquisition in 1996
was an increase in depletion, depreciation and road amortization expense (due to
a higher cost basis for the Company's timber, timberlands and logging roads) and
interest expense (due to borrowings to finance the Weyerhaeuser Acquisition).

      Revenues. Revenues in 1997 were $77.3 million, an increase of 161% over
revenues of $29.6 million in 1996. This increase was primarily attributable to a
$32.8 million increase in revenues from log and stumpage sales and a $15.2
million increase in timber and property sales, partially offset by a decrease of
$0.3 million in by-products and other revenues.

      Log and stumpage sales volumes in 1997 were 127,900 MBF, an increase of
103% over log and stumpage sales volumes of 63,000 MBF in 1996. The significant
increase in the volume harvested was mainly due to the Company's aggressive
harvest plan compared to that of the Predecessor for the first eight months of
1996, as well as the commencement of log and stumpage sales from the Ochoco
Timberlands which were acquired on July 15, 1997. Average log and stumpage
prices increased by 8%, from $439 per MBF in 1996 to $472 per MBF in 1997,
primarily due to a larger proportion of higher valued timber harvested from the
Ochoco Timberlands during the last half of 1997.

      Revenues from timber and property sales were $15.2 million during 1997.
There were no such timber or property sales during 1996.

      The reduction in by-products and other revenue was primarily attributable
to a 36% decrease in the volume of fiber sold for use as chips. Due to low
demand in the pulp and paper industry, chip prices had decreased to a level
where it was no longer profitable for the Company to process residual fiber for
use as chips for much of 1997. Demand for these chips, however, increased in the
last quarter of 1997.

      Operating Costs. Operating costs were $50.1 million in 1997, an increase
of 58% over operating costs of $31.7 million in 1996. This increase was the
result of a $2.4 million increase in cost of products sold, an $8.7 million
increase in the cost of timber and property sales and a $13.1 million increase
in DD&A expense. These increases were partially offset by a $5.8 million
decrease in selling, general and administrative expenses.

      The increase in cost of products sold was primarily the result of a $4.3
million increase in logging costs and a $0.3 million increase in severance
taxes. Partially offsetting these increases were a $1.2 million decrease in wood
fiber processing costs and a $1.0 million decrease in outside log purchases.
Logging costs and severance taxes increased primarily as a result of a 55%
increase in the level of merchantable grade logs harvested and sold, partially
offset by a 14% decrease in the Company's logging cost per MBF. The decrease in
the Company's logging cost per MBF was primarily the result of the Company's
changing from a mix of internal logging crews and outside contractors during the


                                       17
<PAGE>

first eight months of 1996 to the use of outside contractors for all its logging
operations during the last four months of 1996 and in 1997. Wood fiber
processing costs decreased by 58% as a result of a 14% decrease in the volume of
fiber processed and sold as chips and a write-down to fiber log inventories
during 1996, resulting from a decline in chip prices during the period. During
1997, the Company had timber and property sales with a combined cost basis of
$8.7 million. No sales of tracts of timber or property were made during 1996.

      DD&A expense was $17.3 million in 1997, a $13.1 million increase over DD&A
expense of $4.2 million in 1996. This increase was primarily due to the
significant increase in the Company's depletion rate combined with the large
increase in the volume of logs harvested and sold as previously mentioned. The
increase in the depletion rate was primarily the result of the step-up in asset
values of the Klamath Falls Timberlands upon their acquisition from
Weyerhaeuser. Selling, general and administrative expenses were $6.2 million in
1997, a decrease of 48% from comparable expenses of $12.0 million in 1996. This
decrease in selling, general and administrative expenses was primarily the
result of $4.9 million in one-time payments for advisory services paid to
affiliates of the Company in connection with the Weyerhaeuser Acquisition and
$2.8 million of one-time management fees paid to an affiliate of the Company for
management services in 1996. The advisory fees were incurred in connection with
the Weyerhaeuser Acquisition and its initial financing. The management fee
generally relates to services rendered in connection with the initial formation
of the Company and Old Services. Primarily offsetting these advisory and
management fees were increases in salaries and wages as well as professional
fees resulting from the Company operating as an independent entity rather than
as a division of Weyerhaeuser.

      Interest Expense. Interest expense was $25.3 million during 1997 and
primarily related to $215.0 million of term debt and $90.0 million of revolving
debt incurred in connection with the Weyerhaeuser Acquisition in August 1996 and
$110.0 million of incremental debt incurred in connection with the Ochoco
Acquisition on July 15, 1997. The Company refinanced $225.0 million of its
existing debt on November 19, 1997 by issuing the Notes in the Public Note
Offering and paid down the remaining $190.0 million of outstanding debt between
July 15, 1997 and December 31, 1997 with the proceeds from the Initial Offering
and cash flows from operating activities. The Company incurred $7.3 million in
interest expense during the last four months of 1996. There was no interest
expense and no debt outstanding during the first eight months of 1996, as the
Predecessor participated in Weyerhaeuser's centralized cash management system.

      Amortization of Deferred Financing Fees and Debt Guarantee Fees. The
Company deferred $4.1 million of fees incurred in connection with the financing
of the Weyerhaeuser Acquisition. The Company deferred $6.0 million of fees in
connection with the financing of the Ochoco Acquisition and related term debt
refinancing. These costs were being amortized over the life of the debt. The
Company deferred $6.7 million of fees incurred in connection with the issuance
of $225.0 million of Notes in the Public Note Offering. The Company also
incurred $4.4 million of debt guarantee fees from August 30, 1996 through the
extinguishment of the $130.0 million of debt guaranteed by Weyerhaeuser on
November 19, 1997. The amortization of deferred financing fees and debt
guarantee fee expense during 1997 and 1996 were $4.2 million and $1.3 million,
respectively. There was no deferred financing fee amortization or debt guarantee
fee expense during the first eight months of 1996.

      Interest Income. Interest income was $1.5 million during 1997. For the
last four months of 1996, there was $0.4 million in interest income. There was
no interest income during the first eight months of 1996, as the Predecessor
participated in Weyerhaeuser's centralized cash management system.

      Other Expense, Net. Other expense, net changed from approximately zero in
1996 to $0.6 million in 1997. Other expense, net in 1997 primarily represents a
$0.6 million charge related to an unrealized loss on an unhedged financial
instrument as of December 31, 1997.

      Extraordinary Items. The Company refinanced certain long-term borrowings
during 1997 resulting in extraordinary losses on extinguishment of debt of $9.3
million due to the write-off of existing unamortized deferred financing fees and
other related fees.


                                       18
<PAGE>

Liquidity and Capital Resources

      Effective November 19, 1997, the Master Partnership completed its MLP
Offering of 8,577,487 Common Units (including Common Units issued upon the
exercise by the underwriter's of their over-allotment option in December 1997).
Net proceeds from the MLP Offering were $163.2 million. In addition, the Company
issued $225.0 million of Notes in the Public Note Offering. The proceeds from
the MLP Offering and the Public Note Offering were primarily utilized to retire
all outstanding borrowings under the revolving credit facility and $330.0
million of term debt. For purposes of this discussion, these transactions are
hereafter referred to as the "Transactions." As of December 31, 1998, the
Company has a cash balance of $4.8 million and $1.4 million of working capital.

      Operating Activities. Cash flows provided by operating activities in 1998
were $17.5 million, as compared to cash flows provided by operating activities
of $28.5 million in 1997. The $11.0 million decrease in cash flows provided by
operating activities was primarily due to a $9.0 million decrease in the
proceeds from timber and property sales, $4.2 million increase in selling,
general and administrative expenses and $4.1 million decrease of advance
deposits on stumpage sales contracts. The decrease in operating cash flows was
partially offset by a substantial decrease in interest and debt guarantee fees
in 1998 as compared to 1997, of $3.1 million and $3.5 million, respectively.

      Investing Activities. Cash flows provided by investing activities were
$0.4 million in 1998, as compared to cash flows used by investing activities of
$103.8 million during 1997. During 1998, a $1.1 million receivable from a
customer was paid and $0.7 million was used in timber and road additions and
orchard and nursery operations. During 1997, $110.9 million was used in the
Ochoco Acquisition and a $10.0 million receivable from an affiliate was repaid.

      Financing Activities. Cash flows used in financing activities were $23.7
million in 1998, as compared to cash flows provided by financing activities of
$69.3 million during 1997. During 1998, the Company paid $22.7 million in
distributions to the Master Partnership for distribution to unitholders and
minority interest and paid $1.0 million to an affiliate for redemption of a
certain member's interest. During 1997, the Company refinanced $175.0 million of
long-term debt incurred in connection with the Weyerhaeuser Acquisition and
incurred an additional $110.0 million of long-term debt in connection with the
Ochoco Acquisition. The Company incurred $6.0 million of deferred financing fees
in connection with the refinancing of long-term debt and the incurrence of
financing for the Ochoco Acquisition. In addition, the Company distributed $1.2
million to a member related to his 1997 estimated tax liability. The Company
received $163.2 million in net proceeds from the Master Partnership's MLP
Offering and $218.3 million in proceeds, net of financing fees related to the
issuance of the Notes.

Notes

      On November 14, 1997, the Company issued $225.0 million aggregate
principal amount of Notes (the "Notes") representing unsecured general
obligations of the Company which bear interest at 9-5/8% per annum, payable
semiannually in arrears on May 15 and November 15. The Notes mature on November
15, 2007 unless previously redeemed. The Notes will not require any mandatory
redemption or sinking fund payments prior to maturity and are redeemable at the
option of the Company in whole or in part, on or after November 15, 2002 at
predetermined redemption prices plus accrued interest to the redemption date. In
addition, at any time on or prior to November 15, 2000, the Company, at its
option, may redeem the Notes with the net cash proceeds of a Common Units
offering or other equity interests of the Master Partnership at 109.625% of the
principal amount thereof, plus accrued and unpaid interest thereon to the
redemption date, provided that at least 65% of the principal amount of the Notes
originally issued remain outstanding immediately following such redemption. Upon
the occurrence of certain events constituting a "change of control" (as defined
in the Indenture), the Company must offer to purchase the Notes, at a purchase
price equal to 101% of the principal amount thereof, plus accrued and unpaid
interest to the date of purchase.

      The indenture governing the Notes (the "Indenture") contains various
affirmative and restrictive covenants applicable to the Company and its
subsidiaries, including limitations on the ability of the Company and its
subsidiaries to, among other things, (i) incur additional indebtedness (other
than certain permitted indebtedness) unless the


                                       19
<PAGE>

Company's Consolidated Fixed Charge Coverage Ratio (as defined in the Indenture)
is greater than 2.25 to 1.00, and (ii) make distributions to the Master
Partnership, make investments (other than permitted investments) in any person,
create liens, engage in transactions with affiliates, suffer to exist any
restrictions on the ability of a subsidiary to make distributions or repay
indebtedness to the Master Partnership, engage in sale and leaseback
transactions, enter into a merger, consolidation or sale of all or substantially
all of its assets, sell assets or harvest timber in excess of certain
limitations (which limitations are similar to those for the Bank Credit
Facility) or engage in a different line of business. Under the Indenture, the
Company will be permitted to make cash distributions to the Master Partnership
so long as no default or event of default exists or would exist upon making such
distribution (a) if the Company's Consolidated Fixed Charge Coverage Ratio (as
defined in the Indenture) is greater than 1.75 to 1.00, in an amount, in any
quarter, equal to Available Cash (as defined in the Indenture) for the
immediately preceding fiscal quarter or (b) if the Company's Consolidated Fixed
Charge Coverage Ratio is equal to or less than 1.75 to 1.00, in an aggregate
amount after the closing of this offering not to exceed (i) $7.5 million less
the aggregate of all restricted payments made under this clause (b)(i) during
the immediately preceding 16 fiscal quarters (or shorter period, if applicable,
beginning on the issue date of the Notes), plus (ii) the net proceeds of certain
capital contributions (including the sale of Units) received by the Master
Partnership. The Company was in compliance with these covenants at December 31,
1998 and 1997.

Bank Credit Facility

      Simultaneously with the Closing of the MLP Offering, the Company obtained
the Bank Credit Facility, which consists of the $75.0 million Acquisition
Facility and the $25.0 million Working Capital Facility. As of December 31,
1998, there were no outstanding borrowings under the Bank Credit Facility. The
Bank Credit Facility bears interest at the lower of the Bank's prime rate plus a
margin of 2.0% (9.75% at December 31, 1998) or LIBOR plus a margin of 2.5% (7.6%
at December 31, 1998). The Working Capital Facility expires on November 19, 2000
and all amounts borrowed thereunder shall then be due and payable. At November
19, 2000, the Company may elect to amortize any outstanding loans under the
Acquisition Facility in sixteen equal quarterly installments beginning one
quarter after the conversion to a term loan, subject to certain provisions
contained in the agreement governing the Bank Credit Facility. As of December
31, 1998, the Company was not in compliance with certain covenants of the Bank
Credit Facility, and there were no amounts outstanding under the Credit
Agreement as of such date. On February 11, 1999, the required majority of the
banks comprising the lending group waived such noncompliance. In exchange for
the waiver, the Company agreed that future borrowings in excess of $2.0 million
will require the consent of a majority of the lending group members. On April 6,
1999, the Company advised the Agent Bank that, as of March 31, 1999, the Company
may be in violation of the Minimum Asset Value to Funded Debt covenant (the
"MAVFD Covenant") contained in the Credit Agreement, which is based upon values
set by the California State Board of Equalization ("SBE"). The Banks have agreed
to modify the MAVFD Covenant, effective March 31, 1999, to provide that the
asset value shall be based upon the fair market value of the Company's
Merchantable Timber as set forth in the Company's Annual Timber Report, which
Management believes more accurately reflects the value of the Company's
properties. As modified, the Company is in compliance with such covenant. In
connection with the modification, the Company agreed to terminate the Working
Capital loan agreement as of June 30, 1999 and to terminate the Acquisition
Facility, effective April 6, 1999. As of March 31, 1999, there was $1.3 million
outstanding under the Working Capital Facility. The Company is currently in
discussions with several of the banks to continue the Working Capital Facility,
and one of them has agreed to act as agent bank. In the interim, an affiliate of
the Manager has agreed to make available to the Company, from time to time,
loans of up to $12.0 million with terms and covenants substantially consistent
with the current Bank Credit Facility. In addition, the Company's plan to
engage investment banks to assist it in raising money for acquisitions.

      The Bank Credit Facility contains various affirmative and restrictive
covenants applicable to the Company, including limitations on the ability of the
Company to, among other things, (i) incur certain additional indebtedness, (ii)
incur any liens other than (a) liens on accounts receivable and inventory to
secure indebtedness under a refinancing facility for the Working Capital
Facility and (b) liens for purchase money financing of acquired assets up to an
aggregate $10.0 million, (iii) sell assets or harvest timber in excess of
certain limitations (which limitations are similar to those under the Indenture)
and (iv) make investments, engage in transactions with affiliates, and enter
into a merger, consolidation or sale of assets. The Bank Credit Facility
requires that the Company maintain at all times the following


                                       20
<PAGE>

financial ratios: (i) Minimum Pro Forma EBITDDA (as defined in the Bank Credit
Facility) to Pro Forma Interest Expense (as defined in the Bank Credit Facility)
(calculated on a four quarter rolling basis) of 2.25 to 1.0 through June 30,
1999 and increasing to 2.35 to 1.0 thereafter, (ii) Maximum Funded Debt (as
defined in the Bank Credit Facility) to Pro Forma EBITDDA (as defined in the
Bank Credit Facility) of not more than 4.75 to 1.0 (calculated on a four quarter
rolling basis) through June 30, 1999, and reducing to 4.50 to 1.0 thereafter and
(iii) Minimum Asset Value (as defined in the Bank Credit Facility) to Funded
Debt Ratio (as defined in the Bank Credit Facility) of 175% measured on a
quarterly basis based on quarter end numbers. Under Bank Credit Facility, the
Company's average annual harvest volume over any period of four consecutive
years cannot exceed 150 MMBF (as adjusted for timberland sales and purchases).
The agreements also limit one-year harvest levels and average annual harvest
levels for consecutive two and three year periods.

      Under the Bank Credit Facility, so long as no Event of Default (as defined
in the Bank Credit Facility) exists or would result, the Company will be
permitted to make quarterly cash distributions to the Master Partnership in an
amount not to exceed Available Cash (as defined in the Bank Credit Facility) in
the preceding quarterly period. Available Cash shall reflect a reserve equal to
50% of the interest projected to be paid on the Notes in the next succeeding
quarter, as well as 100% of the aggregate amount of all accrued and unpaid
interest in respect of the Bank Credit Facility on the date of determination. In
addition, in the third, second and first quarters preceding a quarter in which a
scheduled principal payment is to be made on the Notes, Available Cash will be
required to reflect a reserve equal to 25%, 50% and 75%, respectively, of the
principal amount to be repaid on such date. The Bank Credit Facility also
requires Available Cash to reflect a reserve for certain net proceeds from asset
sales and excess harvests pending reinvestment.

Capital Expenditures/Cash Distributions

      Capital expenditures in 1998 totaled $1.8 million. Capital expenditures
incurred were mainly in the nature of land management/silvicultural expenses,
miscellaneous equipment and computer hardware and software. Capital expenditures
were financed through cash flow generated by operations. As the Company does not
currently own and does not plan to own manufacturing facilities, and all logging
is subcontracted to third parties, it is anticipated that capital expenditures
in the future will not be material and will consist mainly of land
management/silvicultural expenditures. It is not currently anticipated that the
Company will either maintain log inventories, although small log inventories may
be maintained for a short period of time, or incur material capital expenditures
for machinery and equipment. The Company anticipates that capital expenditures
will be approximately $1.5 million in 1999. Capital expenditures will consist
primarily of capitalized silvicultural costs and miscellaneous equipment
purchases.

      Cash required to meet the Master Partnership's quarterly cash
distributions, and interest and principal payments on indebtedness will be
significant. The Manager expects that the debt service will be funded from
current operations. The Manager currently expects to make cash distributions
from current funds and cash generated from operations. Given projected harvest
levels, the long term sustainable harvest levels of the timberlands and the
harvest restrictions in the Notes and Bank Credit Facility, unless prices
improve, costs are reduced, new markets are developed or the Company makes
accretive acquisitions, the Company's ability in the future to make
distributions at current levels may be adversely affected. The Company continues
to evaluate means to improve cash flows, including the factors mentioned above.
However, there can be no assurance that prices will improve or that the Company
will be able to take any of these actions.

Effects of Inflation

      Prices for the Company's stumpage and logs may be subject to sharp
cyclical fluctuations due to market or other economic conditions, including the
level of construction activity but generally do not directly follow inflationary
trends. Costs of forest operations and general and administrative expenses
generally reflect inflationary trends.


                                       21
<PAGE>

Year 2000 Compliance

      The Company is aware of the "Year 2000" issue associated with the
programming code in existing computer systems as the millennium (year 2000)
approaches. The Year 2000 issue is pervasive and complex as virtually every
computer operation will be affected in some way by the rollover of a two-digit
year value to 00. The issue is whether computer systems will properly recognize
data sensitive information when the year changes to 2000. Systems that do not
recognize such information could generate erroneous data or cause a system to
fail.

      Since early 1998, the Company has been assessing its computer hardware and
information systems needs and upgrading its systems as appropriate. In 1998 the
Company completed the installation of several major hardware and software
upgrades: general ledger, accounts payable, accounts receivable, log accounting
and telecommunications. Along with this assessment and upgrade of its systems,
the Company is also reviewing its systems and applications to ensure its
computer and information systems will function properly at Year 2000. The
Company anticipates completing this internal assessment by June 30, 1999. At
this time, management of the Company believes that the specific cost of
achieving Year 2000 compliance for its current systems will not have a material
effect on the Company's consolidated financial statements.

      Like other companies, the Company relies on its customers for revenues and
on its vendors for products and services of all kinds; these third parties all
face the Year 2000 issue. An interruption in the ability of any of them to
provide goods or services, or to pay for goods and services provided to them, or
an interruption in the business operations of customers causing a decline in
demand for services, could have a material adverse effect on the Company.

      In addition, there is a risk, the probability of which the Company is not
in a position to estimate, that the Year 2000 will cause wholesale, perhaps
prolonged, failures of electrical generation, banking, telecommunications or
transportation systems in the United States or abroad, disrupting the general
infrastructure of the economy. The effect of such disruptions on the Company
could be material.

      The Company is in the process of identifying and surveying its key vendors
and customers regarding their progress on the Year 2000 issue. The Company's
efforts to determine the readiness of its key vendors and customers are expected
to be ongoing through year-end 1999. However, because so many entities are
exposed to the risk of failure not only of their own systems, but the systems of
other entities, the ultimate effect of the Year 2000 issue is subject to a high
degree of uncertainty.

      The Company believes that its preparations currently underway are adequate
to access and manage the risks presented by the year 2000 issue, and does not
have a formal contingency plan at this time.

      The statements in this section regarding the Year 2000 and the Company's
responses to it are forward-looking statements. They are based on assumptions
that the Company believes to be reasonable in light of its current knowledge and
experience. A number of events could cause actual results to differ materially
from those described in the forward- looking statements made on behalf of the
Company.

SFAS No. 133

      In June 1998, the Financial Accounting Standards Board issued Statement of
Financing Accounting Standard (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This Statement establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. This Statement is effective for all fiscal quarters of fiscal
years beginning after June 15, 1999. The Company will adopt SFAS No. 133 by
January 1, 2000. The Company believes that adoption of this statement will not
have a material impact on the Company.


                                       22
<PAGE>

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

      Not applicable.

Item 8. Financial Statements

      The information required hereunder is included in this report as set forth
in the "Index to Financial Statements" on Page F-1.

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

      On December 1, 1998, Arthur Andersen, LLP (the "Former Accountant")
resigned as the Company's independent accountant. On January 4, 1999, the
Registrant engaged Richard A. Eisner & Company, LLP ("Eisner") to audit its
financial statements for the year ended December 31, 1998. The Company did not
consult with Eisner during the Registrant's two most recent fiscal years and any
subsequent interim period on any matter of the type described in Item 304(a)(2)
of Regulation S-K.

      The Former Accountant's report on the Company's financial statements for
either of the past two years did not contain any adverse opinion or disclaimer
of opinion and was not qualified as to uncertainty, audit scope or accounting
principles.

      In connection with the Former Accountant's audit of the Company's
financial statements for its fiscal year ended December 31, 1996, a period prior
to the time that the Company was a Reporting Company, the Former Accountant
advised the Company of certain material weaknesses in the Company's system of
internal controls over cash. As a result of such weaknesses, the Former
Accountant expanded the scope of its audit procedures related to the Company's
cash disbursements in order to issue an opinion on the Company's year end 1996
Financial Statements. The control weaknesses were addressed to the Former
Accountant's satisfaction.

      In addition, in connection with the audit of the Company's Financial
Statements for its fiscal year ended December 31, 1996, there was an accounting
principle disagreement regarding the classification of a payment to a related
party prior to year end and the repayment of such amount after year end and an
audit scope disagreement regarding the need to confirm with the Company's lender
if the payment and repayment would result in a loan being classified as current.
Each of the foregoing disagreements were resolved to the Former Accountant's
satisfaction.

      Each of the matters described above was communicated to the Company's
audit committee on May 30, 1997.

      The Company has authorized the Former Accountant to respond fully to the
inquiries of any successor accountant concerning the subject matter of each of
the matters described in the two preceding paragraphs.


                                       23
<PAGE>

                                    PART III

Item 10. Directors, Executive Officers, Promoters and Control Persons of the
Registrant

      The Manager manages and operates the activities of the Company. The
Company does not directly employ any of the persons responsible for managing or
operating the Company.

Directors, Executive Officers and Key Employees of the General Partner

      The following table sets forth certain information with respect to the
members of the Board of Directors of the Manager, its executive officers and
certain key employees. Executive officers and directors are elected for one-year
terms.

       Name             Age           Position with General Partner
       ----             ---           -----------------------------

John M. Rudey            55      Chairman, Chief Executive Office, President and
                                 Director(1)
Aubrey L. Cole           75      Director(2)
George R. Hornig         44      Director(3)
William A. Wyman         60      Director(4)
Alan B. Abramson         53      Director(5)
Robert F. Wright         73      Director(6)
Glenn A. Zane            59      Acting Senior Vice President and Director of
                                 Operations
Greg G. Byrne            38      Vice President and Chief Financial Officer
Martin Lugus             58      Vice President, Timberland Operations
Jeffrey B. Groom         30      Corporate Controller, Western Operations
Walter L. Barnes         56      Assistant Vice President, Harvesting
Robert A. Broadhead      47      Assistant Vice President, Marketing
Kurt A. Muller           40      Assistant Vice President, Planning
Christopher J. Sokol     49      Assistant Vice President, Forestry

----------
      (1)   Member of the Executive (Chairman), Nominating (Chairman), Finance
            and Compensation (Chairman) Committees.
      (2)   Member of the Compensation and LTIP Committees.
      (3)   Member of the Executive, Audit, Finance and Compensation Committees.
      (4)   Member of the Audit, Conflicts, Compensation and LTIP Committees.
      (5)   Member of the Audit, Conflicts, Compensation and LTIP Committees.
      (6)   Member of the Nominating, Audit (Chairman) and LTIP (Chairman)
            Committees.

      John M. Rudey serves as Chairman, Chief Executive Officer, President and
as a Director of the Manager. Since 1992, Mr. Rudey has served as Chief
Executive Officer of Garrin Properties Holdings, Inc., a private investment
company that manages and advises investment portfolios principally concentrated
in the timber and forest products industries and in real estate.

      Aubrey L. Cole serves as a Director of the Manager. Since 1989 Mr. Cole
has been a consultant for Aubrey Cole Associates, a sole proprietorship which
provides management consulting services and makes investments. From 1986 to
1989, Mr. Cole was the Vice Chairman of the Board and Director of Champion
International Corporation (a


                                       24
<PAGE>

publicly traded forest products company) and from 1983 to 1993, Mr. Cole was the
Chairman of Champion Realty Corporation (a land sales subsidiary of Champion
International).

      George R. Hornig serves as a Director of the Manager. Since 1993, Mr.
Hornig has been an Executive Vice President of Deutsche Bank Americas Holdings,
Inc. (the United States arm of Deutsche Bank, a German banking concern) and
affiliated predecessor entities. From 1991 to 1993, Mr. Hornig was the President
and Chief Operating Officer of Dubin & Swieca Holdings, Inc., an investment
management business. From 1988 to 1991, Mr. Hornig was a co-founder, Managing
Director and Chief Operating Officer of Wasserstein Perella & Co., Inc. (a
mergers and acquisitions investment bank). From 1983 to 1988, Mr. Hornig was an
investment banker in the Mergers and Acquisitions Group of The First Boston
Corporation. Prior to 1983, Mr. Hornig was an attorney with Skadden, Arps,
Slate, Meagher & Flom. Mr. Hornig is also a director of SL Industries, Inc. and
Forrester Research, Inc.

      William A. Wyman serves as a Director of the Manager, having been elected
to the Board in January, 1999. Mr. Wyman is a former President of the Management
Consulting Group of Booz, Allen & Hamilton. Mr. Wyman joined Booz Allen in 1965,
where, until 1984, he counseled a variety of service, natural resources and
management manufacturing companies on projects concerning strategic profit
improvement and management organization. Mr. Wyman has served as a director of
Donaldson, Lufkin & Jenrette, Belvedere Reinsurance, and SS&C Technologies.

      Alan B. Abramson serves as a Director of the Manager, having been elected
to the Board in January, 1999. Mr. Abramson is the President of Abramson
Brothers Incorporated, a real-estate management and investment firm, where he
has been employed since 1972. He serves as a Director of Datascope, Inc., a
medical technology company.

      Robert F. Wright serves as a Director of the Manager. Since 1988, Mr.
Wright has served as President and Chief Executive Officer of Robert F. Wright
Associates, Inc., a firm making strategic investments and providing business
consulting services. Previously, Mr. Wright spent 40 years, 28 years as a
partner, at Arthur Andersen & Co. Mr. Wright holds a B.A. from Michigan State
University and an M.B.A. from New York University. Mr. Wright is a director of
the following companies: Hanover Direct Inc. (a catalog marketer), Reliance
Standard Life Insurance Co. and affiliates (life insurance companies), The
Navigators Group Inc. (a property insurance company), Rose Technology Group
Limited (a Canadian professional engineering company), Deotexas Inc. (a
development stage company), Universal American Financial Corp. (an insurance
company), Quadlogic Controls Corp. (a meter manufacturer) and G.V.A. Williams
Real Estate Co., Inc. (a real estate company).

      Glenn A. Zane became Acting Senior Vice President and Director of
Operations in January 1999. Since 1975, Mr. Zane has been a principal of Mason,
Bruce & Girard, a forestry consulting firm.

      Greg G. Byrne became Vice President and Chief Financial Officer of the
Manager in January, 1999. From 1996 to 1999, Mr. Byrne was Chief Financial
Officer of P&M Cedar Products, a California-based producer of specialty wood
products. From 1993 to 1996, Mr. Byrne was Vice President of Finance and
Strategic Planning for the Fibreboard Wood Products Company. Prior to 1996, Mr.
Byrne was an Audit Manager with Coopers & Lybrand.

      Martin Lugus serves as Vice President - Timberland Operations of the
Manager, responsible for all land management and operations on fee lands. Mr.
Lugus was employed by Weyerhaeuser for 28 years, during which time he served as
Forestry Manager from 1981 to 1991 and Timberlands Manager from 1991 to 1996.

      Jeffrey B. Groom was appointed Corporate Controller-Western Operations in
January 1999. Prior to joining the Company in 1997, Mr. Groom was a financial
analyst with Fort James Corporation from 1996 until 1997. From 1994 until 1996
he was controller of Ochoco Lumber Company; and from 1991 until 1994 was an
accountant with Arthur Andersen, LLP.


                                       25
<PAGE>

Key Employees

      Walter L. Barnes serves as Assistant Vice President - Harvesting of the
Manager, responsible for all solid wood logging and fiber operations. From
1993-1996, prior to joining the Manager, Mr. Barnes acted as the Operations
Harvest Manager for Weyerhaeuser. Mr. Barnes was employed by Weyerhaeuser for 28
years and has extensive experience managing different harvesting systems on both
the East and West sides of the Cascade Range.

      Robert A. Broadhead serves as Assistant Vice President - Marketing of the
Manager, responsible for all log and stumpage sales transactions. Mr. Broadhead
was employed by Weyerhaeuser for 20 years and gained additional experience in
investing and planning while serving as Planning Manager from 1981 to 1994.

      Kurt A. Muller serves as Assistant Vice President - Planning of the
Manager, responsible for all harvest planning, as well as operating and
developing the inventory and GIS systems. From 1982 to 1989, Mr. Muller was
President of Woodland Consulting Services, Inc., during which time he gained
additional experience in contracting forestry operations and forest land
management as District Forester. Mr. Muller was employed by Weyerhaeuser for
eight years.

      Christopher J. Sokol serves as Assistant Vice President - Forestry of the
Manager, responsible for forestry operations, environmental relationships,
harvest prescriptions and nursery/orchard operations. Prior to joining the
Manager in 1996, Mr. Sokol was employed by Weyerhaeuser for 22 years and gained
additional experience in forest regeneration and timber sales while serving as
District Forester from 1982 to 1991 and as Forestry Manager thereafter.


                                       26
<PAGE>

Item 11. Executive Compensation

      The Master Partnership and the Manager were formed in June 1997. Under the
terms of the Operating Company Agreement, the Company is required to reimburse
the Manager for expenses relating to the operation of the Company, including
salaries and bonuses of employees employed on behalf of the Company, as well as
the costs of providing benefits to such persons under employee benefit plans and
for the costs of health and life insurance.

      The following table sets forth annual salary, bonus and all other
compensation awards and payouts earned by the Manager's Chief Executive Officer
and those executive officers who earned in excess of $100,000 (the "Named
Executive Officers") for services rendered during the fiscal year ended December
31, 1998:

                           Summary Compensation Table

<TABLE>
<CAPTION>
                                                                                                     Long Term  
                                                                                                   Compensation 
                                                     Annual Compensation                              Awards    
                                                     -------------------                           ------------ 
                                                                                                    Securities
                                     Fiscal                                                         Underlying            All Other
Name and Principal Position           Year        Salary($)         Bonus($)          Other        Options/SARs(#)      Compensation
---------------------------           ----        ---------         --------          -----        ---------------      ------------
<S>                                   <C>         <C>                <C>             <C>              <C>                  <C>
John M. Rudey (1)                     1998        300,000            150,000             --           107,218(7)            --
 Chairman and                                                                      
 Chief Executive Officer                                                           
                                                                                   
Allen E. Symington (2)(5)(6)          1998        249,167            130,000             --           107,218(8)            --
  President and                                                                    
  Chief Financial Officer                                                          

Robert E.L. Michie (3)(5)(6)          1998        163,782             87,000         10,500            64,332(8)            --
  Vice President - Operations                                                      

John C. McDowell (4)(5)(6)            1998        138,958             72,500          9,328            34,310(8)            --
  Vice President - Finance                                                         
and Controller                                                                     

Martin Lugus                          1998        101,521             24,625          3,767            64,331(7)            --
 Vice President - Timberland          
 Operations                           
</TABLE>

----------
      (1)   Mr. Rudey served as Chairman of the Board of Directors during 1998.
            Effective January 1, 1999, Mr. Rudey assumed the additional title of
            President.
      (2)   Mr. Symington's employment was terminated effective January 1, 1999.
      (3)   Mr. Michie's employment was terminated effective January 1, 1999.
      (4)   Mr. McDowell's employment was terminated effective January 1, 1999.
      (5)   Pursuant to their respective employment agreements, Messrs.
            Symington, Michie and McDowell each received one year's salary as
            severance upon their termination.
      (6)   Excludes severance payments made in January 1999. See, "Repurchase
            of Certain Members' Interest; Severance Payments."
      (7)   Options granted in 1997 were repriced on December 14, 1998. (8)
      (8)   Options were granted on January 5 or 12, 1998, repriced on December
            14, 1998 and expired on January 1, 1999 as a result of his
            termination as an officer of the Company.


                                       27
<PAGE>

Long-Term Incentive Plan

      The Manager has adopted the U.S. Timberlands Company, L.P. Amended and
Restated 1997 Long-Term Incentive Plan (the "Long-Term Incentive Plan") for key
employees and directors of the Manager and its affiliates. The summary of the
Long-Term Incentive Plan contained herein does not purport to be complete and is
qualified in its entirety by reference to the Long-Term Incentive Plan, which is
filed as an exhibit to the Company's Form S-1 Registration Statement. The Long-
Term Incentive Plan consists of two components, a unit option plan (the "Unit
Option Plan") and a restricted unit plan (the "Restricted Unit Plan"). The
Long-Term Incentive Plan currently permits the grant of Unit Options and
Restricted Units covering an aggregate of 857,748 Common Units.

      Unit Option Plan. The Unit Option Plan currently permits the grant of
options ("Unit Options") covering 857,748 Common Units. Unit Options granted
during the Subordination Period will become exercisable automatically upon, and
in the same proportions as, the conversion of the Subordinated Units to Common
Units. If a grantee's employment is terminated by reason of his death,
disability or retirement, the grantee's Unit Options will become immediately
exercisable. In addition, a grantee's Unit Options will become immediately
exercisable in the event of a "change of control" of the Company (as defined in
the Long-Term Incentive Plan).

      Upon exercise of a Unit Option, the Manager will acquire Common Units in
the open market at a price equal to the then-prevailing price on the principal
national securities exchange upon which the Common Units are then traded, or
directly from the Company or any other person, or use Common Units already owned
by the Manager, or any combination of the foregoing. The Manager will be
entitled to reimbursement by the Company for the difference between the cost
incurred by the Manager in acquiring such Common Units and the proceeds received
by the Manager from an optionee at the time of exercise. Thus, the cost of the
Unit Options will be borne by the Company. If the Master Partnership issues new
Common Units upon exercise of the Unit Options, the total number of Units
outstanding will increase and the Manager will remit the proceeds received from
the optionee to the Company.

      The Unit Option Plan has been designed to furnish additional compensation
to key executives and key directors and to increase their proprietary interest
in the future performance of the Company measured in terms of growth in the
market value of Common Units.

      The following table sets forth certain information with respect to Unit
Options granted to the named executive officers during the fiscal year 1998:

              Long-Term Incentive Plans--Awards in Last Fiscal Year

<TABLE>
<CAPTION>
                                                                                           Performance or Other
                                                                                         Period Until Maturation
                            Name                               Number of Unit Options          or Payout (3)
<S>                                                                  <C>                          <C>    
John M. Rudey ...............................................        107,218(1)                   2 years

Allen E. Symington ..........................................        107,218(2)                   2 years

Robert E. L. Michie .........................................         64,332(2)                   2 years

John C. McDowell ............................................         34,310(2)                   2 years

Martin Lugus.................................................         64,331(1)                   2 years
</TABLE>

----------
      (1)   Options granted in 1997 were repriced on December 14, 1998.
      (2)   These Unit Options granted to Messrs. Symington, Michie and McDowell
            in January 1998 were repriced on December 14, 1998 and expired
            unexercised on January 1, 1999 as a result of their termination.


                                       28
<PAGE>

      (3)   The Unit Options become exercisable automatically upon, and in the
            same proportion as, the conversion of the Subordinated Units to
            Common Units, which date shall be no earlier than December 31, 2000.

      The following table sets forth certain information with respect to option
grants to the named executive officers during fiscal 1998:

                     Options/SAR Grants in Last Fiscal Year

<TABLE>
<CAPTION>
                                                                                                  Potential Realizable Value
                           Number of          % of Total                                            at Assumed Annual Rates
                          Securities         Options/SARs                                            of Stock Appreciation
                          Underlying            Granted          Exercise or                          for Option Term(4)
                         Options/SARs        to Employees        Base Price      Expiration           ---------------
Name                        Granted       during Fiscal Year     ($/Sh) (3)         Date            5%                10%
----                        -------       ------------------     ------             ----            --                ---
<S>                       <C>                  <C>               <C>               <C>             <C>            <C>      
John M. Rudey             107,218(1)           14.2%             14.750              11/19/07      994,983        2,520,695

Allen E. Symington        107,218(2)           14.2%             14.750             1/5/08(2)      994,983        2,520,695

Robert E.L. Michie         64,332(2)            8.5%             14.750            1/12/08(2)      597,001        1,512,445

John C. McDowell           34,310(2)            4.5%             14.750             1/5/08(2)      318,397          806,628

Martin Lugus               64,331(1)            8.5%             14.750              11/19/07      596,992        1,512,422
</TABLE>

----------
      (1)   Options granted in 1997 were repriced on December 14, 1998.
      (2)   The Unit Options granted to Messrs. Symington, Michie and McDowell
            expired unexercised as a result of their termination.
      (3)   The Unit Options become exercisable automatically upon, and in the
            same proportion as, the conversion of the Subordinated Units to
            Common Units, which date shall be no earlier than December 31, 2000.
      (4)   A ten year period (the maximum length of the Unit Option term) was
            used for compounding purposes in the above calculations.

      The following table sets forth certain information with respect to the
aggregate number and value of options at the fiscal year-end 1998:

             Aggregated Option/SAR Exercises in Last Fiscal Year and
                       Fiscal Year Ended Option/SAR Values

<TABLE>
<CAPTION>
                                                                   Number of Securities
                                                                  Underlying/Unexercised           Value of Unexercised
                                                                      Option/SARs at           In-the-Money Options/SARs at
                                                                    December 31, 1998               December 31, 1998
                                                                    -----------------               -----------------
                        Shares Acquired
                          on Exercise       Value Realized      Exercisable   Unexercisable    Exercisable          Unexercisable
                          -----------       --------------      -----------   -------------    -----------          -------------

<S>                            <C>               <C>                <C>         <C>                <C>               <C>
John M. Rudey                  --                $--                --             107,218         $--            N/A(2)

Allen E. Symington             --                $--                --          107,218(1)         $--            N/A(2)

Robert E.L. Michie             --                $--                --           64,332(1)         $--            N/A(2)

John C. McDowell               --                $--                --           34,310(1)         $--            N/A(2)

Martin Lugus                   --                $--                --              64,331         $--            N/A(2)
</TABLE>

----------
      (1)   The Unit Options granted to Messrs. Symington, Michie and McDowell
            expired unexercised as a result of their termination.


                                       29
<PAGE>

      (2)   At the close of trading on December 31, 1998, the market value of
            the Common Units was $13.375 per common unit. Since the Units
            Options, once exercisable, would be exercisable at $14.750 per unit,
            the in-the-money computation is inapplicable.

      Restricted Unit Plan. A Restricted Unit is a "phantom" unit that entitles
the grantee to receive a Common Unit upon the vesting of the phantom unit. No
grants have been made under the Restricted Unit Plan. The LTIP Committee may, in
the future, determine to make grants under such plan to key employees and
directors containing such terms as the Committee shall determine. Restricted
Units granted during the Subordination Period will vest automatically upon, and
in the same proportions as, the conversion of the Subordinated Units to Common
Units. Common Units to be delivered upon the "vesting" of rights may be Common
Units acquired by the Manager in the open market, Common Units already owned by
the Manager, Common Units acquired by the Manager directly from the Company or
any other person, or any combination of the foregoing. The Manager will be
entitled to reimbursement by the Company for the cost incurred in acquiring such
Common Units. If the Master Partnership issues new Common Units, the total
number of Units outstanding will increase and the Company will receive no
remuneration.

      The issuance of the Common Units pursuant to the Restricted Unit Plan is
intended to serve as a means of incentive compensation for performance and not
primarily as an opportunity to participate in the equity appreciation in respect
of the Common Units. Therefore, no consideration will be payable by the plan
participants upon vesting and issuance of the Common Units.

      The Manager's Board of Directors in its discretion may terminate the
Long-Term Incentive Plan at any time with respect to any Common Units or Unit
Options for which a grant has not theretofore been made. The Manager's Board of
Directors will also have the right to alter or amend the Long-Term Incentive
Plan or any part thereof from time to time; provided, however, that no change in
any outstanding grant may be made that would impair the rights of the
participant without the consent of such participant.

Compensation of Directors

      No additional remuneration will be paid to employees who also serve as
directors. Each independent director receives $50,000 annually, for which they
each agree to participate in four regular meetings of the Board of Directors and
four Audit/Conflicts Committee meetings. Each other non-employee director
receives $50,000 annually (to be paid in cash or Subordinated Units, as
determined by each director), for which they each agree to participate in four
regular meetings of the Board of Directors. Each non-employee director will
receive $1,250 for each additional meeting in which he participates. In
addition, each non-employee director will be reimbursed for his out-of-pocket
expenses in connection with attending meetings of the Board of Directors or
committees thereof. Each director will be fully indemnified by the Company for
his actions associated with being a director to the extent permitted under
Delaware law.

      The Manager has entered into consulting agreements with each of Aubrey
Cole Associates (a consulting firm affiliated with Mr. Cole), Robert F. Wright
Associates, Inc. (a consulting firm affiliated with Mr. Wright) and Mr. Hornig
pursuant to which each such person or firm provides consulting services to the
Manager. Each such agreement provides for an annual retainer of $25,000, plus
$150 per hour (with a maximum per diem of $1,200) for services rendered at the
request of the Manager. Each consulting agreement will be reviewed annually by a
majority of the directors who do not have consulting agreements.

Employment Agreements

      The Manager has entered into an employment agreement with Mr. Rudey (the
"Executive"). The agreement has a term expiring on December 31, 2002, and
includes confidentiality and noncompete provisions.

      The agreement provides for an annual base salary of $450,000, subject to
such increases as the Board of Directors of the Manager may authorize from time
to time. In addition, the Executive is eligible to receive an annual cash


                                       30
<PAGE>

bonus to be determined by the Compensation Committee not to exceed 100% of his
base salary. The Executive will be entitled to participate in such other benefit
plans and programs as the Manager may provide for its employees in general.

      The agreement provides that in the event the Executive's employment is
terminated without "Cause" (as defined in the Employment Agreements) or if the
Executive terminates his employment for "Good Reason" (as defined below), such
individual will be entitled to receive a severance payment in an amount equal to
his base salary for the remainder of the employment term under the Employment
Agreement or 12 months, whichever is less, plus a prorated bonus for the year of
such termination calculated based on the bonus being equal to 100% of base
salary. In the event of termination due to death or disability, the Executive
will be entitled to accrued salary and benefits up to the date of the
termination. In the event the individual's employment is terminated for "Cause,"
he will receive accrued salary and benefits up to the date of termination.

      Good Reason is defined in the agreement generally as: (i) failure of the
Manager's members to elect or re-elect the Executive to the Board of Directors,
(ii) failure of the Manager to vest in the Executive the position, duties and
responsibilities contemplated by his Employment Agreement, (iii) failure of the
Manager to pay any portion of the Executive's compensation, (iv) any material
breach by the Manager of any material provision of the Employment Agreement and
(v) a material reduction in the individual's duties, responsibilities or status
upon a "change of control" as defined in the Employment Agreement. "Cause" is
defined generally as: (i) any felony conviction, (ii) any material breach by the
Executive of a material written agreement between the Executive and the Company,
(iii) any breach caused by the Executive of the Partnership Agreement, (iv) any
willful misconduct by the Executive materially injurious to the Company, (v) any
willful failure by the Executive to comply with any material policies,
procedures or directives of the Board of Directors of the Manager or (vi) any
fraud, misappropriation of funds, embezzlement or other similar acts of
misconduct with respect to the Company.

      The Company had similar agreements with Messrs. Symington, Michie and
McDowell, each of whose employment was terminated effective January 1, 1999.

Committee Interlocks and Insider Participation in Compensation Decisions

      The Compensation Committee of the Manager is composed of Messrs. Rudey,
Abramson, Wyman, Hornig and Cole. Mr. Rudey also serves as Chairman of the
Manager.

Item 12. Security Ownership of Certain Beneficial Owners and Management

      None.

Item 13. Certain Relationships and Related Transactions

      The Company is managed by the Manager pursuant to the Operating Company
Agreement. Under the Operating Company Agreement, the Manager is entitled to
reimbursement of certain costs of managing the Company. These costs included
compensation and benefits payable to officers and employees of the Manager,
payroll taxes, general and administrative expenses and legal and professional
fees.

Consulting Agreements

      The Manager has entered into consulting agreements with each of Aubrey
Cole Associates (a consulting firm affiliated with Mr. Cole), Robert F. Wright
Associates, Inc. (a consulting firm affiliated with Mr. Wright) and Mr. Hornig
pursuant to which each such person or firm provides consulting services to the
Manager. Each such agreement provides for an annual retainer of $25,000, plus
$150 per hour (with a maximum per diem of $1,200) for services rendered at the
request of the Manager. Each consulting agreement will be reviewed annually by a
majority of the directors who do not have consulting agreements.


                                       31
<PAGE>

Related Party Transactions

      During January 1999, Glenn A. Zane was appointed Acting Senior Vice
President and Director of Operations for the Company. Throughout 1998, the
Company paid approximately $183,000 to Mason, Bruce & Girard, of which Mr. Zane
is a partner, for consulting services.

      Pursuant to an agreement dated as of July 29, 1997 between John J.
Stephens, a Founding Director and the former President and Chief Executive
Officer of the Manager, and the Company, Old Services, Mr., Rudey and certain of
his affiliates, Mr. Stephen's interest in Old Services was redeemed for 95,238
Subordinated Units upon the consummation of the Transactions and $1,000,000 paid
in January 1998. Pursuant to an agreement dated as of July 29, 1997 between Mr.
Hornig and the Company, Old Services, Mr. Rudey and certain of his affiliates,
Mr. Hornig's interest in Old Services was redeemed upon the closing of the
Transactions for 48,160 Subordinated Units.

Repurchase of Certain Member Interests; Severance Payments

      On January 5, 1998, the Manager made certain changes in senior management.
In connection therewith, Edward J. Kobacker, the former Executive Vice President
and Chief Operating Officer and a former Director of the Manager, became
entitled to receive approximately $700,000 in severance payments pursuant to his
employment agreement. In addition, pursuant to the terms of the Manager's
operating agreement, the member interests of each of Mr. Stephens, Mr. Kobacker
and John H. Beuter, a former Director of the Manager, were subject to repurchase
at an aggregate price of $385,000 payable in three annual installments
commencing February 1, 1998. The Company has reimbursed the Manager for such
repurchase payments.

      During January 1999, the Company paid $260,000, $175,000 and $145,000 to
Messrs. Symington, Michie and McDowell, respectively, as severance under their
employment agreements with the Company.


                                       32
<PAGE>

                                     PART IV

Item 14. Exhibits, Financial Statements, and Reports on Form 8-K

(a)(1) and (2) Financial Statements

      See "Index to Financial Statements" set forth on page F-1.

(a)(3) Exhibits

      +3.2      --Second Amended and Restated Operating Agreement of U.S.
                Timberlands Klamath Falls, L.L.C.

      +10.1     --Credit Agreement among U.S. Timberlands Klamath Falls, L.L.C.
                and certain banks

      +10.2     --Indenture among U.S. Timberlands Klamath Falls, L.L.C., U.S.
                Timberlands Finance Corp. and State Street Bank and Trust
                Company, as trustee

      +10.3     --Contribution, Conveyance and Assumption Agreement among U.S.
                Timberlands Klamath Falls, LLC and certain other parties

      *10.4     --Form of U.S. Timberlands Company, L.P. 1997 Long-Term
                Incentive Plan

      *10.5     Employment Agreement for Mr. Rudey

      **10.6    Employment Agreement for Mr. Symington

      **10.7    Employment Agreement for Mr. Michie

      **10.8    Employment Agreement for Mr. McDowell

      *10.9     --Supply Agreement between U.S. Timberlands Klamath Falls,
                L.L.C. and Collins Products LLC

      ***16     Letter from Arthur Andersen, LLP dated December 8, 1998.

      *21.1     --List of Subsidiaries

      27.1      --Financial Data Schedule

----------

*     Incorporated by reference to the same numbered Exhibit to the Registrant's
      Registration Statement on Form S-1 filed November 13, 1997.
+     Incorporated by reference to the same numbered Exhibit to the Master
      Partnership's Current Report on Form 8-K filed January 15, 1998.
**    Incorporated by reference to the same numbered Exhibit to the Registrant's
      Annual Report on Form 10-K filed March 31, 1998.
***   Incorporated by reference to Exhibit 1 to the Registrant's Form 8-K filed
      on December 8, 1998.


                                       33
<PAGE>

(b) Reports on Form 8-K

      On December 8, 1998, the Company filed a Form 8-K reporting the
resignation, on December 1, 1998 of its former accountant.

                                   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 on this 15th of April,
1999.

                                U.S. TIMBERLANDS KLAMATH FALLS, L.L.C.

                                By:  U.S. Timberlands Services Company, L.L.C.
                                     Its Manager


                                By:  /s/ John M. Rudey
                                     -------------------------------------------
                                     John M. Rudey, Chairman, Chief Executive 
                                     Officer and President

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons in the capacities and on the
dates indicated.

<TABLE>
<S>                                          <C>                                             <C> 
/s/ John M. Rudey                            Chairman, Chief Executive Officer,              April 15, 1999
---------------------------------------      President and Director (Principal Executive 
                 John M. Rudey               Officer)
                                             
                                             
/s/ Greg G. Byrne                            Chief Financial Officer                         April 15, 1999
---------------------------------------      
                 Greg G. Byrne             

                                             
/s/ Jeffrey B. Groom                         Corporate Controller -                          April 15, 1999
---------------------------------------         Western Operations              
                 Jeffrey B. Groom               (Principal Accounting Officer)  


/s/ Aubrey L. Cole                           Director                                        April 15, 1999
---------------------------------------      
                 Aubrey L. Cole             


/s/ George R. Hornig                         Director                                        April 15, 1999
---------------------------------------      
                 George R. Hornig            


/s/ Alan B. Abramson                         Director                                        April 15, 1999
---------------------------------------      
                 Alan B. Abramson            


/s/ William A. Wyman                         Director                                        April 15, 1999
---------------------------------------      
                 William A. Wyman            


/s/ Robert F. Wright                         
---------------------------------------      
                 Robert F. Wright            Director                                        April 15, 1999
</TABLE>

<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Contents

                                                                            Page
                                                                            ----
Consolidated Financial Statements

  Independent auditors' report                                               F-2
  
  Balance sheets as of December 31, 1998 and 1997                            F-3
  
  Statements of operations for the years ended December 31, 1998 and
     1997, for the period from August 30, 1996 through December 31, 1996
     (Company) and for the period from January 1, 1996 through August
     29, 1996 (Predecessor)                                                  F-4
  
  Statements of changes in members' equity (deficit) and Weyerhaeuser
     investment and advances for the years ended December 31, 1998 and
     1997, for the period from August 30, 1996 through December 31, 1996
     (Company) and for the period from January 1, 1996 through August
     29, 1996 (Predecessor)                                                  F-5
  
  Statements of cash flows for the years ended December 31, 1998 and
     1997, for the period from August 30, 1996 through December 31, 1996
     (Company) and for the period from January 1, 1996 through August
     29, 1996 (Predecessor)                                                  F-6
  
  Notes to financial statements                                              F-7
  
  
                                                                             F-1
<PAGE>

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Members of
U.S. Timberlands Klamath Falls, L.L.C.

We have audited the accompanying consolidated balance sheet of U.S. Timberlands
Klamath Falls, L.L.C. and subsidiary as of December 31, 1998, and the related
consolidated statements of operations, changes in members' equity (deficit) and
cash flows for the year then ended. 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 audit.

We conducted our audit 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 audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements enumerated above present
fairly, in all material respects, the consolidated financial position of U.S.
Timberlands Klamath Falls, L.L.C. and subsidiary as of December 31, 1998, and
the results of their operations and their cash flows for the year then ended, in
conformity with generally accepted accounting principles.

Richard A. Eisner & Company, LLP

New York, New York
January 27, 1999, except as to the third
and fourth paragraphs of Note E[2], the
dates of which are February 16, 1999 and
April 12, 1999, respectively


                                                                             F-2
<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors of
U.S. Timberlands Klamath Falls, L.L.C.:

We have audited the accompanying consolidated balance sheet of U.S. Timberlands,
as described in Note 1, as of December 31, 1997, and the related consolidated
statements of operations, changes in members' equity (deficit), and cash flows
for the year ended December 31, 1997 and the period from inception (August 30,
1996) through December 31, 1996. We have also audited the statements of
operations, changes in Weyerhaeuser investment and advances and cash flows of
the Predecessor for the period from January 1, 1996 through August 29, 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 U.S. Timberlands as of December
31, 1997, and the results of its operations and its cash flows for the year
ended December 31, 1997 and the period from inception (August 30, 1996) through
December 31, 1996, and the results of the Predecessor's operations and cash
flows for the period from January 1, 1996 through August 29, 1996 in conformity
with generally accepted accounting principles.


                                                     ARTHUR ANDERSEN LLP

Portland, Oregon,
   January 23, 1998


                                                                            F-2a

<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Consolidated Balance Sheets
(in thousands)

<TABLE>
<CAPTION>
                                                                                         December 31,
                                                                                   ----------------------
                                                                                        1998         1997
                                                                                   ---------    ---------
<S>                                                                                <C>          <C>      
ASSETS
Current assets:
   Cash and cash equivalents                                                       $   4,824    $  10,625
   Accounts receivable, net of allowance for doubtful accounts of $200 and $100,
     respectively                                                                      1,527        2,526
   Other receivables                                                                   1,113          174
   Notes receivable                                                                    1,179        1,073
   Prepaid expenses                                                                      426          534
                                                                                   ---------    ---------
       Total current assets                                                            9,069       14,932
                                                                                   ---------    ---------
Timber, timberlands and logging roads, net                                           332,593      359,349
                                                                                   ---------    ---------

Seed orchard and nursery stock                                                         1,883        1,828
                                                                                   ---------    ---------
Property, plant and equipment, at cost:
   Equipment                                                                             637          605
   Buildings and land improvements                                                       843          843
   Less accumulated depreciation                                                        (326)        (187)
                                                                                   ---------    ---------
       Property, plant and equipment, net                                              1,154        1,261
                                                                                   ---------    ---------
Long-term notes receivable                                                                --        1,171
                                                                                   ---------    ---------

Deferred financing fees, less accumulated amortization of $752 and $77,
respectively                                                                           5,998        6,673
                                                                                   ---------    ---------
       Total assets                                                                $ 350,697    $ 385,214
                                                                                   =========    =========
LIABILITIES AND MEMBERS' EQUITY
Current liabilities:
   Accounts payable                                                                $     733    $   1,404
   Accrued liabilities                                                                 4,405        4,697
   Deferred revenue                                                                    1,614        5,744
   Payable to affiliate                                                                   --        1,000
   Payable to manager                                                                    914          252
                                                                                   ---------    ---------
       Total current liabilities                                                       7,666       13,097
                                                                                   ---------    ---------
Long-term debt                                                                       225,000      225,000
                                                                                   ---------    ---------
Members' equity:
   Managing member's interest                                                          1,180        1,471
   Nonmanging member's interest                                                      116,851      145,646
                                                                                   ---------    ---------

                                                                                     118,031      147,117
                                                                                   ---------    ---------
       Total liabilities and members' equity                                       $ 350,697    $ 385,214
                                                                                   =========    =========
</TABLE>

See notes to financial statements


                                                                             F-3
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Consolidated Statements of Operations
(in thousands)

<TABLE>
<CAPTION>
                                                     U.S. Timberlands Klamath Falls,
                                                          L.L.C. and Subsidiary           Predecessor (a)
                                                  ------------------------------------    ---------------
                                                                          August 30,         January 1,   
                                                        Year Ended          1996               1996       
                                                       December 31,       Through             Through
                                                   -------------------   December 31,        August 29,   
                                                      1998        1997      1996                1996     
                                                   --------    --------   -----------         --------    
<S>                                                <C>         <C>         <C>                <C>         
Revenues:                                                                                                 
   Log and stumpage sales                          $ 63,636    $ 60,445    $ 13,590           $ 14,077    
   Timber and property sales                          6,275      15,244          --                 --    
   By-products and other                              1,413       1,656         429              1,501    
                                                   --------    --------    --------           --------    
                                                                                                          
                                                     71,324      77,345      14,019             15,578    
                                                   --------    --------    --------           --------    
Operating costs:                                                                                          
   Costs of products sold                            16,683      17,778       6,179              9,225    
   Cost of timber and property sales                  5,917       8,746          --                 --    
   Depreciation, depletion and road amortization     21,938      17,303       3,323                927    
   Selling, general and administrative expenses      10,462       6,250       9,284              2,730    
                                                   --------    --------    --------           --------    
                                                                                                          
                                                     55,000      50,077      18,786             12,882    
                                                   --------    --------    --------           --------    
                                                                                                          
Operating income (loss)                              16,324      27,268      (4,767)             2,696    

Interest expense                                     22,183      25,321       7,316                 --    
Amortization of deferred financing fees and                                                               
   debt guarantee fees                                  675       4,193       1,326                 --    
Interest income                                        (460)     (1,452)       (409)                --    
Other expense, net                                      309         574          36                  1    
                                                   --------    --------    --------           --------    
                                                                                                          
Income (loss) before extraordinary items             (6,383)     (1,368)    (13,036)             2,695    
Extraordinary items, losses on extinguishment                                                             
   of debt                                               --      (9,337)         --                 --    
                                                   --------    --------    --------           --------    
                                                                                                          
Net income (loss)                                  $ (6,383)   $(10,705)   $(13,036)          $  2,695    
                                                   ========    ========    ========           ========    
</TABLE>

(a)   Due to the Weyerhaeuser Acquisition on August 30, 1996, the consolidated
      statements of operations subsequent to that date are not comparable with
      the results of operations of the Predecessor.

See notes to financial statements 


                                                                             F-4
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Consolidated Statements of Changes in Members' Equity (Deficit) and 
Weyerhaeuser Investment and Advances 
(in thousands)

<TABLE>
<CAPTION>
                                                          U.S.                                                      
                                                       Timberlands                                                  
                                                       Management                                                   
                                                        Company,                                                    
                                         Predecessor     L.L.C.             U.S. Timberlands Klamath Falls, L.L.C     
                                        -------------  -----------     -------------------------------------------------------------
                                                                        Members'
                                                                         Equity 
                                         Weyerhaeuser                   (Deficit)                                          Total    
                                          Investment    Members'         Prior to          Managing   Nonmanaging         Members'  
                                             and         Equity            the              Members'    Members'           Equity   
                                           Advances     (Deficit)      Transactions        Interest    Interest           (Deficit) 
                                        ------------   -----------     ------------      -----------  ------------     -------------
<S>                                      <C>             <C>             <C>                  <C>           <C>            <C>    
Balance, January 1, 1996                 $   29,155                                                                               
Net income for the period                     2,695                                                                               
Net distributions to
   Weyerhaeuser Company                      (5,054)                                                                              
Net asset transfer from
   Weyerhaeuser Company                       1,043                                                                               
                                         ----------
Balance, August 29, 1996                 $   27,839                                                                               
                                         ==========
Members' contributions                                   $      100      $   10,000                                      $  10,100
Net loss                                                     (1,227)        (11,809)                                       (13,036)
                                                         ----------      ----------                                      ---------

Balance, December 31, 1996                                   (1,127)         (1,809)                                        (2,936)
Members' distribution                                        (1,191)             --                                         (1,191)
Net loss January 1, 1997
   through November 18, 1997                                 (2,009)         (7,424)                     $       --         (9,433)
Redemption of member's
   interest                                                  (1,000)             --                              --         (1,000)
Assumption of Old Services
   net liabilities                                            5,327          (5,584)                                          (257)
Allocation of managing and
   nonmanging members'
   interests in members' deficit                                             14,817      $     (148)        (14,669)            --
Members' contributions                                           --              --           1,632         161,574        163,206
Net loss - November 19, 1997
   through December 31, 1997                                     --              --             (13)         (1,259)        (1,272)
                                                         ----------      ----------      ----------      ----------      ---------

Balance, December 31, 1997                               $        0      $        0           1,471         145,646        147,117
                                                         ==========      ==========      
Distributions to members                                                                       (227)        (22,476)       (22,703)
Net loss                                                                                        (64)         (6,319)        (6,383)
                                                                                         ----------      ----------      ---------

Balance, December 31, 1998                                                               $    1,180      $  116,851      $ 118,031
                                                                                         ==========      ==========      =========
</TABLE>

----------
Due to the Weyerhaeuser Acquisition on August 30, 1996, the consolidated
statements of changes in members' equity (deficit) for the years ended December
31, 1998 and 1997 and the combined statement of changes in members' deficit for
the period from August 30, 1996 through December 31, 1996 are not comparable to
the statements of changes in Weyerhaeuser investment and advances of the
Predecessor. See the accompanying notes for additional information.

See notes to financial statements


                                                                             F-5
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Consolidated Statements of Cash Flows
(in thousands)

<TABLE>
<CAPTION>
                                                                     U.S. Timberlands Klamath Falls, L.L.C.
                                                                                  Subsidiary                     Predecessor 
                                                                  --------------------------------------------   ------------
                                                                                                  August 30,       January 1,
                                                                          Year Ended                1996             1996    
                                                                         December 31,              Through          Through  
                                                                  -------------------------       December 31,     August 29,
                                                                     1998            1997           1996             1996
                                                                  ---------       ---------       ---------       ---------
<S>                                                               <C>             <C>             <C>             <C>      
Cash flows from operating activities:
   Net income (loss)                                              $  (6,383)      $ (10,705)      $ (13,036)      $   2,695
   Adjustments to reconcile net income (loss) to net cash
     provided by (used in) operating activities:
       Depreciation, depletion, amortization and cost of
        timber and property sold                                     27,855          26,775           3,549             927
       Write-off and amortization of deferred financing fees            675           9,148              --              --
       Other noncash items                                              361             630              51               6
       Changes in assets and liabilities:
         Receivables                                                    999          (1,006)         (1,694)            699
         Interest receivable from affiliate                              --             121            (121)             --
         Inventories                                                     --              78             921           1,348
         Other receivables                                             (939)             --              --              --
         Prepaid expenses                                               108             146            (680)            371
         Accounts payable                                              (671)            515             889            (292)
         Accrued liabilities                                           (653)         (3,171)          7,137            (242)
         Deferred revenue                                            (4,130)          5,744              --              --
         Payable to manager                                             257             252              --              --
                                                                  ---------       ---------       ---------       ---------

           Net cash provided by (used in) operating
             activities                                              17,479          28,527          (2,984)          5,512
                                                                  ---------       ---------       ---------       ---------

Cash flows from investing activities:
   Acquisition of Weyerhaeuser timberlands                               --              --        (283,464)             --
   Receivable from affiliate                                             --          10,000         (10,000)             --
   Purchase of property, plant and equipment                            (32)           (319)           (212)             (6)
   Decrease (increase) in note receivable                             1,065          (2,244)             --              --
   Proceeds from sales of property, plant and equipment                  --             400           2,374              --
   Acquisition of Ochoco Timberlands                                     --        (110,873)             --              --
   Timber and road additions                                           (347)           (534)            (12)            (26)
   Capitalized seed orchard and nursery costs                          (263)           (240)           (136)           (427)
                                                                  ---------       ---------       ---------       ---------

           Net cash provided by (used in) investing
             activities                                                 423        (103,810)       (291,450)           (459)
                                                                  ---------       ---------       ---------       ---------

Cash flows from financing activities:
   Weyerhaeuser investment and advances, net                             --              --              --          (5,054)
   Members' contributions                                                --         163,206          10,100              --
   Member's distribution                                                 --          (1,191)             --              --
   Distributions to members                                         (22,703)             --              --              --
   Deferred financing fees                                               --         (12,720)         (4,053)             --
   Long-term borrowings                                                  --         510,000         305,000              --
   Repayment of long-term borrowings                                     --        (590,000)             --              --
   Payment to affiliate                                              (1,000)             --              --              --
                                                                  ---------       ---------       ---------       ---------

           Net cash provided by (used in) financing
             activities                                             (23,703)         69,295         311,047          (5,054)
                                                                  ---------       ---------       ---------       ---------

Net (decrease) increase in cash and cash equivalents                 (5,801)         (5,988)         16,613              (1)
Cash and cash equivalents, beginning of period                       10,625          16,613              --               1
                                                                  ---------       ---------       ---------       ---------

Cash and cash equivalents, end of period                          $   4,824       $  10,625       $  16,613       $       0
                                                                  =========       =========       =========       =========

Supplemental cash flow information:

   Cash paid for interest                                         $  21,418       $  28,083       $   2,062       $      --

Noncash activities:
   Net asset transfers from Weyerhaeuser Company,
     principally property, plant equipment                        $      --       $      --       $      --       $   1,043
   Redemption of member's interest in old services                $      --       $   1,000       $      --       $      --
</TABLE>

----------
Due to the Weyerhaeuser Acquisition on August 30, 1996, the consolidated
statements of cash flows for 1998 and 1997 and the combined statement of cash
flows for the period from August 30, 1996 through December 31, 1996 are not
comparable to statements of cash flows of the Predecessor. See the accompanying
notes for additional information.

See notes to financial statements


                                                                             F-6
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Notes to Financial Statements
December 31, 1998 and 1997
(dollar amounts in thousands)

NOTE A - ORGANIZATION, NATURE OF OPERATIONS AND BASIS OF PRESENTATION

[1]   Organization:

      The accompanying consolidated financial statements include the accounts of
      U.S. Timberlands Klamath Falls, L.L.C. ("USTK"), a Delaware limited
      liability company, and its wholly owned subsidiary, U.S. Timberlands
      Finance Corp. ("Finance Corp."), collectively referred to hereafter as the
      Company. Finance Corp. serves as co-obligor for USTK's notes (defined
      below). It has nominal assets and does not conduct operations. All
      intercompany transactions have been eliminated in consolidation.

      U.S. Timberlands Company, L.P. (the "MLP") owns a 99% nonmanaging member
      interest in USTK. The MLP was formed on June 27, 1997 to acquire and own
      substantially all of the equity interests in USTK and to acquire and own
      the business and assets of U.S. Timberlands Management Company, L.L.C.,
      formerly known as U.S. Timberlands Services Company, L.L.C. ("Old
      Services"). U.S. Timberlands Service Company, L.L.C. (the "Manager")
      manages the businesses of the Company and owns a 1% managing member
      interest in USTK.

[2]   Nature of operations:

      The primary activity of the Company is the growing of trees and the sale
      of logs and standing timber to third party wood processors. The Company's
      timber is located in Oregon, east of the Cascade Range. Logs harvested
      from the Timberlands are sold to unaffiliated domestic conversion
      facilities. These logs are processed for sale as lumber, plywood and other
      wood products, primarily for use in new residential home construction,
      home remodeling and repair and general industrial applications.

[3]   Initial public offering and related transactions:

      On November 19, 1997, the MLP completed an initial public offering (the
      "Common Units Offering") of 8,577,487 common units (including the
      1,118,803 common units issued upon exercise of the underwriters'
      overallotment option in December 1997) representing limited partner
      interests ("Common Units"). In addition, the Company issued $225,000 of
      senior unsecured notes in a public offering (the "Notes"). Concurrent with
      the Common Units Offering, Old Services contributed all of its assets to
      the Manager in exchange for interests therein. Immediately thereafter,
      USTK assumed certain indebtedness of U.S. Timberlands Holdings, L.L.C.
      ("Holdings"), an affiliate of USTK, and the Manager contributed its timber
      operations to USTK in exchange for a member's interest in USTK. The
      Manager then contributed all but a 1% member interest in USTK to the MLP
      in exchange for a general partner interest, 1,387,963 subordinated units
      representing limited partner interests ("Subordinated Units") and the
      right to receive certain incentive distributions. The Manager distributed
      the 1,387,963 Subordinated Units to Old Services and Old Services used a
      portion of such Subordinated Units to redeem interests in Old Services.
      Holdings also contributed all of its member interest in USTK to the MLP in
      exchange for 2,894,157 Subordinated Units. (This series of transactions is
      hereafter referred to as the "Transactions".) Since the controlling owner
      of Old Services and USTK prior to the Transactions now controls the
      Manager, the Transactions were recorded as a reorganization under common
      control and therefore remain at their historical costs.

[4]   Basis of presentation - prior to the Transactions:

      During 1996, USTK and Old Services were formed and subsequently entered
      into an agreement with Weyerhaeuser Company on August 30, 1996 to purchase
      approximately 604,000 acres of timber and timberlands and certain other
      assets (the "Weyerhaeuser Acquisition") as discussed further in Note C. As
      legal entities, USTK and Old Services were not consolidated. However, due
      to common ownership and management, the financial statements of USTK and
      Old Services prior to the Transactions have been presented on a combined
      basis. All intercompany transactions between the above entities have been
      eliminated in the accompanying financial statements.


                                                                             F-7
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Notes to Financial Statements
December 31, 1998 and 1997
(dollar amounts in thousands)

NOTE A - ORGANIZATION, NATURE OF OPERATIONS AND BASIS OF PRESENTATION
(CONTINUED)

      [5]   Basis of presentation - predecessor:

      As a result of the Weyerhaeuser Acquisition, USTK acquired the Klamath
      Falls Timberlands and certain related assets of Weyerhaeuser Company (as
      used herein, the acquired timberlands and related assets as owned by
      Weyerhaeuser are referred to as the "Predecessor"). All of the financial
      statements provided herein (including the financial statements pertaining
      to the Predecessor) were prepared by, and are solely the responsibility
      of, the Company. The Weyerhaeuser Acquisition was accounted for as a
      purchase and, therefore, the accompanying financial statements as of and
      for the periods ended prior to the date of the Weyerhaeuser Acquisition
      are accounted for under the pre-Weyerhaeuser Acquisition basis of
      accounting. Because the Predecessor did not operate or legally exist as a
      stand-alone entity, there are no separate meaningful equity accounts of
      the Predecessor prior to the Weyerhaeuser Acquisition. Significant changes
      could have occurred in the funding and operations of the Predecessor were
      it to have operated as an independent stand-alone entity. As a result, the
      financial information included herein is not necessarily indicative of the
      financial position and results of operations of the Predecessor which may
      have occurred if it were an independent, stand-alone company during the
      periods presented.

      Revenues for the Predecessor principally represent logs harvested for sale
      to Weyerhaeuser's Klamath Falls wood conversion facilities at prices
      determined in accordance with Weyerhaeuser's transfer pricing policy.
      These transfer prices are not necessarily indicative of the prices the
      Predecessor would have achieved if the logs had been sold to unaffiliated
      wood processors. Revenues from Weyerhaeuser wood conversion facilities and
      unaffiliated wood processors are summarized as follows:

                                                For the
                                                Period
                                            January 1, 1996
                                                Through
              Source of Revenues            August 29, 1996
      --------------------------------      ----------------

      Weyerhaeuser Company                     $ 10,157
      Unaffiliated wood processors                5,421
                                               --------

                                               $ 15,578
                                               ========

      Concurrent with the Weyerhaeuser Acquisition, Collins Products Company
      L.L.C. ("Collins"), an unaffiliated party, acquired Weyerhaeuser's Klamath
      Falls wood conversion facilities. The Company has entered into a 10-year
      log supply agreement with Collins providing for the delivery by the
      Company to Collins of 34 million board feet of merchantable timber each
      year at market prices as discussed in Note I.

      The Predecessor participated in Weyerhaeuser Company's centralized cash
      management system and, as such, its operating and capital expenditure
      needs were met by Weyerhaeuser Company. The net advances from and
      distributions to Weyerhaeuser Company are presented in the accompanying
      financial statements as a component of Weyerhaeuser investment and
      advances prior to the Weyerhaeuser Acquisition. The Weyerhaeuser
      investment and advances account is noninterest bearing.

      Certain costs incurred by Weyerhaeuser Company for financial services,
      information systems and other indirect costs have been allocated to the
      Predecessor on a revenue and volume harvested basis. The resulting charge
      to the Predecessor was $445 in the period from January 1, 1996 through
      August 29, 1996 and is included in selling, general and administrative
      expenses in the accompanying statements of operations. Management of the
      Company believes the allocation methods used provide the Predecessor with
      a reasonable share of such expenses.


                                                                             F-8
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Notes to Financial Statements
December 31, 1998 and 1997
(dollar amounts in thousands)

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies summarized below include both those of the
Company and the Predecessor, unless otherwise noted.

[1]   Use of estimates:

      The preparation of financial statements in conformity with generally
      accepted accounting principles requires management to make estimates and
      assumptions that affect the reported amounts of assets and liabilities and
      disclosure of contingent liabilities at the date of the financial
      statements and the reported amounts of revenues and expenses during the
      reporting period. Actual results could differ from those estimates.

[2]   Revenue recognition:

      Revenue on delivered log sales is recognized upon delivery to the
      customer. Revenue on timber deeds and timber and property sales is
      generally recognized upon closing. Revenue from timber sold under stumpage
      contracts (i.e., the customer arranges to harvest and deliver the logs) is
      recognized when the timber is harvested. Deferred revenue as of December
      31, 1998 and 1997, represents cash received in advance of logs harvested
      under stumpage contracts.

[3]   Concentration of credit risk:

      As of December 31, 1998, the Company had accounts receivable from three
      individual customers that represent 53%, 24% and 13% of total accounts
      receivable, respectively. As of December 31, 1997, the Company had
      accounts receivable from five individual customers that represent 25%,
      21%, 20%, 17% and 12% of total accounts receivable, respectively.

      The Company had sales to individual customers that were greater than 10%
      of total sales for the respective periods as follows:

                                      The Company               Predecessor
                            --------------------------------  ---------------
                                                For the           For the
                                                 Period           Period
                              Year Ended    August 30, 1996   January 1, 1996
                             December 31,       Through           Through
                             ------------     December 31,      August 29,
                             1998    1997         1996             1996
                             ----    ----   ----------------  ---------------

Unaffiliated customer          27%   23%          54%               14%
Unaffiliated customer          18%   21%          14%               10%
Unaffiliated customer          17%   15%          11%               --
Unaffiliated customer          16%   11%          --                --
Weyerhaeuser Company           --    --           --                65%

[4]   Cash and cash equivalents:

      Cash and cash equivalents consist of highly liquid investments with
      maturities at date of purchase of 90 days or less.


                                                                             F-9
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Notes to Financial Statements
December 31, 1998 and 1997
(dollar amounts in thousands)

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

[5]   Timber, timberlands and logging roads:

      Timber, timberlands and logging roads are stated at cost less depletion
      and amortization for timber previously harvested. The depletion rate is
      calculated using a single composite pool by dividing the total cost of
      merchantable timber by the related estimated net merchantable volume.
      Depletion in any given year represents the net merchantable volume
      harvested multiplied by the depletion rate. These estimates are subject to
      change based on periodic reevaluations of merchantable volume. Logging
      road costs for main and spur roads are amortized based on the net
      merchantable volume harvested.

      The components of timber, timberlands, logging roads and related
      accumulated depletion and amortization is as follows:

                                                            December 31,
                                                    ---------------------------
                                                       1998              1997
                                                    ---------         ---------

           Timber                                   $ 329,520         $ 333,721
           Timberlands                                 43,118            44,189
           Logging roads                                1,803             1,847
           Accumulated depletion                      (41,552)          (20,243)
           Accumulated road amortization                 (296)             (165)
                                                    ---------         ---------

                                                    $ 332,593         $ 359,349
                                                    =========         =========

[6]   Seed orchard and nursery stock:

      The Company operates and maintains a seed orchard and nursery. Costs
      incurred by the orchard and nursery to produce seed and seedlings utilized
      in the reforestation of the Company's timberlands are capitalized to seed
      orchard and nursery stock in the accompanying balance sheets. A certain
      amount of seed and seedling stock is sold to unaffiliated customers and is
      reflected as a component of by-products and other revenues in the
      accompanying statements of operations.

[7]   Property, plant and equipment:

      Property, plant and equipment are stated at cost. Additions and
      betterments to buildings and equipment are capitalized. Maintenance and
      repairs are expensed as incurred. Depreciation is provided over the useful
      lives of the assets on the straight-line method. The estimated useful life
      of buildings and land improvements is 40 years and equipment ranges from
      three to five years.

[8]   Deferred financing fees:

      Deferred financing fees consist of fees incurred in connection with
      obtaining the related debt financing. The Company amortizes deferred
      financing fees over the terms of the related debt which approximates the
      effective interest method.

[9]   Income taxes:

      USTK and Old Services are both limited liability companies ("L.L.C.'s").
      Accordingly, they are not liable for federal or state income taxes since
      the respective L.L.C.'s income or loss is reported on the separate tax
      returns of the members. Accordingly, no provision for current or deferred
      income taxes has been reflected in the accompanying financial statements.


                                                                            F-10
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Notes to Financial Statements
December 31, 1998 and 1997
(dollar amounts in thousands)

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

[10]  Financial instruments:

      A summary of the fair value of the Company's significant financial
      instruments and the methods and significant assumptions used to estimate
      those values is as follows:

      (a)   Short-term financial instruments - The fair value of short-term
            financial instruments, including cash, trade and other receivables,
            notes receivable, trade accounts payable and certain accrued
            liabilities, approximates their carrying amounts in the financial
            statements due to the short maturities of such items.

      (b)   Long-term debt - The estimated fair value of the Company's long-term
            debt, which was based upon the quoted market prices of the related
            senior notes at December 31, 1998, approximated its carrying amount
            of $225,000. The estimated fair value at December 31, 1997, based
            upon interest rates and maturity dates for similar obligations with
            like maturities, was $235,328.

      (c)   Interest rate collar agreement - The Company entered into interest
            rate collar agreements to manage interest rate risk. Contemplated
            variable rate borrowings did not occur, and accordingly, these
            agreements are marked to market. The fair value of these agreements
            is the estimated amount that the Company would receive or pay upon
            termination of the agreements at the balance sheet date or other
            specific point in time. Unrealized losses on these agreements were
            estimated to be $991 at December 31, 1998 and $630 at December 31,
            1997. Losses on these agreements charged to other expense in the
            accompanying statements of operations amounted to $361 in 1998 and
            $630 in 1997.

[11]  Unit-based compensation plans:

      The Company's parent (the MLP) accounts for its unit-based compensation
      plans under the provisions of the Accounting Principles Board Opinion No.
      25, "Accounting for Stock Issued to Employees" ("APB 25"). The MLP has
      adopted the disclosure only provisions of the Financial Accounting
      Standards Board Statement No. 123 ("SFAS 123"), "Accounting for
      Stock-Based Compensation." Accordingly, any compensation expense related
      to such plans will be accounted for by the Company under APB 25.

NOTE C - TIMBERLAND ACQUISITIONS

[1]   Weyerhaeuser Company:

      The total purchase price for the Weyerhaeuser Acquisition referred to in
      Note A was $283,464, including direct costs of the acquisition. The
      Weyerhaeuser Acquisition was accounted for as a purchase with the purchase
      price allocated first to current assets acquired, principally inventory,
      and the remaining balance being allocated to noncurrent assets acquired,
      primarily timber, timberlands and logging roads based on the relative fair
      market values of the noncurrent assets as determined by an appraisal.
      Concurrent with the Weyerhaeuser Acquisition, the Company changed to the
      use of outside contractors for all of its logging operations. Accordingly,
      logging equipment acquired was recorded at its estimated resale value.

      Pro forma results of operations for 1996 had the Weyerhaeuser Acquisition
      occurred on January 1, 1996 are as follows:

                                                               1996
                                                            -----------
                                                            (unaudited)

              Revenues                                      $  29,597
              Net loss                                        (25,845)


                                                                            F-11
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Notes to Financial Statements
December 31, 1998 and 1997
(dollar amounts in thousands)

NOTE C - TIMBERLAND ACQUISITIONS (CONTINUED)

[2]   Ochoco:

      On July 15, 1997, the Company acquired approximately 42,000 acres of
      timber and timberlands and approximately 3,000 acres of timber cutting
      rights from Ochoco Lumber Company L.P. for $110,873 (the "Ochoco
      Timberlands"). Substantially all of the purchase price was allocated to
      timber, timberlands and logging roads. The acquisition was principally
      financed through $110,000 of debt financing. Because the Company's
      acquisition of the Ochoco Timberlands did not represent an acquisition of
      an existing business, the pro forma impact on operations for periods prior
      to and including the acquisition has not been disclosed.

NOTE  D - ACCRUED LIABILITIES

The Company's accrued liabilities consist of the following:

                                                               December 31,
                                                          ----------------------
                                                           1998            1997
                                                          ------          ------

       Interest                                           $2,729          $2,492
       Severance and harvest tax                             224             269
       Employee compensation                                 300             450
       Equity issuance costs                                  --             617
       Loss on interest rate collar                          991             630
       Other                                                 161             239
                                                          ------          ------

                                                          $4,405          $4,697
                                                          ======          ======

NOTE E - DEBT

[1]   Senior notes:

      At December 31, 1998 and 1997, long-term debt consists of $225,000 of
      principal amount of 9-5/8% notes due in 2007.

      The notes, which were issued concurrent with the Transactions, were issued
      jointly and severally by USTK and Finance Corp., (collectively, the
      "Issuers"). The Issuers serve as co-obligators of the Notes. The Notes
      represent unsecured general obligations of the Issuers and bear interest
      at 9-5/8% payable semiannually in arrears on May 15 and November 15, and
      mature on November 15, 2007 unless previously redeemed. The Notes are
      redeemable at the option of the Issuers in whole or in part, on or after
      November 15, 2002 at predetermined redemption prices plus accrued interest
      to the redemption date.

      In addition, at any time on or prior to November 15, 2000, the Issuers, at
      their option, may redeem the Notes with the net cash proceeds of a common
      units offering or other equity interests of the Company or the MLP, at
      106.625% of the principal amount thereof, plus accrued and unpaid interest
      thereon to the redemption date, provided that at least 65% of the
      principal amount of the Notes originally issued remain outstanding
      immediately following such redemption. The Notes contain certain
      restrictive convenants, including limiting the ability of the Company to
      make cash distributions, incur additional indebtedness, sell assets or
      harvest timber in excess of certain limitations.


                                                                            F-12
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Notes to Financial Statements
December 31, 1998 and 1997
(dollar amounts in thousands)

NOTE E - DEBT (CONTINUED)

[1]   Senior notes: (continued)

      In conjunction with the Notes issuance, USTK retired all existing debt
      under certain pre-existing long-term financing arrangements. This resulted
      in an extraordinary loss on extinguishment of debt of $5,766 in 1997 due
      principally to the write-off of existing unamortized deferred financing
      fees.

[2]   Bank credit facility:

      Concurrent with the Transactions, the USTK entered into a revolving credit
      facility (the "Bank Credit Facility") with a commercial bank (the "Bank").
      The Bank Credit Facility consists of a $75,000 acquisition facility (the
      "Acquisition Facility") and a $25,000 working capital facility (the
      "Working Capital Facility"). USTK's obligations under the Bank Credit
      Facility represent unsecured general obligations. Average borrowings on
      the Bank Credit Facility were $259 and $14,512 in 1998 and 1997,
      respectively. As of December 31, 1998 and 1997, there were no outstanding
      borrowings on the Bank Credit Facility.

      The Bank Credit Facility bears interest at the lower of the Bank's prime
      rate, plus a margin of 2.0% (9.75% at December 31, 1998) or LIBOR plus a
      margin of 2.5% (7.6% at December 31, 1998). The Working Capital Facility
      expires on November 19, 2000 and all amounts borrowed thereunder shall
      then be due and payable. At November 19, 2000, the Company may elect to
      amortize any outstanding loans under the Acquisition Facility in sixteen
      equal quarterly installments beginning one quarter after the conversion to
      a term loan, subject to certain provisions contained in the Bank Credit
      Facility agreement.

      The Bank Credit Facility contains certain restrictive covenants, including
      limiting the ability of the Company to make cash distributions, incur
      certain additional indebtedness, incur certain liens, or sell assets or
      harvest timber in excess of certain limitations. In addition, the bank
      Credit Facility requires that the Company maintain certain financial
      ratios. As of December 31, 1998, the Company was not in compliance with
      certain covenants of the Bank Credit Facility. On February 16, 1999, the
      required majority of the banks comprising the lending group waived such
      noncompliance. In exchange for the waiver, the Company agreed that future
      borrowings in excess of $2,000 will require the consent of a majority of
      the lending group members.

      On April 6, 1999, the Operating Company advised the Agent Bank that, as of
      March 31, 1999, it may be in violation of another covenant of the Bank
      Credit Facility. The banks have agreed to modify such covenant, effective
      March 31, 1999, and as modified, the Company is in compliance with such
      covenant. In connection with the modification, the Company agreed to
      terminate the Working Capital Facility as of June 30, 1999 and to
      terminate the Acquisition Facility effective April 6, 1999. As of March
      31, 1999, there was $1,300 outstanding under the working capital line.

[3]   USTK debt - prior to the Transactions:

      On July 14, 1997, USTK entered into a long-term financing arrangement with
      certain banks to finance the Ochoco Acquisition discussed in Note C and to
      refinance certain borrowings under the USTK revolving credit facility and
      USTK term loan (the "Long-Term Financing Arrangement"). The retirement of
      debt under credit facilities existing as of July 14, 1997 resulted in an
      extraordinary loss on extinguishment of debt of $3,571 due principally to
      the write-off of unamortized deferred financing fees.

      In connection with the Long-Term Financing Arrangement, USTK incurred
      $5,970 of fees which were deferred.


                                                                            F-13
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Notes to Financial Statements
December 31, 1998 and 1997
(dollar amounts in thousands)

NOTE E - DEBT (CONTINUED)

[4]   Holdings debt - prior to the Transactions:

      As of December 31, 1996, Holdings had $130,000 of outstanding term loan
      debt related to the Weyerhaeuser Acquisition (the "Holdings Debt"). The
      Holdings Debt was guaranteed by Weyerhaeuser. In connection with the
      Holdings Debt, Holdings was required to pay Weyerhaeuser a debt guarantee
      fee. The Holdings Debt and the related debt guarantee fee of $4,368 were
      paid with proceeds from the Transactions. The debt guarantee fee is
      included in amortization of deferred financing fees and debt guarantee
      fees in the accompanying statements of operations.

NOTE F - MEMBERS' EQUITY (DEFICIT)

[1]   Common units offering:

      On November 19, 1997, the MLP issued 7,458,684 Common Units. Proceeds from
      such offering were $141,265, net of underwriter fees and other related
      costs of $15,367. Concurrent with such offering, 4,282,120 Subordinated
      Units were issued in exchange for all members' interests in USTK and Old
      Services. On December 12, 1997, the underwriters exercised their
      overallotment option and the MLP issued an additional 1,118,803 Common
      Units. Proceeds from the exercise of the overallotment option were
      $21,940, net of $1,555 of underwriters' fees. Net proceeds of $163,206
      from the Common Units offering were contributed by the MLP to USTK upon
      closing of the transactions.

[2]   Allocation of income (loss):

      As provided in the Company's Operating Agreement, income and losses are
      allocated 99% to the MLP and 1% to New Services.

[3]   Cash distributions:

      The MLP is required to make quarterly cash distributions from Available
      Cash, as defined in the MLP's Partnership Agreement. The Company
      distributes cash to the MLP to the extent necessary for the MLP to meet
      its required quarterly cash distributions, in accordance with USTK's
      Operating Agreement. Generally, cash distributions are paid in order of
      preferences: first, the minimum quarterly distribution of $.50 per unit
      (the "MQD") to the MLP's Common Unitholders and the Manager, and second,
      to the extent cash remains available, to Subordinated Unitholders.

      The MLP Agreement sets forth certain cash distribution target rates for
      the MLP to meet in order for the Manager's share of Available Cash to
      increase (such increases referred to as "Incentive Distributions"). To the
      extent that the quarterly distributions exceed $.550 per Common and
      Subordinated Unit, the Manager receives 15% of the excess Available Cash
      rather than the base amount of 2%. To the extent that the quarterly
      distributions exceed $.633 per Common and Subordinated Unit, the Manager
      receives 25% of the excess Available Cash and to the extent that the
      quarterly distributions exceed $.822 per Common and Subordinated Unit, the
      Manager receives 50% of the excess Available Cash. Since the quarterly
      distributions did not exceed the minimum quarterly distributions for 1998,
      the Manager did not receive any such Incentive Distributions for 1998.


                                                                            F-14
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Notes to Financial Statements
December 31, 1998 and 1997
(dollar amounts in thousands)

NOTE G - CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

[1]   Relationship with the Manager:

      The Manager has the ability to control management of the Company and the
      MLP and has all voting rights of the Company and the MLP except for
      certain matters set forth in USTK's Operating Agreement and in the MLP's
      Partnership Agreement. The ownership of the Subordinated Units by certain
      affiliates of the Manager effectively gives the Manager the ability to
      prevent its removal.

      The Manager does not receive any management fee or other compensation in
      connection with its management of the Company. The Manager and its
      affiliates perform services for the Company and are reimbursed for all
      expenses incurred on behalf of the Company, including the costs of
      employee, officer and director compensation properly allocable to the
      Company, and all other expenses necessary or appropriate to the conduct of
      the business of, and allocable to, the Company. USTK's Operating Agreement
      provides that the Manager will determine the expenses that are allocable
      to the Company in any reasonable manner determined by the Manager in its
      sole discretion. Related noninterest bearing receivables and payables
      between the Manager and the Company are settled in the ordinary course of
      business. As of December 31, 1998 and 1997, the Company had a payable to
      the Manager of $914 and $252, respectively. During 1998 and 1997, expenses
      allocated to and reimbursed by the Company totaled $9,058 and $310,
      respectively.

[2]   Consulting agreements:

      As of December 31, 1998 and 1997, the Manager has consulting agreements
      with certain affiliated parties pursuant to which each such person or firm
      has provided and/or will provide consulting services to the Manager. Each
      agreement provides for an annual retainer of $25, plus an hourly rate for
      services rendered at the request of the Manager. Payments by the Manager
      related to consulting agreements in 1998 and 1997 were not significant.

[3]   Payable to affiliate:

      In connection with the Transactions, the member interest of John J.
      Stephens in Old Services was redeemed for $1,000 and certain subordinated
      units in the MLP. The $1,000 was paid to Old Services by the Company in
      January 1998. The above transaction has been reflected as a direct
      reduction of equity in the accompanying financial statements.

[4]   Management and advisory fees:

      In connection with the Weyerhaeuser Acquisition, the Company paid a fee of
      $4,135 to Timberlands Management Group (the "TMG"), an entity 100% owned
      and controlled by John M. Rudey, Chairman. In addition, during the period
      from August 30, 1996 to December 31, 1996, the Company paid TMG management
      fees of $2,800. These payments have been recorded in selling, general and
      administrative expenses in the accompanying statements of operations.

[5]   Receivable from affiliate:

      During the period from August 30, 1996 through December 31, 1996, the
      Company paid $10,000 to TMG. The receivable and the related interest were
      repaid in February 1997.


                                                                            F-15
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Notes to Financial Statements
December 31, 1998 and 1997
(dollar amounts in thousands)

NOTE H - MANAGEMENT INCENTIVE PLANS

[1]   Unit option plan:

      The MLP maintains a Unit Option Plan which provides for the granting of
      unit options ("Unit Options") to employees and directors of the Manager.

      The Plan permits the grant of Unit Options covering 857,749 of the MLP's
      Common Units. Unit Options granted under the MLP's Unit Option Plan are
      determined by the Long-Term Incentive Plan Committee of the MLP's Board of
      Directors (the "LTIP Committee") and are granted at fair market value at
      the date of the grant. Concurrent with the consummation of the
      Transactions, 604,153 Unit Options were granted to key employees and
      directors of the MLP's General Partner. An additional 90,622 Unit Options
      were granted to key employees and directors on December 12, 1997, in
      connection with the closing of the sale of 1,118,803 Common Units pursuant
      to the exercise by the underwriters of their overallotment option and, in
      1998, 100,000 Unit Options were granted to directors and 240,170 options
      were granted to employees. The Unit Options granted expire ten years from
      the date of grant and become exercisable automatically upon and in the
      same proportion as the conversion of the MLP's Subordinated Units to
      Common Units. Provided that the minimum quarterly distribution (as that
      term is defined in the MLP Agreement) has been paid to Common and
      Subordinated Unitholders for three consecutive four-quarter periods and
      that such distributions are equal to or less than the MLP's Adjusted
      Operating Surplus, as that term is defined in the MLP Agreement, for two
      consecutive four-quarter periods, 25% of the Subordinated Units will
      convert to Common Units as early as 2001, 25% as early as 2002 and the
      remaining 50% may convert to Common Units as early as 2003. Once the
      performance criteria are achieved, the Company will record compensation
      expense for the difference between the exercise price and fair value of
      the Common Units, with a corresponding increase to members' equity. As of
      December 31, 1997, none of the performance criteria had been achieved.
      Although the performance criteria were met for the year ended December 31,
      1998, no compensation expense was recorded during such year as the market
      price of the units was less than the exercise price during the year.

      Activity with respect to the MLP's unit options plan follows:

<TABLE>
<CAPTION>
                                                        1998                       1997
                                              -----------------------     ---------------------
                                                            Weighted                   Weighted 
                                                            Average                    Average  
                                                Number     Exercise        Number     Exercise 
                                               of Shares   Price (a)      of Shares   Price (a) 
                                              ----------   ----------     ---------   ---------
<S>                                            <C>           <C>          <C>          <C>    
Unit options outstanding at beginning of
 year                                          694,775       $  14.75          --            --
Unit options granted                           340,170          14.75     694,775      $  14.75
Unit options exercised                              --             --          --            --
Unit options cancelled                        (584,628)         14.75          --            --
                                               -------                    -------               

Unit options outstanding at end of year        450,317          14.75     694,775         14.75
                                               =======                    =======
</TABLE>

      (a)   Options were originally granted with exercise prices ranging from
            $21.00 to $21.44 per unit. During December 1998, the exercise price
            was reduced to $14.75 per unit by the MLP's Board of Directors.

There were no unit options exercisable at either December 31, 1998 or 1997.

In January 1999, the MLP granted 222,000 options to employees and directors with
an exercise price of $13.38, the fair value of the MLP's units on such date.


                                                                            F-16
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Notes to Financial Statements
December 31, 1998 and 1997
(dollar amounts in thousands)

NOTE H - MANAGEMENT INCENTIVE PLANS (CONTINUED)

[1]   Unit option plan: (continued)

      The MLP has computed, for pro forma disclosure purposes as required by
      SFAS 123, the value of the Unit Options granted under the Unit Option
      Plan. These computations were made using the Black-Scholes option-pricing
      model, as prescribed by SFAS 123, with the following weighted average
      assumptions for 1998 and 1997:

                                                         1998      1997
                                                         ----      ----

           Risk-free interest rate                       5.50%     6.00%
           Expected dividend yield                       9.52%     9.52%
           Expected life of the Unit Options           5 years   5 years
           Expected volatility                          25.50%    20.32%

      The weighted average fair value of unit options was $2.02 for options
      granted in 1998 and $1.50 for options granted in 1997.

      If the MLP had adopted the expensing provisions of SFAS 123, the impact on
      1998 and 1997's net loss of the Company would have been as follows:

                                                     Year Ended December 31,
                                                     -----------------------
                                                       1998          1997
                                                     ---------   -----------
           Net loss - as reported                   $ (6,383)    $ (10,705)
           Net loss - pro forma                       (6,629)      (10,732)

      For purposes of the pro forma disclosures, the estimated fair value of the
      unit options is amortized to expense over their estimated exercise period,
      which corresponds to the assumed subordinated units conversion period (see
      page F-16).

[2]   Restricted unit plan:

      Effective with the closing of the Transactions, the MLP authorized the
      establishment of a restricted unit plan (the "Restricted Unit Plan") which
      allows it to grant units (the "Restricted Units") to employees at the
      discretion of the LTIP Committee. No consideration will be payable by the
      plan participants upon vesting and issuance of the Restricted Units.
      Restricted Units granted during the subordination period would vest
      automatically upon and in the same proportion as the conversion of
      Subordinated Units to Common Units. Restricted Units granted subsequent to
      the subordination period are the equivalent of Common Units. No Restricted
      Units have been granted as of December 31, 1998.

[3]   Income interests in the General Partner:

      In connection with the Common Units offering and the related formation of
      the MLP's General Partner, the General Partner issued income interests to
      certain officers and directors of the General Partner at no cost. Such
      income interests participate pro rata in cash distributions from USTK and
      the MLP. Under certain circumstances, the General Partner is required to
      repurchase the income interests from officers and directors upon
      termination of their employment at fair market value as determined by
      independent appraisal. During the year ended December 31, 1998, in
      connection with the termination of certain officers and directors, an
      accrual to repurchase income interests valued at $385,000 by independent
      appraisal was recorded by the Company, and charged to compensation
      expense.


                                                                            F-17
<PAGE>

U.S. TIMBERLANDS KLAMATH FALLS, L.L.C. AND SUBSIDIARY

Notes to Financial Statements
December 31, 1998 and 1997
(dollar amounts in thousands)

NOTE I - COMMITMENTS

On August 30, 1996, the Company entered into a wood supply agreement with
Collins to supply a volume of approximately 34 million board feet of
merchantable timber to Collins at market prices. The term of the agreement is
ten years and is renewable for two additional terms of five years, each at the
option of Collins.

NOTE J - QUARTERLY RESULTS FOR 1998 (RESTATED) AND 1997 (UNAUDITED)

<TABLE>
<CAPTION>
                                                         Quarter Ended
                            -----------------------------------------------------------------------
                            December 31 (a)   September 30   June 30 (a)  March 31 (a)   Total Year
                            ---------------   ------------   -----------  ------------   ----------
<S>                             <C>             <C>           <C>           <C>          <C>      
1998 (Restated)
Revenues                        $ 20,417        $ 24,528      $ 18,622      $  7,757     $  71,324
Gross profit (b)                   8,409          11,531         4,503         2,343        26,786
Net income (loss)                    649           2,570        (2,886)       (6,716)       (6,383)

1997
Revenues                        $ 36,288        $ 17,261      $ 11,462      $ 12,334     $  77,345
Gross profit (b)                  16,511           7,608         4,141         5,258        33,518
Income (loss) before
   extraordinary item              5,457          (1,051)       (3,827)       (1,947)       (1,368)
</TABLE>

(a)   The quarter ended June 30, 1998 includes revenues of $6,275 and related
      costs of $5,917 from a property sale. The quarter ended December 31, 1997
      includes revenues of $11,750 and related costs of $7,555 from a property
      sale. The quarter ended March 31, 1997 includes revenues of $3,494 and
      related costs of $1,191 from a timber deed sale.

(b)   Gross profit is calculated as revenues less cost of products sold, cost of
      timber and property sales and depreciation, depletion and road
      amortization.

Restatement of quarterly results for the three months ended September 30, 1998
and June 30, 1998

During 1999, the Company determined that certain revenues recorded during the
second and third quarters of 1998, respectively, should be deferred until
certain additional criteria are achieved. As a result, the Company has restated
its quarterly results of operations for the affected periods, as follows:

                                                            Quarter Ended
                                                    ----------------------------
                                                    September 30,       June 30,
                                                        1998             1998
                                                    -------------  -------------

            Net income (loss) - as reported           $ 3,397          $  (910)
            Net income (loss) - restated                2,570           (2,886)

NOTE K - CONTINGENCIES

The Company is involved in legal proceedings and claims arising in the normal
course of business. In the opinion of management, the outcome of such legal
proceedings and claims will not have a material adverse effect on the Company's
results of operations and financial position.


                                                                            F-18
<PAGE>

                                  EXHIBIT INDEX

                                                                        Page No.
                                                                        --------

      27.1  Financial Data Schedule                                       36


                                       35