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

                                   FORM 10-K

  (Mark One)
      [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

                  For the fiscal year ended DECEMBER 31, 1998

                                       OR

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

                         Commission file number 1-12147

                           DELTIC TIMBER CORPORATION
             (Exact name of registrant as specified in its charter)

         Delaware                                     71-0795870
(State or other jurisdiction of          (I.R.S. Employer Identification Number)
incorporation or organization)
                                             
 210 East Elm Street, P. O. Box 7200, El Dorado, Arkansas         71731-7200
     (Address of principal executive offices)                     (Zip Code)

      Registrant's telephone number, including area code:  (870) 881-9400

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

 
        Title of each class           Name of each exchange on which registered

     Common Stock, $.01 Par Value               New York Stock Exchange, Inc.

     Series A Participating Cumulative          New York Stock Exchange, Inc.
     Preferred Stock Purchase Rights

  Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
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 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 this
Form 10-K. [X]

The aggregate market value of the Common Stock held by non-affiliates of the
registrant, based on the average of the high and low prices of the Common Stock
on the New York Stock Exchange on February 26, 1999, was $184,446,598. For
purposes of this computation, all officers, directors, and 5% beneficial owners
of the registrant (as indicated in Item 12) are deemed to be affiliates.  Such
determination should not be deemed an admission that such directors, officers,
or 5% beneficial owners are, in fact, affiliates of the registrant.

Number of shares of Common Stock, $.01 Par Value, outstanding at February 28,
1999, was 12,776,779.

                      Documents incorporated by reference:

The Registrant's definitive Proxy Statement relating to the Annual Meeting of
Stockholders on April 29, 1999.

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<PAGE>
 
                   TABLE OF CONTENTS - 1998 FORM 10-K REPORT

<TABLE>
<CAPTION>
                                                                                      Page
                                                                                    Numbers
                                                                                    -------
<S>                                                                                 <C>
                                    PART I
 
Item   1.          Business                                                           3
 
Item   2.          Properties                                                        13
 
Item   3.          Legal Proceedings                                                 14
 
Item   4.          Submission of Matters to a Vote of Security Holders               14
 
                                    PART II
 
Item   5.          Market for Registrant's Common Equity and Related Stockholder
                   Matters                                                           15
 
Item   6.          Selected Financial Data                                           16
 
Item   7.          Management's Discussion and Analysis of Financial Condition and
                   Results of Operations                                             17
 
Item   7A.         Quantitative and Qualitative Disclosures about Market Risk        28
 
Item   8.          Financial Statements and Supplementary Data                       29
 
Item   9.          Changes in and Disagreements with Accountants on Accounting
                   and Financial Disclosure                                          58        
 
                                   PART III
 
Item 10.           Directors and Executive Officers of the Registrant                59
 
Item 11.           Executive Compensation                                            59
 
Item 12.           Security Ownership of Certain Beneficial Owners and Management    59
 
Item 13.           Certain Relationships and Related Transactions                    59
 
                                    PART IV
 
Item 14.           Exhibits, Financial Statement Schedules, and Reports on Form 8-K  60
 
Signatures                                                                           62
</TABLE>

                                       2
<PAGE>
 
                                    PART I


ITEM 1.  BUSINESS

     Introduction.  Deltic Timber Corporation ("Deltic" or the "Company") is a
natural resources company engaged primarily in the growing and harvesting of
timber and the manufacture and marketing of lumber.  The Company owns
approximately 444,000 acres in Arkansas and north Louisiana, including 397,000
acres of timberland (the "timberlands").  Sawmill operations consist of two
mills, one at Ola in central Arkansas and another at Waldo in south Arkansas.

     In addition to its timber and lumber operations, Deltic is engaged in real
estate development projects in central Arkansas and owns approximately 37,000
acres of farmland in northeast Louisiana. The Company also holds a 50 percent
interest in a joint venture to manufacture and market medium density fiberboard
("MDF"), which began production operations in April 1998.

     Deltic believes that its primary strengths are its strategically located
timberlands, its efficient sawmill operations, its well-established real estate
developments, its experienced management team, and its capacity to pursue a
timber-based acquisition strategy.

     The timberlands consist primarily of Southern Pine.  Management considers
the timberlands to be Deltic's most valuable asset and the harvest of this
stumpage to be the Company's most significant source of income.  Estimated pine
sawtimber inventory as of December 31, 1998 was 9,603,000 tons. The southern
United States, in which all of the Company's operations are located, is a major
timber and lumber producing region.  Unlike other major timber-producing areas
in North America, most timber acreage in the southern United States is privately
held, rendering it potentially available for acquisition. Deltic's current
growth strategy emphasizes a significant timberlands acquisition program in such
region, which has facilitated an increase in harvest levels.

     The Company harvests timber from the timberlands in accordance with its
harvest plans and either sells timber in the domestic market or converts timber
to lumber in its sawmills.  In 1998, Deltic harvested approximately 431,600 tons
of pine sawtimber from its timberlands.  The Company's two sawmills employ
modern technology in order to improve efficiency, reduce labor costs, maximize
utilization of the timber resource, and maintain high quality standards of
production.  In addition, each sawmill is strategically located near significant
portions of the timberlands.  During 1998, Deltic's sawmills produced
approximately 159.7 million board feet of lumber.  Logs processed for the
production of lumber are obtained from the timberlands and from public and
private landowners.  The Company selects logs for processing in its sawmills
based on size, grade, and the then prevailing market price. The Ola Mill is
equipped for maximum utilization of smaller diameter logs, while the Waldo Mill
can process both smaller and larger diameter logs.  Approximately $31.6 million
has been invested in upgrades of the two sawmills over the past five years,
expanding both production capacity and product lines.  Combined annual capacity
is currently 226 million board feet.  The Company's sawmills produce a variety
of products, including dimension lumber, boards, timbers, decking, and secondary
manufacturing products such as finger-jointed studs.  The lumber is sold
primarily to wholesalers and treaters in the South and Midwest and is used in
residential construction, roof trusses, laminated beams, and remanufactured
items.

                                       3
<PAGE>
 
     The Company's real estate operations were started in 1985 to add value to
former timberland strategically located in the growth corridor of west Little
Rock, Arkansas.  Since that time, the Company has been developing a 4,800-acre
premier upscale planned community, Chenal Valley, centered around a Robert Trent
Jones, Jr. designed golf course at Chenal Country Club.  The property is being
developed in stages, and real estate sales to date have consisted primarily of
residential lots.  Commercial development began in 1996.

     In addition to Chenal Valley, Deltic is developing Chenal Downs, a 400-acre
equestrian development located outside of Chenal Valley being sold in estate-
sized lots of approximately five acres each with controlled access, and Red Oak
Ridge, Deltic's first real estate development outside of the Little Rock/Pulaski
County area.  The first phase of lot sales in Chenal Downs was offered in
December 1997, with 25 of the 44 lots offered sold as of the end of 1998.  Red
Oak Ridge, located near Hot Springs, Arkansas, is an 800-acre, upscale community
designed for residential, resort, or retirement living.  The first two
neighborhoods in this development, offering a choice of either estate-sized
homesites, with many overlooking one of the two lakes, or lots in a garden-home
neighborhood, were offered for sale in late 1998.

     The Company owns 37,000 acres of farmland in northeast Louisiana.
Approximately 26,000 acres of the total are farmed by Deltic, while the majority
of the remaining 11,000 acres is rented to third parties.  Crops grown on
Company-farmed acreage in 1998 were soybeans and corn.

     Deltic owns 50 percent of the membership interest of Del-Tin Fiber, L.L.C.
("Del-Tin Fiber"), a joint venture to manufacture and market medium density
fiberboard. The Del-Tin Fiber plant is located near El Dorado, Arkansas.
Construction of this facility commenced in mid-1996 and initial production began
on April 29, 1998. MDF, which is used in the furniture, flooring, and molding
industries, is manufactured from sawmill residuals, such as chips, shavings, and
sawdust, held together by an adhesive bond. The plant is designed to have an
annual production capacity of approximately 150 million square feet, 3/4" basis,
making it one of the largest of its type in the world. The plant also adds value
to Deltic's operations by providing an additional outlet for wood chip and bark
production from the Waldo Mill. During 1998, Deltic sold approximately
$2,126,000 of these lumber manufacturing by-products to Del-Tin Fiber.

FOREST PRODUCTS

     The demand for, and prices of, timber and manufactured wood products depend
on the level of housing starts, repair and remodeling activity, industrial
construction activity, competition from non-wood products, and seasonal factors
such as weather. These factors in turn are strongly influenced by overall
economic activity, interest rates, and demographics. Reductions in levels of
construction activity are generally followed by declining lumber prices, which
are ordinarily followed by declining timber prices within several months.
However, despite strong economic conditions and housing starts in the U.S.
during 1998, a downturn in Asian export markets caused the North American lumber
market to be oversupplied for much of 1998. Lumber that was normally exported
from North America to Asia was redirected to U.S. markets, causing supply to
outpace demand and depressing prices. However, demand for timber, as well as
timber prices, remained relatively strong during 1998.

     The supply of timber, and therefore lumber, is significantly affected by
the availability of timber from public lands, particularly in the Pacific
Northwest. In recent years, the U.S. government has dramatically reduced the
amount of timber offered for sale in response to environmental concerns. This
has resulted in increased demand for timber in the southern U.S., as well as
increased lumber imports from Canada.

                                       4
<PAGE>
 
     The southern U.S., in which all of the Company's operations are located, is
a major timber and lumber producing region. There are an estimated 209 million
acres of timberland in the region, of which approximately 91 million acres
contain softwood, predominately Southern Pine. Unlike other major timber-
producing areas in North America, most of this acreage is privately held. The
estimated breakdown of ownership of softwood timberland in the southern U.S. is
89 percent private, seven percent national forest, and four percent other
public. Although there can be no assurance, management anticipates that the
southern U.S. timber resource will be subject to strong demand in the future and
also believes that the South will have a strategic advantage over other U.S.
timber-producing regions due to regulatory, geographic, and other factors.

WOODLANDS

     The Company owns approximately 397,000 acres of timberland, primarily in
Arkansas and north Louisiana, stocked principally with Southern Pine.
Management considers the timberlands to be Deltic's most valuable asset and the
harvest of this stumpage to be the Company's most significant source of income.

The breakdown of the Company's timberland acreage at year-end 1998 consisted of
the following:

<TABLE>
<CAPTION>
                                                            Acres
                                                           -------
           <S>                                             <C>
           Pine forest..................................   240,000
           Pine plantation (less than 15 years old).....    90,000
           Hardwood forest..............................    32,000
           Other........................................    35,000
                                                           -------
           Total........................................   397,000
                                                           =======
</TABLE>

     Timber Inventory.  The Company's estimated standing timber inventory on
this acreage is calculated for each tract by utilizing growth formulas based on
representative sample tracts and tree counts for various diameter
classifications.  The calculation of pine inventory is subject to periodic
adjustments based on sample cruises or actual volumes harvested from related
tracts.  The hardwood inventory shown in the following table is only an
approximation, so physical quantity of such timber may vary significantly from
this approximation.  Estimated inventory of standing timber as of December 31,
1998 consisted of the following:

<TABLE>
<CAPTION>
                                                    Estimated 
                                                     Volume   
                                                     (Tons)   
                                                    ----------
               <S>                                  <C>       
               Pine timber                                    
                   Sawtimber.....................    9,603,000
                   Pulpwood......................    4,797,000
                                                              
               Hardwood timber                                
                   Sawtimber.....................    1,063,000
                   Pulpwood......................    1,345,000 
</TABLE>

     The Company's pine sawtimber is either used in its sawmills or sold to
third parties. Products manufactured from this resource include dimension
lumber, boards, timbers, decking, and secondary manufacturing products, used
primarily in residential construction. Deltic's hardwood sawtimber is sold to
third parties and is primarily used in the production of railroad ties,
flooring, and pallets. Pulpwood consists of logs with a diameter of less than
nine inches. Both pine and hardwood pulpwood are sold to third parties for use
primarily in the manufacture of paper.

                                       5
<PAGE>
 
     Timber Growth.  Timber growth rate is an important variable for forest
products companies since it ultimately determines how much timber can be
harvested. A higher growth rate permits larger annual harvests as replacement
timber regenerates. Growth rates vary depending on species, location, age, and
forestry management practices. The growth rate for Deltic's Southern Pine is on
average, net of mortality, 5 percent to 5 1/2 percent of standing inventory per
annum.

     The Company's timberlands are well diversified by age distribution. A
significant portion of the timberlands contains mature timber that is ready to
be harvested in the next several years. The Company considers a 30 to 35 year
rotation optimal for most of the timberlands. Timber under 15 years of age is
generally considered premerchantable.

     Access.  Substantially all of the timberlands are accessible by a system of
low maintenance roads. Deltic generally uses third-party road crews to conduct
construction and maintenance of these roads and the Company regularly exchanges
access easements and cooperates with other area forest products companies and
the U.S. Forest Service.

     Reforestation.  Deltic has developed and operates its own seed orchard.
Seeds from the orchard are grown by third parties to produce genetically-
superior seedlings for planting. These seedlings are developed through selective
cross-pollination to produce trees with preferred characteristics, including
higher growth rates, fewer limbs, straighter trunks, and greater resistance to
disease. The seedlings are planted in all-aged stands or a site is completely
replanted with these superior seedlings in the case of a regeneration harvest.
During 1998, 2,800 acres were planted using seedlings grown from seeds produced
at the orchard facility. This level is expected to accelerate significantly with
approximately 6,000 acres scheduled for reforestation in 1999, as the Company's
land acquisition program continues. The Company meets or exceeds, in all
material respects, the reforestation recommendations of the Arkansas Forestry
Commission's Best Management Practices.

     Harvest Plans.  Management views the timberlands as assets with substantial
inherent value apart from the sawmills and intends to manage the timberlands on
a basis that permits regeneration of the timberlands over time. The Company
intends to continue to manage the timberlands on a sustainable-yield basis and
has no plans to harvest timber at levels that exceed growth. Under the current
plan, Deltic intends to increase its harvest level to 445,000 tons of pine
sawtimber in 1999, an increase of three percent over 1998 levels. (See "Growth
Strategy".)

     The Company's harvest plans are generally designed to project multi-year
harvest schedules. In addition, harvest plans are updated at least annually and
reviewed on a monthly basis to monitor performance and to make any necessary
modifications to the plans in response to changing forestry conditions, market
conditions, contractual obligations, regulatory limitations, and other relevant
factors.

     Since harvest plans are based on projections of demand, price, availability
of timber from other sources, and other factors that may be outside of the
Company's control, actual harvesting levels may vary. Management believes that
the Company's harvest plans, which are reviewed monthly and revised at least
annually, are sufficiently flexible to permit modification in response to
fluctuations in the markets for logs and lumber.

     Timber Resource Management.  The Company's timber operations involve forest
management, harvesting operations, and ongoing reforestation. Forest management
decisions are based upon information which includes site indices, classification
of soils, the species and number of trees by size and age classification, and
stocking per acre, as well as information on forest management costs. From this
data, Deltic develops its annual harvest plans, which are based upon
silvicultural considerations and existing and expected future economic and
market conditions, with a view toward maximizing the value of its timber and
timberland assets over time.

                                       6
<PAGE>
 
     Particular forestry practices vary by geographic region and depend upon
factors such as soil productivity, weather, terrain, tree size, age, and timber
stocking. Forest stands are thinned periodically, to improve growth and stand
quality, until they are harvested. Different areas within a forest may be
planted or seeded in successive years to provide a distribution of age classes
within the forest. This distribution of age classes will tend to provide Deltic
with an annual revenue stream, as the various timber stands reach harvestable
age.

     The timing of harvest of merchantable timber depends in part on growth
cycles and in part on economic conditions. Growth cycles for timber tend to
change over time as a result of technological and genetic advances that improve
forest management practices. The Company will continue to develop its forest
management operations to take advantage of such advances and improve timber
yields.

     The Company actively utilizes commercial-thinning timber management
practices.  In the context of long-term value maximization, commercial thinning
improves the overall productivity of the timberlands by enhancing the growth of
the remaining trees while generating revenues.

     Client-Land Management.  In addition to managing its own timberlands,
Deltic also manages timberlands owned by others under management contracts with
one-year renewable terms.  This program provides harvest planning, silvicultural
improvements, and maintenance work for approximately 79,000 acres.

SAWMILLS

     The Company's two sawmills are located at Ola in central Arkansas and at
Waldo in south Arkansas, near significant portions of the timberlands. The Ola
Mill is equipped for maximum utilization of smaller diameter logs, while the
Waldo Mill can process both smaller and larger diameter logs. Approximately
$31.6 million has been invested in the two sawmills over the past five years,
expanding both production capacity and product lines. Combined annual capacity
at December 31, 1998 was 226 million board feet.

     Deltic employs modern technology in its sawmills in order to improve
overall efficiency, reduce labor costs, and maximize utilization of available
timber resources, while continuing to maintain high quality standards for lumber
production.  The Company continues to upgrade and expand its sawmills to
increase production capacity and diversify the product mix offered.

     During 1998, the Ola Mill completed installation of a new boiler system and
an additional kiln. These capital projects increased the annual lumber drying
capacity of this mill to 100 million board feet. A small log processing deck was
placed into service in the second quarter of 1998, allowing the extraction of
small diameter logs from pulpwood to facilitate log supply and reduce log cost.
The Company also began the construction of a new planermill, an automated lumber
sorting system, and an optimized edger system to further increase both
production capability and efficiency at this facility in order to increase
profitability.  These improvements are expected to be completed during the first
half of 1999.

     The Waldo Mill's finger-jointing operation completed its first year of
operation in 1998 with 3.7 million board feet of production. This secondary
manufacturing operation adds value to Waldo's planermill operation by using
short, trim pieces to manufacture finger-jointed studs, an addition to the
product sales mix, instead of selling these pieces at low prices, thus enhancing
the mill's sales price average. Residual by-products from the Waldo Mill are now
being used by Del-Tin Fiber in the production of medium density fiberboard. The
Company is committed to increased utilization of modern technology at its mills
during 1999, an example of which is the planned addition of a new log
optimization

                                       7
<PAGE>
 
system at the Waldo Mill.  With the completion of installation of this optimized
log bucking system, the Waldo Mill will have been upgraded from its log deck to
its lumber sorting system, which is expected to result in additional production
cost savings for this mill.

     The Company pursues waste minimization practices at both of its sawmills.
Wood chips are usually sold to paper mills or Del-Tin Fiber and bark is
frequently sold for use as fuel.  Bark, sawdust, shavings, and wood chips that
cannot be sold are used as "hog fuel" to fire the boilers that heat the drying
kilns.  In the future, the Company expects to sell a more significant portion of
its Waldo Mill's residual wood chip production to Del-Tin Fiber pursuant to a
fiber supply agreement.

     Each mill facility has the capability to ship its lumber by truck or rail.

     While the cyclicality of the lumber market may occasionally require the
interruption of operations at one or both of the Company's sawmills, suspension
of milling activities is unusual.  Management is not currently anticipating any
interruption of operations at either of Deltic's sawmills, but no assurance can
be given that market conditions or other factors will not render such an action
economically advisable in the future.

GROWTH STRATEGY

     The Company's current strategy for growth continues to emphasize a
significant timberland acquisition program, which has facilitated an increase in
its harvest levels, and the expansion of its manufacturing operations.

     Timberland Acquisitions.  The Company's ongoing timberland acquisition
program will enable it to continue to increase harvest levels, while expanding
its timber inventory.  In addition, it will allow the Company to maintain or
increase the volume of logs supplied to its sawmills from its own timberlands,
when it is economically feasible.

     Timberland acquisitions are necessary for continued growth in harvest
levels over the long-term. The Company intends to continue to focus its
acquisition program on timberlands in the southern United States that range from
fully-stocked to cutover tracts, with preference given to stocked acreage.
Timberland in the southern United States is 89 percent owned by private
landowners, rendering it potentially available for acquisition.  There can be no
assurance that timber properties suitable for acquisition will be identified by
the Company, or that once identified, such properties will ultimately be
acquired by the Company.

     Acting upon this strategy of timberland acquisition, Deltic formed a land
acquisition team. Lands considered for purchase were evaluated based on
location, site index, timber stocking, and growth potential. As a result,
approximately 58,600 acres, 30,400 in 1998, of strategically located pine
timberland have been added since the inception of the acquisition program in
late 1996. Individual land purchases ranged from 10 acres to 16,300 acres, with
the average block to-date being 413 acres. The major acquisition in 1998 was the
former McKinney lands in south Arkansas, consisting of 16,300 acres of heavily-
stocked timberland.

     Manufacturing Operations.  Recent capital projects at the Company's two
sawmills have expanded both production capacity and product mix. Future projects
are expected to continue to increase production levels, add value to existing
production, expand secondary manufacturing operations, improve lumber recovery,
and decrease manufacturing costs. The Company plans to increase lumber
production to 210 million board feet in 1999, an increase of 32 percent over the
1998 level.

                                       8
<PAGE>
 
     The Company's 50 percent interest in Del-Tin Fiber will enable it to expand
its business into the engineered wood products market. Del-Tin Fiber is a joint
venture to manufacture and market MDF. The plant is located near El Dorado,
Arkansas. The construction cost of the facility was approximately $100 million.
Construction commenced in mid-1996 and initial production began on April 29,
1998. The plant is designed to have an annual production capacity of 150 million
square feet, 3/4" basis, making it one of the largest of its type in the world.
MDF, which is used in the furniture, flooring, and molding industries, is
manufactured from sawmill residuals such as chips, shavings, and sawdust held
together by an adhesive bond. Although the technology has existed for decades,
recent improvements in the manufacture of MDF have increased both the quality
and consistency of the product. MDF, with its "real wood" appearance and ability
to be finely milled and accept a variety of finishes, competes primarily against
lumber. In addition to providing an entry into the MDF market, the Del-Tin Fiber
project will provide an outlet for a significant portion of the Company's wood
chips. Pursuant to a fiber supply agreement, the Company has agreed to sell, and
Del-Tin Fiber to buy, all residual wood chips from the Waldo Mill. In addition,
Del-Tin Fiber has an option to purchase residual wood chips from the Ola Mill
and pulpwood chips, shavings, and sawdust from the Waldo Mill.

RAW MATERIALS

     Logs processed by the Company's two sawmills in 1998 totaled 795,700 tons,
and were obtained from either the timberlands or purchased from public and
private landowners.  Of the 431,600 tons of pine sawtimber harvested from the
timberlands in 1998, 203,500 tons, 47 percent, were processed in the Company's
two sawmills.

     Various factors, including environmental and endangered species concerns,
have limited, and will likely continue to limit, the amount of timber offered
for sale by U.S. government agencies. Because of this reduced availability of
federal timber for harvesting, the Company believes that its supply of timber
from the timberlands is a significant competitive advantage. Deltic has
historically supplied a significant portion of the timber processed in the
sawmills from its timberlands.

     In order to operate its sawmills economically, the Company relies on
purchases of timber from third parties to supplement its own timber harvests
from the timberlands. The Company has an active timber procurement department
for each of its sawmills. As of December 31, 1998, the Company had under
contract approximately 469,900 tons of timber on land owned by other parties,
including the U.S. Forest Service, which is expected to be harvested over the
next four years. During 1998, the Company harvested third-party stumpage and
purchased logs from third parties totaling 583,100 tons. Of this volume,
purchases from the U.S. Forest Service during this period represented 12
percent. The balance of such purchases was acquired from private lands.

     As a result of the reduced availability of federal timber, demand for
privately-owned timber has increased, along with prices; and the Company has
increased and foresees further increases in its harvesting and purchasing
activities from private timberlands. Due to this increased demand and higher
timber prices, private timber sources have been prompted to sell their timber
commercially. As a result, Deltic's sources of private timber are many and
diverse. The key factors in a landowner's determination of whether to sell
timber to the Company are price, the Company's relationships with logging
contractors, and the ability of the Company to demonstrate the quality of its
logging practices to landowners. As a result, a landowner will be more likely to
sell timber to a forest products company whose own land has been responsibly
managed and harvested. There is a substantial amount of other private timber
acreage in proximity to each of Deltic's sawmills.

                                       9
<PAGE>
 
PRODUCTS AND COMPETITION

     The Company's principal forest products are timber; lumber products,
primarily finished lumber; and residual wood products.

     Timber.  Timber harvested from the timberlands is utilized by the Company's
sawmills or sold to third parties. The Company's timber sales to third parties
accounted for approximately 12 percent, 14 percent, and 16 percent of
consolidated net sales in 1996, 1997, and 1998, respectively.

     The Company competes in the domestic timber market with numerous private
industrial and non-industrial land and timber owners. Competitive factors with
respect to the domestic timber market generally include price, species and
grade, proximity to wood consuming facilities, and the ability to meet delivery
requirements.

     Lumber Products.  The Company's sawmills produce a wide variety of
products, including dimension lumber, boards, timbers, decking, and secondary
manufacturing products such as finger-jointed studs. Lumber is sold primarily to
wholesalers and treaters in the South and Midwest and is used in residential
construction, roof trusses, laminated beams, and remanufactured items. During
1996, 1997, and 1998, lumber sales as a percentage of consolidated net sales
were approximately 55 percent, 57 percent, and 52 percent, respectively.

     The forest products market is highly competitive with respect to price and
quality of products. In particular, competition in the commodity-grade lumber
market in which the Company competes is primarily based on price. Deltic
competes with other publicly-held forest products companies operating in
Arkansas, many of which have significantly greater financial resources than the
Company, as well as privately-held lumber producers. In addition, Deltic's
management expects the Company's products to experience increased competition
from engineered wood products and other substitute products. Due to the
geographic location of Deltic's timberlands and its high-quality timber, in
addition to the Company's active timber management program, strategically
located and efficient sawmill operations, and highly motivated workforce; Deltic
has been able to compete effectively.

     Chips.  The Company's sawmills produce wood chips as by-products of the
applicable conversion process. Chips are typically sold to Del-Tin Fiber or to
paper mills. During 1998, Deltic's sawmills produced 289,400 tons of wood chips.
During 1996, 1997, and 1998, sales of wood chips and other by-products of the
Company's sawmills accounted for 11 percent, eight percent, and nine percent,
respectively, of Deltic's consolidated net sales. In the future, the Company
expects to continue to sell a significant portion of certain of its residual
wood products to Del-Tin Fiber for the production of MDF. (See "Growth
Strategy".)

REAL ESTATE OPERATIONS

     Deltic's Real Estate operations in Chenal Valley were started in 1985 to
add value to former timberland strategically located in the growth corridor of
west Little Rock, Arkansas. Since that time the Company has been developing a
4,800-acre premier upscale planned community, Chenal Valley, centered around a
Robert Trent Jones, Jr. designed golf course. The golf course was completed in
1990. The property has been developed in stages and real estate sales to date
have consisted primarily of residential lots, with commercial development
beginning in 1996.

     In connection with its Chenal Valley development, the Company developed
Chenal Country Club, consisting of the above-described golf course, a clubhouse,
and related facilities for use by club members; and the club membership agreed
to purchase Chenal Country Club with payments to be made on specified terms
through 1999.  During 1997, the agreement was restructured in order to return
ownership of Chenal Country Club to the Company with the club members making
ongoing membership

                                       10
<PAGE>
 
fee payments. In connection with the restructuring, Deltic agreed to undertake
substantial remodeling and expansion of the clubhouse. (For additional
information, see Note 4 to the consolidated financial statements in Item 8,
"Financial Statements and Supplementary Data", of Part II of this report.)

     Commercial development began in 1996 with the construction of a Deltic-
owned, 50,000 square-foot office building, approximately one-half of which is
leased to a national, financial servicing company. During 1997, commercial sales
activity increased, with more than 26 acres sold for multi-family development.
However, during 1998, commercial acres sold was approximately eight acres.  Site
work for a Deltic-owned retail center began in 1997, and in 1998, Deltic began
construction of the 35,000-square-foot center which will offer retail space for
lease and will be completed during 1999. Construction of Rahling Road, a major
connector street that provides access to Chenal Valley's commercial core, began
in 1997 and was completed in early 1998.  Commercial sites along this street,
increased residential development, and additional infrastructure investment are
expected to result in increased commercial activity.

     Infrastructure and other improvements to support the development and sale
of residential and commercial property are funded directly by the Company and/or
through real property improvement districts.  Such properties are developed only
when sufficient demand exists and all infrastructure is completed.  Future
infrastructure investments are necessary only for the development and sale of
additional property.

     A number of factors have added significant value to the undeveloped portion
of the Company's property. Such factors include: the overall success of Chenal
Valley as a residential development and its image as one of the premier
developments in central Arkansas, the continued westward growth of Little Rock,
the Company's investment in infrastructure in the area, and the established
residential base which is now large enough to support commercial development.
Management expects the undeveloped portion of Chenal Valley to provide growth
and development opportunities in the future.

     When fully developed, Chenal Valley will include approximately 4,700
residential homesites. To date, 1,350 homesites have been developed and 994 lots
sold, with about 850 residences constructed or under construction. Of its 635
total commercial acres, Chenal will offer acreage for office tracts, multi-
family development, and retail locations. The development plan supports the
area's growing demand for corporate and service-oriented products.

     In addition to Chenal Valley, Deltic is developing Chenal Downs, a 400-acre
equestrian development located outside of Chenal Valley being sold in estate-
sized lots of approximately five acres each, and Red Oak Ridge, Deltic's first
real estate development outside of the Little Rock/Pulaski County area.  The
first phase of lot sales in Chenal Downs was offered in December, 1997, with 25
of the 44 lots offered sold as of the end of 1998.  Red Oak Ridge, located at
Hot Springs, Arkansas, is an 800-acre, upscale community designed for
residential, resort, or retirement living.  The first two neighborhoods in this
development, offering a choice of either estate-sized homesites, with many
overlooking one of two lakes, or lots in a garden-home neighborhood, were
offered for sale in late 1998.

AGRICULTURE OPERATIONS

     Deltic owns 37,000 acres of farmland in northeast Louisiana.  Approximately
26,000 acres of the total are farmed by Deltic, while the majority of the
remaining 11,000 acres are rented to third parties. Crops grown on Company-
farmed acreage in 1998, and planned for 1999, were soybeans and corn.

     The installation of two continuous-flow drying systems in 1997 allowed more
than 55 percent of Deltic's 1998 corn production to be dried before delivery to
local markets, which meant lower harvest losses and reduced drying charges from
grain elevator operators.  The purchase of additional new

                                       11
<PAGE>
 
combines allowed Deltic to continue to harvest crops at optimum grain moisture
and field conditions, rather than having to rely on the availability of custom
harvesters.

SEASONALITY

     The Company's operating segments are subject to variances in financial
results due to several seasonal factors. The majority of timber sales are
typically generated in the first half of the year due primarily to weather
conditions and stronger timber prices. Increased housing starts during the
spring usually push lumber prices up and, in turn, can result in higher timber
prices. Forestry operations generally incur expenses related to silvicultural
treatments which are applied during the fall season to achieve maximum
effectiveness. Farming operations generally do not generate significant sales
and operating income until crops are harvested and sold in the second half of
the year.

BUSINESS SEGMENT DATA

     Information concerning net sales, operating income, and identifiable assets
attributable to each of the Company's business segments is set forth in Item 7,
"Management's Discussion and Analysis"; and Note 20 to the consolidated
financial statements in Item 8, "Financial Statements and Supplementary Data",
of Part II of this report.

DECLINE IN AVAILABILITY OF FEDERAL TIMBER

     Various factors, including environmental and endangered species concerns,
have limited, and will likely continue to limit, the amount of timber offered
for sale by certain U.S. government agencies, which historically have been major
suppliers of timber to the U.S. forest products industry. During 1998, the
Company acquired approximately 20 percent of its timber supply for its Ola Mill
from federal sources, primarily the Ouachita and Ozark National Forests. Any
future decline in the availability of timber from federally-owned lands will
require that the Company, in order to supply the Ola Mill, rely more heavily on
harvests from the Company's timberlands, including harvests from timberlands
acquired in the future to the extent that suitable opportunities arise, and on
the acquisition of timber from other sources, such as private timber owners. The
Company's Waldo Mill does not currently process any timber acquired from federal
sources.

ENVIRONMENTAL MATTERS

     The Company is subject to extensive and changing federal, state, and local
environmental laws and regulations relating to the protection of human health
and the environment, including laws relating to air and water emissions, the use
of pesticides and herbicides on the farm and timberlands, regulation of
"wetlands", and the protection of endangered species. Environmental legislation
and regulations, and the interpretation and enforcement thereof, are expected to
become increasingly stringent. The Company has made, and will continue to make,
expenditures to comply with such requirements in the ordinary course of its
operations. Historically, these expenditures have not been material and the
Company expects that this will continue to be the case. Liability under certain
environmental regulations may be imposed without regard to fault or the legality
of the original actions, and may be joint and several with other responsible
parties. As a result, in addition to ongoing compliance costs, the Company may
be subject to liability for activities undertaken on its properties prior to its
ownership or operation and by third parties, including tenants. The Company
currently leases the rights to drill for oil and gas on some of its lands to
third parties. Pursuant to these leases, the lessee indemnifies the Company from
environmental liability relating to the lessee's operations. Based on its
present knowledge, including the fact that the Company is not currently aware of
any facts that indicate that the Company will be required to incur any material
costs relating to environmental matters, and currently applicable laws and
regulations, the Company believes that environmental matters are not likely to
have a material adverse effect on the Company's financial condition, results of
operations, or liquidity.

                                       12
<PAGE>
 
     In addition, the federal "Endangered Species Act" protects species
threatened with possible extinction and restricts timber harvesting activities
on private and federal lands. Certain of the Company's timberlands are subject
to such restrictions due to the presence on the lands of the Red Cockaded
Woodpecker, a species protected under the Act. There can be no assurance that
the presence of this species or the discovery of other protected species will
not subject the Company to future harvesting restrictions. However, based on the
Company's knowledge of its timberlands, the Company does not believe that its
ability to harvest its timberlands will be materially adversely effected by the
protection of endangered species.

EMPLOYEES

     As of February 28, 1999, the Company had 500 employees.


ITEM 2.  PROPERTIES

     The Company's properties, primarily located in Arkansas and north
Louisiana, consist principally of fee timber and timberlands, purchased stumpage
inventory, two sawmills, land held for residential and commercial development
and sale, and farmland. As of December 31, 1998, the Company's gross investment
in timber and timberlands, gross property, plant, and equipment, and investment
in real estate held for development and sale consisted of the following:

<TABLE>
<CAPTION>
          (Thousands of dollars)                                             
          <S>                                                        <C>     
          Timberlands                                                $ 54,710
          Fee timber and logging facilities                           129,852
          Purchased stumpage inventory                                 13,210
          Real estate held for development and sale                    27,295
          Land and land improvements                                    8,471
          Buildings and structures                                      8,573
          Machinery and equipment                                      62,949
                                                                     --------
                                                                     $305,060
                                                                     ========
</TABLE>

     "Timberlands" consist of the historical cost of land on which fee timber is
grown and related land acquisitions stated at acquisition cost. "Fee timber"
consists of the historical cost of company standing timber inventory, including
capitalized reforestation costs, and related timber acquisitions stated at
acquisition cost. "Logging facilities" consist primarily of the costs of roads
constructed and other land improvements. "Purchased stumpage inventory" consists
of the purchase price paid for unharvested third party timber. "Real estate held
for development and sale" consist primarily of the unamortized costs, including
amenities, incurred to develop the real estate for sale. "Land and land
improvements" consist primarily of the farmland. "Buildings and structures" and
"Machinery and equipment" primarily consist of the sawmill buildings and
equipment, farming structures and equipment, and a commercial office building
held for lease.

     The Company owns all of the properties discussed above. Other than
approximately $.4 million of timber notes payable for certain investments in
timber and $1.4 million of owner-financed acquisitions of real estate acreage
and timberland, the Company's properties are not subject to mortgages or other
forms of debt financing. (For further information on the location and type of
the Company's properties, see the descriptions of the Company's operations in
Item 1.)

                                       13
<PAGE>
 
ITEM 3.   LEGAL PROCEEDINGS

     From time to time, the Company is involved in litigation incidental to its
business.  Currently, there are no material legal proceedings.


ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     None.


EXECUTIVE OFFICERS OF THE REGISTRANT

     The age (at January 1, 1999), present corporate office, and length of
service in office of each of the Company's executive officers and persons chosen
to become officers are reported in the following listing.  Executive officers
are elected annually but may be removed from office at any time by the Board of
Directors.

     Robert C. Nolan - Age 57; Chairman of the Board effective December 17,
1996. For the past 27 years, Mr. Nolan has been Managing Partner of Munoco
Company, an Arkansas partnership principally engaged in the exploration for and
production of oil and gas. In addition, Mr. Nolan has over 26 years experience
in timberland management.

     Ron L. Pearce - Age 57; President and Chief Executive Officer and a
director of the Company effective December 17, 1996. From June 1993 to December
1996, Mr. Pearce was President of Deltic Farm & Timber Co., Inc. ("Deltic Farm &
Timber"), the predecessor corporation of the Company. Prior to such time, Mr.
Pearce was Manager of Operations and Planning for Deltic Farm & Timber, a
position he held beginning in February, 1991.

     Emily R. Evers - Age 48; Controller effective December 31, 1996. From 1989
to December 1996, Ms. Evers was Controller of Deltic Farm & Timber.

     W. Bayless Rowe - Age 46; General Counsel and Secretary effective December
31, 1996. From 1988 to December 1996, Mr. Rowe was Secretary and General
Attorney of Murphy Oil Corporation ("Murphy Oil").

     Clefton D. Vaughan - Age 57; Vice President, Finance and Administration and
Treasurer effective December 31, 1996. From October 1994 to December 1996, Mr.
Vaughan was Vice President of Murphy Oil, a position he also held from 1989
through October 1992. From October 1992 to October 1994, Mr. Vaughan was Vice
President of Murphy Exploration & Production Company.

                                       14
<PAGE>
 
                                    PART II


ITEM 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

     Common Stock of Deltic Timber Corporation is traded on the New York Stock
Exchange under the symbol DEL.  The following table sets forth the high, low,
and ending prices, along with the quarterly dividends declared, for each of the
quarters indicated:

<TABLE>
<CAPTION>
                                 Sales Prices/1/                         Dividend per
                            ---------------------------------------
                                 High            Low       Close/2/      Common Share
                            ---------------  ------------  --------      ------------
      <S>                   <C>              <C>           <C>           <C>
      1998
          First Quarter           $ 30-1/16     26-1/4      29-5/16            .0625
          Second Quarter          $ 30-1/16     25          25-1/16            .0625
          Third Quarter           $ 25          18          18                 .0625
          Fourth Quarter          $ 24-15/16    18          20-3/8             .0625
                                                                                   
      1997                                                                         
          First Quarter           $ 28-1/2      22-1/4      28-3/8             .0625
          Second Quarter          $ 29-5/16     25          29-5/16            .0625
          Third Quarter           $ 32-7/8      24-15/16    32-11/16           .0625
          Fourth Quarter          $ 32-1/2      26-15/16    27-3/8             .0625
</TABLE>

      /1/  Daily closing price.
      /2/  At period end.


     Common stock dividends were declared for each quarter during 1998 and 1997.
As of February 28, 1999, there were approximately 3,181 stockholders of record
of Deltic's Common Stock.

                                       15
<PAGE>
 
ITEM 6.   SELECTED FINANCIAL DATA

     The following table presents certain selected consolidated financial data
for each of the years in the five-year period ended December 31, 1998:

<TABLE>
<CAPTION>
(Thousands of dollars, except per share amounts)       1998        1997        1996        1995        1994
                                                    ----------  ----------  ----------  ----------  ----------
<S>                                                 <C>         <C>         <C>         <C>         <C>
RESULTS OF OPERATIONS FOR THE YEAR
 
Net sales.......................................    $ 106,957     104,208      86,498      80,662      92,457
Operating income................................    $  18,278      25,609      17,940      13,343      28,375
Income before income taxes......................    $  13,777      27,252      21,933      15,894      30,576
Net income......................................    $   8,474      16,574      13,161      10,016      18,142
Earnings per Common share*
 Basic..........................................    $     .48        1.29        1.03         N/A         N/A
 Assuming dilution..............................    $     .48        1.29        1.03         N/A         N/A
Cash dividends declared per Common share........    $     .25         .25         N/A         N/A   N/A
Net cash provided/(required) by
 Operating activities...........................    $  26,987      23,917      21,731      16,865      23,894
 Investing activities...........................    $ (85,517)    (37,804)     (6,108)    (16,134)    (23,875)
 Financing activities...........................    $  35,645      26,090        (419)     (1,644)       (101)
Percentage return on
 Average stockholders' equity...................          4.7         9.6         7.8         6.1        12.0
 Average borrowed and invested capital..........          4.3         9.5         7.9         6.2        12.0
 Average total assets...........................          3.5         8.7         7.2         5.7        11.3
 
CAPITAL EXPENDITURES FOR THE YEAR
 
 Woodlands......................................    $  59,839      16,380       2,754         563         171
 Mills..........................................        7,918      11,506       2,927       2,149       7,051
 Real Estate....................................       11,531       6,378       6,669       4,638       3,849
 Agriculture....................................          721       1,000         272         245         266
 Corporate......................................          524         574       1,512       1,538          66
                                                    ---------------------------------------------------------
                                                    $  80,533      35,838      14,134       9,133      11,403
                                                    =========================================================
FINANCIAL CONDITION AT YEAR-END
 
 Working capital................................    $  16,539      37,971      25,758       6,822      11,314
 Current ratio..................................     3.5 to 1    5.9 to 1    5.3 to 1    1.9 to 1    3.4 to 1
 Total assets...................................    $ 272,544     225,375     180,078     185,247     169,373
 Long-term debt.................................    $  45,198       1,093       2,685       2,817         163
 Redeemable preferred stock.....................    $  30,000      30,000           -           -           -
 Stockholders' equity...........................    $ 183,134     179,996     166,708     170,289     160,273
 Long-term debt to stockholders' equity ratio...    .247 to 1   .006 to 1   .016 to 1   .017 to 1   .001 to 1
</TABLE>

* 1996 amounts are presented on a pro forma basis. The distribution of the
  Company's Common Stock did not occur until December 31, 1996.

                                       16
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS


OVERVIEW

     Deltic Timber Corporation ("Deltic" or the "Company") is a natural
resources company engaged primarily in the growing and harvesting of timber and
the manufacture and marketing of lumber. The Company owns approximately 397,000
acres of timberland in Arkansas and north Louisiana. The Company's sawmill
operations are located at Ola in central Arkansas (the "Ola Mill") and at Waldo
in south Arkansas (the "Waldo Mill"). In addition to its timber and lumber
operations, the Company is engaged in real estate development in central
Arkansas and owns approximately 37,000 acres of farmland in northeast Louisiana.
The Company also holds a 50 percent interest in Del-Tin Fiber L.L.C. ("Del-Tin
Fiber"), a joint venture to manufacture and market medium density fiberboard,
which began production in April 1998.

     On November 11, 1996, the Board of Directors of Murphy Oil Corporation
("Murphy Oil") declared a dividend payable to holders of record of Murphy Common
Stock at the close of business on December 2, 1996 (the "Record Date") of one
share of Deltic Common Stock for every 3.5 shares of Murphy Common Stock owned
of record on the Record Date. As a result, 100 percent of the outstanding shares
of Company Common Stock was distributed to Murphy Oil shareholders on December
31, 1996 (the "Distribution Date"). Prior to the Distribution Date, the Company
was operated as part of Murphy Oil. The financial information for the year of
1996, presented herein, reflects a period during which the Company did not
operate as an independent company. Such information, therefore, may not
necessarily reflect the results of operations or the financial condition of the
Company which would have resulted had the Company been an independent, public
company during that reporting period, and are not necessarily indicative of the
Company's future operating results or financial condition.

     The Company's results of operations are affected primarily by the cyclical
supply and demand factors of the forest products industry. Despite strong
economic conditions and housing starts in the U.S., the downturn in Asian
markets caused the North American lumber market to be oversupplied for much of
1998. Lumber that was normally exported from North America to Asia was
redirected to U.S. markets, causing supply to outpace demand and depressing
prices. However, demand for timber, as well as timber prices, remained
relatively strong during 1998. While beneficial to the Company's Woodlands
segment, strong timber prices combined with depressed lumber prices negatively
impacted the performance of the Mills segment. Other factors impacting operating
results of the Company include interest rates, commodity prices, adverse
weather, and general economic conditions.


RESULTS OF OPERATIONS

     Consolidated net income for 1998 was $8.5 million, $.48 a share, compared
to $16.6 million, $1.29 a share, for 1997.  The decrease was primarily the
result of lower operating income from the Company's Mills and Agriculture
segments combined with a $4.6 million loss for the Company's share of equity in
Del-Tin Fiber's plant start-up costs incurred to-date and operating losses
reported since initial production commenced in late April 1998.  In 1996, the
Company earned $13.2 million, $1.03 a share on a pro forma basis.

     Operating income for 1998 decreased $7.3 million to $18.3 million.  The
Woodlands segment increased $2.5 million due primarily to a 21 percent increase
in pine sawtimber harvest levels, partially offset by a four percent decrease in
the average price for pine sawtimber sold.  The Company's Mills segment
operating results decreased $10.2 million as the result of a $53 per thousand
board feet ("MBF") drop in the average lumber sales price and a five percent
higher cost of production per MBF 

                                       17
<PAGE>
 
sold, which caused a negative margin per MBF. Real Estate operations increased
$1.8 million and benefited from a 55 percent increase in the number of
residential lots sold. The Agriculture segment decreased $2 million as the
result of reduced sales prices for soybeans and corn in 1998, combined with 1997
benefiting from the timing of sales of soybeans grown during 1996.

     In 1997, operating income increased $7.6 million to $25.6 million. The
Company's Woodlands operations increased $5.5 million as the result of a 20
percent rise in the average price for pine sawtimber sold coupled with a 21
percent increase in harvest levels of pine sawtimber. The Mills segment results
increased $4 million due primarily to an 18 percent increase in average finished
lumber sales price. Real Estate operating income increased $1.6 million due
primarily to increased commercial sales. The Agriculture segment results were
virtually unchanged from 1996. The cost of corporate functions increased $2.9
million.

     In the following table, the Company's net sales and results of operations
for the three years ended December 31, 1998 are presented by segment.  A review
of the information follows the table.

<TABLE>
<CAPTION>
                                  Years Ended December 31,
                                  ------------------------
(Millions of dollars)              1998     1997    1996
                                  -------  ------  -------
<S>                               <C>      <C>     <C>
Net sales
    Woodlands                      $ 26.6    22.6   16.4
    Mills                            65.8    67.7   57.9
    Real Estate                      15.9    11.6    6.3
    Agriculture                       6.5     9.5   10.6
    Eliminations                     (7.8)   (7.2)  (4.7)
                                   ------   -----   ----
        Net sales                  $107.0   104.2   86.5
                                   ======   =====   ====
 
Operating income and net income
    Woodlands                      $ 20.5    18.0   12.5
    Mills                            (2.8)    7.4    3.4
    Real Estate                       5.0     3.2    1.6
    Agriculture                        .8     2.8    2.8
    Corporate                        (5.0)   (5.2)  (2.3)
    Eliminations                      (.2)    (.6)     -
                                   ------   -----   ----
        Operating income             18.3    25.6   18.0
Equity in loss of Del-Tin Fiber      (4.6)      -      -
Interest income                       1.1      .7    3.1
Interest expense                     (1.4)    (.4)   (.3)
Other income/(expense)                 .4     1.4    1.2
Income tax expense                   (5.3)  (10.7)  (8.8)
                                   ------   -----   ----
        Net income                 $  8.5    16.6   13.2
                                   ======   =====   ====
</TABLE>

   Woodlands

     Net sales for the Company's Woodlands segment totaled $26.6 million in
1998, $22.6 million in 1997, and $16.4 million in 1996. Operating income for
this segment was $20.5 million in 1998, $18 million in 1997, and $12.5 million
in 1996.

     During 1998, net sales increased $4 million, 18 percent, to $26.6 million.
Pine sawtimber sales increased $3.2 million in 1998 which reflects the impact of
a $3.8 million increase attributable to higher sales volume, partially offset by
a $.7 million decrease due to lower average sales price.  The Company 

                                       18
<PAGE>
 
harvested 431,600 tons of pine sawtimber in 1998, an increase of 21 percent when
compared to 356,500 tons in 1997. The acquisition program, which began during
1996, has added approximately 58,600 acres of timberland and facilitated the
increased harvest level. Average sales price for Deltic's pine sawtimber was $51
per ton in 1998 versus $53 per ton in 1997, a decrease of four percent. Pine
pulpwood sales increased $.9 million due to increased harvest levels as the
Company thinned its maturing pine plantations. Sales of hardwood sawtimber
decreased $.3 million from $1.4 million primarily as the result of a decrease in
sales price. Other net sales for Woodlands increased slightly.

     Net sales in 1997 increased $6.2 million, 38 percent, to $22.6 million.
Sales of pine sawtimber increased $5.9 million over 1996 which reflects an
increase of $3.3 million attributable to higher sales volume coupled with a $2.6
million increase due to higher average sales price. The Company increased
harvest levels of pine sawtimber from 294,100 tons in 1996 to 356,500 tons in
1997, an increase of 21 percent. Deltic's average sales price for pine sawtimber
increased 20 percent, $53 per ton in 1997 compared to $44 per ton in 1996. The
increase in the price of pine sawtimber was the result of strong demand caused
by the high level of regional lumber production. Pine pulpwood and hardwood
sales increased $.5 million in 1997 due to higher volume and sales price. Other
net sales decreased $.2 million in 1997.

     Operating income of $20.5 million for 1998 was $2.5 million more than in
1997 due primarily to the increase in net sales discussed above.  The cost of
fee timber harvested increased $.8 million in 1998 due to an increase in timber
harvested and to higher depletion rates which are the result of acquiring
timberland.  An increase in cull timber release expense of $.3 million resulted
from the increase in the Company's timberland acreage.

     In 1997, operating income increased $5.5 million to $18 million as the
result of increased net sales, partially offset by an increase of $.3 million in
the cost of fee timber harvested and a $.3 million increase in cull timber
release expense.

   Mills

     Net sales for the Company's Mills segment were $65.8 million in 1998,
compared to $67.7 million in 1997 and $57.9 million in 1996.  An operating loss
of $2.8 million was recorded in 1998, while operating income was $7.4 million in
1997 and $3.4 million in 1996.

     In 1998, net sales decreased $1.9 million to $65.8 million.  Although
finished lumber sales volume increased nine percent to 162.2 million board feet
("MMBF") in 1998, a $53 per MBF decrease in average sales price to $343 per MBF
caused a decrease in net sales of $3.5 million.  Sawmill residual product sales
increased $1.1 million in 1998.  During 1998, the Company recorded a $.5 million
settlement of the business interruption claim filed as a result of a fire at the
Ola Mill during 1997.

     During 1997, net sales for this segment totaled $67.7 million, an increase
of $9.8 million. Finished lumber sales increased $11.2 million due to an $8.8
million increase which resulted from higher average sales price and a $2.4
million increase from greater sales volume.  In 1997, average sales price for
finished lumber was $396 per MBF, an 18 percent increase when compared to $335
per MBF in 1996.  The Company's sawmills experienced a four percent increase in
finished lumber sales volume, from 143.4 MMBF in 1996 to 149.4 MMBF in 1997.
Residual product sales declined by $1.4 million.

     A loss from operations of $2.8 million during 1998 compared to operating
income of $7.4 million in 1997.  The decrease was primarily the result of the
drop in net sales combined with a five percent increase in the cost of
production per MBF sold, partially offset by the previously mentioned business
interruption claim settled during 1998.  The increase in the cost of lumber
produced resulted from increases in log cost and depreciation expense.

                                       19
<PAGE>
 
     Operating income of $7.4 million for 1997 was $4 million more than for
1996, primarily attributable to a $61 per MBF increase in sales price to $396
per MBF coupled with a four percent increase in finished lumber sales volume,
partially offset by a 17 percent increase in the cost of logs used in the
Company's sawmills.

   Real Estate

     The Company's Real Estate operations generated net sales of $15.9 million
in 1998, $11.6 million in 1997, and $6.3 million in 1996. Operating income for
this segment totaled $5 million in 1998, $3.2 million in 1997, and $1.6 million
in 1996.

     Net sales in 1998 increased $4.3 million, 37 percent, from $11.6 million in
1997. Residential lot sales increased by 62 lots to 175, with the average sales
price up six percent over 1997, from $52,400 per lot to $55,600. During 1998,
325 lots were developed and offered for sale in Chenal Valley in west Little
Rock, Arkansas, and in Red Oak Ridge near Hot Springs, Arkansas. Sales of
approximately 96 acres of undeveloped real estate acreage for $.6 million in
1998 compares to the sale of 9.5 acres for $.2 million during 1997. Commercial
sales revenue decreased $1.1 million due to the sale of approximately 26 acres
at an average price per acre of $90,900 in 1997, which compares to sales of
about eight acres for $158,000 per acre in 1998. Net sales from the Company's
Chenal Country Club operation were $3.3 million for 1998 versus $2.3 million for
the eight months of 1997 following the acquisition of the Club by Deltic.
Operating income for the Real Estate segment increased $1.8 million to $5
million due primarily to a $1.9 million increase in the margin realized on sales
of real estate in 1998.

     In 1997, Real Estate operations generated net sales of $11.6 million, $5.3
million more than in 1996. Sales of residential and commercial property
increased $2.6 million. The sale of residential lots increased 19 percent, from
95 lots in 1996 to 113 lots in 1997, with a slight decrease in average sales
price from $55,400 to $52,400. During 1997, 149 lots were developed and offered
for sale in Bayonne Place; DuQuesne Place, Chenal Valley's newest neighborhood
which was priced to enter a new segment of the market; and Chenal Downs, a 400-
acre equestrian development located outside of Chenal Valley. Two commercial
sites were sold in 1997 for multi-family developments and totaled 26.4 acres at
an average price per acre of $90,900, which compares to a 2.1-acre tract for
$199,500 per acre in 1996. On May 1, 1997, the Company acquired Chenal Country
Club, Inc., a newly-formed entity that operates the Club amenity around which
Chenal Valley is centered. The acquisition was accomplished by exchanging a $5.6
million interest-bearing receivable from the club membership, which was
previously held by Deltic, for an investment in the newly-formed subsidiary.
Chenal Country Club, Inc.'s financial results included net sales of $2.3 million
and cost of sales totaling $2.1 million. The cost of the clubhouse and golf
course facilities acquired is being accounted for as an additional amenity for
the Chenal Valley development. Real Estate operating income of $3.2 million for
1997 increased $1.6 million when compared to 1996, due primarily to the same
factors impacting net sales.

   Agriculture

     Deltic's Agriculture segment recorded net sales of $6.5 million during
1998, compared to $9.5 million in 1997 and $10.6 million in 1996. Operating
income totaled $.8 million in 1998, and $2.8 million in both 1997 and 1996.

     During 1998, net sales of $6.5 million decreased $3 million from 1997. The
decrease was the result of lower commodity prices and soybean yields, combined
with the prior year benefiting from the sale of products which were grown during
1996. Operating income of $.8 million was down $2 million from 1997 and was
negatively impacted by an increase in harvesting costs for corn due to an
outbreak of Aflatoxin, a toxin-producing fungus, in addition to lower net sales
discussed earlier. In 1998, soybean 

                                       20
<PAGE>
 
yields per acre decreased nine percent and the sales price was 19 percent lower
than in 1997. Although corn yields per acre increased four percent, sales prices
were down ten percent in 1998.

     Agriculture operations contributed $9.5 million in net sales during 1997,
down $1.1 million from 1996. This decrease was primarily due to a 43 percent
reduction in cotton production volume in 1997 compared to 1996, which resulted
from diverting about 2,000 acres from cotton production to other crops. Although
revenue decreased in 1997, a corresponding reduction in crop costs was achieved.
Operating income of $2.8 million in 1997 was essentially unchanged from 1996. In
1997, crop yields per acre for cotton and wheat increased 19 percent and 25
percent, respectively, while per acre yields for soybeans and corn decreased
nine percent and four percent.

   Corporate

     Corporate operating expense was $5 million in 1998, $5.2 million in 1997,
and $2.3 million in 1996.  During 1998, the Company's general and administrative
expenses decreased $.4 million.  These expenses increased $2.7 million in 1997
due to higher expenses incurred as an independent, public company.  The cost of
certain administrative and financial services provided by Murphy Oil, Deltic's
parent prior to spin-off, was included in general and administrative expenses
and totaled $.5 million in 1997 and $1.3 million in 1996.  These services were
provided by Murphy Oil through June 30, 1997.

   Equity in Del-Tin Fiber

     In 1998, the Company recorded equity in the loss of Del-Tin Fiber totaling
$4.6 million, which included plant start-up costs incurred to-date and operating
losses reported since initial production began in late April 1998.

   Interest Income/Expense

     Interest income during 1998 was $1.1 million, compared to $.7 million in
1997 and $3.1 million in 1996.  The $2.4 million decrease in 1997 was due
primarily to settlement of an interest-bearing receivable from Murphy Oil.
Deltic's interest income from this receivable was $2.4 million in 1996.  In
1998, interest expense was $1.4 million, versus $.4 million in 1997 and $.3
million in 1996.  The increase of $1 million during 1998 was due primarily to
increased borrowings required for Deltic's land acquisition program.

   Other Income

     Other income was $.4 million in 1998, $1.4 million in 1997, and $1.2
million in 1996.  During 1997, the Company realized a $1.2 million gain on
settlement of a physical damage insurance claim which was the result of a fire
that destroyed the Ola Mill lumber planer.  A $.7 million gain on the sale of
approximately 3,200 acres of Arkansas farmland was recorded during 1996.

   Income Tax Expense

     The Company's income tax expense was $5.3 million for 1998, $10.7 million
for 1997, and $8.8 million for 1996. The effective income tax rate was 38
percent, 39 percent, and 40 percent in 1998, 1997, and 1996, respectively. The
Company's income tax expense declined $5.4 million, from $10.7 million in 1997,
primarily due to lower pretax earnings. The increase in income tax expense of
$1.9 million in 1997 was due to similar increases in pretax earnings.

                                       21
<PAGE>
 
LIQUIDITY AND CAPITAL RESOURCES

   Cash Flows and Capital Expenditures

     Net cash provided by operating activities was $27 million in 1998, compared
to $23.9 million in 1997 and $21.7 million in 1996. Changes in operating working
capital, other than cash and cash equivalents, required cash of $.2 million in
1998 and $.5 million in 1997, but provided cash of $.6 million in 1996. The
Company's accompanying Consolidated Statements of Cash Flows identify other
differences between net income and cash provided by operating activities for
each of those years.

     Capital expenditures required cash of $80.1 million in 1998, $35.7 million
in 1997, and $14.1 million in 1996. Other owner-financed capital expenditures,
not requiring cash, included timberland acquisitions of $.4 million in 1998 and
$.1 million in 1997. Total capital expenditures are presented by segment in the
following table for the years ended December 31, 1998, 1997, and 1996.

<TABLE>
<CAPTION>
(Millions of dollars)                    1998   1997   1996
                                         ----   ----   ----
<S>                                     <C>     <C>    <C>
    Woodlands                           $59.9   16.4    2.7
    Mills                                 7.9   11.5    2.9
    Real Estate                          11.5    6.4    6.7
    Agriculture                            .7    1.0     .3
    Corporate                              .5     .5    1.5
                                        -----   ----   ----
        Total capital expenditures       80.5   35.8   14.1
    Owner-financed expenditures           (.4)   (.1)     -
                                        -----   ----   ----
        Expenditures requiring cash     $80.1   35.7   14.1
                                        =====   ====   ====
</TABLE>

     Woodlands capital expenditures included timberland acquisitions of
approximately 30,400 acres at a cost of $59.1 million in 1998, approximately
25,100 acres at a cost of $15.9 million in 1997, and approximately 3,100 acres
at a cost of $2.5 million in 1996. Reforestation site preparation and planting
required expenditures of $.4 million in 1998, $.2 million in 1997, and $.1
million in 1996.

     During 1998, $3.5 million was expended for the Ola Mill's planer upgrade.
The installation of a new boiler system and an additional kiln, which will
increase drying capacity by 30 million board feet annually, required
expenditures of $1.6 million in 1998 and $3 million in 1997. A small log
processing deck, which has enabled the mill to extract small diameter logs from
pulpwood to facilitate log supply and reduce log cost, required expenditures of
$.4 million in 1998 and $1.4 million in 1997. In 1996, $.7 million was expended
to expand the lumber sorting system. At the Waldo Mill, $.5 million was expended
in 1998 and $1.6 million in 1997 to install a new secondary manufacturing
operation, which has expanded the Mill's product mix to include products such as
finger-jointed studs. The Waldo Mill's planer upgrade required capital
expenditures of $4.1 million in 1997 and $1.4 million in 1996.

     Capital expenditures for Real Estate operations related to cost of lot
development were $5.1 million in 1998, $2.1 million in 1997, and $.4 million in
1996. Commercial development expenditures included $.4 million in 1998 for site
work for outparcel sites adjacent to the Company's 35,000-square-foot retail
center for which construction is planned to be completed during 1999, $.6
million in 1997 for site work for the retail center, and $4.5 million in 1996
for construction of a 50,000-square-foot office building which the Company
offers for lease. In 1998, infrastructure construction totaled $.8 million,
compared to $1.3 million in 1997 and $.4 million in 1996. An expansion of the
clubhouse at Chenal Country Club required capital expenditures of $3 million in
1998 and $.6 million in 1997. Other expenditures were primarily for various
amenity improvements.

                                       22
<PAGE>
 
     Agriculture expenditures included $.4 million in both 1998 and 1997 for
purchase of harvesting combines. In 1997, two continuous-flow drying systems
were installed for $.4 million. Other capital requirements were mainly for
replacement of various machinery and equipment.

     Corporate operations had capital expenditures for purchases of additional
investment in a consolidated entity of $.4 million in 1998 and $.9 million in
1996. Expenditures for 1997 of $.5 million were primarily for the purchase of
office furniture and computer equipment, including software, required when the
Company's offices were relocated after being spun off from Murphy Oil.

     At December 31, 1998, the Company had commitments of $12.3 million for
capital projects in progress, including $3.7 million for improvements at the Ola
Mill and $7.9 million related to residential lot and commercial development,
infrastructure construction, and amenity improvements at the Company's real
estate developments.  The Ola Mill's commitments consisted of $1.9 million for
an edger and edger optimizer, $1.3 million for completion of a planer upgrade,
and $.5 million for sawmill building improvements.

     The net change in purchased stumpage inventory required cash of $2.7
million in 1998 and $2.9 million in 1997, and provided cash of $2.8 million in
1996. Proceeds from the sales of assets provided $.4 million in 1998; $1.4
million in 1997, due primarily to the involuntary conversion of the Ola Mill's
planer which was destroyed by fire; and $2.9 million in 1996, primarily from the
sale of approximately 3,200 acres of Arkansas farmland. In 1996, as part of the
spin-off of the Company by Murphy Oil, the Company received a $17.2 million cash
payment from Murphy Oil in partial settlement of its receivable from Murphy Oil.
Prior to the spin-off, the Company remitted to Murphy Oil cash funds generated
in excess of its daily requirements. As a result, the receivable had increased
by $7.9 million in 1996. Also, in connection with the spin-off, the Company
recorded an $18.8 million noncash dividend to Murphy Oil which reduced the
outstanding balance of the receivable. (Refer to Note 2 to the consolidated
financial statements.) The Company advanced to Del-Tin Fiber $9.6 million, $1
million, and $6.8 million in 1998, 1997, and 1996, respectively. In December
1998, Del-Tin Fiber repaid $5.6 million of previous advances when project
financing for the facility was obtained. In conjunction with this repayment, the
remaining outstanding advances receivable amount was deemed to be a capital
contribution to the joint venture.

     During 1998, the Company borrowed $48 million under its revolving credit
facility, primarily to finance timberland acquisitions. (Refer to Note 9 to the
consolidated financial statements.) Upon issuance of $40 million of privately-
placed, fixed-interest rate, long-term senior notes with a financial institution
on December 18, 1998, the Company used the proceeds, net of $1.3 million in
prepaid interest and debt issuance costs, to make repayment against its
revolving facility. In addition, $3 million of the repayment received from Del-
Tin Fiber was applied to the revolving facility commitment. During 1997, the
Company issued 600,000 shares of Redeemable Preferred Stock, proceeds of which
were $29.6 million, net of issuance costs. (Refer to Note 10 to the consolidated
financial statements.) In addition, borrowings under Deltic's revolving facility
in 1997 provided $3 million, which were also repaid during the year. Cash
required to repay long-term debt arising from installment payments on notes used
to finance a portion of the Company's timber requirements amounted to $1.8
million in both 1998 and 1997, and $.4 million in 1996. The Company paid
dividends on Common Stock of $3.2 million in both 1998 and 1997. During 1998,
cash required to pay Preferred Stock dividends totaled $2.3 million.

   Financial Condition

     Year-end working capital totaled $16.5 million in 1998 and $38 million in
1997. Cash and cash equivalents at the end of 1998 were $8.2 million, compared
to $31 million at the end of 1997. The reduction for 1998 was primarily
attributable to the amount by which capital expenditures for the year exceeded
net borrowings during the year. During 1998, indebtedness of the Company
increased 

                                       23
<PAGE>
 
$43.5 million. The Company's working capital ratio at December 31, 1998, was 3.5
to 1, compared to 5.9 to 1 at the end of 1997.

   Liquidity

     The primary sources of the Company's liquidity are internally generated
funds, access to outside financing, and working capital. The Company's current
strategy for growth continues to emphasize a significant timberland acquisition
program, which has facilitated an increase in harvest levels, as it is expanding
lumber production and entering the engineered wood products market through its
interest in Del-Tin Fiber.

     To facilitate these growth plans, the Company has an agreement with a group
of banks which provides a revolving credit facility totaling $100 million.  The
agreement will expire on December 31, 2001.  As of December 31, 1998, $95
million was available under this facility.  Current financing arrangements are
set forth in Note 9 to the consolidated financial statements.  Due to the amount
available under its credit facility, combined with successfully obtaining $40
million of privately-placed debt at terms acceptable to the Company, Deltic does
not currently anticipate filing the Common Stock shelf registration with the
Securities and Exchange Commission which was mentioned in the Company's 1997
Form 10-K.

     On January 14, 1999, the Company's Board of Directors authorized a stock
repurchase program through which the Company's management has approval to
purchase up to $10 million of Common Stock, initially.  Under the program, the
Company can purchase shares through the open market and privately negotiated
transactions at prices deemed appropriate by management, utilizing cash provided
by operations and/or from its credit facility.

     Deltic's management believes that the remaining amount available under its
credit facility will be sufficient to meet its expected cash needs and planned
expenditures, including those of the Company's continued timberland acquisition
and authorized Common Stock repurchase programs, for the foreseeable future.


OTHER MATTERS

   Impact of Inflation

     General inflation has not had a significant effect on the Company's
operating results during the three years ended December 31, 1998.  The Company's
timber operations are more significantly impacted by the forces of supply and
demand in the southern United States than by changes in inflation. Lumber
manufacturing operations are affected by the supply of lumber available in the
North American market and by the demand for lumber by both the North American
and foreign export markets.  Sales of real estate are affected by changes in the
general economy and long-term interest rates.

   Market Risk

     Market risk represents the potential loss resulting from adverse changes in
the value of financial instruments, either derivative or non-derivative, caused
by fluctuations in interest rates, foreign exchange rates, commodity prices, and
equity security prices.  The Company handles market risks in accordance with its
established policies; however, Deltic does not enter into derivatives or other
financial instruments for trading or speculative purposes.  The Company does
enter into financial instruments to manage and reduce the impact of changes in
interest rates.  The counterparties in these financial instruments are normally
major financial institutions.  Deltic held various financial instruments at
December 31, 1998 and 1997, consisting of financial assets and liabilities
reported in the Company's 

                                       24
<PAGE>
 
Consolidated Balance Sheets and off-balance sheet exposures resulting from
letters of credit issued by Deltic, primarily in connection with its purchased
stumpage procurement and real estate operations. (For additional information
regarding these financial instruments, refer to Note 13 to the consolidated
financial statements.)

     Interest Rate Risk  -  The Company is subject to interest rate risk from
the utilization of financial instruments, such as term debt and other
borrowings.  The fair market value of long-term, fixed-interest rate debt is
subject to interest rate risk.  Generally, the fair value of fixed-interest rate
debt will increase as interest rates fall and will decrease as interest rates
rise.  Conversely, for floating rate debt, interest rate changes generally do
not affect the instruments' fair value, but do impact future earnings and cash
flows, assuming other factors are held constant.  The estimated fair values of
the Company's long-term debt, including current maturities; Redeemable Preferred
Stock; and letters of credit at December 31, 1998, were $46.2 million, $31.2
million, and $3.5 million, respectively.

     A one percentage-point increase in prevailing interest rates would result
in decreases in the estimated fair value of long-term debt of $4 million and
Redeemable Preferred Stock of $1.2 million, while the fair value of the
Company's letters of credit would be unchanged.  Initial fair values were
determined using the current rates at which the Company could enter into
comparable financial instruments with similar remaining maturities.  The
estimated earnings and cash flows impact for 1999 resulting from a one
percentage-point increase in interest rates would be approximately $35 thousand,
holding other variables constant.

     Foreign-Exchange Rate Risk  -  The Company currently has no exposure to
foreign-exchange rate risk because all of its financial instruments are
denominated in U.S. dollars.

     Commodity Price Risk  -  The Company has no financial instruments subject
to commodity price risk.

     Equity Security Price Risk  -  None of the Company's financial instruments
have potential exposure to equity security price risk.

     The preceding discussion of the Company's estimated fair value of its
financial instruments and the sensitivity analyses resulting from hypothetical
changes in interest rates are "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995.  Such statements reflect
the Company's current expectations and involve uncertainties.  These forward-
looking market risk disclosures are selective in nature and only address the
potential impact from financial instruments. They do not include other potential
effects which could impact Deltic's business as a result of changes in interest
rates, foreign-exchange rates, commodity prices, or equity security prices.

   Impact of Accounting Pronouncements

     In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") 133, Accounting for Derivative
Instruments and Hedging Activities.  This standard establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities.  SFAS 133
is effective for all fiscal quarters for fiscal years beginning after June 15,
1999 and will not require retroactive restatement of prior period financial
statements.  This statement requires the recognition of all derivative
instruments as either assets or liabilities, measured at fair value, in the
statement of financial position. Generally, increases or decreases in the fair
value of derivative instruments will be recognized as gains or losses in
earnings in the period of change.  If certain conditions are met, where the
derivative instrument has been designated as a fair value hedge, the hedged item
may also be marked to market through earnings, thus creating an offset.  If the
derivative is designated and qualifies as a cash flow hedge, the changes in fair
value of the derivative instrument may be recorded in comprehensive income, 

                                       25
<PAGE>
 
as defined by SFAS 130, Reporting Comprehensive Income. The impact of SFAS 133
on the Company's financial statements when adopted, if any, will depend on a
variety of factors, including future interpretive guidance from the FASB, the
level of utilization of derivative instruments, the types of hedging instruments
used, and the effectiveness of any such instruments. However, the Company's
management does not believe the effect of adopting SFAS 133 will be material to
its financial position or results of operations, based on the Company's current
level of derivative and hedging activities.

   Year 2000 Issue

     The Year 2000 issue is the known inability of a significant percentage of
the world's computers, application software, and embedded semiconductor chips to
cope with the change of the year from 1999 to 2000. As a result, some systems
could fail to operate or produce incorrect results.

     The Year 2000 problem, if not corrected, would affect computers, software,
and other equipment used by the Company, as well as those used by its suppliers,
customers, banks, etc.  Accordingly, Deltic has assessed the potential impact
of, and the costs of remediating, the Year 2000 problem for its internal systems
and operational facilities' systems and equipment.

     The Company's business is substantially dependent upon the operation of
computer systems, and as such, Deltic has established a Year 2000 Committee
which is made up of managers from its corporate and operational areas.  The
Committee was created pursuant to the direction of the Company's Board of
Directors and has the involvement of executive management, with top priority
given to its objectives.

     The Company has essentially completed the process of identifying the
computers, application software, and related equipment that must be modified,
upgraded, or replaced to minimize the possibility of a material disruption of
its business. The Company has commenced the process of modifying or upgrading
systems which have been assessed as affected by the Year 2000 problem. For
critical internal computerized systems, the Company expects to complete this
process by the end of the first quarter of 1999. For remaining major systems and
equipment, including those at operational facilities, the Company anticipates
the completion of any modifications or upgrades required no later than the third
quarter of 1999. To-date, the Company has not incurred significant costs for
these modifications since most have been provided by the supplier at no or
minimal cost to Deltic. Therefore, the cost related to the Year 2000 Issue
incurred by the Company for its internal systems and facilities is not expected
to be material.

     In addition to computers and related equipment, the Year 2000 Committee has
completed the assessment of the potential impact of the Year 2000 problem for
its equipment such as fax machines, copiers, telephone and security systems, and
other common devices potentially impacted by the Year 2000 problem. As of
December 31, 1998, all of this equipment has been determined to be Year 2000
compliant.

     The Company has initiated communications with third-party suppliers of the
major computers, software, and other equipment used, operated, or maintained by
the Company, including those at its operational facilities, to identify and, to
the extent possible, resolve issues involving the Year 2000 problem.  Since the
Company has limited or no control over the actions of these suppliers, there can
be no assurance that these suppliers will resolve all Year 2000 problems,
whether currently known or not, or that the Company will be able to obtain
replacement suppliers, before the occurrence of a material disruption to the
business of the Company.

                                       26
<PAGE>
 
     In addition, the Company has issued written communication to all of its
suppliers and significant customers in order to attempt to obtain the status of
their Year 2000 compliance. To-date, the majority of these suppliers and
customers have responded to such communications and have indicated that they
have either already achieved Year 2000 compliance or expect to be able to do so
prior to December 31, 1999. However, the Company can give no assurance that its
suppliers or customers will not be materially impacted by the Year 2000 issue.
In addition, the Company can give no assurance that failure by its suppliers and
customers to achieve Year 2000 compliance will not have a significant impact on
the Company's business. However, Deltic intends to continue follow-up
communications with critical suppliers and customers.

     At this time, the Company is currently developing a contingency plan which
would be implemented in the event that efforts to identify and correct Year 2000
problems are not effective.  As the Company's assessment of its Year 2000
compliance is nearer to completion, the Company's Year 2000 Committee currently
plans to finalize contingency plans for any systems or facilities for which Year
2000 compliance is not reasonably certain.

     The discussion of the Company's efforts, and management's expectations,
relating to Year 2000 compliance are "forward-looking statements" within the
meaning of the federal securities laws.  Such statements reflect the Company's
current expectations and involve risks and uncertainties.  Actual results could
differ materially from those included in such forward-looking statements.  The
Company's ability to achieve Year 2000 compliance and the level of incremental
costs associated therewith, could be adversely impacted by, among other things,
the availability and cost of programming and testing resources, suppliers'
ability to modify proprietary software, and unanticipated problems identified in
the ongoing compliance review.

   Environmental Matters

     Deltic is committed to protecting the environment and has certain
obligations based on federal, state, and local laws for the protection of the
environment. Costs of compliance through 1998 have not been material and the
Company's management currently has no reason to believe that such costs will
become material for the foreseeable future.


OUTLOOK

     Pine sawtimber harvested from the Company's fee lands is projected to
increase annually through 2000, depending on the Company's ability to increase
timber inventory through growth and timberland acquisitions.  Lumber production
is also projected to increase over this period, as the Company continues to
increase the capacity of its manufacturing facilities.  Based on continued
growth in west Little Rock, Arkansas, the Company expects the number of
residential lots and commercial acres sold to increase, barring declines in
economic growth or housing starts in central Arkansas.  Agriculture operations
intend to plant soybeans and corn in 1999, with results subject to a number of
factors including weather conditions, insect infestation, crop disease, and
price fluctuations.  The Company expects medium density fiberboard production
and sales at Del-Tin Fiber to increase significantly in 1999, as capacity
utilization increases following the plant's start-up in April 1998.

     The Company's capital expenditure budget for the year of 1999 was prepared
during the fall of 1998 and provides for expenditures of $38.6 million. The
Woodlands capital budget includes $12.2 million for timberland acquisitions,
which will be dependent on the availability of acreage at prices which meet the
Company's criterion for timber stocking, growth potential, site index, and
location. Sawmill projects are expected to require $9 million during 1999. The
Ola Mill will complete installation of an edger system and planermill in early
1999. At the Company's Waldo Mill, the existing log deck system will be
optimized, which allows scanning of an entire log prior to cutting to length.
This project is 

                                       27
<PAGE>
 
expected to improve recovery and increase mill output by five million board feet
annually. Depending on market conditions, expenditures for residential lot
developments in the amount of $3.2 million are projected to add over 130 lots to
available inventory. Commercial real estate development and infrastructure
construction is estimated at $5.1 million and includes construction of a retail
center in "The Village at Rahling Road", located in Chenal Valley. Golf course
and clubhouse expansion projects are estimated to require capital expenditures
of $2.8 million. Replacements of machinery and equipment for the Agriculture
segment are anticipated to require $.5 million. Capital and other expenditures
are under constant review, and these budgeted amounts may be adjusted to reflect
changes in the Company's estimated cash flows from operations, borrowings under
credit facilities, or general economic conditions.

     Certain statements contained in this report that are not historical in
nature constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995.  Words such as "expects",
"anticipates", "intends", "plans", "estimates", or variations of such words and
similar expressions are intended to identify such forward-looking statements.
These statements reflect the Company's current expectations and involve certain
risks and uncertainties, including those disclosed elsewhere in this report.
Therefore, actual results could differ materially from those included in such
forward-looking statements.


ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

     Information with respect to quantitative and qualitative disclosures about
market risk of the Company is set forth under the caption "Other Matters -
Market Risk" in Item 7 of Part II of this report.

                                       28
<PAGE>
 
ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                           DELTIC TIMBER CORPORATION
                                AND SUBSIDIARIES
                          Consolidated Balance Sheets
                           December 31, 1998 and 1997
                         ---------------------------------
                             (Thousands of dollars)

<TABLE>
<CAPTION>
                                                                 1998         1997   
                                                           ----------      ------- 
<S>                                                         <C>            <C>     
Assets                                                                             
 Current assets                                                                    
   Cash and cash equivalents                                 $  8,160       31,045 
   Trade accounts receivable - net                              3,995        3,772 
   Other receivables                                            1,328          297 
   Inventories                                                  5,851        8,595 
   Prepaid expenses and other current assets                    3,882        2,060 
                                                             --------      ------- 
     Total current assets                                      23,216       45,769 
                                                                                   
 Investment in real estate held for development and sale       27,295       20,365 
 Investment in and advances to Del-Tin Fiber                    6,699        7,383 
 Timber and timberlands - net                                 166,588      108,206 
 Property, plant, and equipment - net                          44,104       39,646 
 Deferred charges and other assets                              4,642        4,006 
                                                             --------      ------- 
                                                                                   
     Total assets                                            $272,544      225,375 
                                                             ========      ======= 

Liabilities and Stockholders' Equity                                               
 Current liabilities                                                               
   Current maturities of long-term debt                      $    990        1,801 
   Notes payable                                                  387          192 
   Trade accounts payable                                       2,164        2,542 
   Accrued taxes other than income taxes                        1,025          979 
   Bank overdraft                                                 817        1,479 
   Other accrued liabilities                                    1,294          805 
                                                             --------      ------- 
     Total current liabilities                                  6,677        7,798 
                                                                                   
 Long-term debt                                                45,198        1,093 
 Deferred credits and other noncurrent liabilities              7,535        6,488 
 Redeemable preferred stock                                    30,000       30,000 
 Stockholders' equity                                                              
   Preferred stock                                                  -            - 
   Common stock                                                   128          128 
   Capital in excess of par value                              68,808       68,372 
   Retained earnings                                          114,498      111,496 
   Unamortized restricted stock awards                           (300)           - 
                                                             --------      ------- 
     Total stockholders' equity                               183,134      179,996 
                                                             --------      ------- 
                                                                                   
     Total liabilities and stockholders' equity              $272,544      225,375 
                                                             ========      =======  
</TABLE>


See accompanying notes to consolidated financial statements.

                                      29
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                                AND SUBSIDIARIES
                       Consolidated Statements of Income
             For the Years Ended December 31, 1998, 1997, and 1996
             -----------------------------------------------------
                (Thousands of dollars, except per share amounts)

<TABLE>
<CAPTION>
                                                      1998      1997     1996
                                                  --------   -------   ------
<S>                                               <C>        <C>       <C>
Net sales                                         $106,957   104,208   86,498
                                                  --------   -------   ------
 
Costs and expenses
 Cost of sales                                      75,656    67,625   61,076
 Depreciation, amortization, and
   cost of fee timber harvested                      7,331     4,912    4,109
 General and administrative expenses                 5,692     6,062    3,373
                                                  --------   -------   ------
 
   Total costs and expenses                         88,679    78,599   68,558
                                                  --------   -------   ------
 
   Operating income                                 18,278    25,609   17,940
 
Equity in loss of Del-Tin Fiber                     (4,657)        -        -
Interest income                                      1,122       646    3,070
Interest expense                                    (1,387)     (370)    (284)
Other income/(expense)                                 421     1,367    1,207
                                                  --------   -------   ------
 
Income before income taxes                          13,777    27,252   21,933
 
Income taxes                                        (5,303)  (10,678)  (8,772)
                                                  --------   -------   ------
 
   Net income                                     $  8,474    16,574   13,161
                                                  ========   =======   ======
 
Earnings per Common share*
 Basic                                            $    .48      1.29     1.03
                                                  ========   =======   ======
 Assuming dilution                                $    .48      1.29     1.03
                                                  ========   =======   ======
 
Dividends declared per Common share               $    .25       .25      N/A
                                                  ========   =======   ======
 
Average Common shares outstanding (thousands)*      12,812    12,798   12,798
                                                  ========   =======   ======
</TABLE>



* 1996 amounts are presented on a pro forma basis. The distribution of the
  Company's Common Stock did not occur until December 31, 1996.


See accompanying notes to consolidated financial statements.

                                      30
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                     Consolidated Statements of Cash Flows
             For the Years Ended December 31, 1998, 1997, and 1996
             -----------------------------------------------------  
                            (Thousands of dollars)


<TABLE> 
<CAPTION> 
                                                                                1998               1997               1996
                                                                            --------           --------           --------
<S>                                                                         <C>                <C>                <C>   
Operating activities
    Net income                                                              $  8,474             16,574             13,161
    Adjustments to reconcile above income to
      net cash provided/(required) by operating activities
       Depreciation, amortization, and cost of
         fee timber harvested                                                  7,331              4,912              4,109
       Deferred and noncurrent income taxes                                    1,255                (65)                52
       (Gains)/losses from sales of assets                                       (77)            (1,449)              (844)
       Real estate costs recovered upon sale                                   4,993              3,732              2,942
       Equity in loss of Del-Tin Fiber                                         4,657                  -                  -
       (Increase)/decrease in operating working
         capital other than cash and cash equivalents                           (184)              (503)               610
       Other                                                                     538                716              1,701
                                                                            --------           --------           --------
          Net cash provided/(required) by operating activities                26,987             23,917             21,731
                                                                            --------           --------           --------

Investing activities
    Capital expenditures requiring cash                                      (80,124)           (35,729)           (14,134)
    Net change in purchased stumpage inventory                                (2,665)            (2,924)             2,781
    Proceeds from sales of assets                                                374              1,359              2,850
    Net (additions)/reductions to noncurrent receivable
      from Murphy Oil                                                              -                  -             10,938
    Investment in and advances to Del-Tin Fiber - net                         (3,860)              (299)            (6,811)
    Other - net                                                                  758                469               (205)
                                                                            --------           --------           --------
          Net cash provided/(required) by investing activities               (85,517)           (37,124)            (4,581)
                                                                            --------           --------           --------

Financing activities
    Proceeds from issuance of Redeemable Preferred
      Stock, net of issuance cost of $395                                          -             29,605                  -
    Proceeds from long-term borrowings                                        88,072              3,000                  -
    Repayments of long-term debt                                             (44,993)            (4,794)              (419)
    Prepaid interest and debt issuance costs -
      long-term borrowings                                                    (1,307)                 -                  -
    Increase/(decrease) in bank overdraft                                       (662)             1,479                  -
    Preferred Stock dividends paid                                            (2,262)                 -                  -
    Common Stock dividends paid                                               (3,203)            (3,200)                 -
                                                                            --------            -------           -------- 
          Net cash provided/(required) by financing activities                35,645             26,090               (419)
                                                                            --------            -------           --------

Net increase/(decrease) in cash and cash equivalents                         (22,885)            12,883             16,731
Cash and cash equivalents at beginning of year                                31,045             18,162              1,431
                                                                            --------            -------           --------

Cash and cash equivalents at end of year                                    $  8,160             31,045             18,162
                                                                            ========            =======            =======
</TABLE> 

See accompanying notes to consolidated financial statements.

                                       31
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                Consolidated Statements of Stockholders' Equity
             For the Years Ended December 31, 1998, 1997, and 1996
             -----------------------------------------------------
                             (Thousands of dollars)

<TABLE>
<CAPTION>
                                                                1998      1997      1996
                                                            --------   -------   ------- 
<S>                                                         <C>        <C>       <C>
Cumulative Preferred Stock - $.01 par, authorized
 20,000,000 shares, 600,000 shares issued as
 Redeemable Preferred Stock at end of year
 (See Note 10 - Redeemable Preferred Stock)                 $      -         -         -
                                                            --------   -------   -------
 
Common Stock - $.01 par, authorized 50,000,000
 shares; 12,813,879, 12,798,323, and 12,798,323
 shares issued at end of 1998, 1997, and 1996,
 respectively                                                    128       128       128
                                                            --------   -------   -------
 
Capital in excess of par value
 Balance at beginning of year                                 68,372    68,372    66,301
 Capital contributions by Murphy Oil for administrative
   and financial services, net of tax                              -         -       384
 Transfer of prepaid retirement and accrued
   postretirement benefit obligation from Murphy Oil
   at spin-off, net of tax                                         -         -     1,687
 Exercise of stock options                                        58         -         -
 Restricted stock awards                                         378         -         -
                                                            --------   -------   -------
 Balance at end of year                                       68,808    68,372    68,372
                                                            --------   -------   -------
 
Retained earnings
 Balance at beginning of year                                111,496    98,208   103,860
 Net income                                                    8,474    16,574    13,161
 Preferred Stock dividends accrued                            (2,269)      (86)        -
 Common Stock dividends declared, $.25 per share              (3,203)   (3,200)        -
 Noncash dividends to Murphy Oil                                   -         -   (18,813)
                                                            --------   -------   -------
 Balance at end of year                                      114,498   111,496    98,208
                                                            --------   -------   -------
 
Unamortized restricted stock awards
 Balance at beginning of year                                      -         -         -
 Stock awards                                                   (378)        -         -
 Amortization to expense                                          78         -         -
                                                            --------   -------   -------
 Balance at end of year                                         (300)        -         -
                                                            --------   -------   -------
 
Total stockholders' equity                                  $183,134   179,996   166,708
                                                            ========   =======   =======
</TABLE>


See accompanying notes to consolidated financial statements.

                                      32
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES

    Principles of Consolidation -- The consolidated financial statements include
       the accounts of Deltic and all majority-owned subsidiaries after
       elimination of significant intercompany transactions and accounts.

    Use of Estimates  --  In the preparation of financial statements of the 
       Company in conformity with generally accepted accounting principles, 
       management has made a number of estimates and assumptions related to the
       reporting of assets and liabilities and the disclosure of contingent 
       assets and liabilities. Actual results may differ from those estimates.

    Cash Equivalents  --  Cash equivalents include U. S. government securities
       that have a maturity of three months or less from the date of purchase.

    Allowance for Doubtful Accounts  --  The Company provides an allowance for
       doubtful accounts based on a review of the specific receivables 
       outstanding. At December 31, 1998 and 1997, the balance in the allowance
       account was $189,000 and $95,000, respectively.

    Inventories  --  Inventories of logs, lumber, agricultural products, and 
       supplies are stated at the lower of cost or market, primarily using the
       average cost method. Log costs include harvest and transportation cost 
       as appropriate. Lumber costs include materials, labor, and production 
       overhead.

    Investment in Real Estate Held for Development and Sale  --  Real estate 
       held for development and sale is stated at the lower of cost or net 
       realizable value, and includes direct costs of land and land development
       and indirect costs, including amenities, less amounts charged to cost 
       of sales. These costs are allocated to individual lots or acreage sold 
       based on relative sales value. Direct costs are allocated on a specific 
       neighborhood basis, while indirect costs for the Company's three 
       development areas, Chenal Valley, Chenal Downs, and Red Oak Ridge, are 
       allocated to neighborhoods over the entire respective development area.

    Investment in Del-Tin Fiber -- Investment in Del-Tin Fiber L.L.C. ("Del-Tin
       Fiber"), the 50 percent- owned limited liability company, is carried at
       cost and is being adjusted for the Company's proportionate share of its
       undistributed earnings or losses.

    Timber and Timberlands  --  Timber and timberlands, which includes 
       purchased stumpage inventory and logging facilities, is stated at 
       acquisition cost less cost of fee timber harvested and accumulated 
       depreciation of logging facilities. The cost of fee timber harvested is 
       based on the volume of timber harvested in relation to the estimated 
       volume of timber recoverable. Logging facilities, which consist 
       primarily of the cost of roads constructed and other land improvements, 
       are depreciated by using the straight-line method over a ten-year 
       estimated life. The Company estimates its fee timber inventory using 
       statistical information and data obtained from physical measurements and
       other information gathering techniques. The cost of timber and 
       timberland purchased and reforestation costs are capitalized. Fee 
       timber carrying costs are expensed as incurred.

                                       33
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


    Property, Plant, and Equipment -- Property, plant, and equipment is stated
       at cost less accumulated depreciation. Depreciation of buildings,
       equipment, and other depreciable assets is primarily determined by using
       the straight-line method. Property, plant, and equipment assets are
       evaluated for possible impairment on a specific asset basis or in groups
       of similar assets, as applicable. Expenditures that substantially improve
       and/or increase the useful life of facilities and equipment are
       capitalized. Maintenance and repair costs are expensed as incurred. Gains
       and losses on disposals or retirements are included in income as they
       occur.

    Revenue Recognition  --  Revenue from the sale of lumber, wood by-products,
       and agricultural commodities is generally recorded at the time of
       shipment. Revenue from the sale of timber-cutting rights to third parties
       is recorded when legal title passes to the purchaser. Revenue from
       intersegment timber sales is recorded when the timber is harvested; such
       intersegment sales, which are made at market prices, are eliminated in
       the consolidated financial statements. Revenue from real estate sales is
       recorded when the sale is closed and legal title is transferred.

    Income Taxes -- The Company uses the asset and liability method of
       accounting for income taxes. Under this method, the provision for income
       taxes includes amounts currently payable and amounts deferred as tax
       assets and liabilities, based on differences between the financial
       statement carrying amounts and the tax basis of existing assets and
       liabilities, and is measured using the enacted tax rates that are assumed
       will be in effect when the differences reverse.

       The Company was included in the consolidated federal tax return of Murphy
       Oil Corporation ("Murphy Oil"), Deltic's parent prior to its spin-off,
       for the 1996 period for which income statements are presented; however,
       for financial accounting purposes, federal income tax has been computed
       and recorded as if the Company filed a separate federal income tax
       return. Deltic filed its initial separate federal income tax return for
       the year of 1997.

    Pensions and Other Postretirement Benefits  --  Effective December 31, 1998,
       the Company adopted Statement of Financial Accounting Standards ("SFAS")
       132, Employers' Disclosures about Pensions and Other Postretirement
       Benefits. The provisions of SFAS 132 revise employers' disclosures about
       pension and other postretirement benefit plans. It does not change the
       measurement or recognition of these plans. It standardizes the disclosure
       requirements for pensions and other postretirement benefits to the extent
       practicable. (For details of required disclosures, see Note 15 - Employee
       and Retiree Benefits.)

    Stock-Based Compensation  --  The Company applies the accounting measurement
       provisions of Accounting Principles Board Opinion ("APB") 25 to account
       for stock-based compensation. Cost of options granted are accrued over
       applicable vesting periods and adjusted for subsequent changes in the
       market value per share of the Company's Common Stock.

    Capital Expenditures -- Capital expenditures include additions to Investment
       in Real Estate Held for Development and Sale; Timber and Timberlands; and
       Property, Plant, and Equipment.

    Net Change in Purchased Stumpage Inventory  --  Purchased stumpage inventory
       consists of timber-cutting rights purchased from third parties
       specifically for use in the Company's sawmills. Depending on the timing
       of acquisition and usage of this acquired stumpage inventory, the net
       change in

                                       34
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


       inventory can either be a source or use of funds in the Company's 
       Consolidated Statements of Cash Flows.

    Earnings per Common Share -- Earnings per share ("EPS") amounts presented
       were calculated under the provisions of SFAS 128, Earnings per Share.
       Basic earnings per share is computed based on earnings available to
       Common shareholders (net income less accrued preferred dividends) and the
       weighted average number of Common shares outstanding. The earnings per
       share assuming dilution amounts presented are computed based on earnings
       available to Common shareholders and the weighted average number of
       Common shares outstanding, including shares assumed to be issued under
       the Company's stock option plan. (For a reconciliation of amounts used in
       per share computations, see Note 18 - Earnings per Share.)

    Reclassifications -- Certain prior year amounts have been reclassified to
       conform with the 1998 presentation format.

NOTE 2 - SPIN-OFF FROM MURPHY OIL CORPORATION

    On December 31, 1996, Deltic Timber Corporation became an independent,
    public company when Murphy Oil, the Company's former parent, surrendered 100
    percent of the outstanding shares of Deltic Common Stock, which were
    distributed to Murphy Oil's shareholders as a dividend. Through December 10,
    1996, the Company operated under Murphy Oil's consolidated cash management
    policy. Under this policy, Deltic remitted cash funds generated in excess of
    its daily operating and capital requirements to Murphy Oil. Such remitted
    funds gave rise to an interest-bearing receivable that was due on demand.
    Settlement of this receivable was accomplished by recording noncash
    dividends from Deltic to Murphy Oil, in the amount of $18,813,000, and a
    cash repayment by Murphy Oil to the Company of $17,200,000, leaving a net
    receivable of $1,858,000 at December 31, 1996, with no amount due at
    December 31, 1998 and 1997. Deltic realized interest income from Murphy Oil,
    related to this receivable, of $2,374,000 in 1996.

    Murphy Oil personnel historically performed certain administrative and
    financial services on behalf of the Company. These services included, among
    others, cash management and consultation related to certain personnel,
    employee benefit, and income tax matters. During 1997, Murphy Oil continued
    to provide, or caused to be provided, certain specified services for a
    transitional period ending June 30, 1997. Deltic personnel have assumed
    responsibility for all functions previously provided by Murphy Oil. The
    Company recorded charges of $427,000 in 1997 and $1,250,000 in 1996 for
    these services. Of the total amount expensed for services during 1996,
    $630,000 ($384,000 net of tax) was a capital contribution (recorded as an
    adjustment to Capital in Excess of Par Value) by Murphy Oil since payment
    was not required. The cost for each year was included in General and
    Administrative Expenses in the Consolidated Statements of Income for the
    respective years.

    In addition, during 1996, capital contributions by Murphy Oil were recorded
    as a result of the transfer of $1,177,000 for prepaid retirement cost and
    $1,419,000 for accrued postretirement obligations from Murphy Oil to Deltic
    for employees and retirees transferred between the two companies. These
    capital contributions ($1,687,000 net of income taxes) are recorded as
    adjustments to Capital in Excess of Par Value.

                                       35
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


NOTE 3 - INVENTORIES

    Inventories at December 31 consisted of the following:

<TABLE> 
<CAPTION> 
       (Thousands of dollars)                                                          1998          1997
                                                                                      -----         -----
       <S>                                                                          <C>             <C> 
       Logs                                                                         $ 1,942         3,278
       Finished products                                                              3,616         5,058
       Materials and supplies                                                           293           259
                                                                                    -------        ------
                                                                                    $ 5,851         8,595
                                                                                    =======        ======
</TABLE> 

NOTE 4 - ACQUISITION OF CHENAL COUNTRY CLUB, INC.

    During 1997, the Company acquired the net assets of Chenal Country Club, the
    entity that had operated the club amenity around which Deltic's Chenal
    Valley real estate development is centered. The cost of the clubhouse and
    golf course facilities acquired is being accounted for as an additional
    amenity for the Chenal Valley development. The acquisition was accomplished
    by exchanging an interest-bearing receivable from the club membership, which
    had been previously held by Deltic, in the amount of $5,600,000, for the
    clubhouse and golf course facilities and an investment in 100 percent of the
    stock of Chenal Country Club, Inc., a wholly-owned subsidiary formed, at the
    time of the acquisition, to continue the daily operating activities of the
    club. The operating assets of the former Chenal Country Club, excluding the
    clubhouse and golf course facilities, were transferred to this subsidiary.

    Deltic had previously constructed the clubhouse and golf course and
    purchased the original operational assets of the club amenity and sold them
    to the club membership in exchange for the original interest-bearing
    receivable. Chenal Country Club, Inc. continued to operate the club for the
    remainder of 1997 and the entire year of 1998. The results of operations of
    Chenal Country Club, Inc., since the date of the acquisition, are included
    in the accompanying financial statements. However, upon the exchange of the
    interest-bearing receivable for the acquisition, Deltic ceased to earn
    interest income related to the receivable as of April 30, 1997.

    The acquisition was recorded using the purchase method of accounting for
    business combinations. Operating income of Chenal Country Club, Inc.
    included in the amounts reported in the Consolidated Statement of Income for
    1997 was $104,000, and was comprised of net sales of $2,277,000, cost of
    sales of $2,065,000, and depreciation expense of $108,000. Due to the
    approximately break-even level for operating income of Chenal Country Club,
    Inc., Deltic's financial statements would not be materially impacted had the
    operations of this new subsidiary been included for 1996 and the entire year
    of 1997. Interest income on the receivable from the club membership prior to
    the acquisition was $173,000 in 1997 and $542,000 in 1996.

NOTE 5 - INVESTMENT IN DEL-TIN FIBER

    Deltic owns 50 percent of the membership interest of Del-Tin Fiber, which
    completed construction of a medium density fiberboard ("MDF") plant near El
    Dorado, Arkansas, in April 1998. The cost to construct the plant was
    approximately $100,000,000. Each of Del-Tin Fiber's two owners recorded an
    initial investment of approximately $12,000,000, with the remainder financed
    by Del-Tin Fiber with a combination of borrowings and issuance of
    interest-bearing bonds. Separate project financing for the plant was
    finalized during 1998.

                                       36
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


    Each owner has agreed to a contingent equity contribution agreement with
    Del-Tin Fiber and the group of banks from whom the project financing was
    obtained. Under this agreement, each owner has agreed to fund any deficiency
    in contributions to either Del-Tin Fiber's bond sinking fund or debt service
    reserve, if any, up to $17,500,000. Del-Tin Fiber's project financing
    agreement does not require sinking fund or debt reserve contributions until
    2000. In addition, each owner has committed to a production support
    agreement, under which each owner has agreed to make support obligation
    payments to Del-Tin Fiber to provide, on the occurrence of certain events,
    additional funds for payment of debt service if the plant is unable to
    successfully complete a minimum production test, planned for the summer of
    1999. Both owners of Del-Tin Fiber have also pledged their respective
    membership interest in the joint venture as collateral under the project
    financing agreement.

    Under the operating agreement, Del-Tin Fiber's employees operate the plant.
    Deltic has committed to provide a portion of the plant's fiber and wood fuel
    supply at market prices. During 1998, Deltic sold approximately $2,126,000
    of these lumber manufacturing by-products to Del-Tin Fiber. The plant
    commenced production operations on April 29, 1998.

    The results of operations for years ended December 31 and financial position
    at December 31 for Del-Tin Fiber consisted of the following:

<TABLE> 
<CAPTION> 
       (Thousands of dollars)                                                                1998               1997
                                                                                         --------           --------
       <S>                                                                               <C>                <C> 
       Condensed Balance Sheet Information
          Current assets                                                                 $ 10,427              9,712
          Property, plant, and equipment - net                                             98,147             82,589
          Other noncurrent assets                                                           4,962              9,940
                                                                                         --------           --------
                 Total assets                                                            $113,536            102,241
                                                                                         ========           ========

          Current liabilities                                                            $ 10,805             51,512
          Long-term debt                                                                   89,000             51,000
          Members' capital/(deficit)                                                       13,731               (271)
                                                                                         --------           --------
                 Total liabilities and members' capital/(deficit)                        $113,536            102,241
                                                                                         ========           ========

       Condensed Income Statement Information
          Net sales                                                                      $  7,365                  -
                                                                                         --------           --------
          Costs and expenses
             Cost of sales                                                                 11,223                  -
             Depreciation                                                                   1,473                  -
             General and administrative expenses                                            2,388                279
                                                                                         --------           --------
                 Total costs and expenses                                                  15,084                279
                                                                                         --------           --------

                 Operating income/(loss)                                                   (7,719)              (279)
          Interest income                                                                     105                  -
          Interest expense                                                                 (2,564)                 -
          Other income/(expense)                                                                -                  4
                                                                                         --------           --------
                 Net income/(loss)                                                       $(10,178)              (275)
                                                                                         ========           ======== 
</TABLE> 

                                       37
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


    At December 31, 1998 and 1997, the Company's share of the underlying net
    assets of Del-Tin Fiber exceeded its investment by $167,000 and $577,000,
    respectively. The excess relates primarily to interest received by the
    Company from Del-Tin Fiber prior to plant start-up, which was capitalized by
    Deltic as a reduction of its investment, and is being amortized into income
    using the straight-line method over a 60-month period.

    The Company accounts for its investment in Del-Tin Fiber under the equity
    method. Accordingly, the investment in Del-Tin Fiber is carried at cost,
    adjusted for the Company's proportionate share of earnings or losses
    recorded on a one-month lag basis.

NOTE 6 - TIMBER AND TIMBERLANDS

    Timber and timberlands at December 31 consisted of the following:

<TABLE> 
<CAPTION> 
       (Thousands of dollars)                                              1998           1997
                                                                      ---------      ---------
       <S>                                                            <C>            <C>                 
       Purchased stumpage inventory                                   $  13,210         10,545
       Timberlands                                                       54,710         44,846
       Fee timber                                                       128,242         80,534
       Logging facilities                                                 1,610          1,592
                                                                      ---------      ---------
                                                                        197,772        137,517
       Less accumulated cost of fee timber harvested              
         and facilities depreciation                                    (31,184)       (29,311)
                                                                      ---------      ---------
                                                                      $ 166,588        108,206
                                                                      =========      =========
</TABLE> 

    Cost of fee timber harvested amounted to $1,800,000 in 1998, $1,404,000 in
    1997, and $1,060,000 in 1996. Depreciation of logging facilities was
    $73,000, $84,000, and $94,000 for the years 1998, 1997, and 1996,
    respectively.

    The Company obtains a portion of its sawmill log requirements by acquiring
    purchased stumpage inventory through cutting contracts with various private
    and governmental landowners. These contracts have terms ranging from a few
    months to several years. At December 31, 1998, the Company's total
    commitment under such contracts amounted to approximately $8,196,000. Based
    on lumber prices at December 31, 1998, management estimated the fair value
    of stumpage under such contracts to be approximately $6,262,000. Depending
    on the market value of this stumpage at time of harvest, the Company's
    sawmills may experience favorable or unfavorable log supply costs. By
    February 5, 1999, the lumber market had improved to the point that the
    estimated fair value of timber under these contracts had increased to
    approximately $7,250,000.

                                       38
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


NOTE 7 - PROPERTY, PLANT, AND EQUIPMENT

    Property, plant, and equipment at December 31 consisted of the following:

<TABLE> 
<CAPTION> 
                                              Range of
       (Thousands of dollars)               Useful Lives                      1998           1997
                                            ------------                  --------       --------
       <S>                                  <C>                           <C>            <C> 
       Land                                     N/A                       $  4,425          4,158
       Land improvements                    10-20 years                      4,046          3,294
       Buildings and structures             10-20 years                      8,573          7,966
       Machinery and equipment               3-15 years                     62,949         58,138
                                                                          --------       --------
                                                                            79,993         73,556
       Less accumulated depreciation                                       (35,889)       (33,910)
                                                                          --------       --------
                                                                          $ 44,104         39,646
                                                                          ========       ======== 
</TABLE> 

    Gains/(losses) on disposals or retirements included in income were $77,000
    in 1998, $1,449,000 in 1997 ($1,196,000 for involuntary conversion of Ola
    planermill due to fire and $186,000 from the sale of 9.5 acres of
    undeveloped real estate acreage), and $844,000 in 1996 ($787,000 from the
    sale of Arkansas farmland).

NOTE 8 - INDEBTEDNESS

    The Company's indebtedness at December 31 consisted of the following:

<TABLE> 
<CAPTION> 
       (Thousands of dollars)                                                1998           1997
                                                                          -------        -------
       <S>                                                          <C>                <C>  
       Short-term notes, 4.5%*                                           $    387            192
       Installment timber notes payable, 4.1%*,                     
         due 1999-2000                                                        394          2,114
       Note payable, 8%, due 1999                                             750            750
       Note payable, 6.6%, due 2001                                         5,000              -
       Senior notes payable, 6.7%, due 2008                                40,000              -
       Other notes payable, 6.9%*, due 1999-2000                               44             30
                                                                         --------       --------
                                                                           46,575          3,086
       Less:  Short-term notes                                               (387)          (192)
                Current maturities of long-term debt                         (990)        (1,801)
                                                                         --------       --------
       Long-term debt at December 31                                     $ 45,198          1,093
                                                                         ========       ========
</TABLE> 

       *Weighted average interest rate at December 31, 1998.

    On December 18, 1998, the Company successfully completed negotiation of the
    private placement of $40,000,000 of senior notes with Pacific Coast Farm
    Credit Services, ACA. These unsecured notes have a fixed stated interest
    rate of 6.7 percent and mature on December 18, 2008. No installment payments
    are required, but the terms allow for prepayments at the option of the
    Company. The agreement contains certain restrictive financial covenants,
    including a minimum consolidated tangible net worth of the sum of
    $135,000,000, plus 25 percent of cumulative consolidated adjusted net income

                                       39
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


    from October 1, 1998, and a maximum funded debt/capitalization ratio of .6
    to 1. The Company incurred $226,000 of costs related to the issuance of
    these notes, which was deferred and is being amortized as additional
    interest expense over the term of the underlying debt.

    In anticipation of issuance of these notes, the Company entered into and
    settled an interest rate hedge contract. Upon settlement of this contract in
    December 1998, the Company paid $1,081,000, which was deferred and is being
    amortized as additional interest expense over the term of the underlying
    debt, resulting in an effective interest rate for these notes of
    approximately 6.9 percent.

    The scheduled maturities of long-term debt for the next five years are
    $990,000 in 1999, $198,000 in 2000, and $5,000,000 in 2001. (For additional
    information regarding financial instruments, see Note 13 - Fair Value of
    Financial Instruments.)

NOTE 9 - CREDIT FACILITIES

    In 1996, Deltic entered into an agreement with NationsBank, N.A. and other
    domestic banks which provides an unsecured, committed revolving credit
    facility totaling $100,000,000. The agreement will expire on December 31,
    2001. As of December 31, 1998, $95,000,000 of committed credit was available
    in excess of all borrowings outstanding under or supported by the facility.
    Borrowings under the agreement bear interest based upon prime or other
    various cost of funds options. Fees associated with this revolving credit
    facility include a commitment fee of .15 to .35 percent per annum on the
    unused portion of the commitment balance. The revolving credit agreement
    contains certain restrictive financial covenants, including a maximum funded
    debt/capitalization ratio of .5 to 1, which is to be maintained throughout
    the term of the credit agreement.

    The Company may also borrow up to $5,000,000 under a short-term credit
    facility with First National Bank of El Dorado. The agreement expires May 8,
    1999, with renewal annually. The amount available to the Company under this
    facility is reduced by any outstanding letters of credit issued by Deltic.
    As of December 31, 1998, letters of credit amounting to $950,000 were
    committed, resulting in $4,050,000 available to the Company. Borrowings bear
    interest based upon the New York Prime and the facility carries a commitment
    fee of .1 percent per annum on the unused amount of the facility.

    In addition, Deltic entered into an agreement with First Commercial Bank of
    Little Rock which provides a $2,555,000 credit facility used primarily to
    support letters of credit issued in connection with the Company's purchased
    stumpage procurement and real estate development operations. The agreement,
    which is renewable annually, carries no facility fees and borrowings bear
    interest based upon prime. Amounts available to Deltic under the facility
    are reduced by any outstanding letters of credit, which amounted to the
    entire balance of the facility at December 31, 1998, leaving none available
    to the Company. (For additional information regarding these financial
    instruments, see Note 13 - Fair Value of Financial Instruments.)

                                       40
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


NOTE 10 - REDEEMABLE PREFERRED STOCK

    During 1997, the Company issued 600,000 shares of its authorized Preferred
    Stock having a par value of $.01 per share. Redemption of these shares,
    designated as Cumulative Mandatory Redeemable Preferred Stock, 7.54% Series
    ("Redeemable Preferred Stock"), by the Company is mandatory on December 31,
    2002 ("Mandatory Redemption Date"). These Redeemable Preferred shares have
    no voting rights, except if at any time, cumulative dividends payable for
    these shares become in arrears for an amount equal to dividends payable for
    six quarterly dividends or the shares are not redeemed in full on the
    Mandatory Redemption Date. If either occurs, the holders of the Redeemable
    Preferred shares shall have the right to elect a director to the Board of
    Directors, which would be in addition to the current number of directors.
    This right shall continue until such time that all cumulative unpaid
    dividends have been paid or the Redeemable Preferred shares are redeemed.

NOTE 11 - INCOME TAXES

    The components of income tax expense/(benefit) for the three years ended
    December 31, 1998, 1997, and 1996 consisted of the following:

<TABLE> 
<CAPTION>
       (Thousands of dollars)                                           1998            1997            1996
<S>                                                                  -------         -------         -------
       Federal                                                    <C>                <C>             <C> 
          Current                                                    $ 3,388           9,143           7,270
          Deferred and noncurrent                                      1,255             (65)             52
                                                                     -------         -------         -------
                                                                       4,643           9,078           7,322
       State                                     
          Current                                                        660           1,600           1,450
                                                                     -------         -------         -------
             Total                                                   $ 5,303          10,678           8,772
                                                                     =======         =======         =======
</TABLE> 

    A reconciliation of the U. S. statutory income tax rate to the Company's
    effective rates on income before income taxes consisted of the following:

<TABLE> 
<CAPTION> 
                                                                        1998            1997            1996
                                                                     -------          ------         -------
<S>                                                                  <C>              <C>            <C>  
       Statutory income tax rate                                          35%             35%             35%
       State income taxes, net of federal income tax benefit               4               4               4
       Other                                                              (1)              -               1
                                                                     -------          ------         -------
          Effective income tax rate                                       38%             39%             40%
                                                                     =======          ======         =======
</TABLE> 

                                       41
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


    An analysis of the Company's deferred tax assets and deferred tax
    liabilities at December 31, 1998 and 1997, showing the tax effects of
    significant temporary differences, consisted of the following:

<TABLE> 
<CAPTION> 
       (Thousands of dollars)                                                              1998           1997
                                                                                       --------       --------
<S>                                                                                <C>               <C> 
       Deferred tax assets
          Investment in real estate held for development and sale                  $      2,803          2,638
          Postretirement and other employee benefits                                        260            277
          Other deferred tax assets                                                         704            422
                                                                                      ---------      ---------
             Total deferred tax assets                                                    3,767          3,337
                                                                                      ---------      ---------
       Deferred tax liabilities                                                    
          Investment in Del-Tin Fiber                                                      (344)             -
          Timber and timberlands                                                           (217)          (244)
          Property, plant, and equipment                                                 (4,367)        (2,997)
          Other deferred tax liabilities                                                   (158)          (158)
                                                                                      ---------      ---------
             Total deferred tax liabilities                                              (5,086)        (3,399)
                                                                                      ---------      ---------
             Net deferred tax assets/(liabilities)                                 $     (1,319)           (62)
                                                                                      =========      =========
</TABLE> 

    Net noncurrent deferred tax liabilities of $1,701,000 at December 31, 1998,
    and $440,000 at December 31, 1997, are included in the Consolidated Balance
    Sheets in Deferred Credits and Other Liabilities for the respective years.
    In addition, current deferred tax assets of $382,000 at December 31, 1998,
    and $378,000 at December 31, 1997, are included in the Consolidated Balance
    Sheets in Prepaid Expenses and Other Current Assets for the respective
    years.

    In management's judgment, the Company's deferred tax assets at December 31,
    1998, will more likely than not be realized as reductions of future taxable
    income or by utilizing available tax planning strategies. There were no
    valuation allowances for deferred tax assets at the end of each year in the
    three years ended December 31, 1998.

NOTE 12- STOCKHOLDERS RIGHTS PLAN

    The Company has a Stockholders Rights Plan, which provides for each eligible
    Common shareholder to receive a dividend of one Preferred Stock purchase
    right ("Right") for each outstanding share of the Company's Common Stock
    held. The Rights will expire on December 31, 2006, unless earlier exchanged
    or redeemed. The Rights will detach from the Common Stock and become
    exercisable: (1) following a specified period of time after the date of the
    first public announcement that a person or group of affiliated or associated
    persons ("Acquiring Person"), other than certain persons, has become the
    beneficial owner of 15 percent or more of the Company's Common Stock or (2)
    following a specified amount of time of the commencement of a tender or
    exchange offer by any Acquiring Person, other than certain persons, which
    would, if consummated, result in such persons becoming the beneficial owner
    of 15 percent or more of the Company's Common Stock. In either case, the
    detachment of the Rights from the Common Stock is subject to extension by a
    majority of the directors of the Company. The Rights have certain
    antitakeover effects and will cause substantial dilution to any Acquiring
    Person that attempts to acquire the Company without conditioning the offer
    on a substantial number of Rights being acquired. The Rights are not
    intended to prevent a takeover, but rather are designed to enhance the
    ability of the Board of Directors of the Company to negotiate with an
    acquiror on behalf of all shareholders. Other terms of the Rights are set
    forth in, and the foregoing description is qualified in its entirety by, the
    Rights Agreement between the Company and Harris Trust and Savings Bank, as
    Rights Agent.

                                       42
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


NOTE 13 - FAIR VALUE OF FINANCIAL INSTRUMENTS

    The following table presents the carrying amounts and estimated fair values
    of financial instruments held by the Company at December 31, 1998 and 1997.
    The fair value of a financial instrument is the amount at which the
    instrument could be exchanged in a current transaction between willing
    parties. The table excludes cash and cash equivalents, trade accounts
    receivable, notes payable, trade accounts payable, and accrued liabilities,
    all of which had fair values approximating carrying values.

<TABLE> 
<CAPTION> 
                                                                   1998                              1997                
                                                     ----------------------------       -----------------------------
                                                     Carrying or        Estimated       Carrying or         Estimated
                                                        Notional             Fair          Notional              Fair
       (Thousands of dollars)                             Amount            Value            Amount             Value
                                                     -----------        ---------       -----------         --------- 
<S>                                                 <C>                 <C>             <C>                 <C>    
       Financial liabilities
          Long-term debt, including
            current maturities                      $    (46,188)         (46,218)           (2,894)           (2,912)
       Redeemable preferred stock                   $    (30,000)         (31,224)          (30,000)          (30,000)
       Off-balance sheet exposures                
          Letters of credit                         $     (3,505)          (3,505)           (2,536)           (2,536)
</TABLE> 

    Long-term debt, including current maturities -- The fair value is estimated
       based on current rates at which the Company could borrow funds with
       similar remaining maturities.

    Redeemable preferred stock -- The fair value is based on the redemption
       amount for the stock, discounted using the Company's estimated borrowing
       rate for debt instruments with similar remaining maturities.

    Letters of credit -- The fair value is based on the estimated cost to settle
       these obligations.

NOTE 14 - CONCENTRATION OF CREDIT RISKS

    Financial instruments which potentially subject the Company to credit risk
    are trade accounts receivable. These receivables normally arise from the
    sale of wood products, primarily finished lumber. Concentration of credit
    with respect to these trade accounts receivable is limited due to the large
    number of customers comprising the Company's customer base. No single
    customer accounted for a significant amount of the Company's sales of timber
    or wood products. At December 31, 1998, one timber sale customer's
    receivable accounted for approximately 12 percent of the Company's
    consolidated trade accounts receivable amount.

    Within the Agriculture segment, the Company is exposed to a minimal level of
    credit risk in that the majority of farm crops grown are delivered to a
    small number of grain elevators and these elevators are limited to the
    geographic area in which the Company's agriculture operations are located.
    However, receipt of payment from these elevators usually occurs at the time
    of delivery. At December 31, 1998, the Company had no significant accounts
    receivable outstanding in this area.

                                       43
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


NOTE 15 - EMPLOYEE AND RETIREE BENEFITS

    The Company provides a retirement plan and other postretirement benefits to
    its employees. Reconciliations of benefit obligations, plan assets, and
    funded status of the plans consisted of the following:

<TABLE> 
<CAPTION> 
                                                                                                       Other
                                                                        Retirement                 Postretirement
                                                                           Plan                       Benefits        
                                                                  --------------------          --------------------
       (Thousands of dollars)                                       1998          1997            1998          1997
                                                                  ------        ------          ------        ------
       <S>                                                      <C>             <C>             <C>           <C> 
       CHANGE IN BENEFIT OBLIGATION
          Benefit obligation at January 1                       $  6,558         5,187           2,602         2,123
             Service cost                                            428           354             155           131
             Interest cost                                           481           389             190           159
             Participant contributions                                 -             -               7             1
             Actuarial (gain)/loss                                 1,150           628             403           189
             Benefits paid                                           (18)            -             (35)           (1)
                                                                 -------       -------         -------       -------
          Benefit obligation at December 31                     $  8,599         6,558           3,322         2,602
                                                                 =======       =======         =======       =======

       CHANGE IN PLAN ASSETS
          Fair value of plan assets at January 1                $  9,884         8,146               -             -
             Actual return on plan assets                            632         1,738               -             -
             Employer contributions/1/                                 -             -              28           119
             Participant contributions/1/                              -             -               7           858
             Benefits paid/1/                                        (18)            -             (35)         (977)
                                                                 -------       -------         -------       -------
          Fair value of plan assets at
            December 31/2/                                      $ 10,498         9,884               -             -
                                                                 =======       =======         =======       =======

       RECONCILIATION OF FUNDED STATUS OF
         PLANS
          Funded status of plans                                $  1,899         3,326          (3,322)       (2,602)
          Unrecognized actuarial (gain)/loss                         591          (766)            533           125
          Unrecognized net asset from transition
            to SFAS 87/3/                                           (233)         (282)              -             -
          Unrecognized prior service cost                            216           241               -             -
                                                                 -------       -------         -------       -------
             Prepaid/(accrued) benefit cost/4/                  $  2,473         2,519          (2,789)       (2,477)
                                                                 =======       =======         =======       =======

       ASSUMPTIONS
          Weighted average discount rate                             6.5%          7.0%            6.5%          7.0%
          Expected return on plan assets                             8.5%          8.5%             N/A           N/A
          Rate of compensation increase                              4.6%          4.6%             N/A           N/A
</TABLE> 

    /1/1997 amounts reflect the transfer from Murphy Oil of the Company's
       portion of respective plans as of January 1, 1997.
    /2/Primarily includes listed stocks and bonds, government securities, and
       U.S. agency bonds.
    /3/Being amortized over a period of 15 years. 
    /4/Included in the Consolidated Balance Sheets in Deferred Charges and Other
       Assets/Deferred Credits and Other Noncurrent Liabilities.

                                       44
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


    Components of net periodic retirement expense/(expense reduction) and other
    postretirement benefits expense consisted of the following:

<TABLE> 
<CAPTION> 
       (Thousands of dollars)                                           1998            1997          1996
                                                                      ------          ------        ------
<S>                                                                   <C>            <C>            <C>                         
       RETIREMENT PLAN                                           
          Service cost                                                $   428           354           337
          Interest cost                                                   481           389           686
          Expected return on plan assets                                 (839)         (692)         (956)
          Amortization of prior service cost                               25            25             7
          Amortization of transitional asset                              (49)          (49)         (143)
                                                                      -------       -------       -------
             Net retirement expense/(expense reduction)               $    46            27           (69)
                                                                      =======       =======       =======
                                                                 
       OTHER POSTRETIREMENT BENEFITS                             
          Service cost                                                $   156           132           136
          Interest cost                                                   190           159           296
          Recognized actuarial (gain)/loss                                  1             -             1
                                                                      -------       -------       -------
             Other postretirement benefits expense                    $   347           291           433
                                                                      =======       =======       =======
</TABLE>

    Through December 31, 1996, Deltic employees were participants in the
    employee and retiree benefit plans of Murphy Oil. Amounts presented for 1996
    reflect the Company's portion of these respective plans. Effective January
    1, 1997, separate plans were implemented for active Deltic employees. Any
    vesting in the plans of Murphy Oil was retained by employees for Deltic's
    plans; and plans implemented by the Company were similar, in all aspects, to
    those of Murphy Oil.

    Retirement Plan -- The Company has a noncontributory, defined benefit
       retirement plan that covers substantially all employees. Benefits are
       based on years of service, including those with Murphy Oil, and final
       career-average-pay formulas as defined by the plan.

    Thrift Plan -- Employees of the Company may participate in its thrift plan
       by allotting up to a specific percentage of their base pay. The Company
       matches contributions at a stated percentage of each employee's
       allotment, based on length of participation in the plan. Company
       contributions to this plan were $371,000 in 1998, $279,000 in 1997, and
       $190,000 in 1996.

    Postretirement Benefits -- The Company sponsors a plan that provides
       Comprehensive health care benefits (supplementing Medicare benefits for
       those eligible) and life insurance benefits for retired employees. Costs
       are accrued for this plan during the service lives of covered employees.
       Retirees contribute a portion of the self-funded cost of health care
       benefits; the Company contributes the remainder. The Company pays
       premiums for life insurance coverage, arranged through an insurance
       company. The health care plan is funded on a pay-as-you-go basis. The
       Company retains the right to modify or terminate the benefits and/or cost
       sharing provisions.

                                       45
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


    In determining the accumulated benefit obligation for health care, at
    December 31, 1998 and 1997, health care inflation cost was assumed to
    increase at an annual rate of 7.5 percent, decreasing one percent per year
    to 4.5 percent in 2002 and thereafter. A one percentage-point increase in
    the assumed health care cost trend rate would increase the aggregate service
    and interest cost components of periodic benefit cost for 1998 by $42,000
    and the benefit obligation by $364,000, while a one percentage-point
    decrease in the assumed rate would decrease the 1998 cost components by
    $39,000 and the benefit obligation by $338,000.

NOTE 16 - INCENTIVE PLANS

    STOCK INCENTIVE PLAN

    The Company's 1996 Stock Incentive Plan ("the Plan") permits annual awards
    of shares of the Company's Common Stock to executives and other key
    employees. Under the Plan, the Executive Compensation Committee ("the
    Committee") is authorized to grant: (1) stock options, nonqualified or
    incentive; (2) stock appreciation rights; and (3) restricted stock awards.
    Total annual options granted, excluding any replacement options issued due
    to the spin-off from Murphy Oil, may not exceed .5 percent of Common shares
    issued and outstanding as of the date of issuance of the options. In
    subsequent years, the Committee may award up to .5 percent of Common shares
    issued and outstanding at the end of the preceding year; any allowed shares
    not granted may be available for grant in subsequent years. The Company
    applies APB 25 to account for stock-based compensation plans. Cost of
    options are accrued over the vesting periods and adjusted for subsequent
    changes in fair market value of the shares.

    Stock Options -- For each option granted under the Plan, the Committee fixes
       the option price at no less than fair market value on the date of the
       grant and the option term, not to exceed 10 years from date of grant.
       Replacement options granted were for 10 years from original grant date
       and nonqualified. Options granted in 1998 and 1997 were for 10 years and
       primarily incentive. All options have an option price no less than the
       fair market value on the grant date, with a range in option prices of
       $9.90 to $28.03 per share, and each grantee is permitted to surrender
       options for equivalent value of stock at the date of surrender. For
       options granted in 1998, one half may be exercised or surrendered after
       one year and the remainder after three years. For options granted in
       1997, exclusive of replacement options, one half may be exercised or
       surrendered after two years and the remainder after three years.

                                       46
<PAGE>
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998

       Changes in options outstanding, including replacement options, consisted
of the following:
<TABLE> 
<CAPTION> 
                                                                                    Number             Average
                                                                                      of               Exercise
                                                                                    Options             Price  
                                                                                    -------            --------
          <S>                                                                       <C>                <C>   
          Outstanding at January 1, 1997                                                  -                 N/A
             Granted                                                                103,355            $  20.38
             Surrendered                                                                  -                 N/A
                                                                                    -------
          Outstanding at December 31, 1997                                          103,355            $  20.38
             Granted                                                                 50,950            $  28.03
             Surrendered                                                             (6,250)           $  13.01
                                                                                    -------
          Outstanding at December 31, 1998                                          148,055            $  23.33
                                                                                    =======

          Exercisable at December 31, 1997                                            9,375            $  12.78
                                                                                    =======
          Exercisable at December 31, 1998                                           17,875            $  13.01
                                                                                    =======
</TABLE> 

       Additional information about stock options outstanding at December 31,
1998, consisted of the following:

<TABLE> 
<CAPTION> 
                                                  Options Outstanding                       Options Exercisable
                                        -----------------------------------------         ------------------------
               Range of                  Number         Average          Average          Number          Average
               Exercise                    of             Life           Exercise           of            Exercise
                Prices                  Options         in Years          Price           Options          Price   
          -----------------             -------         --------         --------         -------         --------    
          <S>                           <C>             <C>              <C>              <C>             <C>   
          $ 9.90 to $13.90               25,875              6.5           $12.82          17,875           $13.01
          $23.19 to $28.03              122,180              8.5           $25.56               -              N/A
                                        -------                                            ------           
          $ 9.90 to $28.03              148,055              8.1           $23.33          17,875           $13.01
                                        =======                                            ======
</TABLE> 

    Stock Appreciation Rights  --  Stock appreciation rights may be granted in
       conjunction with, or independent of, stock options. The Committee
       determines when these rights may be exercised and the price. No stock
       appreciation rights have been granted.

    Restricted Stock  --  The Committee may award restricted stock to selected
       employees, with conditions to vesting for each grant established by the
       Committee. During the vesting period, the grantee may vote and receive
       dividends on the shares, but shares are subject to transfer restrictions
       and are all, or partially, forfeited if a grantee terminates, depending
       on the reason. The grantee may be reimbursed by the Company for personal
       income tax liability on the value of stock awarded.

       During 1998, initial grants of 13,500 shares of restricted stock were
       awarded by the Committee. The fair value per share of restricted stock
       granted was $28.03. Unearned compensation was charged for the market
       value of the restricted shares. The unearned compensation is shown as a
       reduction of shareholders' equity in the Consolidated Balance Sheet at
       December 31, 1998, as Unamortized Restricted Stock Awards, and is being
       amortized to expense over the four-year restricted period.

                                       47
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


    Stock-based compensation reflected in income was a benefit of $163,000 in
    1998 and a charge of $491,000 in 1997. Had cost of the Company's stock-based
    compensation plans been determined based on the fair value of the
    instruments at the grant dates using the provisions of SFAS 123, the
    Company's net income and earnings per share would be the following pro forma
    amounts.

<TABLE> 
<CAPTION> 
             (Thousands of dollars, except per share amounts)                 1998                1997
                                                                            -------             -------
             <S>                                                            <C>                 <C>   
             Net income                                                    
                 As reported                                                $ 8,474              16,574
                 Pro forma                                                    7,833              16,378
                                                                           
             Basic earnings per share                                      
                 As reported                                                $   .48                1.29
                 Pro forma                                                      .43                1.27
                                                                           
             Dilutive earnings per share                                   
                 As reported                                                $   .48                1.29
                 Pro forma                                                      .43                1.27
</TABLE> 

    For the pro forma net income calculation in the preceding table, the fair
    value of each option on the date of grant was estimated using the
    Black-Scholes option-pricing model and the following assumptions for awards
    in 1998 and 1997, respectively: dividend yields of .70 percent and .90
    percent; expected volatility of 25.22 percent and 26.39 percent; risk-free
    interest rates of 5.74 percent and 6.38 percent; and expected lives of five
    years. Using these assumptions, the weighted average grant-date fair value
    per share of options granted in 1998 and 1997 were $8.62 and $6.65,
    respectively.

    INCENTIVE COMPENSATION PLAN

    Cash Awards -- The Company has an Incentive Compensation Plan that provides
       for annual cash awards to officers, directors, and key employees based on
       actual results for a year compared to objectives established by the
       Executive Compensation Committee, which administers the Plan, at the
       beginning of that year. Initial awards under the Plan were granted in
       1998, based on 1997 results of operations. Provisions for cash incentive
       awards of $270,000 and $425,000 were recorded in 1998 and 1997,
       respectively; no provisions were recorded in the 1996 Consolidated
       Statement of Income presented.

                                       48
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


NOTE 17 - SUPPLEMENTAL CASH FLOWS DISCLOSURES

    Income taxes paid, net of refunds, were $5,753,000, $11,159,000, and
    $1,016,000 in 1998, 1997, and 1996, respectively. Federal income taxes for
    1996 were included in Murphy Oil's consolidated tax returns and were settled
    through intercompany accounts. Interest paid, net of amounts capitalized,
    was $1,285,000, $449,000, and $110,000 in 1998, 1997, and 1996,
    respectively.

    Noncash investing and financing activities excluded from the Consolidated
    Statements of Cash Flows were: (1) assumptions of owner-financed debt in the
    amount of $410,000 in 1998 and $496,000 in 1997 related to acquisitions of
    land and timber-cutting rights and (2) addition of $1,656,000 during 1996 to
    the noncurrent receivable from Murphy Oil as a result of recording the
    transfer of all mineral leases previously acquired by Deltic.

    (Increases)/decreases in operating working capital, other than cash and cash
    equivalents, for each of the three years ended December 31 consisted of the
    following:

<TABLE> 
<CAPTION> 
       (Thousands of dollars)                                                    1998            1997           1996
                                                                              -------         -------        -------
       <S>                                                              <C>                   <C>            <C>     
       Trade accounts receivable                                        $        (224)           (137)           378
       Other receivables                                                       (1,031)          2,532           (676)
       Inventories                                                              2,744          (2,998)         2,102
       Prepaid expenses and other current assets                               (1,822)            342           (297)
       Trade accounts payable                                                    (377)            413         (1,868)
       Accrued liabilities                                                        526            (655)           971
                                                                             --------         -------        -------

                                                                        $        (184)           (503)           610
                                                                             ========         =======        =======
</TABLE> 

NOTE 18 - EARNINGS PER SHARE

    The amounts used in computing earnings per share and the effect on income
    and weighted average number of shares outstanding of dilutive potential
    Common Stock consisted of the following:

<TABLE> 
<CAPTION> 
       (Thousands of dollars)                                                                    1998           1997
                                                                                              -------        -------
       <S>                                                                               <C>                 <C> 
       Net income                                                                        $      8,474         16,574
       Less Preferred dividends                                                                (2,269)           (86)
                                                                                              -------        -------
             Income available to Common shareholders                                     $      6,205         16,488
                                                                                              =======        =======
       Weighted average number of Common shares
         used in basic EPS                                                                     12,812         12,798
       Effect of dilutive stock options                                                            18             27
                                                                                              -------        -------
             Weighted average number of Common shares
               and dilutive potential Common Stock used in
               EPS assuming dilution                                                           12,830         12,825
                                                                                              =======        =======

       Earnings per Common share
          Basic                                                                          $        .48           1.29
                                                                                              =======           ==== 
          Assuming dilution                                                              $        .48           1.29
                                                                                              =======           ==== 
</TABLE> 

                                       49
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


    Options on 122,180 shares of Common Stock were not included in computing
    dilutive EPS for 1998 because their effects were antidilutive.

NOTE 19 - COMMITMENTS AND CONTINGENCIES

    Commitments  --  Commitments for capital expenditures at December 31, 1998,
       were approximately $205,000 for timber and timberlands; $4,091,000 for
       property, plant, and equipment; and $7,965,000 for investment in real
       estate held for development and sale.

    Contingencies -- The Company is involved in litigation incidental to its
       business from time to time. Currently, there are no material legal
       proceedings outstanding.

NOTE 20 - BUSINESS SEGMENTS

    In June 1997, the Financial Accounting Standards Board issued SFAS 131,
    Disclosures about Segments of an Enterprise and Related Information. SFAS
    131 supersedes and/or amends the business segment disclosures required under
    various preceding pronouncements, effective for fiscal years beginning after
    December 15, 1997, with earlier application encouraged. This new standard
    defines additional information to be disclosed for each reportable segment
    and requires that each operating segment for which an enterprise's chief
    operating decision maker regularly assesses performance be disclosed as a
    reportable segment. As a result, the Company has determined that its
    previous Forest Products segment should be divided into two separate
    reporting segments, Woodlands and Mills. Deltic elected to adopt SFAS 131
    effective for the first quarter of 1998. All 1997 and 1996 business segment
    information has been restated for comparative purposes.

    The Company's five reporting segments consist of Deltic's four operating
    business units and its corporate function. Each reporting entity has a
    separate management team and infrastructure that offers different products
    and/or services.

    Woodlands operations manage the Company's 397,000 acres of Southern Pine
    timberland located in Arkansas and north Louisiana and derive revenue from
    the harvest of timber from the timberlands, in accordance with its harvest
    plans, and either sells timber to third parties in the domestic market or to
    the Company's Mills segment for conversion into lumber.

    The Mills segment consists of Deltic's two sawmills which employ modern
    technology to convert timber, purchased from third parties or the Company's
    Woodlands segment, into finished lumber. These mills produce a variety of
    products, including dimension lumber, boards, timbers, decking, and
    secondary manufacturing products, such as finger-jointed studs. These
    products are sold primarily to wholesalers and lumber treaters in the South
    and Midwest and used in residential construction, roof trusses, laminated
    beams, and remanufactured items.

    Real Estate operations, which currently include three separate real estate
    developments, add value to former timberland by developing it into upscale,
    planned residential and commercial developments. These developments, each of
    which is, or will be, centered around a core amenity, are being developed in
    stages. To-date, real estate sales have consisted primarily of residential
    lots sold to builders or individuals and commercial site sales. In addition,
    this segment currently leases office space to third parties in a building
    constructed by the Company in one of its developments and is in

                                       50
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


    the process of constructing a retail center in which space will be leased to
    third-party retailers. This segment also manages a real estate brokerage
    subsidiary which currently generates commission revenue by reselling
    existing homesites in one of the Company developments.

    The Agriculture segment operates 37,000 acres of farmland in northeast
    Louisiana. Approximately 26,000 acres of the total are farmed by Deltic,
    while the majority of the remaining 11,000 acres are rented to third
    parties. Crops grown on Company-farmed acreage in 1998 were soybeans and
    corn. This business unit derives the majority of its revenues from sales of
    farm crops grown to grain elevators and from rents received from third-party
    farmland renters.

    Corporate operations consist primarily of the planning, accounting,
    information systems, human resources, treasury, income tax, and legal staff
    functions that provide support services to the operating business units. The
    Company currently does not allocate the cost of maintaining these support
    functions to its operating units.

    The accounting policies of the reportable segments are the same as those
    described in Note 1 - Significant Accounting Policies. The Company evaluates
    the performance of its segments based on operating income before equity in
    the results of Del-Tin Fiber, an equity method investee; interest income and
    expense; other nonoperating income or expense; and income taxes.
    Intersegment revenues consist primarily of timber sales from the Woodlands
    segment to the Mills operations.

    Information about the Company's business segments consisted of the
following:

<TABLE> 
<CAPTION> 
    (Thousands of dollars)                               1998            1997           1996
                                                    ---------       ---------      ---------
    <S>                                             <C>             <C>            <C>            
    Net sales
       Woodlands                                     $ 26,569          22,579         16,353
       Mills                                           65,857          67,688         57,933
       Real Estate                                     15,879          11,550          6,346
       Agriculture                                      6,484           9,509         10,585
       Eliminations/1/                                 (7,832)         (7,118)        (4,719)
                                                     --------         -------       --------
                                                     $106,957         104,208         86,498
                                                                   
    Income before income taxes
       Operating income
          Woodlands                                  $ 20,447          17,995         12,500
          Mills                                        (2,784)          7,381          3,370
          Real Estate                                   5,032           3,266          1,578
          Agriculture                                     758           2,778          2,760
          Corporate                                    (5,004)         (5,231)        (2,268)
          Eliminations                                   (171)           (580)             -
                                                     --------         -------       --------
               Operating income                        18,278          25,609         17,940
       Equity in loss of Del-Tin Fiber                 (4,657)              -              -
       Interest income                                  1,122             646          3,070
       Interest expense                                (1,387)           (370)          (284)
       Other income/(expense)                             421           1,367          1,207
                                                     --------         -------       --------
                                                     $ 13,777          27,252         21,933
                                                     ========         =======       ========
</TABLE> 

                                       51
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


<TABLE> 
<CAPTION> 
   (Thousands of dollars)                                                        1998            1997           1996
                                                                             --------        --------       --------
    <S>                                                                      <C> 
    Total assets at year-end
       Woodlands                                                             $167,364         109,167         92,915
       Mills                                                                   36,996          38,212         24,603
       Real Estate                                                             34,223          27,278         25,516
       Agriculture                                                             12,397          11,517         11,697
       Corporate/2/                                                            21,564          39,201         25,347
                                                                             --------        --------       --------
                                                                             $272,544         225,375        180,078
                                                                             ========        ========       ========
    Depreciation, amortization, and
      cost of fee timber harvested
       Woodlands                                                             $  2,481           1,598          1,243
       Mills                                                                    3,673           2,369          2,313
       Real Estate                                                                420             365            120
       Agriculture                                                                514             468            515
       Corporate                                                                  243             112            (82)
                                                                             --------        --------       --------
                                                                             $  7,331           4,912          4,109
                                                                             ========        ========       ========
    Capital expenditures
       Woodlands                                                             $ 59,839          16,380          2,754
       Mills                                                                    7,918          11,506          2,927
       Real Estate                                                             11,531           6,378          6,669
       Agriculture                                                                721           1,000            272
       Corporate                                                                  524             574          1,512
                                                                             --------        --------       --------
                                                                             $ 80,533          35,838         14,134
                                                                             ========        ========       ========
</TABLE> 

/1/ Intersegment sales of timber from Woodlands to Mills.
/2/ Includes investment in Del-Tin Fiber, an equity method investee, of
    $6,699,000 and $7,383,000 at December 31, 1998 and 1997, respectively.

                                       52
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


NOTE 21 - FINANCIAL RESULTS BY QUARTER (UNAUDITED)

(Thousands of dollars, except per share amounts)

<TABLE> 
<CAPTION>   
                                                                                      1998
                                                       ----------------------------------------------------------------------
                                                        First          Second          Third          Fourth
                                                       Quarter        Quarter         Quarter         Quarter            Year   
                                                       -------        -------         -------         -------         -------
<S>                                                   <C>             <C>             <C>             <C>             <C>          
Net sales                                             $ 27,008         26,211          29,088          24,650         106,957
Operating income                                      $  6,389          3,919           2,987           4,983          18,278
Net income                                            $  3,806          2,077             936           1,655           8,474
Earnings per Common share
    Basic                                             $    .25            .12             .03             .09             .48
    Assuming dilution                                 $    .25            .12             .03             .09             .48
Dividends per Common share                            $  .0625          .0625           .0625           .0625             .25
Market price per Common share
    High                                              $30-1/16        30-1/16              25        24-15/16         30-1/16
    Low                                               $ 26-1/4             25              18              18              18
    Close, at period end                              $29-5/16        25-1/16              18          20-3/8          20-3/8

<CAPTION> 
                                                                                      1997
                                                       ----------------------------------------------------------------------    
                                                        First         Second           Third          Fourth
                                                       Quarter        Quarter         Quarter         Quarter            Year   
                                                       -------        -------         -------         -------         -------
<S>                                                   <C>             <C>             <C>             <C>             <C>   
Net sales                                             $ 24,364         26,581          28,992          24,271         104,208
Operating income                                      $  7,815          7,199           6,523           4,072          25,609
Net income                                            $  4,865          4,544           3,881           3,284          16,574
Earnings per Common share*
    Basic                                             $    .38            .36             .30             .25            1.29
    Assuming dilution                                 $    .38            .35             .30             .25            1.29
Dividends per Common share                            $  .0625          .0625           .0625           .0625             .25
Market price per Common share
    High                                              $ 28-1/2        29-5/16          32-7/8          32-1/2          32-7/8
    Low                                               $ 22-1/4             25        24-15/16        26-15/16          22-1/4
    Close, at period end                              $ 28-3/8        29-5/16        32-11/16          27-3/8          27-3/8
</TABLE> 

*  Interim period EPS amounts for each of the first three quarters of 1997 have
   been restated as specified in SFAS 128. Amounts for basic earnings per share
   presented here are unchanged from primary EPS amounts as previously reported
   under the provisions of APB 15. The per share amounts assuming dilution have
   been added as required by SFAS 128; the Company was not previously required
   to present fully diluted EPS amounts under APB 15.

                                       53
<PAGE>
 
                           DELTIC TIMBER CORPORATION
                               AND SUBSIDIARIES
                  Notes to Consolidated Financial Statements
                               December 31, 1998


NOTE 22 - SUBSEQUENT EVENT

    On January 14, 1999, the Company announced that its Board of Directors had
    authorized the repurchase, initially, of up to $10,000,000 of its Common
    Stock. Under the program, the Company can purchase shares through the open
    market and privately negotiated transactions at prices deemed appropriate by
    management, utilizing cash provided by operations and/or from Deltic's
    credit facility.

                                       54
<PAGE>
 
                             REPORT OF MANAGEMENT
                             --------------------

The Shareholders
Deltic Timber Corporation:


The management of Deltic Timber Corporation has prepared and is responsible for
the Company's consolidated financial statements. The statements are prepared in
conformity with generally accepted accounting principles appropriate in the
circumstances. In preparing the financial statements, management has, when
necessary, made judgments and estimates with consideration given to materiality.

The Company maintains internal control systems and related policies and
procedures designed to provide reasonable assurance that assets are safeguarded
against loss or unauthorized use, that the accounting records accurately reflect
business transactions, and that the transactions are in accordance with
management's authorization. The design, monitoring, and revision of the systems
of internal control involve, among other things, our judgment with respect to
the relative cost and expected benefits of specific control measures. The
Company has engaged an outside accounting firm to provide internal audit
services in order to monitor the effectiveness of the controls, while
independently and systematically evaluating and formally reporting on the
adequacy and effectiveness of components of the system.

The Company's consolidated financial statements have been audited by KPMG LLP,
independent certified public accountants, who have expressed their opinion with
respect to the fairness of the consolidated financial statements. Their audit
was conducted in accordance with generally accepted auditing standards, which
include the consideration of the Company's internal controls to the extent
necessary to form an independent opinion on the consolidated financial
statements prepared by management. The Board of Directors appoints the
independent auditors; ratification of the appointment is solicited annually from
the shareholders.

The Audit Committee of the Board of Directors is composed of directors who are
not officers or employees of the Company. The Committee meets periodically with
the independent certified public accountants, the firm providing internal audit
services, and representatives of management to review the Company's internal
controls, the quality of its financial reporting, and the scope and results of
audits. The independent auditors have unrestricted access to the Committee,
without management's presence, to discuss audit findings and other financial
matters.



Clefton D. Vaughan
Vice President and Chief Financial Officer
February 5, 1999

                                       55
<PAGE>
 
                         INDEPENDENT AUDITORS' REPORT
                         ----------------------------

The Board of Directors
Deltic Timber Corporation:


We have audited the accompanying consolidated balance sheets of Deltic Timber
Corporation and Subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the years in the three-year period ended December 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Deltic Timber
Corporation and Subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1998, in conformity with generally accepted accounting
principles.



KPMG LLP
Shreveport, Louisiana
February 5, 1999

                                       56
<PAGE>
 
                       AUDIT COMMITTEE CHAIRMAN'S LETTER
                       ---------------------------------  


The Shareholders
Deltic Timber Corporation:


The members of the Company's Audit Committee ("the Committee") are selected by
the Board of Directors. The Committee consists of five outside directors and met
twice during 1998.

The Audit Committee oversees the financial reporting process on behalf of the
Board of Directors. As part of that responsibility, the Committee recommended to
the Board of Directors, subject to shareholder approval, the selection of the
Company's independent auditors. The Committee discussed the overall scope and
specific plans for annual audits with the outside accounting firm that provides
the Company's internal audit services and with KPMG LLP, the Company's
independent auditors. The Committee also discussed the Company's annual
consolidated financial statements and the adequacy of internal controls
currently in place. In addition, the Committee met with the internal auditors
and KPMG LLP, without management present, to discuss the results of their
respective audits, their evaluations of the Company's internal controls, and the
overall quality of the Company's financial reporting. The meetings were also
designed to facilitate any private communication with the Committee desired by
the internal audit firm or the Company's independent auditors.



John C. Shealy
Chairman, Audit Committee
February 18, 1999

                                       57
<PAGE>
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
         AND FINANCIAL DISCLOSURE.

     None

                                       58
<PAGE>
 
                                    PART III


ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

     The sections entitled "Nominees For Election as Directors" and "Directors
Whose Term of Office Continues" appearing in the Registrant's proxy statement
for the annual meeting of shareholders to be held on April 29, 1999, sets forth
certain information with respect to the directors of the registrant and is
incorporated herein by reference.  Certain information with respect to persons
who are or may be deemed to be executive officers of the Registrant is set forth
under the caption "Executive Officers of the Registrant" in Part I of this
report.

ITEM 11.   EXECUTIVE COMPENSATION

     The information required by Item 11 is incorporated by reference to the
definitive form of the Proxy Statement which was filed with the SEC on March 17,
1999.

ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information required by Item 12 is incorporated by reference to the
definitive form of the Proxy Statement which was filed with the SEC on March 17,
1999.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by Item 13 is incorporated by reference to the
definitive form of the Proxy Statement which was filed with the SEC on March 17,
1999.

                                       59
<PAGE>
 
                                    PART IV


ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

      a.   Financial Statement Schedules and Exhibits.

        1.   Consolidated Financial Statements.

             Consolidated Balance Sheets - December 31, 1998 and 1997.

             Consolidated Statements of Income for the Years Ended December
             31, 1998, 1997,and 1996.
           
             Consolidated Statements of Cash Flows for the Years Ended
             December 31, 1998, 1997, and 1996. 
           
             Consolidated Statements of Stockholders' Equity for the Years 
             Ended December 31,1998, 1997, and 1996.
            
             Notes to Consolidated Financial Statements, including
             Consolidated Quarterly Income Information (unaudited).
          
             Independent Auditors' Report on Consolidated Financial
             Statements.

        2.   Financial Statement Schedules.

             Financial Statements of Del-Tin Fiber L.L.C., an affiliate
             accounted for by the equity method, which constituted a 
             significant subsidiary for the year ended December 31, 1998.

             All other financial statement schedules are omitted because
             either they are not applicable or the required information is
             included in the consolidated financial statements or notes
             thereto.

        3.   Exhibits.

             3   Articles of Incorporation and Bylaws.

             3.1 Amended and Restated Certificate of Incorporation of
                 Deltic Timber Corporation  as of December 17, 1996
                 (incorporated by reference to Exhibit 3.1 to Registrant's
                 Annual Report on Form 10-K for the year ended December 31,
                 1996).

             3.2 Amended and Restated Bylaws of Deltic Timber Corporation
                 (incorporated by
                 reference to Exhibit 3.2 to Registrant's Annual Report on Form
                 10-K for the year ended December 31, 1996).

             4   Instruments Defining the Rights of Security Holders.

             4.1 Rights Agreement dated as of December 11, 1996 between
                 Deltic Timber Corporation and Harris Trust and Savings Bank,
                 as Rights Agent (incorporated by reference to Exhibit 4 to
                 Registrant's Annual Report on Form 10-K for the year ended
                 December 31, 1996).

                                       60
<PAGE>
 
            10   Material contracts.

            10.1 Deltic Timber Corporation 1996 Stock Incentive Plan
                 (incorporated by reference to Exhibit 10.1 to Registrant's
                 Annual Report on Form 10-K for the year ended December 31,
                 1996).

            10.2 Distribution Agreement (incorporated by reference to Exhibit
                 10.2 to Registrant's Annual Report on Form 10-K for the year
                 ended December 31,1996).

            10.3 Tax Sharing Agreement (incorporated by reference to Exhibit
                 10.3 to Registrant's Annual Report on Form 10-K for the year
                 ended December 31, 1996).

            10.4 Credit facility dated December 19, 1996 (incorporated by
                 reference to Exhibit 10.4 to Registrant's Quarterly Report 
                 on Form 10-Q for the quarter ended September 30, 1997).

            10.5 Certificate of Designation of the Cumulative Redeemable
                 Preferred Stock, 7.54% Series ($.01 Par Value), of Deltic
                 Timber Corporation (incorporated by reference to Exhibit 10.5 
                 to Registrant's Annual Report on Form 10-K for the year ended 
                 December 31, 1997).

            10.6 Fiber Supply Agreement dated February 21, 1995 with Del-Tin
                 Fiber L.L.C. (incorporated by reference to Exhibit 10.2 to
                 Registrant's Registration of Securities Report on Form 10).
                   
            10.7 Note Purchase Agreement dated December 18, 1998, included
                 elsewhere herein.

            10.8 Selective Sections of Del-Tin Fiber L.L.C.'s Project Credit
                 Agreement dated November 23, 1998, included elsewhere herein.

            21   Subsidiaries of the Registrant, included elsewhere herein.

            23   Independent Auditors' Consent, included elsewhere herein.

            27   Financial Data Schedule for 1998 (electronic filing only),
                 included elsewhere herein.

            99   Form 11-K, Annual Report for the fiscal year ended December 31,
                 1998,covering Thrift Plan of Deltic Timber Corporation.  To
                 be filed as an amendment of this Annual Report on Form 10-K,
                 not later than 180 days after December 31, 1998.

            Exhibits other than those listed above have been omitted since they
            either are not required or are not applicable.

     b. Reports on Form 8-K.

        No reports on Form 8-K were filed during the quarter ended December 31,
        1998.

                                       61
<PAGE>
 
                                   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.

DELTIC TIMBER CORPORATION



By:    /s/ Ron L. Pearce                        Date:    March 25, 1999
   -------------------------------------             --------------------------
       Ron L. Pearce, President


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on March 25, 1999 by the following persons on behalf of
the registrant and in the capacities indicated.


       /s/ Robert C. Nolan                          /s/ William L. Rosoff
----------------------------------------     --------------------------------
Robert C. Nolan, Chairman and Director            William L. Rosoff, Director



       /s/ Ron L. Pearce                            /s/ O. H. Darling, Jr.
----------------------------------------     --------------------------------
  Ron L. Pearce, President and Chief             O. H. Darling, Jr., Director
     Executive Officer and Director
     (Principal Executive Officer)



       /s/ R. Madison Murphy                        /s/ John C. Shealy 
----------------------------------------     --------------------------------
    R. Madison Murphy, Director                  John C. Shealy, Director



       /s/ Eric M. Heiner                            /s/ Clefton D. Vaughan
----------------------------------------     --------------------------------
      Eric M. Heiner, Director               Clefton D. Vaughan, Vice President,
                                                    Finance and Administration
                                                   (Principal Financial Officer)


       /s/ Christoph Keller, III                     /s/ Emily R. Evers
----------------------------------------     --------------------------------
     Christoph Keller, III, Director              Emily R. Evers, Controller
                                                 (Principal Accounting Officer)


       /s/ Alex R. Lieblong
----------------------------------------
      Alex R. Lieblong, Director

                                       62
<PAGE>
 
                                                    FINANCIAL STATEMENT SCHEDULE
                                                       PURSUANT TO ITEM 14(a)2



                             DEL-TIN FIBER L.L.C.

                             Financial Statements

                          December 31, 1998 and 1997

                  (With Independent Auditors' Report Thereon)
<PAGE>
 
                         Independent Auditors' Report
                         ----------------------------



The Board of Managers
Del-Tin Fiber L.L.C.:


We have audited the accompanying balance sheets of Del-Tin Fiber L.L.C. as of
December 31, 1998 and 1997, and the related statements of operations, members'
capital, and cash flows for the years 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 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 Del-Tin Fiber L.L.C. as of
December 31, 1998 and 1997, and the results of its operations and its cash flows
for the years then ended, in conformity with generally accepted accounting
principles.



KPMG LLP
Shreveport, Louisiana
January 29, 1999
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                                Balance Sheets
                          December 31, 1998 and 1997



<TABLE>
<CAPTION>
                                                                               1998                  1997
                                                                       ------------          ------------
<S>                                                                    <C>                   <C>
Assets                                                                              
  Current assets                                                                    
    Cash and cash equivalents                                          $     47,494             9,172,126
    Trade accounts receivable                                             1,049,667                     -
    Other receivables                                                     1,474,628               173,312
    Inventories                                                           3,597,488               366,560
    Prepaid expenses and other current assets                                73,897                     -
                                                                       ------------           -----------
      Total current assets                                                6,243,174             9,711,998
                                                                                                        
  Debt service reserve funds                                              4,183,957                     -
  Funds held by trustee                                                   3,323,059             9,940,181
  Property, plant, and equipment - net                                   98,146,794            82,589,303
  Deferred debt costs                                                     1,638,722                     -
                                                                       ------------           -----------
      Total assets                                                     $113,535,706           102,241,482
                                                                       ============           ===========
                                                                                                        
Liabilities and Members' Capital/(Deficit)                                                              
  Current liabilities                                                                                   
    Accounts payable                                                   $  5,280,305            12,376,137
    Retainage payable                                                             -               684,610
    Accrued expenses and other                                              524,088               251,311
    Note payable - bank                                                   5,000,000            30,100,000
    Note payable - Deltic Timber Corporation                                      -             8,100,000
                                                                       ------------           -----------
      Total current liabilities                                          10,804,393            51,512,058
                                                                                                        
  Long-term debt                                                         89,000,000            51,000,000
                                                                       ------------           -----------
      Total liabilities                                                  99,804,393           102,512,058
                                                                                    
  Members' capital/(deficit)                                             13,731,313              (270,576)
                                                                       ------------           -----------
      Total liabilities and members' capital/(deficit)                 $113,535,706           102,241,482
                                                                       ============           ===========
</TABLE>



See accompanying notes to financial statements.

                                       2
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                           Statements of Operations
                For the years ended December 31, 1998 and 1997



                                                    1998          1997
                                            ------------      --------
                                                          
Net sales                                   $  7,364,998             -
                                            ------------      --------
                                                          
Costs and expenses                                        
 Cost of sales                                11,223,319             -
 Depreciation                                  1,473,448        10,508
 General and administrative expenses           2,387,481       269,085
                                            ------------      --------
   Total costs and expenses                   15,084,248       279,593
                                            ------------      --------
                                                          
   Loss from operations                       (7,719,250)     (279,593)
                                                          
Other income/(expense)                                    
 Interest income                                 105,221             -
 Interest expense                             (2,563,676)            -
 Gain on disposition of assets                         -         4,337
                                            ------------      --------
                                                          
   Net loss                                 $(10,177,705)     (275,256)
                                            ============      ========
 



See accompanying notes to financial statements.

                                       3
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                           Statements of Cash Flows
                For the years ended December 31, 1998 and 1997


<TABLE>
<CAPTION>
                                                                             1998                 1997
                                                                     ------------          -----------
<S>                                                                  <C>                   <C>
Cash flows from operating activities                                           
  Net loss                                                           $(10,177,705)            (275,256)
  Adjustments to reconcile net loss to net cash                                
   used in operating activities                                               
    Depreciation expense                                                1,473,448               10,508
    (Gains)/losses on dispositions of assets                                    -               (4,337)
    Changes in current assets and liabilities                                  
      Increase in trade accounts receivable                            (1,049,667)                   -
      Increase in other receivables                                    (1,301,316)            (173,312)
      Increase in inventories                                          (3,230,928)            (366,560)
      Increase in prepaid assets and other                                     
       current assets                                                     (73,897)                   -
      Increase in accounts payable                                      1,231,894                    -
      Decrease in retainage payable                                       (17,832)                   -
      Increase/(decrease) in accrued expenses                                  
       and other                                                          290,609              251,311
                                                                     ------------          -----------
        Net cash used in operating activities                         (12,855,394)            (557,646)
                                                                     ------------          -----------
Cash flows from investing activities                                           
  Capital expenditures requiring cash                                 (26,043,275)         (69,545,831)
  Proceeds from dispositions of assets                                          -               11,104
  Net (increase)/decrease in funds held by trustee                      6,617,122           (9,940,181)
                                                                     ------------          -----------
        Net cash used in investing activities                         (19,426,153)         (79,474,908)
                                                                     ------------          -----------
Cash flows from financing activities                                           
  Proceeds from issuance of debt                                       13,000,000           52,100,000
  Proceeds from issuance of bonds                                      60,000,000           29,000,000
  Advances from Deltic Timber Corporation                               2,000,000            8,100,000
  Repayments of debt                                                  (60,100,000)                   -
  Repayments of advances from Deltic Timber                                    
   Corporation                                                         (5,600,000)                   -
  Net (increase)/decrease in debt service reserve funds                (4,183,957)                   -
  Payment of debt costs                                                  (459,128)                   -
  Capital contributions by members                                     18,500,000                4,680
                                                                     ------------          -----------
        Net cash provided by financing activities                      23,156,915           89,204,680
                                                                     ------------          -----------
        Net increase/(decrease) in cash and cash                               
         equivalents                                                   (9,124,632)           9,172,126
Cash and cash equivalents at beginning of period                        9,172,126                    -
                                                                     ------------          -----------
Cash and cash equivalents at the end of period                       $     47,494            9,172,126
                                                                     ============          ===========
</TABLE>


See accompanying notes to financial statements.

                                       4
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                        Statements of Members' Capital
                For the years ended December 31, 1998 and 1997



Balance at January 1, 1997                                $              -
                                                           
  Capital contributions                                              4,680
                                                           
  Net loss                                                        (275,256)
                                                              ------------
                                                           
Balance at December 31, 1997                                      (270,576)
                                                           
  Net loss                                                     (10,177,705)
                                                           
  Capital contributions                                         24,179,594
                                                              ------------
                                                           
Balance at December 31, 1998                              $     13,731,313
                                                              ============



See accompanying notes to financial statements.

                                       5
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                         Notes to Financial Statements
                          December 31, 1998 and 1997



Note 1  -  Summary of Significant Accounting Policies

     Description of Business

     Del-Tin Fiber L.L.C. ("Del-Tin" or the "Company") is an Arkansas limited
     liability company organized in February 1995 and is equally owned by 
     Temple-Inland Forest Products Corporation ("Temple-Inland"), a Delaware
     corporation, and Deltic Timber Corporation ("Deltic"), a Delaware
     corporation. Del-Tin is to exist until December 31, 2024 unless the Company
     is earlier dissolved in accordance with either the provisions of the
     Operating Agreement or the Arkansas Small Business Entity Tax Pass Through
     Act. The business of the Company is to manufacture, distribute, and sell
     medium density fiberboard ("MDF") under the trade name "Solidium." Within
     the United States, MDF is sold primarily to manufacturers and distributors
     of laminated flooring, furniture, cabinets, fixtures, and molding.

     Under the terms of a separate Fiber Supply Agreement, Deltic will be the
     preferred supplier of wood fiber, consisting of sawdust, shavings, and
     chips. Del-Tin will purchase the majority of residual chips produced by
     Deltic's Waldo, Arkansas sawmill, at a delivered price that approximates
     the weighted average delivered price of like-kind residual chips available
     to Del-Tin from third parties in the area. Del-Tin will also have first
     call on residual chips from Deltic's sawmill in Ola, Arkansas.

     Under the terms of a separate MDF Marketing Agreement, Temple-Inland will
     serve as the exclusive marketing agent for all MDF produced at the facility
     for a period of five years from the first day of production of MDF. The MDF
     Marketing Agreement shall be automatically extended for successive five
     year periods unless either party elects not to extend.

     The Company was considered to be a development stage enterprise for the
     year ended December 31, 1997. No substantial operations occurred prior to
     January 1, 1997.

     Cash and Cash Equivalents

     The Company considers short-term investments with a remaining maturity of
     three months or less at the date of purchase to be cash equivalents.

     Inventories

     Inventories are stated at the lower of cost or market. Cost is determined
     using the weighted average method for all inventories, other than spare
     parts for which the specific identification method is used to determine
     cost.

                                       6
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                         Notes to Financial Statements
                          December 31, 1998 and 1997



     Debt Service Reserve Funds

     Debt service reserve funds consists of cash account balances, restricted
     under the Company's permanent credit facility, to be used solely to pay
     debt service to the extent sufficient funds are not available for such
     scheduled debt service payments in the Company operating account.

     Property, Plant, and Equipment

     Property, plant, and equipment is stated at cost less accumulated
     depreciation. Depreciation of buildings, equipment, and other depreciable
     assets is calculated over the estimated useful lives of the assets by using
     the units of production method for machinery and equipment and the 
     straight-line method for all other depreciable assets. The estimated useful
     lives for property, plant, and equipment are as follows:

                   Buildings                     40 years
                   Land improvements             20 years
                   Machinery and equipment       15 years
                   Vehicles                      3 to 5 years

     Routine maintenance and repairs are charged to operating expense, while
     costs of equipment upgrades and replacements are capitalized. When an asset
     is retired or sold, its cost and related accumulated depreciation are
     removed from the accounts and the difference between the net book value of
     the asset and proceeds from disposition is recognized as a gain or loss.

     Long-lived assets are accounted for under Statement of Financial Accounting
     Standards ("SFAS") No. 121, Accounting for the Impairment of Long-Lived
     Assets and for Long-Lived Assets to be Disposed Of, and accordingly the
     Company will record impairment losses on long-lived assets used in
     operations when events and circumstances indicate that the assets might be
     impaired and the estimated undiscounted cash flows to be generated by those
     assets are less than the carrying amounts of those assets. The Company
     recorded no such impairment in 1998 or 1997.

     Deferred Debt Costs

     Deferred debt costs consists of various costs related to obtaining the
     permanent credit facility, the issuance of the Union County, Arkansas
     Taxable Industrial Development Bonds (Del-Tin Fiber Project) 1998 Series
     (the "Taxable Bonds"), and the substitution of the letters of credit
     supporting the Union County, Arkansas Solid Waste Disposal Revenue Bonds
     (Del-Tin Fiber Project) 1997 Series A & B (the "Tax Exempt Bonds"). (The
     Taxable Bonds and the Tax Exempt Bonds are collectively called the
     "Bonds".) Such costs are stated on the 1998 Balance Sheet at original
     issuance cost, net of amortization on a straight-line basis over the life
     of the Bonds. (For additional information regarding the Company's financing
     arrangements, see Note 4 - Long-Term Debt Financing Arrangements.)

                                       7
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                         Notes to Financial Statements
                          December 31, 1998 and 1997



     Start-up Costs

     For 1998 and 1997, the Company expensed all costs related to the start-up
     of the Company.

     Income Taxes

     Because the Company is a limited liability company, it has the option of
     being taxed as a partnership or a corporation. The Company elected to be
     taxed as a partnership and as such is not subject to income taxes at the
     Company level. All taxes are recognized by the members of the Company.

     Use of Estimates

     Management of the Company has made a number of estimates and assumptions,
     relating to the reporting of assets and liabilities and the disclosure of
     contingent assets and liabilities, to prepare these financial statements in
     conformity with generally accepted accounting principles. Actual results
     could differ from those estimates.

     Reclassifications

     Certain 1997 amounts have been reclassified to conform with the 1998
     presentation.
 
Note 2  -  Inventories
 
     Inventories at December 31, 1998 and 1997 consisted of the following:
 
                                                          1998            1997
                                                    ----------      ----------
          Raw materials                         $      286,802               -
          Spare parts                                1,714,698         366,560
          Work in progress/finished goods            1,595,988               -
                                                    ----------      ----------
                                                $    3,597,488         366,560
                                                    ==========      ==========
 
Note 3  -  Property, Plant, and Equipment
 
     Property, plant, and equipment at December 31, 1998 and 1997 consisted of
     the following:
                                                          1998            1997
                                                    ----------       ---------
          Land                                  $      331,789         331,789
          Buildings                                  7,420,798               -
          Land improvements                          2,667,676               -
          Machinery and equipment                   89,188,955               -
          Vehicles                                      11,024               -
          Construction-in-progress                           -      82,257,514
                                                   ----------       ----------
                                                    99,620,242      82,589,303
          Less accumulated depreciation             (1,473,448)              -
                                                   ----------       ----------
                                                $   98,146,794      82,589,303
                                                    ==========      ==========

                                       8
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                         Notes to Financial Statements
                          December 31, 1998 and 1997



     Depreciation expense totaled $1,473,448 for 1998.

     During the construction period of the Company's primary plant facility,
     applicable interest expense was capitalized, net of interest income on
     invested debt proceeds. Such amounts capitalized were $4,863,715 in 1998
     and $2,500,000 in 1997.

Note 4  -  Long-Term Debt and Financing Arrangements

     Long-term debt at December 31, 1998 and 1997 consisted of the following:
 
                                                             1998        1997
                                                    -------------  ----------
     Union County, Arkansas Taxable Industrial
       Development Revenue Bonds
       (Del-Tin Fiber Project) 1998 Series,
       due October 1, 2027                          $  60,000,000           -
 
     Union County, Arkansas Solid Waste
       Disposal Revenue Bonds
       (Del-Tin Fiber Project) 1997 Series A,
       due October 1, 2027                             14,500,000  14,500,000
 
     Union County, Arkansas Solid Waste
       Disposal Revenue Bonds
       (Del-Tin Fiber Project) 1997 Series B,
       due October 1, 2027                             14,500,000  14,500,000
 
     Note payable to banks                                      -  22,000,000
                                                       ----------  ----------
                                                       89,000,000  51,000,000
       Less current maturities of long-term debt                -           -
                                                       ----------  ----------
       Long-term debt, excluding current
         installments                               $  89,000,000  51,000,000
                                                       ==========  ==========

     The scheduled maturities of required debt sinking fund deposits for the
     next five years are $1,045,750 in 2001, $4,972,875 in 2002, and $7,676,250
     in 2003. (For additional information regarding financial instruments, see
     Note 6 - Fair Value of Financial Instruments.)

     The Permanent Credit Facility

     In 1998, the Company entered into a permanent credit facility (the "Credit
     Facility") with several major banking institutions (the "Lenders") having a
     stated maturity of December 17, 2005 (the "Stated Maturity Date"). The
     Credit Facility provides a working capital commitment of $10,000,000 (the
     "Working Capital Commitment Amount") and a letter of credit commitment of
     $91,225,000 (the "Letter of Credit Commitment Amount") for a total
     commitment of $101,225,000. Both the working capital and the letter of
     credit

                                       9
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                         Notes to Financial Statements
                          December 31, 1998 and 1997



     commitments terminate on December 17, 2001 (the "Termination Date"), but
     the Termination Date for either or both commitments may be annually
     extended if the Company so requests and all the Lenders agree. In any case,
     the Termination Date may not be extended beyond the Stated Maturity Date.

     In connection with the Credit Facility, and with the issuance of the Bonds,
     the Company incurred approximately $1,638,000 in related costs. Such costs
     are included in the 1998 Balance Sheet in Deferred Debt Costs and are being
     amortized on a straight-line basis over the life of the Bonds.

          The Working Capital Commitment -- The Company may from time to time
          receiveworking capital loans from the Lenders, and the amount so
          loaned may be borrowed, repaid, and reborrowed at the Company's
          discretion. However, the aggregate amount of working capital loans
          outstanding must not be more than (1) the Working Capital Commitment
          Amount at any time; (2) $5 million for 30 consecutive days during
          1999; and (3) zero ($0) for 30 consecutive days in each following year
          of the working capital commitment. Any unpaid principal and interest
          on working capital loans is due and payable at the termination of the
          working capital loan commitment. At December 31, 1998, there was one
          working capital loan outstanding in the amount of $5,000,000, bearing
          interest at a rate of 6.955 percent.

          The Letter of Credit Commitment -- Three letters of credit have been
          issued pursuantto the Credit Facility in the aggregate stated amount
          of $89,824,657 as of December 31, 1998. The letters of credit have a
          stated expiration of December 17, 2001. Under the Credit Facility, the
          letters of credit may be extended to the extent that the Termination
          Date of the letter of credit commitment is extended. If the letters of
          credit expire before the Stated Maturity Date and are not renewed or
          replaced, the Lenders will make loans to the Company to purchase the
          Bonds. Any such loans would be finally due and payable at the Stated
          Maturity Date.

          The three letters of credit provide a payment mechanism for the Bonds
          and security for the Bondholders. Two of the letters of credit were
          issued to replace letters of credit supporting the Tax Exempt Bonds
          previously issued under the Interim Credit Facilities (described
          below) and the third was issued to provide initial letter of credit
          support for the Taxable Bonds. On December 31, 1998, the maximum
          amount available to be drawn was $14,639,041 under each of the two
          letters of credit supporting the Tax Exempt Bonds and $60,546,575
          under the letter of credit supporting the Taxable Bonds. The maximum
          amount available to be drawn under the letters of credit cover the
          principal amount of the relevant Bonds, plus an additional amount to
          cover interest.

          Security for the Permanent Credit Facility --Substantially all of the
          Company's assetsare pledged to the Lenders as security for the Credit
          Facility. The Credit Facility requires the Company to maintain debt
          service reserve funds in an amount equal to six months' debt service.
          The debt service to be reserved against includes all required payments
          for principal (other than for working capital loans), interest, and
          fees under

                                       10
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                         Notes to Financial Statements
                          December 31, 1998 and 1997



          both the Credit Facility and the Bonds. The funds in the debt service
          reserve bank accounts may be withdrawn solely to pay debt service to
          the extent sufficient funds are not available in the Company's
          operating account. The total amount in the debt service reserve funds
          as of December 31, 1998 was $4,183,957 and has been classified as
          noncurrent on the 1998 Balance Sheet due to the restriction placed on
          the funds.

          The Credit Facility requires the Company to make quarterly deposits
          into two sinking funds beginning in December of 2001. Failure to make
          such deposits is a default under the Credit Facility. The amount of
          the required deposits increases over the term of the Credit Facility,
          from $1,045,750 per quarter in December 2001, to $3,115,000 per
          quarter beginning in December 2005. In September 2006, the Company
          must deposit $49,662,000 into the sinking funds. The Company may not
          withdraw amounts deposited in the sinking funds during the term of the
          Credit Facility.

          As further security for the Credit Facility, each member has agreed
          (1) to provide to the Company up to $17,500,000 (for a combined total
          of $35,000,000) in the form of additional cash equity contributions or
          subordinated loans, if and to the extent, that the Company is in
          default under the Credit Facility; or a deficiency exists in the
          Credit Facility debt service reserve funds or sinking funds; and (2)
          to pay to the Company in the form of additional cash equity
          contributions or subordinated loans, the member's prorata portion of
          the difference between the Company's projected operating cash flow at
          90 percent of rated capacity, and the Company's projected operating
          cash flow at the production rate actually achieved by the Company (the
          "Operating Cash Flow Variance"), if, and to the extent that, the
          Company still does not have sufficient funds to pay debt service. The
          members will no longer be obligated to pay the Operating Cash Flow
          Variance once the plant successfully completes a minimum production
          test, planned for the summer of 1999.

     The Bonds

        The Bonds were issued by Union County, Arkansas, to finance the
        completion of the construction of the Company's MDF plant, as well as
        the acquisition, construction, and improvement of certain sewage and
        solid waste disposal facilities related to the Company's MDF plant.
        Neither the State of Arkansas nor Union County, Arkansas have any
        liability under the Bonds. The Bonds are payable solely from the
        proceeds of the letters of credit issued to support the respective Bonds
        and from Company payments under the Loan Agreement and the Lease
        Agreement (both described below) with Union County, Arkansas. The
        Company has also unconditionally guaranteed the payment of all amounts
        owing under the Bonds to the bondholders. The Company's indebtedness has
        been presented in these financial statements as though the Company was
        directly liable for the Bonds.

        The Bonds currently bear interest at a variable rate determined weekly
        by the remarketing agent of the respective Bonds. Interest is due on the
        first business day of the month, and all unpaid interest and all
        principal is due on October 1, 2027. The maximum interest rate for the
        Tax Exempt Bonds is ten percent and 9.5 percent for

                                       11
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                         Notes to Financial Statements
                          December 31, 1998 and 1997



        the Taxable Bonds. The interest rate on the Tax Exempt Bonds at December
        31, 1998 and 1997 was 4.2 percent and 3.8 percent, respectively. The
        interest rate on the Taxable Bonds at December 31, 1998 was 5.7 percent.

        The Company has the right to convert the interest rate payable on the
        Bonds to either a flexible daily, term, or fixed rate, as defined in the
        trust indentures for the respective Bonds.

        Union County issued the Tax Exempt Bonds in October 1997 which were
        issued in two series, Series A and Series B, each in the amount of
        $14,500,000. In conjunction with this bond issuance, the Company and
        Union County entered into a loan agreement (the "Loan Agreement") which
        obligates the Company to make loan payments in the amount required to
        pay the debt service on the Tax Exempt Bonds. The Tax Exempt Bonds were
        originally supported by letters of credit (the "Interim Letters of
        Credit") issued pursuant to the Interim Credit Facilities. As described
        above, two letters of credit were issued in December 1998 pursuant to
        the Credit Facility, which replaced the Interim Letters of Credit. The
        Interim Letters of Credit were canceled prior to December 31, 1998.

        In December 1998, Union County issued the Taxable Bonds, in the amount
        of $60,000,000. The Company and Union County contemporaneously entered
        into a lease agreement (the "Lease Agreement") that obligates the
        Company to make lease payments in an amount necessary to fund the debt
        service on the Taxable Bonds. As described above, a letter of credit was
        issued under the Credit Facility to support the Taxable Bonds.

     The Interim Credit Facilities

        Prior to the funding of the Credit Facility, the Company was a party to
        three interim credit facilities (the "Interim Credit Facilities"). The
        payment terms and fees and interest payable under each interim credit
        facility were identical. Borrowings bore interest based upon prime or
        other various cost of funds options. Facility fees accrued at .05
        percent per annum for the unused commitment balances and .20 percent per
        annum for letters of credit and were payable quarterly. As of December
        31, 1998, no amounts were outstanding, and no letters of credit were
        issued, against any Interim Credit Facility.

        The Company is party with a group of major banks to an Interim Credit
        Facility totaling $40,000,000. At December 31, 1998, there were no
        amounts outstanding under either the letters of credit or line of credit
        portion of this Interim Credit Facility. At December 31, 1997, there
        were $14,639,000 in letters of credit outstanding under this agreement
        and $22,000,000 outstanding under the revolving line of credit. This
        Interim Credit Facility is supported by an unconditional guarantee of
        Deltic and expires December 31, 2001. The Company intends to terminate
        this facility during 1999.

                                       12
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                         Notes to Financial Statements
                          December 31, 1998 and 1997



        During 1997 and 1998, the Company was a party with a bank to an Interim
        Credit Facility totaling $65,000,000. At December 31, 1998, this Interim
        Credit Facility had been terminated. At December 31, 1997, there was
        $14,639,000 in letters of credit outstanding under this agreement and
        $30,100,000 outstanding under the term loan. The $30,100,000 is included
        in current liabilities in the 1997 Balance Sheet. This Interim Credit
        Facility was supported by unconditional guaranties of Temple-Inland
        Forest Products Corporation. The obligations of Temple-Inland Forest
        Products Corporation under its guarantee are guaranteed by Temple-
        Inland, Inc.

        During 1997 and 1998, the Company was a party with Deltic to an Interim
        Credit Facility. At December 31, 1998, this Interim Credit Facility had
        been terminated. At December 31, 1997, there was $8,100,000 outstanding
        under this revolving line of credit Interim Credit Facility.

Note 5  -  Funds Held by Trustee

     At December 31, 1998 and 1997, the Company had funds held by the trustee
     related to the Union County, Arkansas Solid Waste Disposal Bonds Project
     1997 Series A and B that were restricted for construction purposes and can
     be released for payment upon the submission of qualified construction
     expenditures. At December 31, 1998 and 1997, the funds consisted of money
     market funds totaling $23,059 and $140,181, respectively, and investments
     in New York City municipal bonds totaling $3,300,000 and $9,800,000,
     respectively. The bonds are variable rate and reset weekly, with a maturity
     date of February 15, 2016. The balance has been classified as noncurrent
     due to the restriction placed on the funds. At December 31, 1998, the bonds
     were priced at par, which approximates fair value.

                                       13
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                         Notes to Financial Statements
                          December 31, 1998 and 1997



Note 6  -  Fair Value of Financial Instruments

     The following table presents the carrying amounts and estimated fair values
     of the Company's financial instruments at December 31, 1998 and 1997. The
     fair value of a financial instrument is the amount at which the instrument
     could be exchanged in a current transaction between willing parties.
<TABLE>
<CAPTION>
                                                                    1998                                       1997
                                                       ----------------------------                ---------------------------
                                                        Carrying            Fair                    Carrying           Fair
                                                         Amount            Value                     Amount           Value
                                                       -----------       ----------                ----------       ----------
<S>                                                  <C>                 <C>                       <C>              <C>
      Financial assets                                                                                             
        Cash and cash equivalents                    $      47,494           47,494                 9,172,126        9,172,126
        Trade accounts receivable                    $   1,049,667        1,049,667                         -                -
        Other receivables                            $   1,474,628        1,474,628                   173,212          173,212
        Debt service reserve funds                   $   4,183,957        4,183,957                         -                -
        Funds held by trustee                        $   3,323,059        3,323,059                 9,940,181        9,940,181
                                                                                                                   
      Financial liabilities                                                                                        
        Accounts payable                             $   5,280,305        5,280,305                12,376,137       12,376,137
        Accrued expenses and other                   $     524,088          524,088                   251,311          251,311
        Notes payable to bank                                                                                      
          Retainage payable                          $           -                -                   684,610          684,610
          Note payable - Deltic                                                                                    
            Timber Corporation                       $           -                -                 8,100,000        8,100,000
          Long-term debt                             $  89,000,000       89,000,000                51,000,000       51,000,000
                                                                                                                   
        Off balance sheet financial                                                                                
         instruments                                                                                               
          Letters of credit                          $           -                -                29,278,000       29,278,000
</TABLE>

     The carrying amounts shown in the table are included in the Balance Sheets
     under the indicated captions.

     The following methods and assumptions were used to estimate the fair value
     of each class of financial instruments:

        . Cash and Cash Equivalents, Trade Accounts Receivable, Other
          Receivables, Accounts Payable, Retainage Payable, Accrued Expenses and
          Other, and Note Payable - Deltic Timber Corporation -- The carrying
          amounts approximate fair value because of the short maturity of these
          instruments.

        . Debt Service Reserve Funds -- The carrying amount approximates fair
          value since the interest earned on these deposits fluctuates with
          changes in current market rates.

        . Funds Held by Trustee -- The balance at December 31, 1998, consisted
          of money market funds and New York City municipal bonds. The money
          market funds are cash equivalents and the carrying amount approximates
          fair value. The fair value of the bonds is based on quoted market
          prices and at December 31, 1998 and 1997, the bonds are recorded at
          fair value.

                                       14
<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                         Notes to Financial Statements
                          December 31, 1998 and 1997



        . Long-term debt, including current maturities -- The carrying amount
          approximates fair value based on either the short-term maturity of the
          instrument or variable rates offered that approximate current market
          rates.

        . Letters of credit -- The fair value approximates the notional amount,
          which is based on the estimated cost to settle these obligations.

Note 7  -  Lease Commitments

     The Company is obligated under noncancelable operating leases for various
     equipment.

     As of December 31, 1998, future minimum lease commitments under
     noncancelable operating leases consisted of the following:
 
                      1999                  $  187,846
                      2000                  $  187,846
                      2001                  $   85,771
                      2002                  $   22,566

     Rent expense for all operating leases was $195,430 for 1998.

Note 8  -  Related-Party Transactions

     The Company is assessed a fee for marketing services by Temple-Inland. This
     expense amounted to $227,036 for the year ended December 31, 1998, and is
     included in Cost of Sales in the accompanying Statements of Operations. The
     Company is also assessed a fee for computer services by Temple-Inland. This
     fee amounted to $62,500 in 1998 and is included in General and
     Administrative Expenses in the accompanying Statements of Operations. As of
     December 31, 1998, the Company's balance due Temple-Inland for these
     services totaled $40,154.

     The Company purchases raw materials from Deltic. Total purchases of bark
     and chips amounted to $2,126,000 for the year ended December 31, 1998. In
     relation to these purchases, the Company had an outstanding balance payable
     to Deltic of $70,742 at December 31, 1998.

     The Company had sales of MDF to Temple-Inland totaling $49,567 for the year
     ended December 31, 1998, which is included in Net Sales in the accompanying
     Statements of Operations. In relation to these sales, Del-Tin had a
     receivable of $49,567 from Temple-Inland at December 31, 1998.

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<PAGE>
 
                             DEL-TIN FIBER L.L.C.
                         Notes to Financial Statements
                          December 31, 1998 and 1997



Note 9  -  Supplemental Cash Flows Disclosures

     Interest paid, net of amounts capitalized, was $2,548,434 in 1998. Noncash
     investing and financing activities, excluded from the Statements of Cash
     Flows, were: (1) assumptions of accounts payable of $4,048,411 in 1998 and
     $13,060,741 in 1997 related to capital expenditures for additions of
     property, plant, and equipment and (2) non-cash capital contributions by
     the members during 1998 for payment of debt amounting to $4,500,000 and for
     debt costs paid on behalf of the Company of $1,179,594.

Note 10  -  Year 2000

     In 1998, the Company initiated a plan ("Plan") to identify, assess, and
     remediate Year 2000 issues within each of its significant computer programs
     and certain equipment which contain micro-processors. The Plan is
     addressing the issue of computer programs and embedded computer chips being
     unable to distinguish between the year 1900 and the year 2000, if a program
     or chip uses only two digits rather than four to define the applicable
     year. Systems which have been determined not to be Year 2000 compliant are
     being either replaced or reprogrammed, and thereafter tested for Year 2000
     compliance.

     The Company is in the process of identifying and contacting critical
     suppliers and customers whose computerized systems interface with the
     Company's systems, regarding their plans and progress in addressing their
     Year 2000 issues. The Company has received varying information from such
     third parties on the state of compliance or expected compliance.
     Contingency plans are being developed in the event that any critical
     supplier or customer is not compliant.

     The failure to correct a material Year 2000 problem could result in an
     interruption in, or a failure of, certain normal business activities or
     operations. Such failures could materially and adversely affect the
     Company's operations, liquidity, and financial condition. Due to the
     general uncertainty inherent in the Year 2000 problem, resulting in part
     from the uncertainty of the Year 2000 readiness of third-party suppliers
     and customers, the Company is unable to determine at this time whether the
     consequences of Year 2000 failures will have a material impact on the
     Company's operations, liquidity, or financial condition.

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