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

                               FORM 10-K/A
                            (Amendment No. 1)

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

              For the fiscal year ended December 31, 2006 Commission File
                            Number 1-3924

                              MAXXAM INC.
        (Exact name of Registrant as Specified in its Charter)

         Delaware                                                 95-2078752
(State or other jurisdiction                                   (I.R.S. Employer
of incorporation or organization)                         Identification Number)

    1330 Post Oak Blvd., Suite 2000                                   77056
            Houston, Texas                                         (Zip Code)
    (Address of Principal Executive Offices)

         Registrant's telephone number, including area code: (713) 975-7600

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

                                                          Name of each exchange
         Title of each class                                on which registered
Common Stock, $.50 par value                                        American

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

     Indicate by check mark if the Registrant is a well-known  seasoned  issuer,
as defined in Rule 405 of the Securities Act. Yes     No X>

     Indicate by check mark if the  Registrant  is not  required to file reports
pursuant to Section 13 or Section 15(d) of the Act.Yes No X

     Indicate  by check mark  whether the  Registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
Registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days.
Yes X    No

     Indicate by check mark 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.

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

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

     The aggregate market value of the voting and non-voting  common equity held
by non-affiliates  computed by reference to the price at which the common equity
was last sold,  as of the last  business day of the  Registrant's  most recently
completed second fiscal quarter: $67.2 million.

     Number of shares of common stock outstanding at March 26, 2007: 5,255,717

                DOCUMENTS INCORPORATED BY REFERENCE:

     Certain portions of Registrant's  definitive  proxy statement,  to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A not later
than 120 days after the close of the Registrant's  fiscal year, are incorporated
by reference under Part III.

                         EXPLANATORY NOTE

     MAXXAM Inc. (the  "Company") is filing this  Amendment No. 1 on Form 10-K/A
("Amendment  No.  1") to its  Annual  Report  on Form  10-K for the  year  ended
December 31, 2006 (the "2006 Form 10-K"), which was originally filed on April 2,
2007 (the "Original Filing"). This Amendment No. 1 modifies Items 1, 1A, 3, 7, 8
and 9A of the  Original  Filing to make various  conforming  changes and correct
several  typographical  errors.  Pursuant  to Rule 12b-15  under the  Securities
Exchange Act of 1934 (the "Exchange  Act"),  this Amendment No. 1 sets forth the
text of such  items,  as  amended,  in their  entirety,  and  includes  both new
certifications pursuant to Rules 13a-14(a) and (b) of the Exchange Act and a new
Exhibit 23.1, Consent of Deloitte &Touche LLP.

     This  Amendment  No. 1  contains  only the  sections  and  exhibits  to the
Original  Filing that are being amended  (other than Item 15 hereto,  which sets
forth the exhibits  being filed with this  Amendment  No. 1). In addition,  this
Amendment  No. 1 speaks as of the date of the Original  Filing,  and the Company
has not updated the  disclosures  contained  herein to reflect any  developments
that may  have  occurred  since  the date of the  Original  Filing.  In order to
facilitate  review of the 2006 Form 10-K,  the  Company has  included  with this
filing  a pdf  copy  of such  document  in its  entirety  (as  modified  by this
Amendment No. 1).

                                     PART I

ITEM 1. BUSINESS

General

     MAXXAM Inc. and its controlled  subsidiaries are  collectively  referred to
herein as the "Company" or "MAXXAM"  unless  otherwise  indicated or the context
indicates otherwise. Any reference herein to a company includes the subsidiaries
of that company unless otherwise noted or the context indicates  otherwise.  The
term "MAXXAM  Parent"  refers to the Company on a stand-alone  basis without its
subsidiaries. The term "MGHI" refers to MAXXAM Group Holdings Inc., which is the
parent of MAXXAM Group Inc.  (see below).  Some terms used herein are defined in
the  Glossary  of Defined  Term found at the end of this  document.  The Company
conducts the  substantial  portion of its operations  through its  subsidiaries,
which operate in three principal industries:

o    Forest  products,  through MAXXAM Group Inc. ("MGI") and MGI's wholly owned
     subsidiaries,  principally  The Pacific  Lumber Company  ("Palco"),  Scotia
     Pacific Company LLC ("Scopac"), Britt Lumber Co., Inc. ("Britt") and Scotia
     Development LLC ("SDLLC"). MGI and its subsidiaries primarily engage in the
     growing and harvesting of redwood and  Douglas-fir  timber,  the milling of
     logs into  lumber and related  operations  and  activities.  On January 18,
     2007,  Palco,  Scopac,  Britt,  SDLLC and Palco's other  subsidiaries  (the
     "Debtors") filed for reorganization under Chapter 11 of the U.S. Bankruptcy
     Code (the "Bankruptcy  Code") in the United States Bankruptcy Court for the
     Southern  District  of Texas  (the  "Bankruptcy  Court").  The term  "Palco
     Debtors" is used to refer to all of the Debtors other than Scopac. See Note
     1,  "-Reorganization  Proceedings  of  Palco  and  its  Subsidiaries."  The
     proceedings  of the  Debtors  are  collectively  referred  to herein as the
     "Bankruptcy Cases."

o    Real estate  investment and  development,  through MAXXAM Property  Company
     ("MPC") and other wholly  owned  subsidiaries  of the  Company,  as well as
     joint  ventures.   These  subsidiaries  are  engaged  in  the  business  of
     residential  and  commercial  real  estate   investment  and   development,
     primarily  in  Arizona,  California,   Puerto  Rico  and  Texas,  including
     associated golf course or resort operations in certain locations,  and also
     own several commercial real estate properties that are subject to long-term
     lease arrangements.

o    Racing  operations,  through Sam Houston Race Park, Ltd. ("SHRP,  Ltd."), a
     Texas limited partnership wholly owned by the Company.  SHRP, Ltd. owns and
     operates a Texas Class 1 pari-mutuel  horse racing  facility in the greater
     Houston  metropolitan area, and a pari-mutuel  greyhound racing facility in
     Harlingen, Texas.

     The  Company  previously  owned  approximately  63% of the common  stock of
Kaiser  Aluminum  Corporation  ("Kaiser"),  which  engaged in several  principal
aspects of the aluminum  industry.  In February 2002,  Kaiser and certain of its
subsidiaries filed for  reorganization  under Chapter 11 of the Bankruptcy Code.
Kaiser's plan of reorganization, which provided for the cancellation of Kaiser's
equity,  including  the common shares held by the Company,  became  effective on
July 6, 2006. As a result,  the Company no longer has any ownership  interest in
or affiliation  with Kaiser.  See "- Kaiser  Aluminum" and Notes 1 and 10 to the
Consolidated  Financial  Statements  contained  herein for further  information.
Except as otherwise indicated,  any reference in this document to a "Note" means
the Notes to the Consolidated Financial Statements contained herein.

     This   Annual   Report   on   Form   10-K   contains    statements    which
constitute"forward-looking   statements"  within  the  meaning  of  the  Private
Securities Litigation Reform Act of 1995 (the "PSLRA").  These statements appear
in a number of places (see Item 1."Business-Forest Products Operations-Principal
Assets" and "-Regulatory and Environmental Factors;" most sections under Item 3.
"Legal Proceedings;" and several sections under Item 7. "Management's Discussion
and Analysis of Financial Condition and Results of Operations"). Such statements
can be identified by the use of forward-looking  terminology such as "believes,"
"expects,"  "may,"   "estimates,"   "should,"   "could,"   "plans,"   "intends,"
"projects,"   "seeks,"  or  "anticipates"  or  the  negative  thereof  or  other
variations  thereon or comparable  terminology,  or by  discussions of strategy.
Readers  are  cautioned  that  any  such  forward-looking   statements  are  not
guarantees   of  future   performance   and   involve   significant   risks  and
uncertainties,   and  that  actual   results  may  vary   materially   from  the
forward-looking statements as a result of various factors. These factors include
the effectiveness of management's strategies and decisions, general economic and
business  conditions,   developments  in  technology,   the  ability  to  obtain
financing, new or modified statutory,  environmental or regulatory requirements,
litigation developments,  and changing prices and market conditions. This Report
identifies   other   factors   which  could  cause   differences   between  such
forward-looking  statements  and actual  results.  These or other  factors could
cause actual results to vary  materially  from the  forward-looking  statements.
Forest Products Operations

     General

     The Company  engages in forest products  operations and related  operations
and  activities  through MGI,  Palco,  and wholly owned  subsidiaries  of Palco,
principally  Scopac,  Britt  and  SDLLC.  Palco,  which  has been in  continuous
operation for over 135 years,  engages in the growing and  harvesting of redwood
and Douglas-fir  timber,  the milling of logs into lumber products,  and certain
related  operations.  Scopac  has  experienced  difficulties  and  delays in the
approval of its timber harvesting plans ("THPs") as the result of regulatory and
litigation  challenges.  These  matters have  resulted in declines in actual and
expected  harvest  levels and cash flows,  significant  increases in the cost of
logging operations,  increased costs related to timber harvest  litigation,  and
materially  adverse effects on the operations and financial  condition of Palco,
Scopac and Palco's other subsidiaries.  As a result, on January 18, 2007, Palco,
Scopac,  Britt,  SDLLC and Palco's other  subsidiaries  filed for reorganization
under  Chapter  11  of  the  Bankruptcy  Code.  See  Note  1,   "-Reorganization
Proceedings of Palco and its Subsidiaries."

     Principal Assets

     This  section  contains   statements   which  constitute   "forward-looking
statements"   within   the   meaning   of   the   PSLRA.   See   this   section,
"Business-General"  above  and Item 1A.  "Risk  Factors"  below  for  cautionary
information with respect to such forward-looking statements.

     Palco owns and manages,  principally through Scopac,  approximately 210,000
acres of virtually contiguous commercial  timberlands located in Humboldt County
along the northern California coast (the "Palco Timberlands"), an area which has
very favorable soil and climate  conditions for growing timber.  Palco also owns
substantially all of the assets in the town of Scotia,  California,  including a
sawmill and other industrial use facilities,  a co-generation  plant, 270 homes,
various commercial properties, and all of the land associated with these assets.
A number of Palco  employees  live in  Scotia.  Palco  also  owns and  operates,
through Britt, a sawmill in Arcata, California.

     The Palco  Timberlands,  which are  located in close  proximity  to Palco's
sawmills and have an extensive network of roads, contain  predominantly  conifer
timber.  As of December  31, 2006,  Palco's  conifers  consisted  (by volume) of
approximately  66%  redwood,  30%  Douglas-fir,  and 4%  other  conifer  timber.
Approximately  200,000  acres of Palco's  timberlands  are owned by Scopac  (the
"Scopac  Timberlands"),  and Scopac  has the  exclusive  right to  harvest  (the
"Scopac Timber Rights") approximately 10,000 acres of timberlands owned by Palco
and its subsidiary,  Salmon Creek LLC ("Salmon Creek"). The timber in respect of
the Scopac Timberlands and the Scopac Timber Rights is collectively  referred to
as the "Scopac  Timber" and the  timberlands in respect of the Scopac Timber are
referred  to as the  "Scopac  Timber  Property."  Substantially  all of Scopac's
assets  are  pledged  as  security  for its  6.55%  Series  B Class  A-1  Timber
Collateralized  Notes, 7.11% Series B Class A-2 Timber  Collateralized Notes and
7.71%  Series B Class  A-3  Timber  Collateralized  Notes  (the  "Scopac  Timber
Notes").  The Indenture  governing the Scopac Timber Notes is referred to as the
"Scopac  Indenture." Under a master purchase  agreement between Palco and Scopac
(the "Master  Purchase  Agreement"),  Palco  harvests and purchases  from Scopac
virtually all of the logs harvested from the Scopac Timber. See  "-Relationships
among  the  Palco   Companies"  below  for  a  description  of  this  and  other
relationships among Palco, Scopac and Salmon Creek.

     Timber generally is categorized by species and the age of a tree when it is
harvested. "Old growth" trees are often defined as trees which have been growing
for  approximately  200 years or longer  and "young  growth" or "second  growth"
trees are those  which have been  growing  for less than 200  years.  The forest
products  industry  grades  lumber into  various  classifications  according  to
quality.  The two broad  categories  into  which all  grades  fall  based on the
absence  or  presence  of  knots  are  called   "upper"  and  "common"   grades,
respectively.  Old growth trees have a higher  percentage  of upper grade lumber
than young growth trees.

     Scopac's  foresters,   wildlife  and  fisheries   biologists,   geologists,
botanists and other personnel provide a number of forest stewardship techniques,
including protecting the Scopac Timber from forest fires,  erosion,  insects and
other  damage,  overseeing  reforestation   activities,   and  implementing  and
monitoring the numerous  aspects of the extensive  environmental  and regulatory
compliance  required in  connection  with  operation  of the Palco  Timberlands,
including  the  various  requirements  of  the  HCP  described  below.  Scopac's
personnel also prepare THPs and maintain and update the information contained in
its geographical  information  system (the "GIS").  See "-Harvesting  Practices"
below for a  description  of the GIS  updating  process and the THP  preparation
process.  Palco and Scopac engage in extensive efforts to supplement the natural
regeneration  of  timber  and  increase  the  amount  of  timber  on  the  Palco
Timberlands.  Scopac and Palco are required to comply with  California  forestry
regulations  regarding  reforestation,  which generally  require that an area be
reforested to specified  standards  within an established  period of time. Palco
conducts  regeneration  activities  on the  Scopac  Timber  Property  as part of
Palco's  services  to  Scopac  under  the  services   agreement  (the  "Services
Agreement") between Palco and Scopac described below (see "-Relationships  among
the Palco Companies"). Reforestation of redwood timber generally is accomplished
through  redwood  sprouts that grow from the stumps of  harvested  trees and the
planting of redwood seedlings at levels designed to optimize growth. Douglas-fir
timber is regenerated almost entirely by planting seedlings.  During 2006, Palco
planted an estimated 585,000 redwood seedlings.

     California  law requires  large  timberland  owners,  including  Palco,  to
demonstrate  that their timber  operations  will not  decrease  the  sustainable
productivity of their  timberlands.  The applicable  regulations  require timber
companies  to project  timber  growth and  harvest on their  timberlands  over a
100-year  planning period and to demonstrate  sustained yield,  i.e., that their
projected  average  annual  harvest for any decade within the 100-year  planning
period  will  not  exceed  the  average  annual  growth  level at the end of the
100-year  planning  period. A timber company may comply with this requirement by
submitting a sustained  yield plan to the California  Department of Forestry and
Fire Protection (the "CDF") for review and approval.  Timber  companies which do
not have a  sustained  yield plan are allowed to follow  alternative  procedures
(see below).

     Palco and Scopac are also subject to federal and state laws  providing  for
the protection and  conservation of wildlife  species which have been designated
as  endangered  or  threatened,   certain  of  which  are  found  on  the  Palco
Timberlands.  These laws  generally  prohibit  certain  adverse  impacts on such
species  (referred to as a "take"),  except for  incidental  take which does not
jeopardize  the  continued  existence  of the  affected  species and occurs as a
result of operations that comply with an approved habitat  conservation plan and
related incidental take permit. A habitat  conservation plan analyzes the impact
of the incidental take and specifies measures to monitor,  minimize and mitigate
such impact.  As part of the Headwaters  Agreement  described below, the federal
and  state  governments  approved  a  sustained  yield  plan (the  "SYP")  and a
comprehensive  multi-species habitat conservation plan ("HCP," and together with
the SYP, the "Environmental Plans") in respect of substantially all of the Palco
Timberlands. See "-Regulatory and Environmental Factors-Environmental Plans."

     In December  2005,  a  California  appellate  court  reversed a trial court
decision  invalidating  the  SYP and  the  incidental  take  permits  issued  by
California  in  connection  with  the   Environmental   Plans  (the  "California
Permits").   The  plaintiffs  appealed  the  appellate  court  decision  to  the
California  Supreme Court, which has accepted the appeal for review. See Item 3.
"Legal Proceedings-Forest Products Litigation" for further information regarding
this matter.  As a result of these  cases,  Scopac from October 2002 until March
2005 obtained review and approval of its THPs under an alternative  procedure in
the California  forest practice rules known as "Option C." Option C is available
to  landowners  who have  submitted an "Option A" plan to the CDF for review (as
was done by Palco).  An approved  Option A plan is an  alternative  to obtaining
approval of a sustained yield plan.  Palco's Option A plan (the "Option A Plan")
was  approved by the CDF in March 2005.  Scopac is  currently  relying  upon the
Option A Plan to obtain THP approvals.

     Harvesting Practices

     The  ability  of Palco to  harvest  timber  depends  in large part upon the
ability to obtain  regulatory  approval of THPs prepared by Scopac's  foresters.
Prior to harvesting timber in California,  companies are obligated to obtain the
CDF's  approval of a detailed  THP for the area to be  harvested.  A THP must be
submitted  by a  Registered  Professional  Forester  and is required to include,
among many other things,  information  regarding  the method of proposed  timber
operations for a specified  area,  whether the operations  will have any adverse
impact on the  environment  and,  if so, the  mitigation  measures to be used to
reduce any such impact.  The CDF's  evaluation of THPs  incorporates  review and
analysis  of such THPs by several  California  and federal  agencies  and public
comments  received  with respect to such THPs.  The number of Scopac's  approved
THPs and the amount of timber covered by such THPs can vary  significantly  from
time to time,  depending  upon the timing of agency  review  and other  factors.
Timber  covered by an  approved  THP is  typically  harvested  within a one-year
period from the date that harvesting first begins.

     The Scopac  Indenture  requires Scopac to use its best efforts  (consistent
with  prudent  business  practices)  to maintain a number of pending THPs which,
together with THPs previously approved, would cover rights to harvest a quantity
of Scopac Timber  adequate to pay interest and principal  amortization  based on
the  Minimum  Principal  Amortization  schedule  (as  set  forth  in the  Scopac
Indenture)  for the Scopac  Timber  Notes for the next  succeeding  twelve-month
period.  See  "Management's  Discussion and Analysis of Financial  Condition and
Results  of   Operations-Financial   Condition   and   Investing  and  Financing
Activities-Financial  Difficulties  of Forest Products  Entities-Future  Harvest
Levels" for information  regarding Scopac's estimate of future harvest levels in
respect of the Scopac Timber Property.  Also see "-Regulatory and  Environmental
Factors," Item 3. "Legal  Proceedings-Forest  Products  Litigation," and Item 7.
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations" for various legal,  regulatory,  environmental  and other challenges
being  faced by Palco,  Scopac  and  Salmon  Creek (the  "Palco  Companies")  in
connection with timber harvesting and other operations on their timberlands.

     Scopac  maintains  the GIS,  a  detailed  geographical  information  system
covering the Palco Timberlands.  The GIS covers numerous aspects of these timber
properties,  including  timber  type,  site  productivity  class,  wildlife  and
botanical data, geological information,  roads, rivers and streams.  Pursuant to
the  Services  Agreement,  Palco,  to the extent  necessary,  assists  Scopac in
updating,  upgrading and improving the GIS and the other computer  systems owned
by Scopac.  By carefully  monitoring  and updating this data base and conducting
field  studies,  Scopac's  foresters  are better able to develop  detailed  THPs
addressing the various HCP and regulatory  requirements.  Scopac also utilizes a
Global Positioning System ("GPS"),  which is able to provide precise location of
geographic features through satellite  positioning.  Use of the GPS enhances the
quality and efficiency of the GIS data.

     Scopac employs a variety of  well-accepted  methods of selecting  trees for
harvest  designed to achieve  optimal  growth and  regeneration.  These methods,
referred to as "silvicultural  systems" in the forestry  profession,  range from
very light  thinnings  (aimed at enhancing the growth rate of retained trees) to
clear cutting, which results in the harvest of nearly all trees in an area (with
the  exception  of  sub-merchantable  trees  and  trees  retained  for  wildlife
protection  and future  stand  enhancement)  and  replacement  with a new forest
stand.  In between are a number of varying levels of partial harvest that can be
employed.

     Production Facilities

     Palco's sawmills had historically been supplied almost entirely from timber
harvested from the Palco  Timberlands,  which are located in close  proximity to
the   sawmills.   More   recently,   primarily   as  a  result   of   increasing
regulatorily-imposed  harvest  limits,  Palco has had to supplement its internal
log supply with logs purchased from third parties. Palco has not in general been
able to obtain supplies of third party logs,  particularly redwood, on terms and
in quantities sufficient to offset the adverse impact of these harvest limits.

     Palco  has over  the  years  implemented  numerous  technological  advances
intended to increase the operating  efficiency of its production  facilities and
the  recovery  of  finished  products  from its  timber.  In April  2004,  Palco
commenced a mill improvement project, including a new sawmill located in Scotia.
The new sawmill was  constructed in two phases.  The first phase of the project,
the processing of smaller diameter second growth logs (up to 24" in diameter) is
a high-speed  processing line that includes  advanced  scanning and optimization
technology  intended  to  maximize  lumber  recovery.   The  second  phase,  the
relocation  of large log  equipment  from a former  Palco mill,  came on line in
October  2005.  This phase  allows for  processing  of larger  logs up to 60" in
diameter.  In January  2004,  Palco also  completed  a new $5.0  million  planer
project in Scotia.  The new planer is capable of  processing  rough sawn  boards
into finished  lumber much more rapidly than the older planers at Palco's former
Carlotta and Fortuna mills (see below).  These  technology  investments have not
been  sufficient  to overcome  the  adverse  effects of the  regulatory  harvest
limits.

     Britt's primary  business is the processing of small diameter  redwood logs
into  fencing  products  for  sale to  retail  and  wholesale  customers.  Britt
purchases,  primarily from Palco but also from other  timberland  owners,  small
diameter (6 to 15 inch) redwood logs of varying  lengths.  Britt processes these
logs at its mill into a variety of fencing products, including "dog-eared" 1" by
6" fence  stock in six foot  lengths,  4" by 4" fence posts in 6 through 12 foot
lengths,  and other lumber  products in 6 through 12 foot lengths.  Britt's mill
and  related  facilities  are  located in  Arcata,  California.  Britt  produced
approximately 69, 79 and 86 million board feet of lumber in 2006, 2005 and 2004,
respectively.

     Two other mills,  Carlotta and Fortuna, were permanently closed in 2004 and
2005,  respectively,  in  connection  with  the  mill  improvement  project.  In
addition, a finishing and remanufacturing  plant in Scotia was closed in 2006 as
part of Palco's ongoing efforts to operate more efficiently.

     Subject to market  conditions and lumber  supply,  Palco dries a portion of
its lumber before it is processed or sold.  Air or kiln-dried  lumber  generally
commands higher prices than "green"  lumber,  which is lumber sold before it has
been dried.  Drying also allows Palco to compete in  additional  markets (due to
lower  shipping  costs  resulting  from the moisture and weight  reduction  that
occurs in the drying process).  Palco owns and can operate up to 31 kilns having
an annual capacity of approximately 38 million board feet.

     Palco owns and operates a  cogeneration  power plant which is fueled by the
wood residue from logging and lumber  production  operations.  The operations of
Palco and Britt  supplied 53% of the fuel in 2006. The power plant is capable of
producing up to 32.5 megawatts per hour and generates  substantially  all of the
energy requirements of Scotia, California.  Palco sells surplus power to Pacific
Gas and Electric  Company.  In 2006,  the sale of surplus  power  accounted  for
approximately 6% of MGI's total revenues.

     Products

     MGI produced  218.7,  266.8 and 298.1 million board feet of lumber in 2006,
2005 and 2004, respectively.  The following table sets forth the distribution of
MGI's  lumber  production  (on a net board foot  basis) and  revenues by product
line:

                                          Year Ended December 31, 2006            Year Ended December 31, 2005
                                     ---------------------------------------- ------------------------------------
                                     % of Total                               % of Total
                                     Lumber        % of Total                 Lumber       % of Total
                                     Production    Lumber       % of Total    Production   Lumber       % of Total
              Product                Volume        Revenues     Revenues      Volume       Revenues       Revenues
------------------------------------ ------------- -------------------------- ------------ ------------ ----------
Upper grade redwood lumber                2%            5%           5%           2%           5%           4%
Common grade redwood lumber              66%           76%          75%          64%          72%          61%
                                ------------- -------------- ----------- ------------ ------------ ------------
   Total redwood lumber                  68%           81%          80%          66%          77%          65%
                                ------------- -------------- ----------- ------------ ------------ ------------
Upper grade Douglas-fir lumber           -             -            -             -            -            -
Common grade Douglas-fir lumber          32%           19%          20%          33%          22%          19%
                                ------------- -------------- ----------- ------------ ------------ ------------
   Total Douglas-fir lumber              32%           19%          20%          33%          22%          19%
                                ------------- -------------  ----------- ------------ ------------ ------------
Other grades of lumber                    -             -            -            1%           1%           1%
                                ------------- -------------- ----------- ------------ ------------ ------------
         Total lumber                   100%          100%         100%         100%         100%          85%
                                ============= ============== =========== ============ ============ ============

Logs                                                                 3%                                     5%
                                                             ===========                           ============

Wood chips........                                                   2%                                     2%
                                                             =============                         ============

     In  2006,  MGI  sold  206.6  million  board  feet of  lumber.  See  Item 7.
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations-Results  of  Operations-Forest  Products  Operations"  for additional
information.  Lumber  products  vary  greatly by the  species and quality of the
timber from which they are  produced.  Lumber is sold not only by grade (such as
"upper"  grade  versus  "common"  grade),  but also by board size and the drying
process associated with the lumber.

     Redwood  lumber has  historically  been  MGI's  largest  product  category.
Redwood is  commercially  available  only along the northern coast of California
and  possesses  certain  unique  characteristics  that permit it to be sold at a
premium to many other wood products.  Such  characteristics  include its natural
beauty,  superior  ability  to  retain  paint and  other  finishes,  dimensional
stability  and  innate  resistance  to decay,  insects  and  chemicals.  Typical
applications  include exterior siding,  trim and fascia for both residential and
commercial construction, outdoor furniture, decks, planters, retaining walls and
other  specialty  applications.   Redwood  also  has  a  variety  of  industrial
applications  because of its chemical  resistance and because it does not impart
any taste or odor to liquids or solids.

     Upper grade redwood lumber, which is derived primarily from larger diameter
logs and is characterized by an absence of knots and other defects, little to no
sapwood,  and a tighter grain,  is used  primarily in  distinctive  interior and
exterior applications.  Common grade redwood lumber,  historically MGI's largest
volume product, has many of the same aesthetic and structural qualities as upper
grade redwood,  but has some knots,  sapwood and a coarser grain. Such lumber is
commonly used for construction  purposes,  including outdoor  structures such as
decks and fencing.

     Douglas-fir  lumber  is  used  primarily  for  new  construction  and  some
decorative purposes and is widely recognized for its strength,  hard surface and
attractive appearance. Douglas-fir is grown commercially along the west coast of
North America and in Chile and New Zealand.  Upper grade  Douglas-fir  lumber is
derived  primarily  from  larger  diameter   Douglas-fir   timber  and  is  used
principally in finished carpentry applications.  Common grade Douglas-fir lumber
is  used  for a  variety  of  general  construction  purposes  and  is  somewhat
interchangeable  with common  grades of other  whitewood  species,  although the
strength of Douglas-fir makes it more desirable in certain applications.

     During 2006, MGI purchased  approximately one-third of its logs (52 million
board feet) from third parties.  MGI does not have any  significant  contractual
relationships  with  third  parties  relating  to the  purchase  of logs.  Palco
produces softwood chips from the wood residue from its milling operations. These
chips  are sold to third  parties  for the  production  of wood  pulp and  paper
products.  Subject principally to economic feasibility,  Palco also produces and
sells to third parties wood chips from hardwood trees.

   Backlog and Seasonality

     MGI's  backlog  of sales  orders at  December  31,  2006 was $7.8  million,
substantially  all of which was shipped in the first quarter of 2007.  The sales
backlog at December  31,  2005,  was $11.8  million,  of which $5.3  million was
shipped in the first quarter of 2006.  MGI has  historically  experienced  lower
first quarter sales due largely to the general  decline in  construction-related
activity  during the winter months.  As a consequence,  MGI's results in any one
quarter are not  necessarily  indicative  of results to be expected for the full
year.

     Marketing

     The housing,  construction  and remodeling  markets are the primary markets
for  MGI's  lumber  products.  MGI's  goal  is to  maintain  a  wide  geographic
distribution of its products.  MGI's accounts are primarily wholesale,  followed
by industrial end users,  manufacturers,  retailers and exporters. MGI's redwood
and Douglas-fir  lumber is sold throughout the entire United States,  as well as
to export markets.  Common grades of redwood lumber are sold principally west of
the Mississippi  River,  with  California  accounting for  approximately  81% of
common redwood sales in 2006. Common grades of Douglas-fir  lumber are also sold
primarily in California.  In 2006,  MGI's largest three customers  accounted for
approximately  13%, 9% and 7%,  respectively,  of MGI's total net lumber sales.
Exports of lumber  accounted for less than 1% of MGI's total net lumber sales in
2006.  MGI  markets its  products  through its own sales  staff,  which  focuses
primarily on domestic sales.

     Competition

     MGI's  lumber  is  sold  in  highly  competitive  markets.  Competition  is
generally based upon a combination of price,  service,  product availability and
product  quality.  MGI's products  compete not only with other wood products but
with  metals,  masonry,  plastic  and  other  construction  materials  made from
non-renewable  resources. The level of demand for MGI's products is dependent on
such  broad  factors  as  overall  economic   conditions,   interest  rates  and
demographic  trends.  In  addition,  competitive  considerations,  such as total
industry  production  and  competitors'  pricing,  as well as the price of other
construction  products,  affect  the sales  prices  for MGI's  lumber  products.
Competition  in the  common  grade  redwood  and  Douglas-fir  lumber  market is
intense, with MGI competing with numerous large and small lumber producers.  MGI
primarily  competes  with the  northern  California  mills of  Simpson,  Redwood
Empire,  Sierra  Pacific,  Canadian  cedar  lumber  producers,  as well as other
imports and non-wood alternatives.

     Employees

       As of March 1, 2007, MGI had approximately 475 employees.

     Relationships among the Palco Companies

     The Palco  Companies  are  parties to several  agreements  between or among
themselves,  including the Master Purchase Agreement, the Services Agreement, an
additional   services   agreement,   a  reciprocal  rights  agreement,   and  an
environmental indemnification agreement.

     The Master Purchase  Agreement between Palco and Scopac governs the sale to
Palco of logs harvested from the Scopac Timber Property. As Palco purchases logs
from Scopac pursuant to the Master Purchase Agreement,  Palco is responsible for
harvesting and removing,  at its own expense  (either  directly or through third
party  contractors),  the standing  Scopac Timber  covered by approved THPs. The
purchase price is based upon "stumpage  prices" and title to, and the obligation
to pay for,  harvested  logs  passes to Palco  when the logs are  measured.  The
Master Purchase Agreement contemplates that all sales of logs by Scopac to Palco
will be at fair market  value  (based on stumpage  prices) for each  species and
category of timber.  The Master Purchase Agreement provides that if the purchase
price equals or exceeds the SBE Price (as defined below) and a structuring price
set forth in a schedule to the Scopac Indenture, the purchase price is deemed to
be at fair market value.  If the purchase price equals or exceeds the SBE Price,
but is less than the  structuring  price,  then  Scopac is required to engage an
independent forestry consultant to confirm that the purchase price reflects fair
market value. "SBE Price" is the stumpage price for each species and category of
timber  as set  forth  in the  most  recent  "Harvest  Value  Schedule"  (or any
successor  publication)  published by the California State Board of Equalization
(or any successor  agency)  applicable to the timber sold during the  applicable
period.  Harvest  Value  Schedules  are  published  twice a year for purposes of
computing a yield tax imposed on timber harvested between January 1 through June
30 and July 1 through December 31. SBE Prices are not necessarily representative
of actual  prices that would be realized  from  unrelated  parties at subsequent
dates.

     Scopac  relies on Palco,  pursuant to the  Services  Agreement  between the
companies, to provide operational, management and related services not performed
by Scopac's own  employees  with respect to the Scopac  Timber  Property.  These
services  include  protecting the Scopac Timber from fire,  disease and insects;
maintaining and rehabilitating roads on the Scopac Timber Property; building new
roads to permit  the  harvesting  of Scopac  Timber;  providing  certain  timber
management  services,   such  as  replanting  and  reforestation,   designed  to
supplement  the natural  regeneration  of, and  increase  the amount of,  Scopac
Timber;  assisting  Scopac to comply  with all  applicable  environmental  laws;
advising and consulting with Scopac regarding legislative matters; preparing and
filing on behalf of Scopac (at Palco's  cost) all  pleadings  and  motions,  and
otherwise  diligently  pursuing,  appeals  of  any  denial  and  defense  of any
challenge to approval of any THP or the  Environmental  Plans or similar plan or
permit and related matters;  and otherwise  furnishing all equipment,  personnel
and expertise not within the Scopac's  possession and  reasonably  necessary for
the operation and maintenance of the Scopac Timber Property and Scopac Timber.

     Palco is required to provide all services under the Services Agreement in a
manner consistent in all material respects with prudent business  practices that
are  consistent  with  then-current  applicable  industry  standards  and are in
compliance in all material respects with all applicable timber laws. Scopac pays
Palco a services fee, which is adjusted annually based on a specified government
price index  relating to wood  products,  and which  covers a portion of Palco's
costs of  providing  services.  Scopac  also  reimburses  Palco  for the cost of
constructing, rehabilitating and maintaining roads, and performing reforestation
services,  on the Scopac Timber Property.  Certain of such reimbursable expenses
vary in relation to the amount of timber harvesting in any given period.

     Scopac is required  to provide  certain  services  to Palco  pursuant to an
additional  services  agreement  between the companies.  These services  include
assisting  Palco to operate,  maintain  and  harvest its own timber  properties,
updating and providing access to the GIS with respect to information  concerning
Palco's  own timber  properties,  and  assisting  Palco with its  statutory  and
regulatory compliance. This agreement provides that Palco shall pay Scopac a fee
for such services equal to Scopac's  actual cost of providing such services,  as
determined in accordance with accounting  principles  generally  accepted in the
United States.

     The Palco Companies are parties to a reciprocal  rights agreement  whereby,
among other things,  the parties have granted to each other  certain  reciprocal
rights of egress and ingress through their  respective  properties in connection
with the operation  and  maintenance  of such  properties  and their  respective
businesses.  In  addition,  Palco and  Scopac are  parties  to an  environmental
indemnification  agreement,  pursuant  to which  Palco has  agreed to  indemnify
Scopac from and against  certain  present and future  liabilities  arising  with
respect to hazardous  materials,  hazardous materials  contamination or disposal
sites, or under  environmental  laws with respect to the Scopac Timber Property.
In particular,  Palco is liable with respect to any contamination which occurred
on the Scopac Timber Property prior to the date of its transfer to Scopac.

     Regulatory and Environmental Factors

     This  section  contains   statements   which  constitute   "forward-looking
statements"   within  the   meaning  of  the  PSLRA.   See  this   section   and
"Business-General"  above  and Item 1A.  "Risk  Factors"  below  for  cautionary
information with respect to such forward-looking statements.

     General
     The  businesses  of Palco and Scopac are subject to a variety of California
and  federal  laws and  regulations,  as well as the HCP,  dealing  with  timber
harvesting  practices,  threatened and  endangered  species and habitat for such
species,  and air and water quality.  Compliance  with such laws and regulations
also plays a significant  role in these  companies'  businesses.  The California
Forest Practice Act (the "Forest Practice Act") and related  regulations adopted
by the California  Board of Forestry and Fire  Protection  (the "BOF") set forth
detailed  requirements  for the  conduct  of  timber  harvesting  operations  in
California.  These  requirements  include the obligation of timber  companies to
obtain regulatory approval of detailed THPs containing  information with respect
to areas proposed to be harvested. See "-Harvesting Practices" above. California
law also  requires  large  timberland  owners,  including  Palco and Scopac,  to
demonstrate that their proposed timber  operations will result in but not exceed
the  maximum  sustainable   production  of  their  timberlands  over  time.  See
"-Principal Assets" above.

     The federal  Endangered  Species Act (the "ESA") and California  Endangered
Species Act (the "CESA") provide in general for the protection and  conservation
of specifically  listed wildlife and plants.  These laws generally  prohibit the
take of certain  species,  except for  specifically  authorized  incidental take
pursuant to otherwise  lawful  activities  which do not jeopardize the continued
existence  of the  affected  species  and which are made in  accordance  with an
approved  habitat  conservation  plan and related  incidental  take  permits.  A
habitat  conservation  plan, among other things,  specifies measures to minimize
and  mitigate  the  potential  impact of the  incidental  take of species and to
monitor the effects of the activities  covered by the plan. Palco and Scopac are
also  subject  to the  California  Environmental  Quality  Act  ("CEQA"),  which
provides for  protection of the state's air and water quality and wildlife,  and
the California  Porter-Cologne Water Quality Control Act and federal Clean Water
Act ("CWA"),  which  require that Palco and Scopac  conduct  operations so as to
reasonably  protect the water quality of nearby  rivers and streams.  Compliance
with  such  laws  and  related   regulations  and  judicial  and  administrative
interpretations,  together with other regulatory and environmental matters, have
resulted in substantial  restrictions  on the scope and timing of harvesting and
other  operations  on  the  Palco  Timberlands,   increased   operational  costs
significantly,  and engendered  continual litigation and other challenges to its
operations.

     Environmental Plans
     In March  1999,  the Palco  Companies  consummated  their  1996  Headwaters
Agreement (the  "Headwaters  Agreement")  with the United States and California.
Pursuant to the Headwaters  Agreement,  approximately 5,600 acres of timberlands
owned by the Palco Companies were transferred to the United States government in
exchange  for $300.0  million,  approximately  7,700 acres of  timberlands,  and
approval by the federal and state  governments of the  Environmental  Plans.  In
connection with approval of the Environmental  Plans, the California Permits and
federal  incidental  take permits (the "Federal  Permits," and together with the
California  Permits,  the  "Permits"),  were  issued  with  respect  to  certain
threatened, endangered and other species found on the timberlands covered by the
Environmental  Plans.  The Permits were to cover the 50-year term of the HCP and
allow incidental take of 17 different species covered by the HCP, including nine
species which are found on the Palco Timberlands that have been listed under the
ESA and/or  the CESA.  In October  2003,  a  California  trial  court  entered a
judgment  invalidating the SYP and the California  Permits.  Palco appealed this
decision and in December  2005 the  appellate  court  reversed the trial court's
ruling. See Item 3. "Legal  Proceedings-Forest  Products Litigation" for further
information   regarding  this  matter.   The  agreements   which  implement  the
Environmental Plans also provide for various remedies (including the issuance of
written  stop  orders and  liquidated  damages)  in the event of a breach by the
Palco Companies of these agreements or the Environmental Plans.

     Under the HCP,  harvesting  activities  are  prohibited  or  restricted  on
certain areas of the Palco Timberlands.  Some of these restrictions continue for
the entire  50-year  term of the HCP.  For example,  several  areas  (containing
substantial  quantities of timber,  including old growth redwood and Douglas-fir
timber) are designated as habitat conservation areas for the marbled murrelet, a
coastal seabird, and certain other species. Harvesting in certain other areas of
the Palco  Timberlands is currently  prohibited  while these areas are evaluated
for the potential risk of landslide. Further, additional areas alongside streams
have  been  designated  as  buffers,   in  which  harvesting  is  prohibited  or
restricted, to protect aquatic and riparian habitat.  Restrictions on harvest in
streamside  buffers and  potential  landslide  prone areas may be adjusted up or
down,  subject to certain  minimum and maximum  buffers,  based upon the ongoing
watershed  analysis process  described below.  The adaptive  management  process
described below may also be used to modify most of these restrictions.

     The first analysis of a watershed,  Freshwater,  was released in June 2001.
This analysis was used by the Palco Companies and the government agencies (other
than the North  Coast  Water  Board  (as  defined  below)) to  develop  proposed
harvesting prescriptions.  Since then, watershed analysis has been completed and
prescriptions  approved for three  additional  watersheds:  Van Duzen in January
2004,  Lower Eel-Eel Delta in March 2004,  and Elk River in November  2005.  The
Freshwater, Van Duzen, Lower Eel, and Elk River prescriptions each resulted in a
reduction in the size of the streamside  buffers set forth in the  Environmental
Plans and also  provide  for  geologic  reviews in order to  conduct  harvesting
activities  on some  potential  landslide-prone  areas  in  lieu  of  no-harvest
restrictions.  This effectively reduced both constrained acreage and HCP-related
operational  restrictions  in  these  watersheds.   The  analysis  for  a  fifth
watershed,  Upper Eel, has been  completed and the Palco  Companies are awaiting
final agency approval of the prescriptions.

     The HCP required the Palco Companies, together with the government agencies
(other than the North Coast Water Board),  to establish a schedule  resulting in
completion  of the initial  watershed  analysis  process  for all covered  lands
within five years.  However,  due largely to the number of agencies involved and
the depth and complexity of the analyses, the process has required significantly
more time than originally anticipated. Accordingly, the Palco Companies continue
to work with the government agencies to establish  appropriate  timelines and to
streamline  watershed analyses on the remaining portions of Palco Timberlands to
ensure that such  studies are time and cost  efficient  and  continue to provide
scientific  results  necessary to evaluate  potential  changes to the harvesting
restrictions  on those lands.  The Palco  Companies had  previously  received an
extension to March 2007 of the time in which the watershed analysis process must
be  completed.  An  additional  request  for an  extension  to March  2008 is in
process.

     The HCP  contains an adaptive  management  provision  that allows the Palco
Companies  to  propose  changes  to  many of the HCP  prescriptions.  The  Palco
Companies  and the  agencies  (other  than the North  Coast  Water  Board)  have
previously  implemented  various adaptive management changes related to wildlife
and rare plants,  and other changes  relating to roads and  streamside  buffers.
These adaptive  management  changes increased the ability to conduct  harvesting
operations on the Palco  Timberlands  and/or reduced operating costs while still
meeting the obligations of the Environmental Plans.

     The HCP imposes certain restrictions on the use of roads on the timberlands
covered by the HCP during  several  months of the year and during periods of wet
weather.  However,  Palco has  conducted,  and expects to be able to continue to
conduct,  some harvesting  during these periods.  An adaptive  management change
approved in 2003 for the road restrictions has improved the ability to construct
and use roads on the Palco  Timberlands  in ways  that are  consistent  with the
operational needs of the Palco Companies. The HCP also requires that 75 miles of
roads be stormproofed (i.e.,  reconstructed to reduce sediment generation) on an
annual  basis and that  certain  other roads must be improved or  repaired.  The
nature of this work  requires  that it be  performed  in the dry  periods of the
year.

     Water Quality
     Laws and  regulations  dealing with water quality are impacting or have the
potential to impact the Palco Companies primarily in three areas: efforts by the
federal Environmental Protection Agency (the "EPA") and the North Coast Regional
Water Quality  Control Board (the "North Coast Water Board") to establish  total
maximum daily load limits  ("TMDLs") in watercourses  that have been declared to
be water quality impaired; actions by the North Coast Water Board imposing waste
discharge reporting  requirements,  and various mitigation,  erosion control and
clean-up  measures;  and the  development by the North Coast Water Board and its
staff of  special  permitting  requirements  for the  Freshwater  and Elk  River
watersheds known as watershed-wide waste discharge requirements ("WWDRs").

     Under the CWA, the EPA is required to establish TMDLs in watercourses  that
have been declared to be "water  quality  impaired." The EPA and the North Coast
Water  Board  are in  the  process  of  establishing  TMDLs  for  many  northern
California rivers and certain of their tributaries,  including nine watercourses
that flow within the Palco  Timberlands.  The relevant  contaminant on the Palco
Timberlands  is simple  sediment - dust,  dirt and gravel - that is  abundant in
watercourses  largely as a function of the area's  normally  heavy  rainfall and
soil that erodes easily.  The Company expects the process of establishing  TMDLs
to continue into 2010.  The EPA has issued a report  dealing with TMDLs on three
of the nine  watercourses.  The agency indicated that the requirements under the
HCP would  significantly  address  the  sediment  issues  that  resulted in TMDL
requirements for these watercourses.  Presently,  the North Coast Water Board is
in the process of  establishing  the TMDL  requirements  applicable to two other
watercourses on the Palco Timberlands, Freshwater and Elk River, with a targeted
completion of 2008 for these two watercourses.  Scopac's scientists are actively
working with North Coast Water Board staff to ensure that these TMDLs  recognize
and incorporate the environmental protection measures of the HCP. The final TMDL
requirements  applicable to the Palco Timberlands may require aquatic protection
measures  that are  different  from or in  addition  to those in the HCP or that
result from the prescriptions to be developed pursuant to the watershed analysis
process  provided for in the HCP.  These  requirements  could  further  restrict
harvesting on the Palco Timberlands.

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

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

     On May 8,  2006,  the  North  Coast  Water  Board  adopted  WWDRs  for  the
Freshwater  and  Elk  River.  The  decision  allows   harvesting  in  these  two
watersheds,  up to  approximately  50% of the  applicable  annual  harvest limit
established by the CDF for each watershed ("CDF Harvest Limit"),  once the staff
of the North Coast Water Board reviews and enrolls THPs submitted by Scopac. The
North Coast Water  Board's  decision  also allowed the  enrollment of additional
THPs, bringing the total to approximately 75% of the CDF Harvest Limit for these
two  watersheds,  upon  approval of a monitoring  and  reporting  program by the
Executive  Officer of the North Coast  Water Board  staff.  The  monitoring  and
reporting program was approved on September 29, 2006, allowing enrollment by the
staff of the North Coast Water Board of additional THPs for these two watersheds
that were harvested in 2006.  This  monitoring  and reporting  program will also
govern future THPs in these two watersheds.  However,  there can be no assurance
that  additional  THPs in these two  watersheds  will  ultimately be enrolled or
harvested as planned in future years.  The North Coast Water Board's adoption of
these  WWDRs has been  appealed to the State  Water  Board,  but the appeals are
being  held in  abeyance  pending  implementation  of the WWDRs.  As  harvesting
activities on the Palco Timberlands  cannot readily be moved between  watersheds
due to, among other things,  historic harvest patterns,  adjacency restrictions,
and the age classes of trees, development of WWDRs and the various other matters
described could result in reduced harvest levels in future years.

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

     Impact of Future Developments
     Laws,   regulations  and  related  judicial  decisions  and  administrative
interpretations  dealing with MGI's business are subject to change, and new laws
and  regulations  are frequently  introduced  concerning  the California  timber
industry.  From time to time, bills are introduced in the California legislature
and the U.S.  Congress  which  relate  to the  business  of MGI,  including  the
protection and acquisition of old growth and other  timberlands,  threatened and
endangered species,  environmental  protection,  air and water quality,  and the
restriction,  regulation and administration of timber harvesting  practices.  In
addition  to  existing  and  possible  new  or  modified  statutory  enactments,
regulatory  requirements and  administrative  and legal actions,  the California
timber  industry  remains  subject  to  potential  California  or  local  ballot
initiatives,  and federal and California  judicial  decisions which could affect
timber  harvesting  practices.  It is not  possible to assess the effect of such
future  legislative,  judicial  and  administrative  developments  on MGI or its
business.

     Timber Operator's License
     In order to conduct logging  operations,  road building,  stormproofing and
certain other activities, a company must obtain a Timber Operator's License from
the CDF. In December  2005,  Palco was granted a Timber  Operator's  License for
2006-2007.

Real Estate Operations

     General

     The Company, principally through its wholly owned subsidiaries,  invests in
and develops  residential and commercial real estate,  primarily in Puerto Rico,
Arizona,  California,  and Texas.  Real estate  properties and receivables as of
December 31, 2006 are as follows:

                                                                                         Book Value as
                                                                                        of December 31,
                                                                                            2006
                                                                                       -----------------
                                                                                         (In millions)
Palmas del Mar (Puerto Rico):
  Undeveloped land and parcels held for sale                              988 acres    $        30.2
  Property, plant and equipment, receivables and other, net                                     13.3
                                                                                       -----------------
     Total                                                                                      43.5
  Resort operations - Palmas Country Club(1)                                                    20.3
                                                                                       -----------------
     Total                                                                                      63.8
                                                                                       -----------------
Fountain Hills (Arizona):
  Residential developed lots and lots under development                   135 lots              14.3
  Undeveloped residential land                                            431 acres              4.6
  Property, plant, equipment and receivables, net                                                1.2
                                                                                       -----------------
     Total                                                                                      20.1
                                                                                       -----------------
Mirada (California):
  Residential developed lots                                              5 lots                 1.9
  Property, plant, equipment and receivables, net                                                0.2
                                                                                       -----------------
     Total                                                                                       2.1
                                                                                       -----------------
Commercial lease properties:
  Property, plant and equipment,net:
     Lake Pointe Plaza (Texas)                                                                 103.4
     Cooper Cameron building (Texas)                                                            27.2
     Motel 6 facilities (10 states)                                                             40.5
     Other                                                                                       2.8
                                                                                       -----------------
     Total                                                                                     173.9
                                                                                       -----------------
Other, principally receivables                                                                   0.1
                                                                                       -----------------
        Total real estate properties and receivables                                   $       260.0
                                                                                       =================

(1)  Palmas Country Club operations include two 18-hole golf courses, a 20 court
     tennis facility,  a member clubhouse,  and a beach club.  Amounts shown are
     net of accumulated depreciation.
                                                                                         Book Value as
                                                                                         of December 31,
                                                                                               2006
                                                                                        -----------------
                                                                                          (In millions)
Joint Ventures:
   FireRock, LLC
      Golf course, clubhouse and other club facilities(2)                               $        14.5
      Other property, plant and equipment, net(1)                                                 2.5
                                                                                        -----------------
        Total                                                                           $        17.0
                                                                                        =================
      Investment in FireRock, LLC(2)                                                    $         1.5
                                                                                        =================
   RMCAL Development LP(1)
      Residential units under development                                               $        36.2
                                                                                        =================
      Investment in RMCAL Development LP(2)                                             $         2.4
                                                                                        =================

(1) Amounts reflect 100% of the book value of the joint venture's assets.
(2) Amounts reflect the book value of the Company's 50% interest.

     Revenues from real estate  operations were as follows in 2006 and 2005 (see
Item 7. "Management's Discussion and Analysis of Financial Condition and Results
of  Operations-Results  of  Operations-Real  Estate  Operations"  for additional
details regarding 2006, 2005 and 2004 results):

                                                                                                 Years Ended
                                                                                                 December 31,
                                                                                          --------------------------
                                                                                              2006         2005
                                                                                          ------------ -------------
                                                                                                (In millions)
                                                                                          --------------------------

Palmas del Mar:
  Real estate sales                                                                       $   27.6     $   42.3
  Commercial, resort operations and other                                                     12.5         12.1
                                                                                          ------------ -------------
     Total                                                                                    40.1         54.4
                                                                                          ------------ -------------
Fountain Hills:
  Real estate sales                                                                           15.6         42.9
  Commercial operations and other                                                              3.7          5.4
                                                                                          ------------ -------------
     Total                                                                                    19.3         48.3
                                                                                          ------------ -------------
Mirada:
  Real estate sales                                                                           26.6         56.9
  Commercial operations and other                                                              0.3          0.1
                                                                                          ------------ -------------
     Total                                                                                    26.9         57.0
                                                                                          ------------ -------------
Commercial lease properties:
  Lake Pointe Plaza                                                                           11.1         10.9
  Cooper Cameron building                                                                      2.3          2.3
  Motel 6 facilities                                                                           4.8          4.8
  Other                                                                                        0.2          0.3
                                                                                          ------------ -------------
     Total                                                                                    18.4         18.3
                                                                                          ------------ -------------
Other:
  Real estate sales                                                                              -          0.1
  Commercial operations and other                                                              0.2          0.2
                                                                                          ------------ -------------
     Total                                                                                     0.2          0.3
                                                                                          ------------ -------------
       Total                                                                              $  104.9     $  178.3
                                                                                          ============ =============

FireRock, LLC(1):
  Real estate sales                                                                       $      -     $      -
  Golf course operations                                                                       3.7          3.4
                                                                                          ------------ -------------
     Total                                                                                $    3.7     $    3.4
                                                                                          ============ =============
RMCAL Development LP(1):
  Real estate sales                                                                       $    9.1     $      -
                                                                                          ============ =============

(1) Amounts reflect 100% of the joint venture's revenues.

     Palmas del Mar

     Palmas del Mar, a master-planned  residential  community and resort located
on the southeastern coast of Puerto Rico near Humacao  ("Palmas"),  was acquired
by a  subsidiary  of the Company in 1984.  Originally  over 2,700  acres,  as of
December 31, 2006, the Company now has approximately  1,000 acres of undeveloped
land remaining at Palmas.  The Company conducts its operations at Palmas through
Palmas del Mar Properties, Inc. ("PDMPI") and PDMPI's subsidiaries.  PDMPI seeks
developers  and  investors to acquire its acreage.  Resort  operations at Palmas
include  a  country  club  with two golf  courses  and  tennis  and  beach  club
facilities.  Certain  other  amenities,  including a hotel,  marina,  equestrian
center and various restaurants, are owned and operated by third parties.

     Fountain Hills

     In 1968,  a  subsidiary  of the  Company  purchased  and  began  developing
approximately 12,100 acres of real property in Fountain Hills, Arizona, which is
located  near  Phoenix  and  adjacent to  Scottsdale,  Arizona.  Development  of
Fountain Hills is substantially  complete.  Future sales are expected to consist
of fully  developed  lots in two  developments  known as  Eagles  Nest and Adero
Canyon.  Eagles Nest, a 506-acre custom lot  development  planned to include 245
lots,  commenced sales in 2004. Lots are being released in phases,  with 12 lots
and 78 lots having been sold in 2006 and 2005,  respectively.  Development plans
have been formulated for Adero Canyon, a 431-acre custom lot development planned
to  include  171  lots.  Financing  of the  Adero  Canyon  development  will  be
accomplished  either through new or existing credit  facilities or joint venture
arrangements.

     In 1998, a subsidiary of the Company  entered into and holds a 50% interest
in a joint venture named FireRock, LLC ("FireRock,  LLC") to develop an 808-acre
area in Fountain  Hills known as FireRock  Country Club.  The  development  is a
residential,  golf-oriented,  upscale  master-planned  community  consisting  of
custom  lots,  multi-family  parcels  and a private  country  club.  The  club's
championship-level  private 18-hole golf course opened in 2000. The multi-family
parcels  were sold in  2001-2002  and custom lot sales  concluded  in 2004.  The
venture continues to own and operate the country club.

     Mirada

     In 1991, a subsidiary of the Company  acquired  Mirada,  a 220-acre  luxury
resort-residential  project  located in Rancho Mirage,  California.  Mirada is a
master-planned  community  in the  Santa  Rosa  Mountains,  650 feet  above  the
Coachella  Valley floor.  The  Company's  direct  development  activities at the
project are substantially complete. The first of the project's six parcels was a
custom lot subdivision of 46 estate lots. The Ritz-Carlton  Rancho Mirage Hotel,
which is owned and  operated  by a third  party,  was  developed  on the  second
parcel.  The third parcel is a custom lot  subdivision  consisting  of 63 estate
lots.  Sales of these lots began in 2003, and as of December 31, 2006, all but 4
lots had been sold.

     In April 2004,  a  subsidiary  of the Company and a third party real estate
development  company formed a joint venture named RMCAL Development LP ("RMCAL")
to develop the fourth parcel,  a 27-acre  residential  tract. In connection with
the  formation  of RMCAL,  the  Company  sold a 50%  interest  in the parcel and
contributed the remainder of the parcel to the joint venture in return for a 50%
interest in the venture.  RMCAL will construct and sell 46 villas to be built on
the parcel. Four villas and one lot were sold in 2006. Sixteen other villas have
either been completed or are under construction.

     The Company's two remaining  parcels  encompassing  approximately 39 acres,
were sold in 2005.

     Commercial Lease Properties

     In June 2001,  subsidiaries  of the Company  acquired Lake Pointe Plaza, an
office  complex  located in Sugar Land,  Texas,  for a purchase  price of $131.3
million.  The transaction was financed by the subsidiaries  through the issuance
of $122.5 million of non-recourse notes and the balance from available cash. The
office  complex is fully leased to affiliates of the seller through May 2021 and
the parent company has guaranteed all of the lease payments.

     In November  2002, a subsidiary of the Company  acquired the Cooper Cameron
building, an office building located in Houston,  Texas, for a purchase price of
$32.7 million.  The  transaction  was financed by the subsidiary  through a cash
payment of $3.0 million and the issuance of $29.7 million in non-recourse notes.
At the  time  of the  acquisition,  the  subsidiary  simultaneously  leased  the
property back to the seller for a period of 22 years.

     In December 2002, a subsidiary of the Company  acquired two business trusts
which own a  portfolio  of sixteen  motel  properties  located in ten  different
states.  The purchase price  consisted of a cash payment of $3.5 million and the
assumption of certain  non-recourse notes with an outstanding  principal balance
of $49.4 million secured by the properties. The properties were acquired subject
to an existing  lease  agreement  under which the  properties  are fully  leased
through April 2019, and under which all obligations are guaranteed by the parent
company of the current tenant.

     Marketing

     The  Company  is  engaged  in  marketing  and  sales  programs  of  varying
magnitudes  at its real estate  developments.  The  Company  intends to continue
selling  undeveloped acreage and semi-developed  parcels,  generally to builders
and developers,  and fully developed lots to individuals and builders. Sales are
made  directly  to  purchasers  through the  Company's  wholly  owned  brokerage
operations  and  its  marketing  personnel,   as  well  as  through  independent
contractors  such  as real  estate  brokers  who are  compensated  by  means  of
customary real estate  brokerage  commissions.  The Company may also continue to
enter into joint  ventures with third  parties  similar to those entered into in
connection with the FireRock and RMCAL projects.

     Competition and Regulation and Other Industry Factors

     There is intense  competition among companies in the real estate investment
and development  business.  Sales and payments on real estate sales  obligations
depend, in part, on available financing and/or disposable income and, therefore,
are affected by changes in general  economic  conditions and other factors.  The
real estate  development  and commercial  real estate  businesses are subject to
other  risks  such as  shifts in  population,  fluctuations  in the real  estate
market, and unpredictable changes in the desirability of residential, commercial
and  industrial  areas.  The resort  business of Palmas  competes  with  similar
businesses in the Caribbean,  Florida and other  vacation/holiday  destinations.
The Company's Arizona real estate operations  compete with similar businesses in
the  areas  in and  surrounding  Phoenix,  Arizona,  and  the  Company's  Mirada
development  faces  competition  from other  developments in the area, many with
golf courses and other amenities.

     The Company's real estate operations are subject to comprehensive  federal,
state and local  regulation.  Applicable  statutes and  regulations  may require
disclosure of certain information concerning real estate developments and credit
policies of the Company and its subsidiaries. Periodic approval is required from
various agencies in connection with the design of  developments,  the nature and
extent of  improvements,  construction  activity,  land use, zoning and numerous
other matters.  Failure to obtain such approval,  or periodic  renewal  thereof,
could adversely affect the real estate  development and marketing  operations of
the Company and its subsidiaries.  Various jurisdictions also require inspection
of  properties  by  appropriate  authorities,   approval  of  sales  literature,
disclosure  to  purchasers  of  specific   information,   bonding  for  property
improvements,  approval of real estate contract forms and delivery to purchasers
of a report describing the property.

     Employees

     As of March 1, 2007, the Company's real estate operations had approximately
225 employees.

Racing Operations

     General

     SHRP,  Ltd.  owns and operates Sam Houston Race Park, a Texas Class 1 horse
racing facility located within the greater Houston  metropolitan area and Valley
Race Park, a greyhound racing facility  located in Harlingen,  Texas. In January
2004, a subsidiary of the Company,  Laredo Race Park LLC ("Laredo LLC"), applied
to the Texas Racing  Commission  (the  "Racing  Commission")  for an  additional
license to  construct  and  operate a Class 2 horse  racing  facility in Laredo,
Texas.  Following a hearing on Laredo LLC's  application and that of a competing
applicant, in September 2006, two state administrative law judges recommended to
the  Racing  Commission  that  Laredo  LLC be awarded  the  license.  The Racing
Commission  on March 20,  2007  ruled  that both  Laredo  LLC and the  competing
applicant be awarded licenses for the Laredo area. The license awarded to Laredo
LLC is,  however,  conditioned  on SHRP,  Ltd.,  by the next  Racing  Commission
meeting on May 14, 2007,  entering into an agreement  satisfactory  to the Racing
Commission providing for the sale of Valley Race Park.

     Racing Operations and Facilities

     Sam Houston  Race Park and Valley Race Park offer  pari-mutuel  wagering on
live  thoroughbred,  quarter horse and greyhound racing during meets approved by
the Racing  Commission  on a yearly basis and on simulcast  horse and  greyhound
racing  throughout the year. Under the Texas Racing Act and related  regulations
(collectively,  the "Racing Act"), commission revenues for both facilities are a
designated portion of the pari-mutuel handle. Sam Houston Race Park had 110 days
of live racing in 2006 and currently  has 116 days of live racing  scheduled for
2007. Valley Race Park had 94 live racing days during 2006, and currently has 95
live racing days scheduled for 2007.

     Revenues are also earned on simulcast  racing through both guest  simulcast
arrangements  (the receipt by Sam Houston Race Park and Valley Race Park of live
broadcasts  of  racing  conducted  at  other   racetracks)  and  host  simulcast
arrangements  (the live  broadcast  to other race tracks and off track  wagering
sites of racing  conducted at Sam Houston  Race Park and Valley Race Park).  Sam
Houston  Race  Park and  Valley  Race Park also  derive  revenues  from food and
beverages sales, admission and parking fees, group sales and advertising sales.

     Regulation of Racing Operations

     The ownership and operation of horse and greyhound  racetracks in Texas are
subject to significant regulation by the Racing Commission under the Racing Act.
The Racing Act  provides,  among other  things,  for the  allocation of wagering
proceeds among betting participants,  purses, racetracks, the State of Texas and
for other purposes,  and empowers the Racing  Commission to license and regulate
substantially all aspects of horse and greyhound racing in the state. The Racing
Commission  must approve the number of live racing days that may be offered each
year, as well as all simulcast agreements. Class 1 horse racetracks in Texas are
entitled  to conduct at least  seventeen  weeks of live racing for each breed of
horses  (thoroughbreds and quarter horses),  while greyhound tracks are entitled
to conduct live racing nearly year round.

     Marketing and Competition

     SHRP,  Ltd.'s  management  believes  that the  majority of Sam Houston Race
Park's  patrons  reside  within a 25-mile  radius,  which  includes  most of the
greater  Houston  metropolitan  area, and that a secondary  market of occasional
patrons  exists  outside the 25-mile  radius but within a 50-mile  radius of the
facility.  Sam Houston  Race Park uses a number of  marketing  strategies  in an
attempt  to reach  these  people  and make them more  frequent  visitors  to Sam
Houston Race Park. Recent changes to strategies  include increased  newspaper ad
sizes, expansion of website capabilities, radio advertising, increased marketing
of items offered  outside of the racing  product,  a VIP program with  exclusive
promotional  offers, and greater focus on casual and  event-oriented  customers.
Valley Race Park employs similar strategies to attract patrons.  Both Race Parks
also rent out facilities and grounds for group events,  which increase  revenues
and expose the facility to potential  customers even though the events are often
unrelated  to  racing.  As a further  effort to build its fan base,  SHRP,  Ltd.
Intends to begin focusing more on positioning itself as a general  entertainment
venue, including developing a new concert venue.

     Sam  Houston  Race  Park   competes   with  other  forms  of  wagering  and
entertainment,  including  a Louisiana  "racino"  (horse or dog tracks with slot
machines or other forms of gaming) located approximately 120 miles from Houston,
casinos  located  approximately  140 miles from Houston,  a greyhound  racetrack
located 55 miles away from  Houston,  a wide range of sporting  events and other
entertainment  activities  in the Houston  area,  the Texas State  Lottery,  and
charitable  bingo.   Other  competitive   pressures  include  simulcast  signals
broadcast  by racinos,  which are able to offer  larger  purses and  competitive
fields,  resorts  with  gaming,  and  increasing  use of the  Internet for horse
wagering  and  gaming,   including   Internet  betting  services  with  customer
incentives such as cash rebates.  Sam Houston Race Park could in the future also
compete  with other  forms of gambling in Texas,  including  casino  gambling on
Indian reservations elsewhere.

     While Sam Houston Race Park  believes that the location of Sam Houston Race
Park is a  competitive  advantage  over the other more distant  gaming  ventures
mentioned above,  the most significant  challenges for Sam Houston Race Park are
to maintain its customer base in spite of the above competitive pressures and to
develop and educate new racing fans in a market where  pari-mutuel  wagering had
been  absent from the 1930's to 1994.  Other  competitive  factors  faced by Sam
Houston Race Park include the  allocation of sufficient  live racing days by the
Racing  Commission  and  attraction  of a sufficient  number and quality of race
horses to run at Sam  Houston  Race  Park,  particularly  in view of the  larger
purses able to be offered by racinos.  Competitive  factors faced by Valley Race
Park  include  the Texas  State  Lottery,  charitable  bingo and  Internet-based
gaming,  as well as the attraction of sufficient  greyhounds to run live racing,
along with the ability of Valley Race Park to market its simulcast signal due to
its brief live racing season.

     The Texas Legislature  convenes its regular session every other year. It is
expected that this body will, during regular  legislative  session that began in
January and lasts through May 2007,  consider measures to enhance state revenues
though  additional  forms of gaming such as video lottery  terminals at existing
horse and dog racing tracks,  gaming on Indian  reservations,  and full casinos.
Several measures have been introduced to date that include some form of enhanced
gaming  at  horse  and dog  tracks.  The  Company  will  vigorously  pursue  any
legislation  that is favorable to it. As the measures  introduced  to date would
require the approval of two-thirds of each  legislative  house and a majority of
Texas  voters,  no  assurance  can be given  that any such  legislation  will be
enacted or become  effective.  Moreover,  it is impossible to determine what the
provisions of any such legislation would be or its effect on the Company.

     Employees

     As of March 1, 2007, the Company's racing  operations had approximately 370
full  and  part-time   employees  and  approximately  475  additional   seasonal
employees.

Kaiser Aluminum

     The  Company  previously  owned  approximately  63% of the common  stock of
Kaiser, which engaged in several principal aspects of the aluminum industry.  In
February 2002, Kaiser and certain of its subsidiaries  filed for  reorganization
under  Chapter  11 of the  Bankruptcy  Code.  Kaiser's  plan  of  reorganization
provided for the  cancellation of Kaiser's  equity,  including the common shares
held by the Company,  without  consideration  or  obligation.  Kaiser's  plan of
reorganization  became  effective  on July 6,  2006,  and  Kaiser  emerged  from
bankruptcy.  As a result, the Company no longer has any ownership interest in or
affiliation  with  Kaiser.  Since  the  Company's  common  stock in  Kaiser  was
cancelled without obligation,  the Company reversed the $516.2 million of losses
in  excess  of its  investment  in  Kaiser  along  with  the  accumulated  other
comprehensive losses of $85.3 million related to Kaiser, resulting in a net gain
of $430.9  million,  recognized in the third quarter of 2006. As a result of the
cancellation  of the Company's  Kaiser common stock in 2006, the Company expects
it will take a worthless stock deduction on its 2006 consolidated federal income
tax return.  However,  it is  uncertain  whether  the  deduction  meets  certain
criteria required for asset recognition purposes.  Accordingly,  the Company has
not recorded the  resulting  tax asset of  approximately  $135.8  million in its
consolidated balance sheet as of December 31, 2006.

Segment Information

     See Item 7.  "Management's  Discussion and Analysis of Financial  Condition
and  Results of  Operations-Results  of  Operations"  and Note 3 for  additional
information  regarding  revenues,  income  or  loss,  and  total  assets  of the
Company's  three  segments,  as well as  revenues  from the  principal  products
offered by each. None of the Company's  segments have material  foreign sales or
assets.

Employees

     At March 1,  2007,  MAXXAM and its  subsidiaries  had  approximately  1,570
year-round  and  seasonal  employees  none of whom are  covered by a  collective
bargaining agreement.

Company SEC Reports

     As the Company does not maintain an Internet website, the Company's filings
are not available in this manner. However, the Company files electronically with
the  Securities  and  Exchange  Commission  (the  "SEC"),  which has an Internet
website (http://www.sec.gov)  containing the reports, proxy statements and other
information that the Company electronically files with the SEC. In addition, the
Company will provide these  materials free of charge to any  recordholder of the
Company's  securities  or any "street  name" holder that provides a brokerage or
similar  statement  reflecting  such  holdings.  You should send your request to
MAXXAM Inc.,  c/o  Corporate  Secretary,  1330 Post Oak  Boulevard,  Suite 2000,
Houston,  Texas  77056-3058.  The Company will also  consider on a  case-by-case
basis requests for such materials by persons who do not hold Company securities.

ITEM 1A. RISK FACTORS

Risks Related to the Bankruptcy Cases

     The bankruptcies of Palco and its subsidiaries,  including  Scopac,  create
significant risks and uncertainties.

     On January 18, 2007,  each of the Palco  Debtors and Scopac filed  separate
voluntary petitions in the Bankruptcy Court for reorganization  under Chapter 11
of the Bankruptcy  Code. The filing of the Bankruptcy  Cases was precipitated by
liquidity  shortfalls at Palco and Scopac and their resultant  inability to make
January 2007 interest  payments on their  respective debt  obligations,  arising
from regulatory restrictions and limitations on timber harvest, increased timber
harvesting costs and cyclical lumber prices.

     The bankruptcies of the Debtors create  significant risks and uncertainties
for the Debtors and the Company,  including, but not limited to, those described
herein.  The outcome of the Bankruptcy  Cases is impossible to predict and could
have a  material  adverse  effect  on the  businesses  of  the  Debtors,  on the
interests  of  creditors,  and on the  Company.

     The Debtors  may not be able to  reorganize  successfully,  and the Company
could lose some or all of is equity ownership interest.

     The Debtors'  overall  objectives in the Bankruptcy Cases are to achieve an
operational and financial  restructuring  of each of the Debtors  long-term debt
obligations  in view of estimated  lower harvest  levels,  increased  regulatory
compliance  costs  and  cyclical  lumber  prices,  and  also to  continue  their
businesses. The Debtors may not be able to attain these objectives and achieve a
successful  operational  and  financial  reorganization.   If  the  Debtors  are
unsuccessful in attaining a successful operational and financial reorganization,
the  Debtors  could be forced to  surrender  all or  substantially  all of their
assets to their  creditors.  Many of the  matters  discussed  elsewhere  in this
document could adversely  affect the Debtors'  ability to achieve an operational
and financial restructuring.

     As provided by the Bankruptcy  Code, each of the Debtors  generally has the
exclusive right to propose a plan of  reorganization  for 120 days following the
date of  filing of the  Bankruptcy  Cases  (the  "Exclusivity  Period"),  unless
certain statutory exceptions apply or the Bankruptcy Court orders otherwise. For
instance,  a group of holders of Scopac Timber Notes has filed a motion that, if
granted,  might have the effect of shortening the Exclusivity  Period.  There is
substantial  uncertainty as to when each of the Debtors will be able to file its
plan.  Moreover,  the Debtors' efforts to obtain approval of such plan(s) by the
creditors  and equity  holders  entitled to vote on the  plan(s),  and to obtain
confirmation by the Bankruptcy Court of such plan(s), may not be successful.

     If a Debtor's  creditors are not paid in full, the Bankruptcy Code provides
that the  Debtor's  equity  holder  will not be  entitled  to retain  its equity
interest,  unless certain exceptions apply. If the liabilities of one or more of
the Debtors are ultimately found to exceed the fair value of its assets,  claims
of creditors could be paid at less than 100% of their face value. In that event,
Palco could lose all or a material portion of its equity ownership in Scopac and
Palco's  other  subsidiaries,  MGI could lose all or a  material  portion of its
equity ownership in Palco, or the value of such equity ownership interests could
be diluted, impaired or eliminated.

     The Palco Debtors and Scopac may be unable to obtain sufficient  additional
liquidity to continue operations and reorganize successfully under Chapter 11.

     The Palco  Debtors  estimate  that they will have  liquidity  shortfalls in
2007.  The Palco Debtors are pursuing  discussions  with lenders in an effort to
obtain  debtor-in-possession  financing  ("DIP  financing")  in  order  to  have
sufficient  liquidity to fund the Palco Debtors'  ongoing  operating cash needs,
including  bankruptcy-related  costs. The Palco Debtors may not be successful in
obtaining the necessary  additional  liquidity or the necessary Bankruptcy Court
approval, in which case the Palco Debtors may not be able to continue operations
and reorganize successfully under Chapter 11 of the Bankruptcy Code.

     Scopac has been authorized by the Bankruptcy Court to fund budgeted ongoing
operating and  bankruptcy-related  costs using  operating  cash flow and, to the
extent  needed,  funds  available  in Scopac's  Scheduled  Amortization  Reserve
Account  ("SAR  Account"),  subject to no more than $5.0 million in  withdrawals
from the SAR Account being  outstanding  at any given time. See Note 7, "-Scopac
Timber Notes-SAR  Account" for information  regarding the SAR Account.  If these
sources  of  liquidity  are not  adequate,  and if  Scopac  is  unable to obtain
additional  sources of liquidity and the necessary  Bankruptcy Court approval to
utilize such additional sources of liquidity, Scopac may not be able to continue
operations and reorganize successfully under Chapter 11 of the Bankruptcy Code.

     The  bankruptcies  of Scopac and the Palco  Debtors  could result in claims
against, and potential liabilities for, MAXXAM Parent and its affiliates.

     The Bankruptcy  Cases, and the liquidity issues being experienced by Scopac
and Palco,  could  result in claims  against and could have  adverse  impacts on
MAXXAM Parent and its affiliates,  including MGHI and/or MGI. For example, under
ERISA,  if Palco's  pension plan were to be  terminated,  MAXXAM  Parent and its
wholly owned subsidiaries would be jointly and severally liable for any unfunded
pension plan obligations.  The unfunded termination  obligation  attributable to
Palco's  pension  plan as of  December  31,  2006,  is  estimated  to have  been
approximately   $23.0  million  based  upon  annuity  placement   interest  rate
assumptions  as  of  such  date.  In  addition,  it  is  possible  that  certain
transactions could be completed in connection with a potential  restructuring or
reorganization of the Debtors,  such as a sale of all or a portion of the equity
ownership in the Debtors, a sale of a substantial portion of the Debtors' assets
and/or a cancellation of some or all of the Debtors'  indebtedness,  which could
require the  utilization  of all or a  substantial  portion of, or the loss of a
significant  portion  of,  the  Company's  net  operating  losses  or other  tax
attributes  for  federal and state  income tax  purposes  and could  require tax
payments. In addition, the Company may be required to establish certain deferred
tax  liabilities  as a result of loss of control of the Debtors  effective as of
the Filing Date.

Risks Related to Forest Products Regulatory Matters

     Regulatory and legislative actions have the power to significantly restrict
and ultimately  limit the harvest levels of Scopac Timber and require Scopac and
Palco to incur additional costs and have other adverse consequences.

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

     o    The North Coast Water Board has adopted WWDRs for the  Freshwater  and
          Elk River  watersheds.  This decision  allows  harvesting in these two
          watersheds  once THPs are  reviewed  and  enrolled by the staff of the
          North Coast Water Board.  In addition,  the  Executive  Officer of the
          North  Coast  Water  Board has  approved a  monitoring  and  reporting
          program,  which has the effect of allowing  enrollment by the staff of
          the  North  Coast  Water  Board  of  additional  THPs  for  these  two
          watersheds.  There  can  be no  assurance  that  THPs  for  these  two
          watersheds will ultimately be enrolled or harvested as planned in 2007
          or in future  years.  If there are delays in the  enrollment  of these
          THPs, there could be a further  significant  adverse impact on current
          and future harvest levels and the cash flows of both Palco and Scopac.

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

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

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

     o    The Company is uncertain of the operational and financial effects that
          will ultimately  result from Senate Bill 810, which provides  regional
          water quality control boards with additional  authority related to the
          approval of THPs within impaired  watersheds.  Implementation  of this
          law could,  however,  result in delays in obtaining approvals of THPs,
          lower harvest levels, and increased costs.

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

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

     Litigation  proceedings  could result in adverse  effects on the  Company's
forest products operations.

     Palco and Scopac were involved in a variety of pending legal proceedings as
of the date the Bankruptcy Cases were filed.  While these legal  proceedings are
in general  stayed as against the Debtors while the companies are in bankruptcy,
such  proceedings  could be  continued  as  against  the  Debtors if the stay is
modified by the Bankruptcy  Court, if the Bankruptcy Cases are dismissed,  or in
certain circumstances, upon the emergence of the companies from bankruptcy. Were
such legal proceedings to then be decided against the companies,  there could be
an adverse effect upon them,  which effect could under certain  circumstances be
materially  adverse to their  financial  condition,  results of  operations,  or
liquidity.  Moreover, additional legal proceedings could be filed against Palco,
Scopac, the other Debtors, the Company and their affiliates,  further increasing
litigation  costs and subjecting the companies to potential  adverse  decisions.
See Item 3. "Legal Proceedings-Forest Products Litigation."

Other Risks Related to Our Forest Products Operations

     Scopac's  estimate of its future  harvest  levels is subject to significant
uncertainty.

     Scopac  has  estimated  that its  average  annual  harvest  level  over the
ten-year  period  that  began in 2006 is not likely to exceed  approximately  95
million  board feet per year.  This revised  estimated  harvest  level  reflects
Scopac's  further  analysis  of the  cumulative  impact  of  ongoing  regulatory
limitations,  watershed  prescriptions,  the  requirements  of the HCP and other
matters, and is based on a number of assumptions that may or may not prove to be
accurate.  Actual harvest levels are expected to vary significantly from year to
year. Moreover, the average harvest level over the ten-year period could be even
lower due to, among other things,  the various  matters  discussed  elsewhere in
this document.

     Palco may not be able to obtain enough logs to operate efficiently.

     The ability of Palco to operate its mills efficiently depends in large part
on its  ability  to obtain  logs  from  Scopac at the  estimated  harvest  level
indicated  above.  Should these harvest levels not  materialize,  Palco would be
adversely  affected,  perhaps  materially.  In addition,  Palco  expects that to
operate at  profitable  levels,  it will in the future be required to purchase a
significant  portion of its logs from third parties.  These purchases may not be
available,  or  may be  available  on  terms  that  are  not  acceptable  or are
significantly adverse to Palco. In addition, given its liquidity problems, Palco
may not have sufficient liquidity to undertake such purchases.

     Scopac may not be able to sell its logs to third parties.

     Although it is  currently  contemplated  that all or  substantially  all of
Scopac's  revenues will be derived from the sale of logs to Palco,  should Palco
be unable to continue purchasing all of Scopac's logs, Scopac would need to seek
third party  purchasers.  Such purchasers may not be available or, if available,
such purchasers may not acquire  sufficient  quantities of logs at prices and on
terms that would allow Scopac to generate cash flow  equivalent to what sales to
Palco would have  generated due to, among other things,  other mills in the area
generally being farther away from the Scopac Timber Property than Palco's mills.

     Adverse weather  conditions  restrict Palco's ability to harvest timber and
deliver logs to its log decks and to its customers,  adversely affecting Palco's
and Scopac's cash flows.

     Wet weather conditions  restrict Palco's ability to harvest using efficient
logging methods and deliver timber.  Palco's use of inefficient logging methods,
such as helicopter logging,  decreases Scopac's revenues,  and increases Palco's
costs, reducing its operating margins.

     The cyclical  nature of Scopac's  and Palco's  businesses  could  adversely
affect their results of operations.

     Historically,  lumber prices have been subject to wide swings in price. The
demand  for  lumber  is  affected  primarily  by the  level of new  construction
activity and, to a lesser  extent,  remodeling  and repair  activity,  and other
industrial uses. These activities are, in turn,  subject to fluctuations due to,
among other factors:

     o    changes in domestic and international economic conditions;
     o    interest rates or the availability of financing;
     o    population growth and changing demographics; and
     o    seasonal  weather  cycles (e.g.,  dry summers,  wet winters) and other
          weather driven events.

          Decreases in the level of residential  construction activity or repair
     and remodeling activity generally reduce demand for logs and wood products.
     In addition,  timber owners generally increase  production volumes for logs
     and  products   during   favorable  price   environments.   Such  increased
     production,  however,  when  coupled  with  declines  in  demand  for these
     products in general,  could lead to oversupply and lower prices.  By way of
     example,  Douglas-fir  lumber prices have recently declined  significantly,
     and redwood lumber prices have also recently declined, although to a lesser
     extent than Douglas-fir  prices. This has adversely affected the cash flows
     of both Palco and Scopac.

          The  ability  to harvest  timber  may be subject to other  limitations
     which could adversely affect operations.

          In addition to the limitations resulting from regulatory  requirements
     and litigation  proceedings  described  above,  there are many factors that
     could restrict the ability to harvest on the Palco Timberlands, including:

     o    damage by fire, insect infestation, or disease;
     o    prolonged drought;
     o    natural disasters;
     o    timber growth cycles;
     o    weather conditions; and
     o    availability of contract loggers.

     We do not maintain  insurance  coverage with respect to damage to the Palco
Timberlands.

     Competition  in the forest  products  business could  materially  adversely
affect our net sales and our market share.

     The forest products business is highly competitive. We compete primarily on
the basis of:

     o    price;
     o    service;
     o    product availability; and
     o    product quality.

     Our lumber  products  compete not only with other wood products,  which are
oftentimes  less  expensive,   but  with  metals,  masonry,  plastic  and  other
construction   materials   made  from   non-renewable   resources.   Competitive
considerations,  such as total industry production and competitors'  pricing, as
well as the price of other  construction  products,  affect the sales prices for
our lumber  products.  Competition  in the common grade redwood and  Douglas-fir
lumber market is intense,  and we compete with  numerous  large and small lumber
producers.  An increase in the amount of  competition  that we face could have a
material adverse effect on our forest product revenues.

     The loss of key customers would reduce Palco's cash flows.

     Palco has one customer  that  accounted  for 12.5% of its revenues in 2006.
The loss of key customers would adversely impact Palco's cash flows.

Risks Related to Our Real Estate Operations

     Revenues  for our real estate  operations  are  expected to decline for the
foreseeable future.

     In 2005, our real estate operations realized  substantial  revenues related
to sales of  residential  lots and  acreage at our  Fountain  Hills,  Mirada and
Palmas  developments.  As the  proceeds  from  these  asset  sales have not been
redeployed  to other real  estate  assets,  this level of sales  activity is not
expected to recur for the foreseeable future.

     Real estate  development is a cyclical  industry and is affected by changes
in general and local economic conditions.

     The real  estate  development  industry is  cyclical  and is  significantly
affected by changes in general and local economic conditions, including, but not
limited to:

     o employment levels and population growth and shifts;
     o interest rates and the availability of financing;
     o consumer confidence; and
     o changes in the desirability of residential and commercial areas.

     Development  of a project  begins,  and financial  and other  resources are
committed,  long before a real estate project comes to market, which could occur
at a time when the real estate market is depressed.

     Our real estate  operations are subject to various land use regulations and
governmental approvals.

     Our real estate operations are subject to comprehensive  federal, state and
local statutes,  ordinances and regulations  concerning  zoning,  infrastructure
design,  subdivision of land, and  construction.  Periodic  approval is required
from   different   agencies  in  connection   with  various   matters.   Certain
jurisdictions  also  require the  inspection  of  properties,  approval of sales
literature,  disclosure  to  purchasers  of  specific  information,  bonding for
property  improvements,  and approval of real estate contract forms.  Failure to
comply with such regulations and requirements to obtain any such approvals could
adversely affect our real estate operations.

     The land use approval  processes we must follow to  ultimately  develop our
projects have become increasingly complex.  Moreover, the statutes,  regulations
and  ordinances  governing  the approval  processes  provide  third  parties the
opportunity to challenge the proposed plans and approvals, which would result in
additional costs and delays in obtaining  approvals or bringing a development to
market, and could result in litigation  outcomes  unfavorable to us in a variety
of ways such as  affecting  the timing,  design,  completion,  scope,  plans and
profitability of a project.

     We are in competition with other developments for customers and residents.

     There is intense  competition among companies in the real estate investment
and development business. Our Palmas acreage sales and resort operations compete
with similar  businesses in the  Caribbean,  Florida and other  vacation/holiday
destinations,  and our  developments  and  operations in Arizona face  increased
competition  in the area. Our Mirada  development  faces  competition  from both
existing and future developments, many with golf courses and other amenities.

     Claims relating to  infrastructure  obligations  could be filed against our
real estate operations.

     Our real  estate  operations  rely on third party  contractors  to complete
various contractual infrastructure requirements at our real estate developments,
such as installing  electrical lines, piping,  water tanks,  drainage and roads.
The failure of the  contractors  to perform or their  faulty  workmanship  could
result in claims against our real estate operations.

Risks Related to Our Racing Operations

     The  significant  competition  we face from other gaming and  entertainment
operations can be expected to continue adversely  affecting the racing segment's
operating performance.

     Sam  Houston  Race Park  competes  with many other  forms of  wagering  and
entertainment,   including  Louisiana  gaming  facilities,  a  nearby  greyhound
racetrack,  the Texas State Lottery,  bingo and a wide range of sporting  events
and  other  entertainment   activities.   Other  competitive  pressures  include
simulcast  signals  broadcast  by race  tracks able to offer  larger  purses and
competitive fields,  resorts with gaming, and increasing use of the Internet for
horse wagering and gaming,  including  Internet  betting  services with customer
incentives such as cash rebates.  Future risks include  approval of new forms of
gaming in Texas or  elsewhere.  Our racing  operations  are also affected by the
allocation of  sufficient  live racing days by the Racing  Commission  and their
ability  to  attract  a  sufficient  number  and  quality  of  race  horses  and
greyhounds.  Sam  Houston  Race Park and  Valley  Race  Park face a  substantial
challenge to maintain and grow their customer base in light of these competitive
pressures.

     It will be  difficult  to obtain  legislation  that would  allow our racing
operations to increase their revenues.

     Our two racing facilities would be able to increase their revenues,  likely
to a substantial  degree,  were additional  forms of gaming to be allowed at our
existing  horse  and  dog  racing   tracks.   The  Company  and  other  industry
participants have pursued  legislation that would permit video lottery terminals
at  Texas  tracks  during  prior  regular  and  special  sessions  of the  Texas
Legislature. None of these sessions resulted in the passage of such legislation.
While we intend to continue  vigorously  pursuing  legislation  favorable to our
racing operations,  no assurances can be given that it will be enacted or become
effective as some  legislation  may require the approval of  two-thirds  of each
legislative house and a majority of Texas voters.  Moreover, it is impossible to
determine what the provisions of any such  legislation  would be or its ultimate
effect on our racing operations.

Other Risk Factors

     Claims could arise from prior acquisitions.

     The  Company  or its  affiliates  have over  time  acquired  a  variety  of
properties or entities, some with long operating histories. These properties and
entities  may be subject to  environmental  or other  liabilities  that were not
identified at the time of acquisition. Any such claims would likely be costly to
defend  and  their  settlement  or other  resolution  could  potentially  have a
material  adverse effect upon our financial  condition,  results of operation or
liquidity.

     Natural  disasters  or other  catastrophic  events could  adversely  affect
various operations of the Company.

     In  addition  to the fire  and  other  risks  associated  with  our  timber
operations, our other operations are subject to risks from natural disasters and
other catastrophic  events.  For instance,  our Palmas resort in Puerto Rico, as
well as its racing operations at Sam Houston Race Park and Valley Race Park, are
particularly  subject to damage from hurricanes.  Our Mirada development and its
forest  products  operations in Scotia and Arcata,  California are  particularly
subject to the risk of earthquakes.  The Scotia-based lumber operations are also
subject to a special risk of flooding  from the Eel River,  which is adjacent to
the mill.  Moreover,  all of our operations are subject to general risks such as
fire or adverse weather conditions.

     Uninsured  claims and  litigation  could  adversely  impact  our  operating
results.

     We have insurance coverage against a variety of operating hazards including
business  interruption,  liability and other losses to the extent deemed prudent
by our management and to the extent  insurance is available,  but the nature and
amount  of that  insurance  may not be  sufficient  to fully  cover  liabilities
arising out of pending and future  claims and  litigation.  This  insurance  has
deductibles or self-insured retentions and contains certain coverage exclusions.
Insurance does not provide complete protection against losses and risks, and our
results of  operations  would be  adversely  affected  by claims not  covered by
insurance.

     We depend on our management and employees.

     Our success is largely  dependent  on the skills,  experience,  efforts and
availability of our management and employees. The loss of the services of one or
more members of our senior  management  or of numerous  employees  with critical
skills or the  unionization of our workforce could have a negative effect on our
business,  financial  conditions,  results of  operations  or growth.  Given the
bankruptcy  filings  by Palco and  Scopac,  it may be very  difficult  to retain
employees at these  subsidiaries,  especially  in view of their remote  location
relative to large population centers.

     Compliance  with and changes in laws and  regulations  and risks from legal
proceedings could adversely affect operating results.

     Our operations  can be affected by expected and  unexpected  changes in the
legal and business  environments in which we operate.  Changes that could affect
the legal environment  include new legislation,  new regulations,  new policies,
legal  proceedings and new  interpretations  of existing rules and  regulations.
Changes  that affect the  business  environment  include  changes in  accounting
standards,  changes in environmental laws, changes in tax rates or tax laws that
could  have a variety  of  financial  and other  effects,  including,  by way of
example,  the  ability  to  fully  utilize  our tax loss  carryforwards  and tax
credits.

     MAXXAM Parent's investment  portfolio could be adversely affected by market
conditions and other factors.

     MAXXAM Parent has substantial  assets invested in a variety of liquid money
market instruments;  U.S. corporate debt securities,  U.S. treasury  obligations
and other debt securities;  and equity interests in several limited partnerships
which invest in diversified  portfolios of common stocks and equity  securities,
in addition to  exchange-traded  options,  futures,  forward foregoing  currency
contracts,  and other  arbitrage  opportunities.  While  MAXXAM  Parent tries to
minimize  its risk with  respect to its  investment  portfolio,  there can be no
assurance  that a variety of market and other  factors,  such as  interest  rate
changes  and  general  market  fluctuations,   will  not  adversely  affect  the
performance of MAXXAM Parent's investment portfolio.

     Our Chairman controls the election of the Company's Board of Directors.

     Charles  E.  Hurwitz,  the  Company's  Chairman  of the  Board,  controls a
majority of the  Company's  common stock (the  "Common  Stock") and 79.5% of the
Company's  total  combined  voting power.  As a result,  Mr.  Hurwitz is able to
control the election of the  Company's  Board of Directors and controls the vote
on virtually all matters which might be submitted to a vote of our stockholders.

ITEM 3. LEGAL PROCEEDINGS

General

     Several   sections  in  this  Item  contain   statements  which  constitute
"forward-looking  statements"  within the  meaning of the PSLRA.  See this Item,
Item 1.  "Business-General"  and Item 1A. "Risk  Factors"  above for  cautionary
information with respect to such forward-looking statements.

     The following  describes  certain legal proceedings in which the Company or
its subsidiaries  are involved.  The Company and certain of its subsidiaries are
also involved in various  claims,  lawsuits and other  proceedings not discussed
herein which relate to a wide variety of matters.  Uncertainties are inherent in
the final outcome of those and the below-described  matters, and it is presently
impossible to determine the resolution of these matters or the actual costs that
ultimately may be incurred.

     Certain  present  and former  directors  and  officers  of the  Company are
defendants  in certain of the actions  described  below.  The  Company's  bylaws
provide for  indemnification of its officers and directors to the fullest extent
permitted by Delaware law. The Company is obligated to advance  defense costs to
its officers and directors, subject to the individual's obligation to repay such
amount if it is ultimately  determined  that the  individual was not entitled to
indemnification.  In addition,  the  Company's  indemnity  obligation  can under
certain  circumstances  include  amounts  other than  defense  costs,  including
judgments and settlements.

MAXXAM Inc. Litigation

     This section  describes certain legal proceedings in which MAXXAM Parent is
involved. The term "Company," as used in this section,  refers to MAXXAM Parent,
except where reference is made to the Company's consolidated financial position,
results of operations or liquidity.

     OTS Contingency and Related Matters

     In December  1995,  the United States  Department  of Treasury's  Office of
Thrift Supervision (the "OTS") initiated a formal administrative proceeding (the
"OTS  action")  against  the Company and others  alleging,  among other  things,
misconduct  by  the  Company  and  certain  of  its   affiliated   persons  (the
"Respondents")  and  others  with  respect  to the  failure  of  United  Savings
Association of Texas (the "USAT").  The OTS sought  damages  ranging from $326.6
million  to  $821.3  million  under  various  theories.  Following  110  days of
proceedings  before an administrative  law judge during 1997-1999,  and over two
years of post-trial  briefing,  on September 12, 2001,  the  administrative  law
judge issued a recommended  decision in favor of the  Respondents  on each claim
made by the OTS.  On October  17,  2002,  the OTS action  was  settled  for $0.2
million with no admission of wrongdoing on the part of the Respondents.

     As a result of the  dismissal of the OTS action,  a related  civil  action,
alleging  damages in excess of $250 million,  was subsequently  dismissed.  This
action, entitled Federal Deposit Insurance Corporation,  as manager of the FSLIC
Resolution Fund v. Charles E. Hurwitz (the "FDIC action"),  was originally filed
by the Federal Deposit Insurance Corporation (the "FDIC") in August 1995 against
Mr. Charles E. Hurwitz (Chairman and Chief Executive Officer of the Company).

     In May 2000, the Respondents filed a counterclaim to the FDIC action in the
U.S.  District  Court in Houston,  Texas (No.  H95-3956).  In November 2002, the
Respondents  filed an amended  counterclaim  and an amended motion for sanctions
(collectively,  the "Sanctions  Motion").  The Sanctions  Motion states that the
FDIC illegally paid the OTS to bring the OTS action against the  Respondents and
that the FDIC illegally sued for an improper  purpose (i.e., in order to acquire
timberlands held by a subsidiary of the Company). The Respondents are seeking as
a  sanction  to be made  whole for the  attorneys'  fees  they  have paid  (plus
interest) in connection with the OTS and FDIC actions.  As of December 31, 2006,
such fees were in excess of $40.9  million.  On August 23,  2005,  the  District
Court ruled on the Sanctions  Motion,  ordering the FDIC to pay the  Respondents
$72.3  million.  The FDIC has appealed the District  Court  decision to the U.S.
Fifth  Circuit  Court of  Appeals.  The U.S.  District  Court award has not been
accrued as of December 31, 2006. There can be no assurance that the Company will
ultimately collect this award.

Forest Products Reorganization Proceedings

     On January 18, 2007, Palco and its five wholly owned subsidiaries, including
Scopac,  filed separate voluntary petitions for reorganization  under Chapter 11
of the Bankruptcy  Code. See Note 1,  "-Reorganization  Proceedings of Palco and
its Subsidiaries" for further information  regarding the bankruptcy  proceedings
of Palco and its  subsidiaries,  including  potential  adverse impacts on MAXXAM
Parent and its affiliates. Also see Item 1A. "Risk Factors->Risks Related to the
Bankruptcy Cases" and Item 7. "Management's Discussion and Analysis of Financial
Condition  and  Results of  Operations-Financial  Condition  and  Investing  and
Financing Activities-Forest Products Operations."

Forest Products Litigation

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

     In March 1999,  an action  entitled  Environmental  Protection  Information
Association,   Sierra  Club  v.  California  Department  of  Forestry  and  Fire
Protection,  California Department of Fish and Game, The Pacific Lumber Company,
Scotia   Pacific   Company   LLC,   Salmon  Creek   Corporation,   et  al.  (the
"EPIC-SYP/Permits  lawsuit")  was filed in Superior  Court in  Humboldt  County,
California (No.  CV-990445).  This action alleged,  among other things,  various
violations of the CESA and the CEQA,  and  challenged,  among other things,  the
validity and legality of the SYP and the  California  Permits and sought,  among
other things, to prevent  implementation of THPs approved in reliance upon these
documents.  In March 1999, a similar  action,  entitled  United  Steelworkers of
America,  AFL-CIO,  CLC, and Donald Kegley v. California  Department of Forestry
and Fire Protection,  The Pacific Lumber Company, Scotia Pacific Company LLC and
Salmon Creek  Corporation  (the "USWA  lawsuit"),  was filed in Humboldt  County
Superior Court (No. CV-990452) challenging the validity and legality of the SYP.
The EPIC-SYP/Permits and USWA lawsuits were consolidated for trial.

     Following  the  trial,  the  Court  in  October  2003  entered  a  judgment
invalidating  the SYP and the  California  Permits and in September 2004 granted
the  plaintiffs'  request for  reimbursement  of an aggregate of $5.8 million in
attorneys'  fees and  other  expenses.  The  Palco  Companies  and the  State of
California  appealed both  decisions.  In December  2005,  the  appellate  court
reversed the trial  court's  decision  invalidating  the SYP and the  California
Permits.  The  plaintiffs  have appealed the appellate  court's  decision to the
California  Supreme  Court,  which has  accepted  the  appeal  for  review.  The
defendants'  appeal of the trial court's award of attorneys fees and expenses is
still pending at the appellate  court.  Due to the  Bankruptcy  Cases,  both the
California Supreme Court and the appellate court have entered orders staying the
proceedings pending before each court.

     In July  2001,  an action  entitled  Environmental  Protection  Information
Association v. Pacific Lumber,  Scotia Pacific  Company LLC (No.  C01-2821) (the
"Bear Creek  lawsuit")  was filed in the U.S.  District  Court for the  Northern
District of  California,  and later  amended to add the EPA as a defendant.  The
lawsuit alleges that harvesting and other forestry  activities  under certain of
Scopac's  THPs will result in  discharges of pollutants in violation of the CWA.
The  plaintiff  asserts that the CWA requires the  defendants to obtain a permit
from the North Coast Water Board before  beginning  timber  harvesting  and road
construction  activities  and is seeking to enjoin these  activities  until such
permit has been  obtained.  The  plaintiff  also seeks civil  penalties of up to
$27,500 per day for the alleged continued violation of the CWA. In October 2003,
the Court upheld the validity of an EPA regulation  that exempts  harvesting and
other forestry  activities from certain discharge  requirements.  Both state and
federal agencies, along with Palco and other timber companies,  have relied upon
this  regulation  for more than 25 years.  However,  the Court  interpreted  the
regulation in such a way as to narrow the forestry operations that are exempted,
thereby  limiting the  regulation's  applicability  and subjecting  culverts and
ditches to permit requirements.  This ruling has widespread implications for the
timber industry in the United States. The case is not yet final as the trial has
not yet been held, and there are many unresolved issues involving interpretation
of the Court's  decision and its application to actual  operations.  On June 30,
2006,  the  plaintiff  filed a motion for partial  summary  judgment  seeking to
establish the Palco Companies'  liability and the Palco Companies filed a motion
for summary judgment asserting that the plaintiff lacks standing to maintain the
lawsuit.  A hearing on these motions was held on October 3, 2006,  and the Court
took the matter under  submission.  Due to the Bankruptcy  Cases,  the Court has
entered an order staying this matter.

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

     On November 20, 2002,  two similar  actions  entitled  Alan Cook, et al. v.
Gary Clark,  et al. (the "Cook action") and Steve Cave, et al. v. Gary Clark, et
al. (the "Cave  action")  were filed in  Humboldt  County  Superior  Court (Nos.
DR020718  and  DR020719,  respectively),  which  also  name  Palco  and  certain
affiliates as  defendants.  The Cook action  alleges,  among other things,  that
defendants'  logging practices have contributed to an increase in flooding along
Freshwater  Creek  (which runs  through  the Palco  Timberlands),  resulting  in
personal injury and damage to the  plaintiffs'  properties.  Plaintiffs  further
allege that in order to have THPs approved in the affected areas, the defendants
engaged in certain unfair business  practices.  The plaintiffs seek, among other
things,  compensatory and exemplary damages,  injunctive relief, and appointment
of a receiver to ensure that the watershed is restored. The Cave action contains
similar  allegations  and requests  similar relief with respect to the Elk River
watershed (a portion of which is contained on the Palco Timberlands). On October
13, 2005, an action  entitled  Edyth  Johnson,  et.al v. Charles E. Hurwitz,  an
individual;  MAXXAM  Inc.  et al. (No.  DR040720)  was filed in Humboldt  County
Superior Court (the "Johnson  action") and contains  allegations  similar to the
Cave and Cook  actions.  The Company  does not believe the  resolution  of these
actions should result in a material adverse effect on its consolidated financial
condition,  results of operations or liquidity. Notices have been filed with the
Court to stay these matters due to the Bankruptcy Cases.

     On February 25,  2003,  the  District  Attorney of Humboldt  County filed a
civil suit entitled The People of the State of California v. The Pacific  Lumber
Company,  Scotia  Pacific  Holding  Company and Salmon Creek  Corporation in the
Humboldt  County Superior Court (No.  DR030070) (the "Humboldt DA action").  The
suit was filed under  California's  unfair  competition law and alleges that the
Palco  Companies  used certain  unfair  business  practices in  connection  with
completion of the Headwaters Agreement, and that this resulted in the harvest of
significantly more trees than would have otherwise been the case. The suit seeks
a variety of remedies  including a civil  penalty of $2,500 for each  additional
tree that has been or will be harvested due to this alleged increase in harvest,
as well as  restitution  and an injunction in respect of the  additional  timber
harvesting allegedly being conducted. On June 14, 2005, the Court dismissed this
matter in its entirety.  On September 19, 2005, the District  Attorney  appealed
this  decision,  however,  the Company  believes that the  dismissal  ruling has
substantially  diminished  the exposure of the Palco  Companies  with respect to
this matter. Due to the Bankruptcy Cases, the Court has entered an order staying
this matter.

     In December  2005,  Palco and Scopac filed a claim (the  "Claim")  with the
California Victim  Compensation and Government Claims Board (the "Claims Board")
against  the North  Coast  Water  Board,  the State Water Board and the State of
California  (Claim No.  G558159).  The Claim  alleges that the  defendants  have
substantially  impaired  the  contractual  and legal  rights of Palco and Scopac
under the  Headwaters  Agreement  and the related  permits,  authorizations  and
approvals. The Claim also alleges that the actions of the defendants have caused
the companies  substantial  damages,  but does not specify an amount.  While the
Claims Board has indicated  that it is  investigating  the matter,  it failed to
approve or deny the claim by the statutory  deadline.  As a result, the Claim is
by operation  of law treated as having been denied,  and Palco could then file a
suit for damages in  California  state  court.  This suit was filed by Palco and
Scopac on December 20, 2006 in Superior  Court in Fresno,  California  (No. CECG
0422).

     While  the  above-described  legal  proceedings  are in  general  stayed as
against the Debtors  while the  companies are in  bankruptcy,  such  proceedings
could be  dismissed  as  against  the  Debtors  as the stay is  modified  by the
Bankruptcy  Court,  if  the  Bankruptcy  Cases  are  dismissed,  or  in  certain
circumstances,  upon the emergence of the companies  from  bankruptcy.  Also see
Item 1A.  "Risk  Factors-Risk  Factors  Related  to Forest  Products  Regulatory
Matters."

Other Matters
     On September 2, 2004,  MGI was advised  that the New Jersey  Department  of
Environmental  Protection  (the  "NJDEP")  alleged  that  one  of  MGI's  former
subsidiaries  is a successor to a company that  manufactured  munitions  for the
U.S. Navy during World War II. The owner of the  underlying  property,  which is
located in  Cranbury,  New  Jersey,  sought  MGI's  participation  in efforts to
address  contamination  of the site resulting from such  operations.  In January
2005, MGI and the owner of the property entered into an  Administrative  Consent
Order with the NJDEP providing for, among other things, cleanup of the facility.
In April 2005, MGI filed a Complaint  against the United States of America,  the
U.S. Navy, and the U.S. Army for cost recovery and contribution;  the defendants
subsequently  denied all of the claims. In early 2006, the property was sold and
MGI entered into an amendment to the  Administrative  Consent Order substituting
the new owner for the original property owner. MGI has also reached an agreement
with several potentially  responsible parties regarding cleanup at the site, the
terms of which the Company believes will not result in a material adverse effect
on the  Company's  consolidated  financial  position,  results of  operations or
liquidity  and  under  which  MGI  retained  its  cause of  action  against  the
government parties noted above.

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

ITEM 7. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

     The following should be read in conjunction with the Company's Consolidated
Financial Statements and the Notes thereto appearing in Item 8.

Results of Operations

     This  section  contains   statements   which  constitute   "forward-looking
statements"  within the  meaning of the PSLRA.  See Item 1.  "Business-General,"
Item 1A. "Risk  Factors" and below for  cautionary  information  with respect to
such forward-looking statements.

     The  Company  operates in three  industries:  forest  products  and related
operations  and  activities,  through  MGI and its  wholly  owned  subsidiaries,
principally  Palco,   Scopac,  Britt  and  SDLLC;  real  estate  investment  and
development,  through  various  subsidiaries  and  joint  ventures;  and  racing
operations  through  SHRP,  Ltd.  MGHI  owns  100% of MGI and is a wholly  owned
subsidiary  of the  Company.  Any  reference  herein to a company  includes  the
subsidiaries  of that company unless  otherwise  noted or the context  indicates
otherwise.

     In addition to the above, the Company  previously  owned 50,000,000  common
shares (the "Kaiser Shares") of Kaiser,  which represented  approximately 63% of
Kaiser's common stock. In July 2006, the Kaiser Shares were cancelled as part of
Kaiser's Chapter 11 plan of  reorganization.  As a result, the Company no longer
has any ownership interest in or affiliation with Kaiser.

     On  January  18,  2007,  Palco,  Scopac,  Britt,  SDLLC and  Palco's  other
subsidiaries filed for  reorganization  under Chapter 11 of the Bankruptcy Code.
See Note 1,  "-Reorganization  Proceedings  of Palco and its  Subsidiaries"  and
"-Financial  Condition and Investing  and Financing  Activities-Forest  Products
Operations" for further discussion.

     Consolidated Operations

     Selected Operational Data

     The following table presents selected  financial  information for the years
ended  December  31,  2006,  2005  and  2004  for  the  Company's   consolidated
operations.

                                                                                        Years Ended December 31,
                                                                                    --------------------------------
                                                                                       2006      2005       2004
                                                                                    --------------------------------
                                                                                        (In millions of dollars)
Net sales                                                                           $ 291.5   $  406.4    $  347.5
Costs and expenses                                                                   (285.0)    (351.2)     (333.3)
Reversal of net investment in Kaiser                                                  430.9          -           -
Gains on sales of timberlands and other assets                                         11.6        0.3         0.1
                                                                                    --------- ----------- ----------
Operating income                                                                      449.0       55.5        14.3
Other income                                                                            9.6       18.6        12.8
Interest expense                                                                      (87.7)     (78.2)      (74.0)
                                                                                    --------- ----------- ----------
Income (loss) before income taxes and cumulative effect of accounting change          370.9       (4.1)      (46.9)
Benefit (provision) for income taxes                                                    4.2        0.1         0.3
                                                                                    --------- ----------- ----------
Income (loss) before cumulative effect of accounting change                         $ 375.1   $   (4.0)   $  (46.6)
Cumulative effect of accounting change, net of tax                                     (0.7)         -           -
                                                                                    --------- ----------- ----------
Net income (loss)                                                                   $ 374.4   $   (4.0)   $  (46.6)
                                                                                    ========= =========== ==========
Revenues by segment as a percentage of total:
  Forest products                                                                      48.0%      44.7%       58.2%
  Real estate                                                                          36.0%      43.9%       27.3%
  Racing                                                                               16.0%      11.4%       14.5%
                                                                                    --------- ----------- ----------
                                                                                      100.0%     100.0%      100.0%
                                                                                    ========= =========== ==========

     Overview of Consolidated Results of Operations

     Reversal of Net Investment in Kaiser
     In  February  2002,  Kaiser  and  certain  of its  subsidiaries  filed  for
reorganization  under  Chapter  11 of the  Bankruptcy  Code.  Kaiser's  plan  of
reorganization  provided  for the  cancellation  of Kaiser's  equity,  including
common shares held by the Company, without consideration or obligation. Kaiser's
plan of reorganization became effective on July 6, 2006, and Kaiser emerged from
bankruptcy.  As a result, the Company no longer has any ownership interest in or
affiliation  with  Kaiser.  Since the  Company's  Kaiser  Shares were  cancelled
without obligation,  the Company reversed the $516.2 million of losses in excess
of its  investment  in Kaiser  along with the  accumulated  other  comprehensive
losses of $85.3  million  related to Kaiser,  resulting  in a net gain of $430.9
million,  recognized  in  the  third  quarter  of  2006.  As  a  result  of  the
cancellation of the Company's Kaiser Shares in 2006, the Company expects it will
take a worthless  stock  deduction on its 2006  consolidated  federal income tax
return.  However,  it is uncertain  whether the deduction meets certain criteria
required  for asset  recognition  purposes.  Accordingly,  the  Company  has not
recorded  the  resulting  tax  asset  of  approximately  $135.8  million  in its
consolidated balance sheet as of December 31, 2006.

     See  Notes  1 and 10 for  further  discussion  of  Kaiser's  reorganization
proceedings and other information regarding the Company's investment in Kaiser.

     Net Sales
     Net sales for 2006 totaled  $291.5  million,  compared to $406.4 million in
2005.  The decline in net sales was the result of lower lot and acreage sales at
the real estate segment and reduced  throughput at the forest products  segment,
resulting  primarily  from reduced  harvest  levels as the result of  regulatory
restrictions  and  limitations.  Sales at the Company's real estate segment were
$104.9 million in 2006, as compared to $178.3 million in 2005. This  substantial
decrease  in sales was due  primarily  to  reduced  acreage  sales at Palmas and
Mirada and a reduction in the number of lots sold at Fountain  Hills,  partially
offset by increased lot sales at Mirada and higher deferred profit recognized at
Palmas.  In addition to the decline in sales for the real estate segment,  there
was a $41.8  million  decline  in net sales for the  Company's  forest  products
segment.  This decline was due to a decrease in product volume  attributable  to
reduced harvesting caused by regulatory restrictions and limitations, as well as
an unfavorable  shift in lumber sold from redwood to lower-priced,  common grade
Douglas-fir lumber.

     Net sales for 2005 totaled  $406.4  million,  compared to $347.5 million in
2004.  Sales for the Company's real estate segment  increased from $94.8 million
in 2004 to $178.3 million in 2005. This  substantial  increase was due primarily
to large  acreage  sales at Palmas and  Mirada,  favorable  pricing and a higher
volume  of  lot  sales  at  Fountain   Hills  and  Mirada,   and  higher  profit
participation  payments at Palmas.  The increase  was offset by a $20.3  million
decline  in net sales  for the  Company's  forest  products  segment  and a $4.3
million  decline  net sales for the  racing  segment.  Net sales for the  forest
products  segment  declined due to a decrease in product volume  attributable to
reduced harvesting caused by regulatory delays, restrictions and limitations, as
well as an unfavorable shift in lumber sold from redwood to lower-priced, common
grade Douglas-fir lumber. Net sales for the racing segment declined due to fewer
live race days being held in 2005.

     Operating Income (Loss)
     Operating  income was $449.0  million in 2006, as compared to $55.5 million
in 2005. This  substantial  change  resulted  primarily from the reversal of the
Company's net investment in Kaiser (discussed  above),  reduced sales volumes at
the  Company's  real  estate  segment  and  increased  operating  losses  at the
Company's forest products segment.  Operating income for the real estate segment
declined $51.6 million, primarily as a result of a decline in real estate sales,
as discussed above.  The Company's  forest products  segment incurred  operating
losses of $9.1 million in 2006,  net of gains on sales of  timberlands  of $11.6
million. The forest products operating losses were the result of reduced harvest
levels and operational inefficiencies at Palco's Scotia sawmill.

     Operating  income  increased  $41.2  million from $14.3  million in 2004 to
$55.5 million in 2005,  primarily due to the  performance  of the Company's real
estate segment,  which realized  operating  income of $89.0 million in 2005. The
Company's forest products segment incurred  operating losses of $13.4 million in
2005 as compared to  operating  income of $5.4  million in 2004,  primarily as a
result of a decline in lumber  shipments,  compounded by an unfavorable shift in
lumber  sold from  redwood  lumber to  lower-priced,  common  grade  Douglas-fir
lumber,  exacerbated by higher  harvesting,  hauling,  and production  costs and
substantial  legal and  professional  fees,  including fees relating to Scopac's
efforts in 2005 to pursue a negotiated restructuring of the Scopac Timber Notes.

     Loss Before Income Taxes
     The Company's consolidated income before income taxes was $370.9 million in
2006 as compared to $4.1 million loss in 2005. This  significant  improvement is
primarily the result of the net gain of $430.9  million from the reversal of the
Company's net investment in Kaiser (discussed  above),  offset by the decline in
real estate operations (discussed above).

     The Company's  consolidated  loss before income taxes,  was $4.1 million in
2005, as compared to $46.9 million in 2004.  This  significant  improvement  was
primarily the result of strong sales,  higher  operating income by the Company's
real  estate  segment  and an  increase  in  investment  earnings,  offset  by a
reduction in equity earnings from the Company's investment in FireRock,  LLC due
to the sell-out of lots at the development in 2004.

     Forest Products Operations

     Industry Overview and Selected Financial and Operating Data

     This  section  contains   statements   which  constitute   "forward-looking
statements"  within  the  meaning  of the  PSLRA.  See  this  section,  Item  1.
"Business-General"  and Item 1A. "Risk Factors" for cautionary  information with
respect to such forward-looking statements.

     The Company's  forest  products  business  segment has become  increasingly
unpredictable due to regulatory  constraints and ongoing  litigation  challenges
and harvest levels have declined significantly.

     On  January  18,  2007,  the  Debtors  (Palco  and its  five  wholly  owned
subsidiaries,  including Scopac) filed the Bankruptcy Cases,  separate voluntary
petitions for  reorganization  under Chapter 11 of the  Bankruptcy  Code, in the
Bankruptcy Court (the United States  Bankruptcy Court for the Southern  District
of Texas). The six companies that filed for voluntary protection were Scopac and
the Palco  Debtors - Palco,  Britt,  SDLLC,  Salmon  Creek and  Scotia  Inn Inc.
("Scotia  Inn").  The term  "Filing  Date"  shall mean  January  18,  2007.  The
Bankruptcy Cases are being jointly administered (Case No.  07-20027-C-11),  with
the   Debtors    managing   their   business   in   the   ordinary   course   as
debtors-in-possession  subject to the control and  supervision of the Bankruptcy
Court.

     The filing of the Bankruptcy Cases was precipitated by liquidity shortfalls
at Palco and Scopac and their resultant  inability to make January 2007 interest
payments  on  their  respective  debt   obligations,   arising  from  regulatory
restrictions  and limitations on timber  harvest,  increased  timber  harvesting
costs and  cyclical  lumber  prices.  Both  Scopac and Palco  undertook  various
efforts in 2006 to generate  additional  liquidity to satisfy  their  respective
debt  service  obligations;  however,  the cash  generated  from their  efforts,
together  with their cash flows from  operations,  was not  sufficient  to cover
their respective  interest  payment  shortfalls in January 2007. See "-Financial
Condition and Investing and Financial  Activities-Forest Product Operations" for
further discussion.

     During 2001,  comprehensive external and internal reviews were conducted of
Palco's  business  operations.  These  reviews  were  conducted  in an effort to
identify   ways  in  which  Palco  could   operate  on  a  more   efficient  and
cost-effective  basis.  Since 2001,  Palco has  implemented a number of changes,
including:  closing  four  of its  five  sawmills;  eliminating  certain  of its
operations,  including  its  company-staffed  logging  operations  (now  relying
exclusively  on  contract  loggers),  its  soil  amendment  and  concrete  block
activities,  and its Scotia  finishing and  remanufacturing  plant; and adopting
various cost saving  measures.  Palco has  continued to examine ways in which to
achieve cost savings. In April 2004, Palco commenced a mill improvement project,
including  a new  sawmill  located in Scotia,  California.  The new  sawmill was
constructed  in two phases.  The first phase of the project,  the  processing of
smaller  diameter  second  growth logs (up to 24" in  diameter)  is a high-speed
processing  line that includes  advanced  scanning and  optimization  technology
intended to maximize lumber recovery.  The second phase, the relocation of large
log equipment from the Carlotta mill,  came on line in October 2005.  This phase
allows for processing of larger logs up to 60" in diameter. Palco also completed
a new $5.0 million  planer  project in Scotia in January 2004. The new planer is
capable of processing rough sawn boards into finished lumber more rapidly. These
improvements  have not been  sufficient  to  overcome  the  adverse  effects  of
regulatory harvest limits.

     The following table presents selected operational and financial information
for the years ended  December 31, 2006,  2005 and 2004 for the Company's  forest
products operations.

                                                                                       Years Ended December 31,
                                                                                  ----------------------------------
                                                                                     2006       2005        2004
                                                                                  ---------- ----------- -----------
                                                                                       (In millions of dollars,
                                                                                     except shipments and prices)

Timber harvest(1)                                                                     99.6       145.5       144.1
                                                                                  ========== =========== ===========
Shipments:
  Lumber:(2)
    Redwood upper grades                                                               3.4         6.4        17.4
    Redwood common grades                                                            136.5       178.8       209.2
    Douglas-fir upper grades                                                             -         0.6         2.5
    Douglas-fir common grades                                                         66.7        92.6        61.6
    Other                                                                                -         3.6         6.2
                                                                                  ---------- ----------- -----------
  Total lumber                                                                       206.6       282.0       296.9
                                                                                  ========== =========== ===========
  Cogeneration power (3)                                                             111.3       164.0       162.0
                                                                                  ========== =========== ===========
Average sales price:
  Lumber: (4)
    Redwood upper grades                                                          $  1,671   $   1,243   $   1,352
    Redwood common grades                                                              678         620         613
    Douglas-fir upper grades                                                           549         914         980
    Douglas-fir common grades                                                          351         373         408
  Cogeneration power (5)                                                                73          65          65
Net sales:
  Lumber, net of discount                                                         $  121.6   $   155.9    $  179.2
  Logs                                                                                 3.5         8.2         6.1
  Cogeneration power                                                                   8.5        10.9        10.8
  Wood chips                                                                           2.7         3.5         3.1
  Other                                                                                3.7         3.3         2.9
                                                                                  ---------- ----------- -----------
     Total net sales                                                              $  140.0   $   181.8    $  202.1
                                                                                  ========== =========== ===========
Operating income (loss)(6)(7)                                                     $   (9.1)  $   (13.4)   $    5.4
                                                                                  ========== =========== ===========
Loss before income taxes                                                          $  (78.0)  $   (69.9)   $  (49.3)
                                                                                  ========== =========== ===========

(1)  Timber harvest is expressed in millions of board feet, net Scribner scale.
(2)  Lumber shipments are expressed in millions of board feet.
(3)  Power deliveries are expressed in thousands of megawatt hours.
(4)  Dollars per thousand board feet.
(5)  Dollars per megawatt hour.
(6)  Operating losses for 2006 and 2005 include a $0.7 million and $4.6 million,
     respectively,  of impairment charges related to the write-down to estimated
     salvage value of certain long-lived assets.
(7)  Operating  losses  for  2006  includes  a $11.6  million  gain on  sales of
     timberlands.

     Net Sales
     Net sales for the forest products  segment in 2006 were $41.8 million below
the prior  year's net sales.  The decline was due  primarily  to a reduction  in
total lumber  shipments,  compounded by an unfavorable shift in lumber sold from
redwood lumber to lower-priced,  common grade Douglas-fir lumber. Sales of logs,
power and other  products,  which  accounted  for 13.1% of the  segment's  sales
product mix in 2006, decreased $7.5 million compared to the prior year.

     Net sales for the forest products  segment in 2005 were $20.3 million below
the prior  year's net sales.  The decline was due  primarily  to a reduction  in
total lumber  shipments,  compounded by an unfavorable shift in lumber sold from
redwood lumber to lower-priced,  common grade Douglas-fir lumber. Sales of logs,
power and other  products,  which  accounted  for 14.2% of the  segment's  sales
product mix in 2005, increased $3.0 million compared to the prior year.

      Operating Income (Loss)
     The forest products  segment  incurred  operating losses of $9.1 million in
2006,  net of gains on sales of  timberlands  of $11.6  million,  as compared to
operating losses of $13.4 million in 2005. The forest products  operating losses
were the result of reduced  harvest  levels and  operational  inefficiencies  at
Palco's Scotia sawmill.

     The forest products segment  incurred  operating losses of $13.4 million in
2005 and  operating  income of $5.4 million in 2004.  The decline was  primarily
attributable to four factors:  the decline in net sales discussed above,  higher
harvesting,  hauling,  and production costs,  substantial legal and professional
fees relating to Scopac's  efforts to pursue a negotiated  restructuring  of the
Scopac Timber Notes, and asset impairment charges of $4.6 million due to changes
in the expected use of certain  facilities and revised estimates of undiscounted
cash flows of those facilities.

     Loss Before Income Taxes
     The loss before income taxes of $78.0 million, as compared to $69.9 million
of  losses  in  2005,  reflects  the  effects  of the  factors  discussed  above
compounded by additional interest expense related to higher debt levels.

     The loss before income taxes of $69.9 million, as compared to $49.3 million
of  losses  in  2004,  reflects  the  effects  of the  factors  discussed  above
compounded by additional interest expense related to higher debt levels.

     Real Estate Operations

     Industry Overview and Selected Operational Data
     The Company,  through its wholly  owned  subsidiaries  and joint  ventures,
invests in and develops  residential  and  commercial  real estate  primarily in
Puerto Rico,  Arizona,  California,  and Texas.  Results of  operations  between
periods for the Company's  real estate  operations  are generally not comparable
due to the timing of individual real estate  transactions and cash  collections.
The following table presents  selected  financial and operating  information for
the  years  ended  December  31,  2006,  2005 and  2004,  respectively,  for the
Company's real estate operations.

                                                                                    Years Ended December 31,
                                                                            ----------------------------------------
                                                                                2006          2005         2004
                                                                            ------------- ------------ -------------
                                                                                    (In millions of dollars)
Net sales:
  Real estate:
    Fountain Hills                                                           $   15.6     $    42.9    $    12.7
    Mirada                                                                       26.6          56.9         16.1
    Palmas                                                                       27.6          42.3         30.9
    Other                                                                           -           0.1            -
                                                                            ------------- ------------ -------------
      Total                                                                      69.8         142.2         59.7
                                                                            ------------- ------------ -------------
  Resort, commercial and other:
    Fountain Hills                                                                3.7           5.4          6.7
    Mirada                                                                        0.3           0.1          0.1
    Palmas                                                                       12.5          12.1         10.9
    Commercial lease properties                                                  18.4          18.3         17.2
    Other                                                                         0.2           0.2          0.2
                                                                            ------------- ------------ -------------
      Total                                                                      35.1          36.1         35.1
                                                                            ------------- ------------ -------------
  Total net sales                                                           $   104.9     $   178.3    $    94.8
                                                                            ============= ============ =============

Operating income (loss):
  Fountain Hills                                                            $     6.6     $    23.3   $      4.1
  Mirada                                                                         14.6          35.9          6.0
  Palmas                                                                          8.2          22.6         13.3
  Commercial lease properties                                                     9.4           8.3          7.2
  Other                                                                          (1.4)         (1.1)        (0.9)
                                                                            ------------- ------------ -------------
    Total operating income                                                  $    37.4     $    89.0    $    29.7
                                                                            ============= ============ =============

Investment, interest and other income (expense), net:
  Equity in earnings (losses) from real estate joint ventures               $   (0.4)     $    (1.0)   $     2.8
  Other                                                                          5.5            3.4          5.3
                                                                            ------------- ------------ -------------
                                                                            $    5.1      $     2.4    $     8.1
                                                                            ============= ============ =============
Income before taxes                                                         $   25.2      $    74.0    $    19.5
                                                                            ============= ============ =============

     Net Sales
     Net sales for the real  estate  segment  include:  revenues  from  sales of
developed  lots,  acreage and other real property  associated with the Company's
real estate developments;  revenues from resort and other commercial  operations
conducted at these real estate developments; and lease revenues from a number of
commercial properties.

     Net sales for the real estate segment  decreased $73.4 million in 2006 from
the year-ago  period.  The  substantial  decrease  was due  primarily to reduced
acreage sales at Palmas and Mirada and a reduction in the number of lots sold at
Fountain Hills,  partially  offset by increased lot sales at Mirada and deferred
profit recognized at Palmas.

     Net sales for the real estate segment  increased $83.5 million in 2005 from
the prior year  period.  The  substantial  increase  was due  primarily to large
acreage sales at Palmas and Mirada, favorable pricing and a higher volume of lot
sales at Fountain Hills and Mirada, and higher profit participation  payments at
Palmas.

     Operating Income (Loss)
     Operating  income  decreased  $51.6  million from $89.0  million in 2005 to
$37.4  million in 2006 due to the decline in sales  discussed  above.  Operating
income  increased  $59.3  million from $29.7 million in 2004 to $89.0 million in
2005 due to increased sales, as discussed above.

     Income Before Income Taxes
     The  segment's  income  before  income taxes  decreased to $25.2 million in
2006, from $74.0 million in 2005, due to the decline in sales  discussed  above,
offset by higher  interest  income and joint venture  earnings  from RMCAL.  The
segment's  income before income taxes  increased to $74.0 million in 2005,  from
$19.5  million in 2004,  due to the higher  operating  results  discussed  above
offset by a  reduction  in equity  earnings  from the  Company's  investment  in
FireRock, LLC due to the sell-out of lots in 2004.

     Racing Operations

     Industry Overview and Selected Operational Data
     The Company  indirectly owns SHRP,  Ltd., a Texas limited  partnership that
owns and operates  Sam Houston  Race Park,  a Class 1 horse  racing  facility in
Houston,  Texas,  and Valley Race Park, a greyhound  racing facility  located in
Harlingen,  Texas. Results of operations between quarterly periods are generally
not comparable for this segment due to the timing,  varying lengths and types of
racing meets held. Historically, Sam Houston Race Park and Valley Race Park have
derived a significant amount of their annual  pari-mutuel  commissions from live
racing and  simulcasting.  Pari-mutuel  commissions  have typically been highest
during the first and fourth  quarters  of the year,  the time  during  which Sam
Houston  Race  Park and  Valley  Race  Park  have  historically  conducted  live
thoroughbred and greyhound racing, respectively.

     The following table presents selected operational and financial information
for the years ended  December 31,  2006,  2005 and 2004,  respectively,  for the
Company's racing operations.

                                                                Years Ended December 31,
                                                        ----------------------------------------
                                                            2006          2005         2004
                                                        ------------- ------------ -------------
                                                                (In millions of dollars)
Number of live racing days:(1)
  Sam Houston Race Park                                        110           120          167
  Valley Race Park                                              94            89          110

Handle:
  Sam Houston Race Park:
    On-track handle                                     $    132.0    $    126.6   $    137.0
    Off-track handle                                         132.7         140.9        173.7
                                                        ------------- ------------ -------------
      Total                                             $    264.7    $    267.5   $    310.7
                                                        ============= ============ =============

  Valley Race Park:
    On-track handle                                     $     18.2    $     19.0   $     19.4
    Off-track handle                                           3.4           2.5          3.6
                                                        ------------- ------------ -------------
      Total                                             $     21.6    $     21.5   $     23.0
                                                        ============= ============ =============

Net sales:
  Sam Houston Race Park:
    Gross pari-mutuel commissions                       $     32.8    $     32.1   $     34.9
    Other revenues                                             8.5           8.8         10.0
                                                        ------------- ------------ -------------
      Total                                                   41.3          40.9         44.9
                                                        ------------- ------------ -------------
  Valley Race Park:
    Gross pari-mutuel commissions                              4.3           4.4          4.6
    Other revenues                                             1.0           1.0          1.1
                                                        ------------- ------------ -------------
      Total                                                    5.3           5.4          5.7
                                                        ------------- ------------ -------------
Total net sales                                         $     46.6    $     46.3   $     50.6
                                                        ============= ============ =============

Operating loss:
  Sam Houston Race Park                                 $     (3.7)   $     (3.5)  $     (2.1)
  Valley Race Park                                            (0.9)         (0.6)        (1.0)
                                                        ------------- ------------ -------------
    Total operating loss                                $     (4.6)   $     (4.1)  $     (3.1)
                                                        ============= ============ =============
Loss before income taxes                                $     (4.4)   $     (4.1)   $    (3.1)
                                                        ============= ============ =============
-------------

(1)  In 2004,  Sam Houston Race Park was granted an additional 40 live race days
     over what it typically  receives due to circumstances that are not expected
     to recur.

     Net Sales
     Total net sales for the racing  segment  increased $0.3 million in 2006, as
compared to the prior year,  primarily due to an increase in simulcast wagering,
partially  offset by a decline in simulcast  wagering at Valley Race Park. Total
net sales for the racing  segment  declined $4.3 million in 2005, as compared to
the prior  year,  primarily  due to a decrease in the number of live racing days
from 2004.

      Operating Loss and Income Before Income Taxes
      Racing operations' operating loss and loss before income taxes for 2006
increased from 2005, principally due to increased operating costs at Sam Houston
Race Park and Valley Race Park. Racing operations' operating loss and loss
before income taxes for 2005 increased from 2004, principally due to lower net
sales, partially offset by lower operating costs associated with the reduced
number of live racing days at Sam Houston Race Park.

     Other Items Not Directly Related to Industry Segments
                                                                                     Years Ended December 31,

                                                                                  ----------------------------------
                                                                                     2006       2005        2004
                                                                                  ----------- ---------- -----------
                                                                                      (In millions of dollars)
Operating income (loss), including reversal of net investment in Kaiser           $   425.3   $  (16.0)  $   (17.7)
Income (loss) before income taxes                                                     428.1       (4.1)      (14.0)

     Operating Loss
     The   Corporate   segment's   operating   losses   represent   general  and
administrative expenses that are not specifically  attributable to the Company's
segments,   including   stock-based   compensation  expense  and  the  Company's
investment in Kaiser.

     Kaiser's plan of  reorganization  under Chapter 11 of the Bankruptcy  Code,
which  provided for the  cancellation  of the Company's  Kaiser  Shares  without
consideration  or  obligation,  became  effective  on July 6,  2006.  Since  the
Company's Kaiser Shares were cancelled  without  obligation in the third quarter
of 2006, the Company  reversed its net investment in Kaiser,  resulting in a net
gain of $430.9 million in that reporting period.

     The Corporate segment's selling,  general and administrative  expenses were
significantly  lower in 2006,  as  compared to 2005 and 2004,  primarily  due to
changes in stock-based  compensation  expense.  For the years ended December 31,
2006, 2005 and 2004,  stock-based  compensation expense was $(2.0) million, $3.7
million and $6.1  million,  respectively.  Also  included in Corporate  selling,
general and  administrative  expenses for 2005 and 2004 is a $1.9 million charge
in connection with an environmental  matter  associated with a former subsidiary
of the Company. See Note 11 for further information.

     Income (Loss) Before Income Taxes
     Income (loss) before income taxes includes  operating  losses,  investment,
interest  and  other  income  (expense)  and  interest  expense,  which  are not
attributable to the Company's segments.  Results for 2006 include  approximately
$2.5 million of investment,  interest and other income,  a $5.5 million decrease
from 2005,  as well as a net gain of $430.9  million  from the  reversal  of net
investment in Kaiser (see Notes 1 and 10).

     Provision for Income Taxes

     Texas  House Bill 3, signed  into law in May 2006,  eliminates  the taxable
capital and earned surplus  components of the existing  Texas  franchise tax and
replaces these  components  with a margin-based  franchise tax. There will be no
impact  on the  Company's  2006  Texas  state  income  taxes  as the  new law is
effective  for  reports  due on or after  January  1, 2008  (based  on  business
activity  during  2007).  The  Company is  required to include in income for the
period that  includes the date of enactment  the impact of the tax law change on
its deferred state income taxes.  This tax law change resulted in a reduction in
the Company's deferred state income taxes in the amount of $4.1 million,  net of
federal benefit, and the net tax benefit was recognized in the second quarter of
2006.

     The Company  generated a loss before  income taxes of $4.1 million for 2005
and $60.0  million for 2006  (excluding  the reversal of the net  investment  in
Kaiser);  however, the Company has recorded a full valuation allowance to offset
the tax benefit  associated with the tax losses for these periods.  Each period,
the Company  evaluates the appropriate  factors in determining the realizability
of the deferred tax assets  attributable to losses and credits  generated in the
current  period and those being  carried  forward.  These  factors are discussed
further in Note 8. Based on this evaluation, the Company provided full valuation
allowances  with respect to the deferred tax assets  attributable  to losses and
credits generated during 2005 and 2006.

Financial Condition and Investing and Financing Activities

     This  section  contains   statements   which  constitute   "forward-looking
statements"  within  the  meaning  of the PSLRA.  See this  section  and Item 1.
"Business-General"   for   cautionary   information   with   respect   to   such
forward-looking statements.

     Overview

     The Company  conducts its operations  primarily  through its  subsidiaries.
Accordingly, creditors of subsidiaries of the Company have priority with respect
to the assets and earnings of such subsidiaries over the claims of the creditors
of the Company.  Certain of the Company's  subsidiaries,  principally  Palco and
Scopac,  are  restricted by their various debt  instruments  as to the amount of
funds that can be paid in the form of dividends or loaned to affiliates.  Scopac
is highly leveraged and has significant debt service requirements. Palco is also
highly leveraged and has significant debt service obligations.

     On January 18, 2007, Palco, Scopac and Palco's other subsidiaries filed for
reorganization under Chapter 11 of the Bankruptcy Code. The Bankruptcy Cases are
being jointly  administered,  with the Debtors  managing  their  business in the
ordinary course as debtors-in-possession  subject to the control and supervision
of the Bankruptcy  Court. The filing of the Bankruptcy Cases was precipitated by
liquidity  shortfalls at Palco and Scopac and their resultant  inability to make
January 2007 interest  payments on their  respective debt  obligations,  arising
from regulatory restrictions and limitations on timber harvest, increased timber
harvesting  costs and cyclical  lumber prices.  Both Scopac and Palco  undertook
various  efforts in 2006 to  generate  additional  liquidity  to  satisfy  their
respective  debt service  obligations;  however,  the cash  generated from their
efforts,  together with their cash flows from operations,  was not sufficient to
cover  their  respective  interest  payment  shortfalls  in  January  2007.  See
"-Financial  Condition and Investing  and  Financial  Activities-Forest  Product
Operations" for further discussion.

     Cash Flow

     As a result of the  commencement  of the  Bankruptcy  Cases,  the operative
documents  provide that the outstanding  principal of, and accrued  interest on,
all debt obligations of the Debtors became immediately due and payable. However,
the vast  majority  of the claims in  existence  at the Filing  Date  (including
claims for  principal  and accrued  interest on the  Debtors'  indebtedness  and
substantially all legal claims) are stayed (deferred) while the Debtors continue
to  operate  the  businesses  as   debtors-in-possession.   The  automatic  stay
provisions  of  Chapter  11 of  the  Bankruptcy  Code  make  it  unnecessary  to
reclassify  prepetition  long-term liabilities as of the Filing Date even though
prepetition  creditors  might demand payment or there is violation of a covenant
in the debt agreement.  Accordingly, the Debtors' long-term obligations,  except
for the Palco Term Loan,  where the Borrowers' did not meet the required minimum
EBITDA  maintenance  covenant for the three months ended December 31, 2006, have
been  classified in  accordance  with their  contractual  terms in the Company's
consolidated financial statements and in the cash flow table below.

      The following table summarizes certain data related to financial condition
and to investing and financing activities of the Company and its subsidiaries.

                                       Forest Products
                                ------------------------------
                                            Palco                 Real                           MAXXAM
                                 Scopac   and Other      MGI     Estate    Racing      MGHI      Parent     Total
                                --------  -----------  -------  ---------  --------  --------- ----------- ---------
                                                             (In millions of dollars)
Debt and credit facilities
  (excluding intercompany
   notes)
Short-term borrowings and
   current maturities of long-
   term debt:
   December 31, 2006            $ 67.4(1) $  108.4(5)  $     -   $   4.7   $   0.2   $    -    $     -     $  180.7

Long-term debt, excluding
   current maturities and
   discounts:
   December 31, 2006            $669.5    $    0.4     $     -   $ 215.3   $   0.2   $    -    $     -     $  885.4

Cash, cash equivalents,
marketable securities
   and other investments
December 31, 2006:
   Current restricted
     amounts                    $ 39.5(4) $    0.1     $     -   $   0.9   $   2.6   $    -    $     -     $   43.1
   Other current amounts           1.6         0.5         0.7      17.9       3.6        -      136.7        161.0
                                --------- ------------ -------- -------------------- --------------------------------
                                  41.1         0.6         0.7      18.8       6.2        -      136.7        204.1
                                --------- ------------ -------- -------------------- --------------------------------

   Long-term restricted
     amounts                    $  2.5    $    2.4     $     -   $   3.3   $     -   $    -    $    -      $    8.2
                                --------- ------------ -------- -------------------- --------------------------------
                                $ 43.6    $    3.0     $   0.7   $  22.1   $   6.2   $    -    $136.7      $  212.3
                                ========= ============ ======== ==================== ================================

                                       Forest Products
                                ------------------------------
                                            Palco                 Real                           MAXXAM
                                 Scopac    and Other     MGI     Estate     Racing      MGHI     Parent      Total
                                --------- -----------  -------  ---------  --------  --------- ----------- ---------
                                                             (In millions of dollars)
Changes in cash and cash
   equivalents
Capital expenditures:
   December 31, 2006            $  6.6    $    6.7     $     -   $   1.7   $   0.6   $    -    $    -      $   15.6
   December 31, 2005               6.5         8.2           -       1.2       3.4        -       0.4          19.7
   December 31, 2004               7.8        22.0           -       2.4       0.2        -       0.3          32.7

Net proceeds from dispositions
   of property and investments:
   December 31, 2006            $ 13.1    $    2.8     $     -   $     -   $     -   $    -    $    -      $   15.9
   December 31, 2005                 -         0.1           -         -         -        -         -           0.1
   December 31, 2004                 -         0.3           -         -         -        -         -           0.3

Borrowings (repayments) of
   debt and credit facilities,
   net of financing costs:
   December 31, 2006            $ 17.0    $   40.6     $     -   $  (3.8)  $     -   $    -    $    -      $   53.8
   December 31, 2005              (2.5)       42.0           -      (4.6)     (0.1)       -         -          34.8
   December 31, 2004               1.0        12.0           -     (21.5)        -        -         -          (8.5)

Dividends, advances including
   interest paid and tax sharing
   payments received (paid):
   December 31, 2006            $  1.6    $   31.0(2)  $   2.8(3) $(58.8)  $   1.0   $  (1.7)  $ 24.1      $      -
   December 31, 2005                 -         8.0         1.7     (66.2)      9.3       0.1     47.1             -
   December 31, 2004                 -         0.1         0.3     (29.5)        -       0.1     29.0             -

---------------------
(1)  Includes borrowings outstanding under the Scopac Line of Credit (see below)
     of $36.2  million and the current  portion of Scheduled  Amortization  (see
     below) on the Scopac Timber Notes of $31.2 million.
(2)  Reflects $21.0 million of intercompany loans from MGI to Palco used to fund
     Palco's liquidity  shortfalls and $10.0 million of additional  intercompany
     loans from MGI  required in  connection  with the closing of the Palco Term
     Loan and the Palco Revolving Credit Facility in July 2006.
(3)  Advances of $8.1 million were used by MGI to fund timber/log purchases from
     Scopac  during  2006.  At December  31,  2006,  $1.6  million of timber log
     purchases had not been settled.
(4)  Includes $30.2 million of net proceeds from the sale of Scopac Timber Notes
     held  in the  SAR  Account.
(5)  At December 31, 2006, Palco's and Britt's credit facilities were classified
     as short-term  borrowings  since the  Borrowers'  did not meet the required
     minimum EBITDA maintenance covenant for the three months ended December 31,
     2006.

     Operating Activities

     Net cash used for operating  activities of $74.4 million for the year ended
December 31, 2006,  resulted  primarily from  operating  cash  shortfalls at the
Company's forest products segment.  Net cash provided by operating activities of
$53.3  million for the year ended  December 31, 2005 was primarily the result of
higher real estate sales,  partially  offset by operating cash shortfalls at the
Company's forest products segment.

     Net cash  provided by operating  activities  of $26.9  million for the year
ended  December  31,  2004  principally  reflects  net loss  (after  adding back
depreciation, depletion, amortization and other reconciling items, totaling $2.9
million), in addition to a $4.4 million decrease in inventories,  a $5.6 million
decrease in  long-term  assets  (primarily  real  estate),  and a $12.1  million
increase in  long-term  liabilities  (primarily  attributable  to  increases  in
deferred  sales  revenue  at  Fountain  Hills  of  $6.6  million,  increases  in
membership  deposits  at  Palmas  of $2.2  million,  and  increases  in  pension
liabilities of $2.3 million  related to the Company's  defined  benefit  pension
plans).

     Investing Activities
     Net cash  provided by  investing  activities  of $5.0  million for the year
ended  December 31, 2006,  primarily  reflects net proceeds from the Scopac Land
Sale Program (see below), offset by capital expenditures at the Company's forest
products  segment.  Net cash used for investing  activities of $33.5 million for
the year ended December 31, 2005, reflects the liquidation of certain short-term
investments and the use of restricted cash for debt service payments,  offset by
capital  expenditures  in  respect of Palco's  sawmill  project,  infrastructure
requirements  at Scopac and  Fountain  Hills,  and capital  expenditures  at the
Company's horse racing facility.

     Net cash used for investing  activities of $10.9 million for the year ended
December 31, 2004 principally  reflects  capital  expenditures of $32.7 million,
$20.5  million of which were related to Palco's new sawmill  project,  offset by
net proceeds  from  restricted  cash of $13.0 million and the sale of marketable
securities and other short-term investments of $5.8 million.

     Financing Activities
     The $31.3 million of net cash provided by financing activities for the year
ended  December  31,  2006,  principally  reflects the net proceeds of the Palco
refinancing  that  occurred in July 2006 (see below),  offset by treasury  stock
purchases  of $22.5  million by MAXXAM  Parent . Net cash  provided by financing
activities  of $34.6  million for the year ended  December 31, 2005  principally
reflects the net proceeds from a Palco refinancing that occurred in April 2005.

     Net cash used for  financing  activities of $8.5 million for the year ended
December 31, 2004  principally  reflects net  borrowings on Scopac's and Palco's
lines of credit of $18.2  million and $13.1  million,  respectively,  as well as
borrowings  on  real  estate  credit  facilities  of  $5.3  million,  offset  by
repayments  on real  estate  credit  facilities  of $25.7  million  (principally
related to the Mirada  development) and principal payments on and repurchases of
Scopac Timber Notes.

     MAXXAM Parent

     MAXXAM  Parent has in the past  provided,  and may from time to time in the
future,   either  directly  or  through   subsidiaries  and  under   appropriate
circumstances,   provide   various   forms  of  financial   assistance   to  its
subsidiaries,   or  enter  into  financing  or  other   transactions   with  its
subsidiaries,  including  secured or unsecured loans, or asset purchases.  There
can be no assurance that such subsidiaries will have sufficient liquidity in the
future to repay intercompany loans.

     Although  there  are  no  restrictions  on  the  Company's  ability  to pay
dividends on its capital  stock,  the Company has not paid any  dividends  for a
number of years and has no present intention to do so. Additionally, the Company
may from time to time purchase additional shares of its Common Stock on national
exchanges or in privately  negotiated  transactions.  During 2006, MAXXAM Parent
purchased  710,345  shares of its Common  Stock for an  aggregate  cost of $22.5
million.

     At December 31, 2006, MAXXAM Parent had unrestricted cash, cash equivalents
and  marketable  securities  and other  investments of $136.7 million and MAXXAM
Parent did not have any external debt.  MAXXAM Parent believes that its existing
resources will be sufficient to fund its working  capital  requirements  for the
next year. With respect to long-term liquidity,  MAXXAM Parent believes that its
existing cash and cash resources,  together with future  distributions  from the
real estate  segment,  will be sufficient to meet its long-term  working capital
requirements.  See Note 1, "-Potential  Impact on Registrant and Certain Related
Entities"  regarding potential adverse impacts upon MAXXAM Parent as a result of
the Bankruptcy Cases.

     Forest Products Operations

     Substantially  all of MGI's  consolidated  assets are owned by Palco, and a
substantial  portion of  Palco's  consolidated  assets are owned by Scopac.  The
holders of the Scopac Timber Notes have priority over the claims of creditors of
Palco with  respect to the  assets  and cash  flows of  Scopac.  Palco's  credit
facilities contain certain restrictive  covenants which effectively preclude the
distribution of funds from Palco to MGI.

     On  January  18,  2007,  Palco  and its  five  wholly  owned  subsidiaries,
including Scopac,  filed for  reorganization  under Chapter 11 of the Bankruptcy
Code.  The  Bankruptcy  Cases are being jointly  administered,  with the Debtors
managing their business in the ordinary course as debtors-in-possession  subject
to the control and supervision of the Bankruptcy Court.

     The filing of the Bankruptcy Cases was precipitated by liquidity shortfalls
at Palco and Scopac and their resultant  inability to make January 2007 interest
payments  on  their  respective  debt   obligations,   arising  from  regulatory
restrictions  and limitations on timber  harvest,  increased  timber  harvesting
costs and  cyclical  lumber  prices.  Both  Scopac and Palco  undertook  various
efforts in 2006 to generate  additional  liquidity to satisfy  their  respective
debt  service  obligations;  however,  the cash  generated  from their  efforts,
together  with their cash flows from  operations,  was not  sufficient  to cover
their respective interest payment shortfalls in January 2007.

     Scopac's  indebtedness consists of the Scopac Timber Notes, the 6.55% Class
A-1,  7.11% Class A-2 and 7.71% Class A-3 Timber  Collateralized  Notes due 2028
($713.8 million  principal  outstanding as of December 31, 2006), and the Scopac
Line of Credit,  a line of credit with a group of banks pursuant to which Scopac
was  permitted to borrow to pay interest on the Scopac Timber Notes (the "Scopac
Line of Credit") ($36.2 million principal  outstanding as of December 31, 2006),
and each being secured by (i) Scopac's  timber,  timberlands  and timber rights,
(ii)  certain  contract  rights  and other  assets,  (iii) the  proceeds  of the
foregoing and (iv) the funds held by the Trustee under the Scopac Indenture (the
"Trustee")  in  various  accounts  related to the Scopac  Timber  Notes.  Annual
interest  obligations  related to Scopac's debt  facilities  were  approximately
$55.4  million as of  December  31,  2006.  See Note 7 for  further  information
regarding Scopac's debt obligations.

     Palco's  indebtedness  consists of a five-year  $85.0 million  secured term
loan (the "Palco Term Loan") ($84.3 million principal outstanding as of December
31, 2006) and a five-year $60.0 million  secured  asset-based  revolving  credit
facility (the "Palco  Revolving Credit  Facility")  ($24.1 million of borrowings
outstanding  and $13.7  million of letters of credit  issued as of December  31,
2006). These facilities are secured by a security interest in the stock of Palco
held by MGI, and  substantially  all of the assets of the Palco  Debtors  (other
than Palco's equity interest in Scopac).  Annual interest obligations related to
Palco's  long-term  debt  obligations  were  approximately  $17.1  million as of
December 31, 2006.  See Note 7 for further  information  regarding  Palco's debt
obligations.

     The Debtors'  overall  objectives in the Bankruptcy Cases are to achieve an
operational and financial  restructuring of each of the Debtors'  long-term debt
obligations  in view of estimated  lower harvest  levels,  increased  regulatory
compliance costs, cyclical lumber prices, and also to continue their businesses.
See "- Financial  Difficulties of the Forest Products Entities" below. There can
be no assurance  that the Debtors will be able to attain  these  objectives  and
achieve a successful operational and financial reorganization.  In the event the
Debtors are  unsuccessful  in attaining a successful  operational  and financial
reorganization,  the Debtors could be forced to surrender  all or  substantially
all of their assets to their creditors.  Many of the matters discussed elsewhere
in this  document  could  adversely  affect the  Debtors'  ability to achieve an
operational and financial restructuring.  The outcome of the Bankruptcy Cases is
impossible to predict and could have a material adverse effect on the businesses
of the Debtors, on the interests of creditors, and on the Company.

     As provided by the Bankruptcy  Code, each of the Debtors  generally has the
exclusive  right to  propose a plan of  reorganization  during  the  Exclusivity
Period, a 120 day period  following the date of filing of the Bankruptcy  Cases,
unless  certain  statutory  exceptions  apply  or the  Bankruptcy  Court  orders
otherwise.  For instance,  a group of holders of Scopac Timber Notes has filed a
motion that,  if granted,  might have the effect of shortening  the  Exclusivity
Period.  Palco and Scopac have each engaged The Blackstone Group  ("Blackstone")
to serve as its  financial  advisor and assist in the  development  of a plan of
reorganization  for each of Palco and Scopac.  If the Debtors  fail to file such
plan(s)  of  reorganization  during  the  Exclusivity  Period  or any  extension
thereof,  or such plan(s) are not accepted by the requisite  number of creditors
and equity holders entitled to vote on the plan(s), other parties in interest in
the  Bankruptcy  Cases  may  be  permitted  to  propose  their  own  plan(s)  of
reorganization for the Debtors.

     As a  result  of  the  commencement  of  the  Bankruptcy  Cases,  operative
documents  provide that the outstanding  principal of, and accrued  interest on,
all long-term debt of the Debtors became  immediately due and payable.  However,
the vast  majority  of the claims in  existence  at the Filing  Date  (including
claims for  principal  and accrued  interest on the Debtors'  indebtedness,  and
substantially  all legal  proceedings)  are stayed  (deferred) while the Debtors
continue to operate the businesses as debtors-in-possession.  The automatic stay
provisions  of  Chapter  11 of  the  Bankruptcy  Code  make  it  unnecessary  to
reclassify  prepetition  long-term liabilities as of the Filing Date even though
prepetition  creditors  might  demand  payment or there is a violation of a debt
covenant  in the  debt  agreement.  Accordingly,  the  Debtors'  long-term  debt
obligations,  except for the Palco Term Loan,  where the Borrowers' did not meet
the  required  minimum  EBITDA  maintenance  covenant for the three months ended
December 31, 2006,  have been  classified in accordance  with their  contractual
terms in the  accompanying  consolidated  financial  statements.  The Bankruptcy
Court has, however, upon motion by the Debtors,  permitted the Debtors to pay or
otherwise honor certain  unsecured  pre-Filing Date claims,  including  employee
wages and benefits  and  customary  claims in the  ordinary  course of business,
subject to certain  limitations.  The  Debtors  also have the right to assume or
reject  executory  contracts,  subject to Bankruptcy  Court approval and certain
other limitations. In this context, "assumption" means that the Debtors agree to
perform their  obligations and cure certain existing defaults under an executory
contract  and  "rejection"  means  that the  Debtors  are  relieved  from  their
obligations to perform further under an executory  contract and are subject only
to a claim  for  damages  due to the  breach  thereof.  Any  claim  for  damages
resulting  from the  rejection of an executory  contract is treated as a general
unsecured claim in the Bankruptcy Cases.

     The Debtors anticipate that substantially all liabilities of the Debtors as
of the Filing Date will be resolved under one or more plans of reorganization to
be proposed  and voted on in the  Bankruptcy  Cases and in  accordance  with the
provisions of the Bankruptcy Code.  However,  there can be no assurance that the
liabilities  of the  Debtors  will not be  ultimate  ly found to exceed the fair
value  of their  assets.  If a  Debtor's  creditors  are not  paid in full,  the
Bankruptcy  Code provides that a Debtor's  equity holder will not be entitled to
retain its equity interest,  unless certain exceptions apply. If the liabilities
of one or more of the Debtors are  ultimately  found to exceed the fair value of
its assets,  claims of  creditors  could be paid at less than 100% of their face
value. In that event,  Palco could lose all or a material  portion of its equity
ownership  in Scopac and  Palco's  other  subsidiaries,  MGI could lose all or a
material  portion of its equity  ownership in Palco, or the value of such equity
ownership  interests  could  be  diluted,  impaired  or  eliminated.   There  is
substantial  uncertainty  as to when  the  Debtors  will  be  able to file  such
plan(s).  Moreover,  the Debtors'  efforts to obtain approval of such plan(s) by
the creditors and equity holders entitled to vote on the plan(s),  and to obtain
confirmation by the Bankruptcy Court of such plan(s), may not be successful.

     The financial  information of the Debtors contained herein and consolidated
with the Company's  results has been prepared on a "going concern" basis,  which
contemplates the realization of assets and the liquidation of liabilities in the
ordinary  course of business;  however,  as a result of the  commencement of the
Bankruptcy  Cases, such realization of assets and liquidation of liabilities are
subject  to  a  significant  number  of  uncertainties.  Specifically,  but  not
all-inclusive,  the  financial  information  of the  Debtors  for the year ended
December 31, 2006,  contained herein does not present:  (a) the realizable value
of  assets  on a  liquidation  basis,  (b)  the  estimated  costs  and  expenses
associated  with the Bankruptcy  Cases,  (c) the amount that will  ultimately be
paid to  settle  liabilities  and  contingencies  which  may be  allowed  in the
Bankruptcy  Cases,  or (d)  the  effect  of any  changes  that  may be  made  in
connection  with the  Company's  investment  in the Debtors or with the Debtors'
operations  resulting  from a plan of  reorganization.  Because  of the  ongoing
nature of the Bankruptcy Cases, the discussions and financial information of the
Debtors contained herein are subject to material uncertainties.

     Financial Difficulties of Forest Products Entities

     Future Harvest Levels
     Scopac  has  conducted  extensive  reviews  and  analyses  of  its  assets,
operations  and future  prospects.  As a result of these  extensive  reviews and
analyses  Scopac has concluded  that, in the absence of  significant  regulatory
relief and  accommodations,  its future  annual timber  harvest  levels and cash
flows from operations for the  foreseeable  future will be  substantially  below
both historical  harvest levels and the minimum levels necessary to allow Scopac
to  satisfy  the  principal  and  interest  payments  specified  by  the  Scopac
Indenture.  Scopac has estimated  that its average annual harvest level over the
ten-year  period  that  began in 2006 is not likely to exceed  approximately  95
million  board feet per year.  This revised  estimated  harvest  level  reflects
Scopac's  further  analysis  of the  cumulative  impact  of  ongoing  regulatory
limitations,  watershed  prescriptions,  the  requirements  of the HCP and other
matters, and is based on a number of assumptions that may or may not prove to be
accurate.  Actual harvest levels are expected to vary substantially from year to
year. Moreover,  the average annual harvest level over the ten-year period could
be even  lower  due to,  among  other  things,  the  various  matters  discussed
elsewhere in this document.

     Regulatory Matters
     Regulatory and environmental  matters as well as legal actions have had and
are expected to continue to have a significant  adverse  effect on the Company's
forest products  operations and liquidity.  The ability to harvest Scopac Timber
depends in large part upon Scopac's ability to obtain regulatory approval of its
THPs. Scopac has experienced difficulties and delays in the approval of its THPs
as the  result  of  regulatory  and  litigation  challenges  and  expects  these
challenges to persist. The foregoing matters have resulted in declines in actual
and expected harvest levels and cash flows, significant increases in the cost of
logging operations and increased costs related to timber harvest litigation, all
of which have  severely  impacted  the  historical  cash flows of both Palco and
Scopac. These adverse effects are expected to continue.

     Scopac Liquidity
     As noted  above,  in the  absence  of  significant  regulatory  relief  and
accommodations,  Scopac's  annual  timber  harvest  levels  and cash  flows from
operations  will,  for the  foreseeable  future,  be  substantially  below  both
historical  levels and the minimum  levels  necessary to allow Scopac to satisfy
the principal and interest payments specified by the Scopac Indenture.

     In an effort to address expected future interest payment shortfalls, Scopac
in 2005 initiated a program to sell certain  timberland  properties,  as well as
various  non-timberland  properties,  such as ranchlands and recreational  areas
(the  "Scopac  Land Sale  Program").  The  Scopac  Land Sale  Program  generated
proceeds of $13.1 million during 2006, however,  the proceeds generated from the
Scopac Land Sale Program,  together  with other  available  liquidity,  were not
sufficient to cover the expected  interest payment  shortfall on the January 20,
2007, Scopac Timber Notes payment date.

     Scopac experienced  liquidity  shortfalls during 2006. On the Scopac Timber
Notes payment date in January 2006, Scopac used its existing cash resources, all
of the  remaining  funds  available  under the Scopac  Line of  Credit,  and the
additional funds made available from a $2.3 million timber/log  purchase by MGI,
to pay all of the $27.7  million of interest due ($25.8  million net of interest
due in respect of the Scopac Timber Notes held in the SAR Account).  Using funds
held in the SAR Account,  Scopac also repaid  $19.3  million of principal on the
Scopac  Timber  Notes  ($11.9  million net of principal in respect of the Scopac
Timber Notes held in the SAR Account) in accordance with Scheduled Amortization.
"Scheduled  Amortization"  is the amount of principal that Scopac must pay (on a
cumulative basis) through any Scopac Timber Notes payment date in order to avoid
prepayment  or  deficiency  premiums.  See Note 7,  "-Scopac  Timber  Notes" for
further information regarding Scheduled Amortization.

     In April  2006,  Scopac and MGI  consummated  a  timber/log  purchase  that
provided  Scopac  $2.1  million of  additional  liquidity  to pay its  operating
expenses.

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

     As the January 2007 Scopac Timber Notes payment date approached,  it became
apparent  to Scopac  that it would  not have  sufficient  liquidity  to make the
interest payment. The failure of Scopac to pay all of the interest on the Scopac
Timber Notes when due constitutes an event of default under Scopac Indenture. In
the event of a failure to pay  interest on the Scopac  Timber Notes in full when
due,  the Trustee  under the Scopac  Indenture or the holders of at least 25% of
the  aggregate  outstanding  principal  amount of the Scopac  Timber  Notes were
entitled  to cause all  principal,  interest  and other  amounts  related to the
Scopac Timber Notes to become  immediately due and payable.  In the event of any
such  acceleration,  the Agent under the Scopac Line of Credit was also entitled
to accelerate the advances then outstanding thereunder. If such accelerations of
Scopac  Timber  Notes  and/or  advances  under the Scopac Line of Credit were to
occur,  the Trustee  would be entitled to exercise  all rights  under the Scopac
Indenture  and  related  security  documents,  including  applying  funds to pay
accelerated  amounts,  and selling the Scopac Timberlands,  Scopac Timber Rights
and  Scopac's  other assets and using the  proceeds  thereof to pay  accelerated
amounts.  Based upon a review of its  alternatives  under the  circumstance  and
consultation  with its legal  advisors,  on January 18, 2007,  Scopac elected to
file for  voluntary  protection  under Chapter 11 of the  Bankruptcy  Code. As a
result of the  commencement  of the Bankruptcy  Cases,  lender claims are stayed
(deferred)   while  the  Debtors   continue  to  operate   the   businesses   as
debtors-in-possession.

     Scopac has been authorized by the Bankruptcy Court to fund budgeted ongoing
operating and  bankruptcy-related  costs using  operating  cash flow and, to the
extent needed,  funds available in the SAR Account (subject to no more than $5.0
million in withdrawals from the SAR Account being outstanding at any given time.
If these  sources  of  liquidity  are not  adequate,  and if Scopac is unable to
obtain  additional  sources of  liquidity  and the  necessary  Bankruptcy  Court
approval to utilize such additional sources of liquidity, Scopac may not be able
to continue  operations  and  reorganize  successfully  under  Chapter 11 of the
Bankruptcy Code.

     Palco Liquidity

     As of December 31, 2005, and June 30, 2006, Palco and Britt were in default
under the prior  Palco-Britt  term loan and prior  Palco-Britt  revolving credit
facility  (the  "Prior  Palco-Britt   Facilities")  due  to  financial  covenant
breaches.  In the first half of 2006,  additional  liquidity was needed at Palco
and Palco  borrowed  an  aggregate  of $20.0  million  from MGI to meet its cash
shortfalls.

     On July 18, 2006,  Palco and Britt, as Borrowers,  closed on the Palco Term
Loan,  a five-year  $85.0  million  secured term loan,  and the Palco  Revolving
Credit Facility, a five-year $60.0 million secured asset-based  revolving credit
facility, and terminated the Prior Palco-Britt  Facilities.  The Palco Term Loan
was fully funded at closing.  The Palco Term Loan and the Palco Revolving Credit
Facility  required  MGI to  provide  a $10.0  million  subordinated  loan to the
Borrowers,  which was also funded at closing.  The Borrowers used  approximately
$56.5 million of the Palco Term Loan to pay off the Prior Palco-Britt Facilities
and cash collateralize  previously-existing  letters of credit; and $6.0 million
to pay transaction costs. The remaining $32.5 million of loan proceeds were used
for general  corporate  purposes.  As of December  31, 2006,  $84.3  million was
outstanding  under the Palco Term Loan,  and $24.1  million of  borrowings  were
outstanding  and $13.7  million of letters of credit were issued under the Palco
Revolving Credit Facility.

     The Borrowers did not meet the required minimum EBITDA maintenance covenant
for the  three-month  period  ended  September  30,  2006,  due to an  unplanned
severance charge and a legal  settlement.  On November 20, 2006, MGI made a loan
to Palco, enabling the Borrowers to exercise their cure right under the two debt
facilities.  The  Borrowers  also  notified  the lenders  that  changing  market
conditions  and other  factors  would  likely  adversely  affect the  Borrowers'
ability to comply  with the  financial  covenants  at  December  31, 2006 and in
future periods.

     The Borrowers did not meet the required minimum EBITDA maintenance covenant
for the three-month period ended December 31, 2006. Accordingly,  the Palco Term
Loan has been reclassified as a current liability in the Company's  consolidated
balance sheet.

     In January 2007, Palco did not have sufficient  liquidity to pay all of the
interest  due on the Palco  Term Loan.  Based upon a review of its  alternatives
under the  circumstances,  and consultation with its legal advisors,  in January
18, 2007, Palco elected to file for voluntary protection under Chapter 11 of the
Bankruptcy Code. As a result of the commencement of the Bankruptcy Cases, lender
claims  are  stayed  (deferred)  while  the  Debtors  continue  to  operate  the
businesses as debtors-in-possession.

     The liquidity  shortfalls  experienced  by Palco  throughout  2005 and 2006
resulted   primarily  from  reduced  log  supply  from  Scopac  and  operational
inefficiencies   related  to  Palco's  Scotia  sawmill.   Additional   liquidity
shortfalls are expected in 2007. Additionally, in 2006, Palco initiated an asset
sale program  ("Palco Asset Sale Program"),  including real property  associated
with Palco's  former  Fortuna and Carlotta  sawmills  and  Palco-owned  homes in
Scotia, California,  with the objective of reducing Palco's overall debt levels.
The Palco Asset Sale  Program did not  generate any cash flow in 2006 and is not
expected to generate  liquidity in 2007 as, among other  things,  a  substantial
portion  of the  properties  must  be  subdivided  and/or  rezoned  before  such
properties can be sold.

     The Palco  Debtors  estimate  that they will have  liquidity  shortfalls in
2007.  The Palco Debtors are pursuing  discussions  with lenders in an effort to
obtain DIP  financing  in order to have  sufficient  liquidity to fund the Palco
Debtors' ongoing  operating cash needs and  bankruptcy-related  costs. The Palco
Debtors may not be successful in obtaining additional liquidity or the necessary
Bankruptcy  Court  approval,  in which case the Palco Debtors may not be able to
continue  operations  and  reorganize  successfully  under  Chapter  11  of  the
Bankruptcy Code.

     Real Estate Operations

     Real  estate  management   believes  that  the  existing  cash  and  credit
facilities  are  sufficient  to fund the segment's  working  capital and capital
expenditure  requirements  for 2007.  With  respect to the  segment's  long-term
liquidity,  real estate  management  believes  that the ability to generate cash
from the sale of existing assets,  together with the ability to obtain financing
and joint venture partners,  should provide sufficient funds to meet its working
capital and capital expenditure requirements.

     Capital expenditures and real estate improvements and development costs are
expected to be approximately $15.0 million to $19.0 million in 2007. The Company
expects that these  expenditures  will be funded by existing  cash and available
credit  facilities.  Subject to available  resources,  the Company's real estate
segment may purchase additional properties and/or seek other investment ventures
from time to time as appropriate opportunities arise.

     Racing Operations

     During 2006,  SHRP,  Ltd.  borrowed $1.1 million from MAXXAM Parent to fund
its 2006 capital  expenditures and improve its working capital  position.  SHRP,
Ltd.'s management expects that SHRP, Ltd. will require additional  advances from
MAXXAM Parent to fund its  operations  and capital  expenditures  in the future.
SHRP, Ltd. is experiencing strong competition from Internet wagering and racinos
in  surrounding  states.  These  factors will also play a role in the  long-term
liquidity of SHRP, Ltd.

     Capital expenditures are expected to be approximately $0.4 million in 2007.
Subject to  available  resources,  the  Company's  racing  segment may  purchase
additional  properties  and/or  seek to expand  its  operations  as  appropriate
opportunities arise.

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

Contractual Obligations

     As a result of the  commencement  of the  Bankruptcy  Cases,  the operative
documents  provide that the outstanding  principal of, and accrued  interest on,
all debt  obligations  became  immediately  due and payable.  However,  the vast
majority of the claims in  existence  at the Filing Date  (including  claims for
principal and accrued interest on the Debtors'  indebtedness  and  substantially
all legal claims) are stayed  (deferred)  while the Debtors  continue to operate
the  businesses  as  debtors-in-possession.  The  automatic  stay  provisions of
Chapter 11 of the Bankruptcy Code make it unnecessary to reclassify  prepetition
long-term  liabilities as of the Filing Date even though  prepetition  creditors
might demand payment or there is violation of a covenant in the debt  agreement.
Accordingly, the Debtors' long-term obligations, except for the Palco Term Loan,
where  the  Borrowers'  did not meet the  required  minimum  EBITDA  maintenance
covenant for the three months ended December 31,  2006, have  been  classified in
accordance with their contractual terms in the Company's  consolidated financial
statements and in the contractual obligations table below.

     The  following  table  presents  information  with respect to the Company's
contractual obligations as of December 31, 2006 (in millions).

                                                                         Payments Due by Period
                                                     ---------------------------------------------------------------
         Contractual Obligations             Total     2007      2008      2009       2010       2011     Thereafter
----------------------------------------- --------- --------- --------- ---------- ---------- ---------- -----------
Debt obligations(1)                       $1,079.2  $  183.5  $  35.6   $   29.5   $   33.6   $  38.4    $  758.6
Interest due on long-term debt obligations   620.7      89.4     81.3       79.3       77.3      75.1       218.3
Operating lease obligations                   10.6       3.1      2.7        1.9        0.8       0.7         1.4
Pension funding obligations                   15.0       4.4      2.9        1.8        1.8       1.8         2.3
Other long-term liabilities reflected on
the Company's balance sheet(2)(3)(4)(5)        5.6       3.1      2.5          -          -         -           -
                                          --------- --------- --------- ---------- ---------- ---------- -----------
Total                                     $1,731.1  $  283.5  $ 125.0   $  112.5   $  113.5   $ 116.0    $  980.6
                                          ========= ========= ========= ========== ========== ========== ===========

-------------------------
1)   The Scopac  Indenture  provides that a Scopac Timber Note does not cease to
     be  outstanding  because  Scopac  holds the  instrument.  Accordingly,  the
     amounts  shown  in the  table  above  reflect  total  amounts  outstanding,
     including amounts related to Scopac Timber Notes held in the SAR Account.
(2)  Excludes   liabilities   for   litigation,    environmental    remediation,
     self-insurance  claims, and other contingent liabilities due to uncertainty
     as to when cash payments will be required.
(3)  Includes  $1.7  million  in 2007  under  the  terms  of  various  executive
     compensation agreements.
(4)  Includes $2.1 million in 2008 for PDMPI's cost sharing  agreement  with the
     Puerto  Rico  Power  Authority  for  the   construction  of  an  electrical
     substation  that will provide  capacity to new projects  within PDMPI.
(5)  Includes  $1.4  million in 2007 and $0.4  million  in 2008 for  contractual
     amounts owed under agreements with various  professional firms (principally
     audit and tax compliance fees).

Trends

     Forest Products Operations

     The forest products operations have become  increasingly  unpredictable due
to regulatory  constraints and ongoing litigation  challenges and harvest levels
have declined  significantly.  Regulatory and  environmental  matters as well as
legal  actions  have had and are  expected  to  continue  to have a  significant
adverse effect on the Company's forest products operations and liquidity.  These
matters have resulted in declines in actual and expected harvest levels and cash
flows,  significant  increases in the cost of logging  operations  and increased
costs related to timber harvest litigation,  all of which have severely impacted
the historical  cash flows of both Palco and Scopac.  These adverse  effects are
expected to  continue.  Additionally,  the Debtors  expect to incur  substantial
legal and advisor fees as a result of the Bankruptcy Cases.

     Real Estate Operations

     The  company  is  engaged  in  marketing  and  sales  programs  of  varying
magnitudes  at its real estate  developments.  The  Company  intends to continue
selling  undeveloped acreage and semi-developed  parcels,  generally to builders
and developers and fully  developed lots to individuals  and builders.  In 2005,
the Company's real estate operations  realized  substantial  revenues related to
sales at the company's Fountain Hills,  Mirada and Palmas  developments.  As the
proceeds  from these asset sales have not been  redeployed  on other real estate
assets,  this  level  of  sales  activity  is not  expected  to  recur  for  the
foreseeable future.

     Racing Operations

     The Company has in the past and  intends to continue to  vigorously  pursue
Texas gaming  legislation  favorable to it. As some  legislation may require the
approval of  two-thirds  of each  legislative  house and a majority of the Texas
voters,  no assurance can be given that any such  legislation will be enacted or
become effective. Moreover, it is impossible to determine what the provisions of
any such legislation would be or its effect on the Company.

      In January 2004, a subsidiary of the Company, Laredo LLC, applied to the
Racing Commission for an additional license to construct and operate a Class 2
horse racing facility in Laredo, Texas. Following a hearing on Laredo LLC's
application and that of a competing applicant, in September 2006, two state
administrative law judges recommended to the Racing Commission that Laredo LLC
be awarded the license. The Racing Commission on March 20, 2007 ruled that both
Laredo LLC and the competing applicant be awarded licenses for the Laredo area.
The license awarded to Laredo LLC is, however, conditioned on SHRP, Ltd., by the
next Racing Commission meeting on May 14, 2007, entering into an agreement
satisfactory to the Racing Commission providing for the sale of Valley Race
Park.

     Critical Accounting Policies and Estimates

     This  section  contains   statements   which  constitute   "forward-looking
statements"  within the  meaning of the PSLRA.  See Item 1.  "Business-General,"
Item 1A. "Risk  Factors," and below for cautionary  information  with respect to
such forward-looking statements.

     The  discussion  and  analysis of the  Company's  financial  condition  and
results  of  operations  is based  upon  the  Company's  consolidated  financial
statements,  which have been prepared in accordance with  accounting  principles
generally  accepted in the United States of America.  The  preparation  of these
consolidated  financial  statements  requires the Company to make  estimates and
judgments that affect the reported amounts of assets, liabilities,  revenues and
expenses,   and  related  disclosures  of  contingent  assets  and  liabilities.
Estimates are based on historical  experience  and on various other  assumptions
that are believed to be reasonable under the  circumstances.  The result of this
process forms the basis for making  judgments about the carrying value of assets
and liabilities  that are not readily  apparent from other sources.  The Company
re-evaluates its estimates and judgments on a regular basis.  Actual results may
differ  materially from these estimates due to changed facts,  circumstances and
conditions.

     The following  accounting policies and estimates are considered critical in
light of the  potentially  material  impact that the  estimates,  judgments  and
uncertainties  affecting the  application  of these  policies  might have on the
Company's reported financial information.

     Principles of Consolidation
     Under generally accepted  accounting  principles for entities  consolidated
through voting interests, consolidation is generally required for investments of
more  than 50% of the  outstanding  voting  stock of an  investee,  except  when
control  is  not  held  by  the  majority  owner.   Under  these  rules,   legal
reorganization   or   bankruptcy   represent   conditions   which  can  preclude
consolidation in instances where control rests with the bankruptcy court, rather
than the majority owner.

     Financial Reporting by Entities in Reorganization under the Bankruptcy Code
     Under generally accepted accounting principles,  entities in reorganization
proceedings under the Bankruptcy Code generally  continue to apply the financial
reporting  principles they applied before filing petitions;  accordingly,  these
consolidated  financial  statements  do not  reflect  changes  in  the  Debtors'
financial  condition  that may result from the Bankruptcy  Cases.  The automatic
stay  provisions of Chapter 11 of the  Bankruptcy  Code make it  unnecessary  to
reclassify  prepetition  long-term liabilities as of the Filing Date even though
prepetition creditors might demand payment or there is a violation of a covenant
in the debt agreement.  Additionally,  debt discounts,  as well as debt issuance
costs on debts that are not subject to compromise, such as fully secured claims,
should not be adjusted.  Accordingly,  the Debtors'  long-term debt obligations,
except for the Palco Term Loan,  where the  Borrowers' did not meet the required
minimum  EBITDA  maintenance  covenant for the three  months ended  December 31,
2006,  have  been  classified  according  to  their  contractual  terms  in  the
accompanying   consolidated   financial   statements  and  there  have  been  no
adjustments  made to debt  discounts or debt  issuance  costs as a result of the
reorganization proceedings.

     Deconsolidation of Kaiser
     On February  12,  2002,  Kaiser and certain of its  subsidiaries  filed for
reorganization under Chapter 11 of the Bankruptcy Code. As a result, the Company
discontinued  consolidating  Kaiser's  financial results beginning  February 12,
2002, and began reporting its investment in Kaiser using the cost method,  under
which  the  investment  was  reflected  as a  single  amount  on  the  Company's
consolidated  balance  sheet and the recording of earnings or losses from Kaiser
was discontinued after February 11, 2002.

     Kaiser's plan of  reorganization  provided for the cancellation of Kaiser's
equity,   including  the  Company's  Kaiser  Shares,  without  consideration  or
obligation.  Kaiser's plan of  reorganization  became effective on July 6, 2006,
and Kaiser emerged from bankruptcy.  As a result,  the Company no longer has any
ownership  interest in or affiliation  with Kaiser.  Since the Company's  Kaiser
Shares  were  cancelled  without  obligation,  the Company  reversed  the $516.2
million  of  losses  in  excess  of its  investment  in  Kaiser  along  with the
accumulated  other  comprehensive  losses of $85.3  million  related  to Kaiser,
resulting in a net gain of $430.9  million,  recognized  in the third quarter of
2006. As a result of the  cancellation  of the Company's  Kaiser Shares in 2006,
the  Company  expects  it will  take a  worthless  stock  deduction  on its 2006
consolidated  federal income tax return.  However,  it is uncertain  whether the
deduction  meets  certain  criteria  required  for asset  recognition  purposes.
Accordingly,   the  Company  has  not  recorded  the   resulting  tax  asset  of
approximately  $135.8 million in its  consolidated  balance sheet as of December
31, 2006.

     Gain and Loss Contingencies
     The Company is involved in various claims, lawsuits,  environmental matters
and other proceedings including those discussed in Note 11. Such matters involve
uncertainty as to reasonably possible losses and potential gains the Company may
ultimately  realize when one or more future  events occur or fail to occur.  The
Company  accrues  and  charges to income  estimated  losses  (including  related
estimated  legal fees) from  contingencies  when it is probable  (at the balance
sheet date) that an asset has been impaired or liability incurred and the amount
of loss can be reasonably  estimated.  The Company recognizes gain contingencies
when realization is assured.  Differences  between estimates recorded and actual
amounts  determined in  subsequent  periods are treated as changes in accounting
estimates (i.e., they are reflected in the financial statements in the period in
which they are determined to be losses, with no retroactive restatement).

     The  Company  estimates  the  probability  of  gains  and  losses  on legal
contingencies based on the advice of internal and external counsel, the outcomes
from  similar  litigation,  the  status of the  lawsuits  (including  settlement
initiatives),  legislative and regulatory  developments,  and other factors. For
larger  environmental  matters, the Company estimates the losses using estimates
prepared by third party experts and the advice of internal and external counsel.
Risks and  uncertainties  are inherent  with respect to the ultimate  outcome of
litigation and environmental  contingencies.  See Note 11 for further discussion
of the Company's material contingencies.

     Income Taxes
     The  Company  accrues  and  charges  to income  estimated  taxes when it is
probable (at the balance  sheet date) that a liability has been incurred and the
amount of the  liability can be reasonably  estimated,  including  situations in
which the Company has and has not  received  tax  assessments  from the relevant
taxing  authority.  Taxes are  provided  in those  instances  where the  Company
considers  it  probable  that  additional  tax may be due in excess  of  amounts
reflected in our tax returns as filed. The Company  believes  amounts  currently
provided for any such potential  assessments will not be settled within the next
twelve months and settlement of such amounts would not have a significant impact
on the Company's consolidated  financial position,  results of operations and/or
liquidity. See Note 8 for further discussion of the Company's income taxes.

     Deferred Tax Asset Valuation Allowances
     As of December  31,  2006,  the Company had $131.6  million of deferred tax
assets (net of $125.1  million in  valuation  allowances)  and $41.7  million of
deferred tax  liabilities.  The deferred tax assets and liabilities  reported in
the  Company's  consolidated  balance sheet reflect the amount of taxes that the
Company  has  prepaid or for which it will  receive a tax  benefit (an asset) or
will have to pay in the future (a  liability)  because of temporary  differences
that  result  from  differences  in timing of  revenue  recognition  or  expense
deductibility  between generally accepted accounting principles and the Internal
Revenue Code. Accounting rules require that a deferred tax asset be reduced by a
valuation  allowance if, based on the weight of available  evidence,  it is more
likely than not (a  likelihood of more than 50%) that all or some portion of the
deferred tax asset will not be realized.  The Company  considers  all  available
evidence, both positive and negative, to determine whether a valuation allowance
is  needed.  The  need  for a  valuation  allowance  ultimately  depends  on the
existence  of  sufficient  taxable  income to  realize  the  benefit of a future
deductible amount.

     Assessing the need for and amount of a valuation allowance for deferred tax
assets requires  significant  judgment.  The fact that a benefit may be expected
for a portion  but not all of a  deferred  tax asset  increases  the  judgmental
complexity of the determination.  Projections of future taxable income, by their
very nature,  require estimates and judgments about future events that, although
they might  conceivably  be  predictable,  are far less certain than events that
have already occurred and can be objectively measured.

     Uncertainties  that might  exist with  respect  to the  realization  of the
Company's  deferred tax assets relate to future taxable  income.  See Note 8 for
further discussion of the Company's valuation allowances on deferred tax assets.

     Pension and Other Postretirement Benefit Plan Obligations and Expenses
     Estimating  future  benefit  payments  for  purposes of  measuring  pension
benefit  obligations  requires the Company to make a number of assumptions about
future  experience.  These  assumptions  are  combined  with  the  terms  of the
Company's  plans to produce an  estimate of required  future  benefit  payments,
which is discounted to reflect the time value of money. As a result, assumptions
about the covered  population  (demographic  assumptions) and about the economic
environment  (economic  assumptions)  significantly  affect  pension  and  other
postretirement benefit obligations. The most significant demographic assumptions
are expected  retirement  age,  life  expectancy,  and  turnover,  while the key
economic  assumptions  are the discount  rate,  and the expected  return on plan
assets.  At December 31, 2005,  the Company's  pension  plans were frozen.  As a
result,  these plans will  continue,  but no additional  benefits will accrue to
participants  subsequent  to December 31, 2005.  Future  benefit  payments  will
continue  to be measured  based on the same types of  demographic  and  economic
assumptions,  with the  exception of salary  growth as no new  benefits  will be
accrued.

     The projected  benefit  obligation for the Company's  pension plans and the
accumulated   postretirement   benefit   obligation  for  the  Company's   other
postretirement  benefit  plans was  determined  using a discount rate of 6.0% at
December 31, 2006,  and 5.625% at December 31, 2005.  As the pension  plans were
frozen December 31, 2005, there is no assumed weighted average long-term rate of
compensation.  The  assumed  weighted  average  long-term  rate of return on the
assets of the plans is 8.75%.  The assets of the plans  consist  principally  of
common stocks and U.S. government and other fixed-income obligations.

     The  estimated  impact of a 1% decrease in the discount  rate (from 6.0% to
5.0%) would  increase  the  Company's  consolidated  projected  pension  benefit
obligation by  approximately  $14.5 million,  while the estimated impact of a 1%
increase in the discount  rate (from 6.0% to 7.0%) would  decrease the Company's
consolidated projected benefit obligation by approximately $11.6 million.

     See Note 9 for further discussion of the consolidated obligations related to
pension and other postretirement benefit plans.

     Impairment of Noncurrent Assets
     The Company reviews  noncurrent  assets for impairment  when  circumstances
indicate  that  the  carrying  amount  of such  assets  may not be  recoverable.
Impairment is indicated if the total undiscounted  future cash flows expected to
result from use of the assets,  including the possible residual value associated
with  their  eventual  disposition,  are less  than the  carrying  amount of the
assets.  Assets are  written  down to fair value and a loss is  recognized  upon
impairment.   Fair  value  increases  on  assets  previously  written  down  for
impairment losses are not recognized.

     Considerable  judgment is exercised in the Company's assessment of the need
for an impairment  write-down.  Indicators of  impairment  must be present.  The
estimates of future cash flows, based on reasonable and supportable  assumptions
and projections,  require management's  subjective judgments. In some instances,
situations  might exist where  impairments are the result of changes in economic
conditions  or other  factors  that  develop  over  time,  which  increases  the
subjectivity  of assumptions  made.  Depending on the  assumptions and estimates
used, the estimated  future cash flows projected in the evaluation of long-lived
assets can vary within a wide range of outcomes. A probability-weighted approach
is used for  situations  in which  alternative  courses of action to recover the
carrying  amount of  long-lived  assets  are under  consideration  or a range is
estimated for the amount of possible future cash flows.

New Accounting Standards

     See Note 2 for a  discussion  of new  accounting  pronouncements  and their
potential impact on the Company.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
MAXXAM Inc., Houston, Texas

We have audited the accompanying  consolidated balance sheets of MAXXAM Inc. and
subsidiaries  (collectively the "Company") as of December 31, 2006 and 2005, and
the related consolidated statements of operations, cash flows, and stockholders'
deficit for each of the three years in the period ended  December 31, 2006.  Our
audits also included the financial  statement  schedules  listed in the Index at
Item 15(a)(2).  These financial statements and financial statement schedules are
the responsibility of the Company's management. Our responsibility is to express
an opinion on the financial  statements and financial  statement schedules based
on our audits.  We did not audit the  financial  statements  of Sam Houston Race
Park, Ltd. (a subsidiary),  which statements reflect total revenue  constituting
16.0 percent, 11.4 percent and 14.5 percent of the Company's  consolidated total
revenues for the years ended December 31, 2006,  2005,  and 2004,  respectively.
Such financial  statements  were audited by other auditors whose report has been
furnished to us, and our opinion,  insofar as it relates to the amounts included
for Sam Houston  Race Park,  Ltd.,  is based  solely on the report of such other
auditors.

We conducted our audits in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). 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 and the report of
other auditors provide a reasonable basis for our opinion.

In our  opinion,  based on our  audits and the  report of other  auditors,  such
consolidated  financial statements present fairly, in all material respects, the
financial  position of MAXXAM Inc. and  subsidiaries as of December 31, 2006 and
2005,  and the results of their  operations and their cash flows for each of the
three years in the period ended December 31, 2006, in conformity with accounting
principles  generally  accepted in the United  States of America.  Also,  in our
opinion,  based on our audits and (as to the  amounts  included  for Sam Houston
Race  Park,  Ltd.)  the  report  of other  auditors,  such  financial  statement
schedules,  when  considered  in  relation to the basic  consolidated  financial
statements  taken  as a whole,  present  fairly  in all  material  respects  the
information set forth therein.

     The  accompanying  consolidated  financial  statements  have been  prepared
assuming that MAXXAM Inc., and its subsidiaries will continue as going concerns.
As discussed in Note 1 to the consolidated financial statements,  on January 18,
2007,  MAXXAM  Inc.'s  wholly  owned  subsidiary,  The  Pacific  Lumber  Company
("Palco")  and its five wholly  owned  subsidiaries,  including  Scotia  Pacific
Company LLC ("Scopac"),  filed separate voluntary petitions in the United States
Bankruptcy  Court for the Southern  District of Texas for  reorganization  under
Chapter 11 of the  Bankruptcy  Code.  The six companies that filed for voluntary
protection  are as follows:  Palco,  Britt Lumber Co.,  Inc.  ("Britt"),  Scotia
Development  LLC, Salmon Creek LLC, Scotia Inn Inc. and Scopac (the  "Debtors").
The proceedings of the Debtors are  collectively  referred to as the "Bankruptcy
Cases."  The  filing of the  Bankruptcy  Cases  was  precipitated  by  liquidity
shortfalls  at Palco and Scopac and their  resultant  inability  to make January
2007  interest  payments on their  respective  debt  obligations,  arising  from
regulatory  restrictions  and  limitations on timber harvest,  increased  timber
harvesting costs and cyclical lumber prices.  Additionally,  Palco and Britt did
not meet the minimum required EBIDTA maintenance covenant required by their debt
facilities  for the three month  period ended  December  31, 2006.  Management's
plans  concerning these matters are also discussed in Note 1 to the consolidated
financial  statements.  The  Bankruptcy  Cases raise  substantial  doubts  about
Palco's  and  Scopac's  ability to  continue  as going  concerns.  Further,  the
Bankruptcy  Cases raise  substantial  doubt about the ability of MAXXAM Inc. and
subsidiaries  to  realize  their  timber-related   assets  and  discharge  their
timber-related liabilities in the normal course of business and to continue as a
going  concern.  The  consolidated  financial  statements  do  not  include  any
adjustments that might result from the outcome of these uncertainties.

We have also  audited,  in accordance  with the standards of the Public  Company
Accounting  Oversight Board (United States),  the effectiveness of the Company's
internal control over financial  reporting as of December 31, 2006, based on the
criteria  established  in Internal  Control-Integrated  Framework  issued by the
Committee of Sponsoring  Organizations of the Treadway Commission and our report
dated March 30, 2007 expressed an unqualified opinion on management's assessment
of the effectiveness of the Company's internal control over financial  reporting
and an  unqualified  opinion  on the  effectiveness  of the  Company's  internal
control over financial reporting.

                                                       DELOITTE & TOUCHE LLP
Houston, Texas
March 30, 2007

                          MAXXAM INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
               (In millions of dollars, except share information)

                                                                                                  December 31,
                                                                                             -----------------------
                                                                                                2006        2005
                                                                                             ----------- -----------
Assets
Current assets:
  Cash and cash equivalents                                                                  $   34.8    $   72.9
  Marketable securities and other short-term investments                                        126.2       134.6
  Receivables:
    Trade, net of allowance for doubtful accounts of $0.7 and $0.8, respectively                  9.9        11.1
    Other                                                                                         9.7         5.4
  Inventories:
    Lumber                                                                                       16.3         7.6
    Logs                                                                                         25.5        18.9
  Real estate inventory                                                                           5.8        12.6
  Prepaid expenses and other current assets                                                      16.2        16.4
  Restricted cash and marketable securities                                                      43.1        29.1
                                                                                             ----------- -----------
        Total current assets                                                                    287.5       308.6
Property, plant and equipment, net of accumulated depreciation of $234.5 and
  $207.9, respectively                                                                          337.0       355.0
Timber and timberlands, net of accumulated depletion of $232.2 and $226.3, respectively         200.3       208.7
Real estate                                                                                      46.0        43.2
Deferred income taxes                                                                            97.5        95.1
Intangible assets                                                                                 2.0         2.9
Long-term receivables and other assets                                                           31.4        26.9
Restricted cash and marketable securities                                                         8.2         7.9
                                                                                             ----------- -----------
                                                                                             $1,009.9    $1,048.3
                                                                                             =========== ===========
Liabilities and Stockholders' Deficit
Current liabilities:
  Accounts payable                                                                           $   10.0    $   11.2
  Accrued interest                                                                               28.8        25.9
  Accrued compensation and related benefits                                                      13.8        20.7
  Other accrued liabilities                                                                      26.3        37.0
  Short-term borrowings and current maturities of long-term debt                                180.7       112.5
                                                                                             ----------- -----------
        Total current liabilities                                                               260.5       207.3
Long-term debt, less current maturities and discount                                            885.4       889.6
Accrued pension and other postretirement benefits                                                20.8        34.1
Losses in excess of investment in Kaiser                                                            -       516.2
Other noncurrent liabilities                                                                     55.9        62.4
                                                                                             ----------- -----------
        Total liabilities                                                                     1,221.7     1,709.6
                                                                                             ----------- -----------
Commitments and contingencies (see Note 11)

Stockholders' deficit:
  Preferred stock, $0.50 par value; $0.75 liquidation preference; 2,500,000
     shares authorized; Class A $0.05 Non-Cumulative Participating Convertible
     Preferred Stock; 668,964 shares issued; 668,119 shares outstanding                           0.3         0.3
  Common stock, $0.50 par value; 13,000,000 shares authorized; 10,063,359 shares
     issued; 5,257,657 and 5,967,942 outstanding, respectively                                    5.0         5.0
  Additional capital                                                                            225.3       225.3
  Accumulated deficit                                                                          (296.0)     (670.4)
  Accumulated other comprehensive income (loss)                                                   1.0       (96.6)
  Treasury stock, at cost (shares held:  preferred - 845; common - 4,805,702 and
     4,095,417, respectively)                                                                  (147.4)     (124.9)
                                                                                             ----------- -----------
        Total stockholders' deficit                                                            (211.8)     (661.3)
                                                                                             ----------- -----------
                                                                                             $1,009.9    $1,048.3
                                                                                             =========== ===========

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

                          MAXXAM INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS
             (In millions of dollars, except per share information)

                                                                                   Years Ended December 31,
                                                                           -----------------------------------------
                                                                               2006          2005          2004
                                                                           ------------- ------------- -------------
Net sales:
  Forest products                                                          $  140.0      $  181.8      $  202.1
  Real estate                                                                 104.9         178.3          94.8
  Racing                                                                       46.6          46.3          50.6
                                                                           ------------- ------------- -------------
                                                                              291.5         406.4         347.5
                                                                           ------------- ------------- -------------
Cost and expenses:
  Cost of sales and operations:
    Forest products                                                           117.1         146.3         150.1
    Real estate                                                                36.4          52.0          31.7
    Racing                                                                     40.9          40.1          42.7
Selling, general and administrative expenses                                   56.3          72.3          71.7
Gains on sales of timberlands and other assets                                (11.6)         (0.3)         (0.1)
Impairment of assets                                                             .7           4.6             -
Depreciation, depletion and amortization                                       33.6          35.9          37.1
Reversal of net investment in Kaiser                                         (430.9)            -             -
                                                                           ------------- ------------- -------------
                                                                             (157.5)        350.9         333.2
                                                                           ------------- ------------- -------------
Operating income (loss):
  Forest products                                                              (9.1)        (13.4)          5.4
  Real estate                                                                  37.4          89.0          29.7
  Racing                                                                       (4.6)         (4.1)         (3.1)
  Corporate, including reversal of net investment in Kaiser                   425.3         (16.0)        (17.7)
                                                                           ------------- ------------- -------------
                                                                              449.0          55.5          14.3
Other income (expense):
  Investment and interest income                                                7.4          17.5           8.6
  Other income                                                                  2.2           1.1           4.2
  Interest expense                                                            (81.1)        (74.4)        (71.8)
  Amortization of deferred financing costs                                     (6.6)         (3.8)         (2.2)
                                                                           ------------- ------------- -------------
Income (loss) before income taxes and cumulative effect of
  accounting change                                                           370.9          (4.1)        (46.9)
Benefit for income taxes                                                        4.2           0.1           0.3
                                                                           ------------- ------------- -------------
Income (loss) before cumulative effect of accounting change                   375.1          (4.0)        (46.6)
Cumulative effect of accounting change                                         (0.7)            -             -
                                                                           ------------- ------------- -------------
Net income (loss)                                                          $  374.4      $   (4.0)     $  (46.6)
                                                                           ============= ============= =============
Basic income (loss) per common and common equivalent share
before cumulative effect of accounting change                              $  67.77      $  (0.66)     $  (7.79)
Cumulative effect of accounting change                                        (0.13)            -             -
                                                                           ------------- ------------- -------------
Basic income (loss) per common and common equivalent
shares after cumulative effect of accounting change                        $  67.64      $  (0.66)     $  (7.79)
                                                                           ============= ============= =============
Diluted income (loss) per common and common equivalent
  share before cumulative effect of accounting change                      $   59.82     $  (0.66)     $  (7.79)
Cumulative effect of accounting change                                         (0.11)           -             -
                                                                           ------------- ------------- -------------
Diluted income (loss) per common and common equivalent
  share after cumulative effect of accounting change                       $   59.71     $  (0.66)     $  (7.79)
                                                                           ============= ============= =============

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

                          MAXXAM INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                            (In millions of dollars)

                                                                                       Years Ended December 31,
                                                                                  ----------------------------------
                                                                                      2006       2005        2004
                                                                                  ---------- ----------- -----------
Cash flows from operating activities:
  Net income (loss)                                                               $   374.4  $    (4.0)  $    (46.6)
  Adjustments to reconcile net loss to net cash provided
    by (used for) operating activities:
    Reversal of net investment in Kaiser                                             (430.9)         -            -
    Depreciation, depletion and amortization                                           33.6       35.9         37.1
    Non-cash stock-based compensation (benefit) expense                                (2.0)       3.7          6.1
    Non-cash impairment charge                                                           .7        4.6            -
    Gains on sales and/or disposals of timberlands and other assets                   (11.6)      (0.3)        (0.1)
    Net losses (gains) on marketable securities                                        (2.2)      (6.6)         2.2
    Amortization of deferred financing costs and discounts on long-term debt            6.6        3.8          2.2
    Equity in loss (earnings) of unconsolidated affiliates, net of dividends
      received                                                                          0.4        1.0         (0.4)
    Increase (decrease) in cash resulting from changes in:
      Receivables                                                                      (2.8)       5.4         (0.8)
      Inventories                                                                     (15.3)      (1.1)         4.4
      Prepaid expenses and other assets                                                 7.0        0.5          1.5
      Accounts payable                                                                 (1.2)      (3.4)         2.5
      Accrued and deferred income taxes                                                (6.5)       0.2          0.2
      Other accrued liabilities                                                       (14.7)       8.1          1.6
      Accrued interest                                                                  2.9        1.0         (0.9)
      Long-term assets and long-term liabilities                                      (12.8)       4.6         17.7
      Other                                                                               -       (0.1)         0.2
                                                                                  ---------- ----------- -----------
         Net cash provided by (used for) operating activities                         (74.4)      53.3         26.9
                                                                                  ---------- ----------- -----------

Cash flows from investing activities:
  Net proceeds from dispositions of property and investments                           15.9        0.1          0.3
  Sales and maturities of marketable securities and other investments                 627.9      708.3        778.6
  Purchases of marketable securities and other investments                           (625.4)    (728.4)      (772.6)
  Net proceeds from restricted cash                                                     2.2        5.2         13.0
  Capital expenditures                                                                (15.6)     (19.7)       (32.7)
  Return of investment in joint venture                                                   -        0.8          2.1
  Other                                                                                   -        0.2          0.4
                                                                                  ---------- ----------- -----------
         Net cash provided by (used for) investing activities                           5.0      (33.5)       (10.9)
                                                                                  ---------- ----------- -----------

Cash flows from financing activities:
  Proceeds from issuances of long-term debt                                               -        38.0         5.4
  Proceeds from sale of Scopac Timber Notes held in the SAR Account                    31.8           -           -
  Principal payments on long-term debt                                                (67.9)      (32.1)      (48.1)
  Principal payments on Scopac Timber Notes held in the SAR Account                    11.1         9.5         5.0
  Borrowings under revolving and short-term credit facilities                          89.4        23.0        30.0
  Incurrence of deferred financing costs                                              (10.6)       (3.6)       (0.8)
  Treasury stock purchases                                                            (22.5)       (0.2)          -
                                                                                  ---------- ----------- -----------
         Net cash provided by (used for) financing activities                          31.3        34.6        (8.5)
                                                                                  ---------- ----------- -----------

Net increase (decrease) in cash and cash equivalents                                  (38.1)       54.4         7.5
Cash and cash equivalents at beginning of year                                         72.9        18.5        11.0
                                                                                  ---------- ----------- -----------
Cash and cash equivalents at end of year                                          $    34.8  $     72.9  $     18.5
                                                                                  ========== =========== ===========

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

                          MAXXAM INC. AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
                   (In millions, except per share information)

                                                                                  Years Ended December 31,
                                                                         -------------------------------------------
                                                                              2006          2005          2004
                                                                         ------------ -------------- ---------------
Preferred Stock ($.50 Par)
  Balance at beginning and end of year                                   $     0.3    $      0.3     $     0.3
                                                                         ============ ============== ===============
Common Stock ($.50 Par)
  Balance at beginning and end of year                                   $     5.0    $      5.0     $     5.0
                                                                         ============ ============== ===============
Additional Capital
  Balance at beginning and end of year                                   $   225.3    $    225.3     $   225.3
                                                                         ============ ============== ===============
Accumulated Deficit
  Balance at beginning of year                                           $  (670.4)   $   (666.4)    $  (619.8)
    Net income (loss)                                                        374.4          (4.0)        (46.6)
                                                                         ------------ -------------- ---------------
  Balance at end of year                                                 $  (296.0)   $   (670.4)    $  (666.4)
                                                                         ============ ============== ===============
Accumulated Other Comprehensive Income (Loss)
  Minimum pension liability adjustment, net of taxes                     $    11.1    $      0.1     $    (6.9)
  Reversal of other comprehensive income related to Kaiser                    85.3             -             -
  Other                                                                       (0.1)            -             -
  Unrealized gains (losses) on available-for-sale investments                  1.3          (0.1)         (1.7)
                                                                         ------------ -------------- ---------------
  Other comprehensive income (loss)                                           97.6             -          (8.6)
  Accumulated other comprehensive loss at beginning of year                  (96.6)        (96.6)        (88.0)
                                                                         ------------ -------------- ---------------
  Accumulated other comprehensive income (loss) at end of year           $     1.0    $    (96.6)    $   (96.6)
                                                                         ============ ============== ===============

Treasury Stock
  Balance at beginning of year                                           $  (124.9)   $   (124.7)    $  (124.7)
    Treasury stock purchases                                                 (22.5)         (0.2)            -
                                                                         ------------ -------------- ---------------
  Balance at end of year                                                 $  (147.4)   $   (124.9)    $  (124.7)
                                                                         ============ ============== ===============
Comprehensive Income (Loss)
  Net income (loss)                                                      $   374.4    $     (4.0)    $   (46.6)
  Other comprehensive income (loss)                                           97.6             -          (8.6)
                                                                         ------------ -------------- ---------------
  Total comprehensive income (loss)                                      $   472.0    $     (4.0)    $  (55.2)
                                                                         ============ ============== ===============

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

                                 MAXXAM INC. AND SUBSIDIARIES

                             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                 Index of Notes

Number   Description                                                        Page
1        Basis of Presentation and Summary of Significant Accounting Policies...
2        New Accounting Standards...............................................
3        Segment Information and Other Items....................................
4        Cash, Cash Equivalents, Marketable Securities and Other Investments....
5        Property, Plant and Equipment..........................................
6        Investments in Unconsolidated Affiliates...............................
7        Debt...................................................................
8        Income Taxes...........................................................
9        Employee Benefit and Incentive Plans...................................
10       Investment in Kaiser...................................................
11       Commitments and Contingencies..........................................
12       Stockholders' Deficit..................................................
13       Significant Acquisitions and Dispositions..............................
14       Supplemental Cash Flow and Other Information...........................
15       Quarterly Financial Information (Unaudited)............................

1. Basis of Presentation and Summary of Significant Accounting Policies

     Basis of Presentation

     The consolidated  financial  statements include the accounts of MAXXAM Inc.
and its majority and wholly owned controlled subsidiaries. All references to the
"Company"   include  MAXXAM  Inc.  and  its  majority  owned  and  wholly  owned
consolidated  subsidiaries,  unless  otherwise  noted or the  context  indicates
otherwise. The term "MAXXAM Parent" refers to the Company on a stand-alone basis
without its  subsidiaries.  Intercompany  balances  and  transactions  have been
eliminated. Investments in entities over which the Company can exert significant
influence but not control  (generally  20% to 50%  ownership)  are accounted for
using the equity method of accounting.

     MAXXAM Parent  conducts the substantial  portion of its operations  through
its subsidiaries, which operate in three principal industries:

o    Forest  products,  through MAXXAM Group Inc. ("MGI") and MGI's wholly owned
     subsidiaries,  principally  The Pacific  Lumber Company  ("Palco"),  Scotia
     Pacific Company LLC ("Scopac"), Britt Lumber Co., Inc. ("Britt") and Scotia
     Development LLC ("SDLLC"). MGI and its subsidiaries engage primarily in the
     growing and harvesting of redwood and  Douglas-fir  timber,  the milling of
     logs into lumber and  related  operations  and  activities.  A  substantial
     portion of the Company's  consolidated  assets,  liabilities,  revenues and
     results of operations are attributable to the forest products subsidiaries.
     On  January  18,  2007,  Palco,  Scopac,  Britt,  SDLLC and  Palco's  other
     subsidiaries (the "Debtors") filed for  reorganization  under Chapter 11 of
     the  United  States   Bankruptcy   Code  (the   "Bankruptcy   Code").   See
     "-Reorganization  Proceedings  of Palco  and its  Subsidiaries"  below  for
     further information.

o    Real estate  investment and  development,  through MAXXAM Property  Company
     ("MPC") and other wholly  owned  subsidiaries  of the  Company,  as well as
     joint  ventures.   These  subsidiaries  are  engaged  in  the  business  of
     residential  and  commercial  real  estate   investment  and   development,
     primarily  in  Arizona,  California,   Puerto  Rico  and  Texas,  including
     associated golf course or resort operations in certain locations,  and also
     own several commercial real estate properties that are subject to long-term
     lease  arrangements.  A substantial  portion of the Company's  consolidated
     cash flows are attributable to the real estate subsidiaries.

o    Racing  operations,  through Sam Houston Race Park, Ltd. ("SHRP,  Ltd."), a
     Texas limited partnership wholly owned by the Company.  SHRP, Ltd. owns and
     operates a Texas Class 1 pari-mutuel  horse racing  facility in the greater
     Houston  metropolitan area, and a pari-mutuel  greyhound racing facility in
     Harlingen, Texas.

     In addition to the above, the Company  previously  owned 50,000,000  common
shares (the "Kaiser Shares") of Kaiser Aluminum  Corporation  ("Kaiser"),  which
represented approximately 63% of Kaiser's common stock. In July 2006, the Kaiser
Shares were cancelled as part of Kaiser's Chapter 11 plan of reorganization.  As
a result,  the Company no longer has any  ownership  interest in or  affiliation
with Kaiser. See the  "Deconsolidation  of Kaiser" below and Note 10 for further
information regarding this matter.

     Results and activities for MAXXAM Inc. (excluding its subsidiaries) and for
MAXXAM Group Holdings Inc. ("MGHI") are not included in the above segments. MGHI
owns 100% of MGI and is a wholly owned subsidiary of the Company.

     Principles of Consolidation

     Under generally accepted  accounting  principles for entities  consolidated
through voting interests, consolidation is generally required for investments of
more  than 50% of the  outstanding  voting  stock of an  investee,  except  when
control  is  not  held  by  the  majority  owner.   Under  these  rules,   legal
reorganization   or   bankruptcy   represent   conditions   which  can  preclude
consolidation in instances where control rests with the bankruptcy court, rather
than the majority owner.

     Financial Reporting by Entities in Reorganization under the Bankruptcy Code

     On  January  18,  2007,  (The  "Filing  Date") the  Debtors  (Palco and its
subsidiaries) filed for reorganization  under Chapter 11 of the Bankruptcy Code.
As a result,  the Company  expects to  discontinue  consolidating  the  Debtors'
financial  results  beginning  January 18,  2007,  and begin  reporting  its net
investment  in the  Debtors  using  the  cost  method.  See the  "Reorganization
Proceedings of Palco and its Subsidiaries" section below for further information
regarding the status of the Debtors' reorganization proceedings.

     Under generally accepted accounting principles,  entities in reorganization
proceedings under the Bankruptcy Code generally  continue to apply the financial
reporting  principles they applied before filing petitions;  accordingly,  these
consolidated  financial  statements  do not  reflect  changes  in  the  Debtors'
financial  condition  that may result from the Bankruptcy  Cases.  The automatic
stay  provisions of Chapter 11 of the  Bankruptcy  Code make it  unnecessary  to
reclassify  prepetition  long-term liabilities as of the Filing Date even though
prepetition creditors might demand payment or there is a violation of a covenant
in the debt  agreement.  Additionally,  debt  discounts as well as debt issuance
costs on debts that are not subject to compromise, such as fully secured claims,
should not be adjusted.  Accordingly,  the Debtors'  long-term debt obligations,
except for the Palco Term Loan (as defined  below),  where the Borrowers did not
meet the required minimum EBITDA maintenance covenant for the three months ended
December 31, 2006, have been classified  according to their contractual terms in
the  accompanying  consolidated  financial  statements  and  there  have been no
adjustments  made to debt  discounts,  or debt issuance costs as a result of the
reorganization proceedings.

     Deconsolidation of Kaiser

     On February  12,  2002,  Kaiser and certain of its  subsidiaries  filed for
reorganization under Chapter 11 of the Bankruptcy Code. As a result, the Company
discontinued  consolidating  Kaiser's  financial results beginning  February 12,
2002, and began reporting its investment in Kaiser using the cost method,  under
which  the  investment  was  reflected  as a  single  amount  on  the  Company's
consolidated  balance  sheet and the recording of earnings or losses from Kaiser
was discontinued after February 11, 2002.

     Kaiser's plan of  reorganization  provided for the cancellation of Kaiser's
equity,   including  the  Company's  Kaiser  Shares,  without  consideration  or
obligation.  Kaiser's plan of  reorganization  became effective on July 6, 2006,
and Kaiser emerged from bankruptcy.  As a result,  the Company no longer has any
ownership  interest in or affiliation  with Kaiser.  Since the Company's  Kaiser
Shares  were  cancelled  without  obligation,  the Company  reversed  the $516.2
million  of  losses  in  excess  of its  investment  in  Kaiser  along  with the
accumulated  other  comprehensive  losses of $85.3  million  related  to Kaiser,
resulting in a net gain of $430.9  million,  recognized  in the third quarter of
2006. As a result of the  cancellation  of the Company's  Kaiser Shares in 2006,
the  Company  expects  it will  take a  worthless  stock  deduction  on its 2006
consolidated  federal income tax return.  However,  it is uncertain  whether the
deduction  meets  certain  criteria  required  for asset  recognition  purposes.
Accordingly,   the  Company  has  not  recorded  the   resulting  tax  asset  of
approximately  $135.8 million in its  consolidated  balance sheet as of December
31, 2006.

Reorganization Proceedings of Palco and its Subsidiaries (subsequent event)

     On  January  18,  2007,  Palco  and its  five  wholly  owned  subsidiaries,
including  Scopac,  filed  separate  voluntary  petitions  in the United  States
Bankruptcy Court for the Southern District of Texas (the "Bankruptcy Court") for
reorganization  under Chapter 11 of the Bankruptcy  Code. The six companies that
filed for  voluntary  protection  are  Palco,  Britt,  SDLLC,  Salmon  Creek LLC
("Salmon  Creek")  and Scotia Inn  ("Scotia  Inn") ( the  "Palco  Debtors")  and
Scopac.  The  proceedings  of the  Debtors are  collectively  referred to as the
"Bankruptcy Cases." For purposes of these financial statements, the term "Filing
Date" shall mean  January  18,  2007.  The  Bankruptcy  Cases are being  jointly
administered, with the Debtors managing their business in the ordinary course as
debtors-in-possession  subject to the control and  supervision of the Bankruptcy
Court.

     The filing of the Bankruptcy Cases was precipitated by liquidity shortfalls
at Palco and Scopac and their resultant  inability to make January 2007 interest
payments  on  their  respective  debt   obligations,   arising  from  regulatory
restrictions  and limitations on timber  harvest,  increased  timber  harvesting
costs and  cyclical  lumber  prices.  Both  Scopac and Palco  undertook  various
efforts in 2006 to generate  additional  liquidity to satisfy  their  respective
debt  service  obligations;  however,  the cash  generated  from their  efforts,
together  with their cash flows from  operations,  was not  sufficient  to cover
their respective interest payment shortfalls in January 2007.

     Scopac's  indebtedness consists of its 6.55% Class A-1, 7.11% Class A-2 and
7.71% Class A-3 Timber Collateralized Notes due 2028 (the "Scopac Timber Notes")
($713.8  million  principal  outstanding  as of December 31, 2006) and a line of
credit with a group of banks pursuant to which Scopac was permitted to borrow to
pay interest on the Scopac  Timber  Notes (the  "Scopac Line of Credit")  ($36.2
million  principal  outstanding as of December 31, 2006), and each being secured
by (i) Scopac's  timber,  timberlands and timber rights,  (ii) certain  contract
rights and other assets,  (iii) the proceeds of the foregoing and (iv) the funds
held by the  Trustee in various  accounts  related to the Scopac  Timber  Notes.
Annual   interest   obligations   related  to  Scopac's  debt   facilities  were
approximately  $55.4  million as of December  31,  2006.  See Note 7 for further
information regarding Scopac's debt obligations.

     Palco's  indebtedness  consists of a five-year  $85.0 million  secured term
loan (the "Palco Term Loan") ($84.3 million principal outstanding as of December
31, 2006) and a five-year $60.0 million  secured  asset-based  revolving  credit
facility (the "Palco  Revolving Credit  Facility")  ($24.1 million of borrowings
outstanding  and $13.7  million of letters of credit  issued as of December  31,
2006).  These  facilities  are  secured by the stock of Palco  held by MGI,  and
substantially  all of the assets of the Palco Debtors (other than Palco's equity
interest in Scopac).  Annual interest  obligations  related to Palco's long-term
debt obligations were  approximately  $17.1 million as of December 31, 2006. See
Note 7 for further information regarding Palco's debt obligations.

     The Debtors'  overall  objectives in the Bankruptcy Cases are to achieve an
operational and financial  restructuring of each of the Debtors'  long-term debt
obligations  in view of estimated  lower harvest  levels,  increased  regulatory
compliance costs, cyclical lumber prices, and also to continue their businesses.
There  can be no  assurance  that  the  Debtors  will be able  to  attain  these
objectives and achieve a successful operational and financial reorganization. In
the event the Debtors are unsuccessful in attaining a successful operational and
financial  reorganization,  the  Debtors  could be  forced to  surrender  all or
substantially  all of their  assets  to  their  creditors.  Many of the  matters
discussed elsewhere in this document could adversely affect the Debtors' ability
to  achieve an  operational  and  financial  restructuring.  The  outcome of the
Bankruptcy  Cases is  impossible  to predict  and could have a material  adverse
effect on the businesses of the Debtors,  on the interests of creditors,  and on
the Company.

     As provided by the Bankruptcy  Code, each of the Debtors  generally has the
exclusive right to propose a plan of  reorganization  the Exclusivity  Period, a
120 day period  following  the date of filing of the  Bankruptcy  Cases,  unless
certain statutory exceptions apply to the Bankruptcy Court orders otherwise. For
instance,  a group of holders of Scopac Timber Notes has filed a motion that, if
granted,  might have the effect of shortening the Exclusivity Period.  Palco and
Scopac have each engaged The  Blackstone  Group  ("Blackstone")  to serve as its
financial advisor and assist in the development of a plan of reorganization  for
Palco and Scopac.  If the Debtors  fail to file such  plan(s) of  reorganization
during the Exclusivity Period or any extension thereof,  or such plan(s) are not
accepted by the  requisite  number of creditors and equity  holders  entitled to
vote on the plan(s),  other parties in interest in the  Bankruptcy  Cases may be
permitted to propose their own plan(s) of reorganization for the Debtors.

     As a result of the  commencement of the Bankruptcy  Cases,  the outstanding
principal of, and accrued  interest on, all long-term debt of the Debtors became
immediately  due and  payable.  However,  the vast  majority  of the  claims  in
existence  at the Filing  Date  (including  claims  for  principal  and  accrued
interest on the Debtors' indebtedness,  and substantially all legal proceedings)
are stayed  (deferred)  while the Debtors  continue to operate the businesses as
debtors-in-possession.  Accordingly,  the Debtors'  long-term debt  obligations,
except for the Palco Term Loan,  where the  Borrowers' did not meet the required
minimum  EBITDA  maintenance  covenant for the three  months ended  December 31,
2006,  have been classified in accordance  with their  contractual  terms in the
accompanying  consolidated  financial  statements.  The  Bankruptcy  Court  has,
however,  upon motion by the Debtors,  permitted the Debtors to pay or otherwise
honor certain  unsecured  pre-Filing Date claims,  including  employee wages and
benefits and  customary  claims in the ordinary  course of business,  subject to
certain  limitations.  The  Debtors  also  have the  right to  assume  or reject
executory  contracts,  subject to  Bankruptcy  Court  approval and certain other
limitations.  In this  context,  "assumption"  means that the  Debtors  agree to
perform their  obligations and cure certain existing defaults under an executory
contract  and  "rejection"  means  that the  Debtors  are  relieved  from  their
obligations to perform further under an executory  contract and are subject only
to a claim for damages and the breach thereof.  Any claim for damages  resulting
from the  rejection of an executory  contract is treated as a general  unsecured
claim in the Bankruptcy Cases.

     The Debtors anticipate that substantially all liabilities of the Debtors as
of the Filing Date will be resolved under one or more plans of reorganization to
be proposed  and voted on in the  Bankruptcy  Cases and in  accordance  with the
provisions of the Bankruptcy Code.  However,  there can be no assurance that the
liabilities of the Debtors will not be ultimately found to exceed the fair value
of its assets. If a Debtor's creditors are not paid in full, the Bankruptcy Code
provides that a Debtor's equity holder will not be entitled to retain its equity
interest,  unless certain exceptions apply. If the liabilities of one or more of
the  Debtors  are  ultimately  found to exceed the fair  value of their  assets,
claims of creditors could be paid at less than 100% of their face value. In that
event,  Palco could lose all or a material  portion of its equity  ownership  in
Scopac and Palco's other subsidiaries,  MGI could lose all or a material portion
of its  equity  ownership  in  Palco,  or the  value  of such  equity  ownership
interests  could be  diluted,  impaired  or  eliminated.  There  is  substantial
uncertainty  as to when the Debtors will be able to file such  plan(s),  and the
Debtors'  efforts to obtain approval of such plan(s) by the creditors and equity
holders  entitled  to vote on the  plan(s),  and to obtain  confirmation  by the
Bankruptcy Court of such plan(s), may not be successful.

     The financial  information of the Debtors contained herein and consolidated
with the Company's  results has been prepared on a "going concern" basis,  which
contemplates the realization of assets and the liquidation of liabilities in the
ordinary  course of business;  however,  as a result of the  commencement of the
Bankruptcy  Cases, such realization of assets and liquidation of liabilities are
subject  to  a  significant  number  of  uncertainties.  Specifically,  but  not
all-inclusive,  the  financial  information  of the  Debtors  for the year ended
December 31, 2006,  contained herein does not present:  (a) the realizable value
of  assets  on a  liquidation  basis,  (b)  the  estimated  costs  and  expenses
associated  with the Bankruptcy  Cases,  (c) the amount that will  ultimately be
paid to  settle  liabilities  and  contingencies  which  may be  allowed  in the
Bankruptcy  Cases,  or (d)  the  effect  of any  changes  that  may be  made  in
connection  with the  Company's  investment  in the Debtors or with the Debtors'
operations  resulting  from a plan of  reorganization.  Because  of the  ongoing
nature of the Bankruptcy Cases, the discussions and financial information of the
Debtors contained herein are subject to material uncertainties.

     Financial Difficulties of Forest Products Entities

     Future Harvest Levels
     Scopac  has  conducted  extensive  reviews  and  analyses  of  its  assets,
operations  and future  prospects.  As a result of these  extensive  reviews and
analyses  Scopac has concluded  that, in the absence of  significant  regulatory
relief and  accommodations,  its future  annual timber  harvest  levels and cash
flows from operations for the  foreseeable  future will be  substantially  below
both historical  harvest levels and the minimum levels necessary to allow Scopac
to satisfy the principal and interest specified by the Scopac Indenture.  Scopac
has estimated that its average  annual  harvest levels over the ten-year  period
that began in 2006 is not likely to exceed  approximately  95 million board feet
per year.  This  revised  estimated  harvest  level  reflects  Scopac's  further
analysis of the cumulative impact of ongoing regulatory  limitations,  watershed
prescriptions,  the  requirements  of its  comprehensive  multi-species  habitat
conservation  plan (the  "HCP") and other  matters,  and is based on a number of
assumptions that may or may not prove to be accurate.  Actual harvest levels are
expected to vary significantly from year to year.  Moreover,  the average annual
harvest  level over the ten-year  period could be even lower due to, among other
things, the various matters discussed elsewhere in this document.

     Regulatory Matters

     Regulatory and environmental  matters as well as legal actions have had and
are expected to continue to have a significant  adverse  effect on the Company's
forest products  operations and liquidity.  The ability to harvest Scopac Timber
(as  defined  below)  depends  in large  part upon  Scopac's  ability  to obtain
regulatory approval of its timber harvest plans ("THPs"). Scopac has experienced
difficulties  and delays in the approval of its THPs as the result of regulatory
and litigation challenges and expects these challenges to persist. The foregoing
matters have resulted in declines in actual and expected harvest levels and cash
flows,  significant  increases in the cost of logging  operations  and increased
costs related to timber harvest litigation,  all of which have severely impacted
the historical  cash flows of both Palco and Scopac.  These adverse  effects are
expected to continue. The timber on the timberlands owned by Scopac (the "Scopac
Timberlands")  and the timber  that  Scopac has the  exclusive  right to harvest
("Scopac Timber Rights") is collectively referred to as the "Scopac Timber". The
timberlands  in respect of the Scopac  Timber  are  referred  to as the  "Scopac
Timber Property".  The Scopac Timber Property and the timberlands owned by Palco
and Salmon Creek are referred to as the "Palco Timberlands."

     Scopac Liquidity
     As noted  above,  in the  absence  of  significant  regulatory  relief  and
accommodations,  Scopac's  annual  timber  harvest  levels  and cash  flows from
operations  will,  for the  foreseeable  future,  be  substantially  below  both
historical  levels and the minimum  levels  necessary to allow Scopac to satisfy
the principal and interest payments specified by the Scopac Indenture.

     In an effort to address expected future interest payment shortfalls, Scopac
in 2005 initiated a program to sell certain  timberland  properties,  as well as
various  non-timberland  properties,  such as ranchlands and recreational  areas
(the  "Scopac  Land Sale  Program").  The  Scopac  Land Sale  Program  generated
proceeds of $13.1 million during 2006, however,  the proceeds generated from the
Scopac Land Sale Program,  together  with other  available  liquidity,  were not
sufficient to cover the expected  interest payment  shortfall on the January 20,
2007, Scopac Timber Notes payment date.

     Scopac experienced  liquidity  shortfalls during 2006. On the Scopac Timber
Notes payment date in January 2006, Scopac used its existing cash resources, all
of the  remaining  funds  available  under the Scopac  Line of  Credit,  and the
additional funds made available from a $2.3 million timber/log  purchase by MGI,
to pay all of the $27.7  million of interest due ($25.8  million net of interest
due in respect of Scopac Timber Notes held in the Scheduled Amortization Reserve
Account; "SAR Account"). Using funds held in the SAR Account, Scopac also repaid
$19.3  million of  principal on the Scopac  Timber  Notes ($11.9  million net of
principal  in  respect  of  Scopac  Timber  Notes  held in the SAR  Account)  in
accordance with Scheduled Amortization.  "Scheduled  Amortization" is the amount
of  principal  that Scopac must pay (on a cumulative  basis)  through any Scopac
Timber Notes payment date in order to avoid  prepayment or deficiency  premiums.
See Note 7, "-Scopac Timber Notes" for further  information  regarding Scheduled
Amortization and the SAR Account.

     In April  2006,  Scopac and MGI  consummated  a  timber/log  purchase  that
provided  Scopac  $2.1  million of  additional  liquidity  to pay its  operating
expenses.

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

     As the January 2007 Scopac Timber Notes payment date approached,  it became
apparent  to Scopac  that it would  not have  sufficient  liquidity  to make the
interest payment. The failure of Scopac to pay all of the interest on the Scopac
Timber  Notes  when due  constitutes  an event of  default  under the  indenture
governing  the  Scopac  Timber  Notes  ("Scopac  Indenture").  In the event of a
failure to pay interest on the Scopac Timber Notes in full when due, the trustee
under the Scopac Indenture (the "Trustee") or the holders of at least 25% of the
aggregate  outstanding principal amount of the Scopac Timber Notes were entitled
to cause all principal,  interest and other amounts related to the Scopac Timber
Notes  to  become  immediately  due  and  payable.  In the  event  of  any  such
acceleration,  the Agent  under the Scopac  Line of Credit was also  entitled to
accelerate the advances then outstanding  thereunder.  If such  accelerations of
Scopac  Timber  Notes  and/or  advances  under the Scopac Line of Credit were to
occur,  the  Trustee  was  entitled  to  exercise  all  rights  under the Scopac
Indenture  and  related  security  documents,  including  applying  funds to pay
accelerated  amounts,  and selling  the Scopac  Timberlands,  the Scopac  Timber
Rights  and  Scopac's  other  assets  and  using  the  proceeds  thereof  to pay
accelerated  amounts.  Based  upon  a  review  of  its  alternatives  under  the
circumstance  and  consultation  with its legal  advisors,  on January 18, 2007,
Scopac  elected  to  file  for  voluntary  protection  under  Chapter  11 of the
Bankruptcy Code. As a result of the commencement of the Bankruptcy Cases, lender
claims  are  stayed  (deferred)  while  the  Debtors  continue  to  operate  the
businesses as debtors-in-possession.

     Scopac has been authorized by the Bankruptcy Court to fund budgeted ongoing
operating and  bankruptcy-related  costs using  operating  cash flow and, to the
extent needed,  funds available in the SAR Account (subject to no more than $5.0
million in withdrawals from the SAR Account being outstanding at any given time.
If these  sources  of  liquidity  are not  adequate,  and if Scopac is unable to
obtain  additional  sources of  liquidity  and the  necessary  Bankruptcy  Court
approval to utilize such additional sources of liquidity, Scopac may not be able
to continue  operations  and  reorganize  successfully  under  Chapter 11 of the
Bankruptcy Code.

     Palco Liquidity

     As of December 31, 2005, and June 30, 2006, Palco and Britt were in default
under the prior  Palco-Britt  term loan and prior  Palco-Britt  revolving credit
facility  (the  "Prior  Palco-Britt   Facilities")  due  to  financial  covenant
breaches.  In the first half of 2006,  additional  liquidity was needed at Palco
and Palco  borrowed  an  aggregate  of $20.0  million  from MGI to meet its cash
shortfalls.

     On July 18, 2006,  Palco and Britt, as Borrowers,  closed on the Palco Term
Loan, a five-year $85.0 million  secured term loan (the "Palco Term Loan"),  and
the  Palco  Revolving  Credit  Facility,   a  five-year  $60.0  million  secured
asset-based  revolving credit facility (the "Palco Revolving Credit  Facility"),
and terminated the Prior Palco-Britt  Facilities.  The Palco Term Loan was fully
funded at closing.  The Palco Term Loan and the Palco Revolving  Credit Facility
required  MGI to provide a $10.0  million  subordinated  loan to the  Borrowers,
which was also funded at closing. The Borrowers used approximately $56.5 million
of the  Palco  Term Loan to pay off the Prior  Palco-Britt  Facilities  and cash
collateralize  previously-existing  letters of credit;  and $6.0  million to pay
transaction  costs.  The remaining  $32.5 million of loan proceeds were used for
general  corporate  purposes.  As  of  December  31,  2006,  $84.3  million  was
outstanding  under the Palco Term Loan,  and $24.1  million of  borrowings  were
outstanding  and $13.7  million of letters of credit were issued under the Palco
Revolving Credit Facility.

     The Borrowers did not meet the required minimum EBITDA maintenance covenant
for the  three-month  period  ended  September  30,  2006,  due to an  unplanned
severance charge and a legal  settlement.  On November 20, 2006, MGI made a loan
to Palco, enabling the Borrowers to exercise their cure right under the two debt
facilities.  The  Borrowers  also  notified  the lenders  that  changing  market
conditions  and other  factors  would  likely  adversely  affect the  Borrowers'
ability to comply  with the  financial  covenants  at  December  31, 2006 and in
future periods.

     The Borrowers did not meet the required minimum EBITDA maintenance covenant
for the three-month period ended December 31, 2006. Accordingly,  the Palco Term
Loan has been reclassified as a current liability in the Company's  consolidated
balance sheet.

     In January 2007, Palco did not have sufficient  liquidity to pay all of the
interest  due on the Palco  Term Loan.  Based upon a review of its  alternatives
under the circumstance, and consultation with its legal advisors, on January 18,
2007,  Palco  elected to file for voluntary  protection  under Chapter 11 of the
Bankruptcy Code. As a result of the commencement of the Bankruptcy Cases, lender
claims  are  stayed  (deferred)  while  the  Debtors  continue  to  operate  the
businesses as debtors-in-possession.

     The liquidity  shortfalls  experienced  by Palco  throughout  2005 and 2006
resulted   primarily  from  reduced  log  supply  from  Scopac  and  operational
inefficiencies   related  to  Palco's  Scotia  sawmill.   Additional   liquidity
shortfalls are expected in 2007. Additionally, in 2006, Palco initiated an asset
sale program  ("Palco Asset Sale Program"),  including real property  associated
with Palco's  former  Fortuna and Carlotta  sawmills  and  Palco-owned  homes in
Scotia,  California with the objective of reducing  Palco's overall debt levels.
The Palco Asset Sale  Program did not  generate any cash flow in 2006 and is not
expected to generate  liquidity in 2007 as, among other  things,  a  substantial
portion  of the  properties  must  be  subdivided  and/or  rezoned  before  such
properties can be sold.

      The Palco Debtors estimate that they will have liquidity shortfalls in
2007. The Palco Debtors are pursuing discussions with lenders in an effort to
obtain debtor-in-possession financing in order to have sufficient liquidity to
fund the Palco Debtors' ongoing operating cash needs, including
bankruptcy-related costs. The Palco Debtors may not be successful in obtaining
additional liquidity or the necessary Bankruptcy Court approval, in which case
the Palco Debtors may not be able to continue operations and reorganize
successfully under Chapter 11 of the Bankruptcy Code.

     Potential  Impact on Registrant and Certain Related Entities The Bankruptcy
Cases,  and the liquidity  issues being  experienced by Scopac and Palco,  could
result in claims against and could have adverse impacts on MAXXAM Parent and its
affiliates,  including  MGHI and/or MGI.  For example,  under ERISA,  if Palco's
pension  plan  were  to be  terminated,  MAXXAM  Parent  and  its  wholly  owned
subsidiaries would be jointly and severally liable for any unfunded pension plan
obligations. The unfunded termination obligation attributable to Palco's pension
plan as of December 31, 2006,  is  estimated  to have been  approximately  $23.0
million based upon annuity placement  interest rate assumptions as of such date.
In  addition,  it is possible  that certain  transactions  could be completed in
connection with a potential restructuring or reorganization of the Debtors, such
as a sale of all or a portion of the equity ownership in the Debtors,  a sale of
a substantial  portion of the Debtors'  assets and/or a cancellation  of some or
all of the Debtors' indebtedness,  which could require the utilization of all or
a substantial portion of, or the loss of a significant portion of, the Company's
net operating  losses or other tax  attributes  for federal and state income tax
purposes  and could  require  tax  payments.  In  addition,  the  Company may be
required to establish  certain  deferred tax  liabilities as a result of loss of
control of the Debtors effective as of the Filing Date.

     The  following  condensed  pro forma  financial  information  reflects  the
results of  operation  of the Company,  excluding  the  Debtors,  for the period
presented (in millions):

                                                                  Year Ended
                                                                  December 31,
                                                                    2006
                                                              ----------------
Revenues                                                      $      151.5
Costs and expenses                                                  (140.4)
Reversal of net investment in Kaiser                                 430.9
                                                              ----------------
Operating income (loss)                                              442.0
Debtors' loss                                                        (79.0)
Other income (expenses), net                                           7.9
Cumulative effect of accounting change                                (0.7)
Income tax benefit                                                     4.2
                                                              ----------------
Net income                                                    $      374.4
                                                              ================

     The   following   condensed   pro  forma   financial   data   reflects  the
deconsolidation of the Debtors, as of the date presented (in millions):

                                                                     As of
                                                                  December 31,
                                                                     2006
                                                              ------------------
Current assets                                                $      183.4
Property, plant, and equipment, net                                  228.8
Other assets                                                         158.6
                                                              ------------------
                  Total assets                                $      570.8
                                                              ==================
Current liabilities                                                   36.0
Long-term debt, less current maturities                              215.5
Other liabilities                                                     12.8
Net investment in Debtors(1)                                         518.3
                                                              ------------------
                  Total liabilities                                  782.6
Stockholder's deficit                                               (211.8)
                                                              ------------------
                  Total liabilities and stockholder's deficit $      570.8
                                                              ==================

(1)  This amount  represents  the net book value of the  Debtors'  assets  minus
     liabilities  stated  in  accordance  with  generally  accepted   accounting
     principles.

     Use of Estimates and Assumptions

     The  preparation  of financial  statements  in accordance  with  accounting
principles  generally  accepted in the United States of America requires the use
of estimates and assumptions  that affect (i) the reported amounts of assets and
liabilities,  (ii) the disclosure of contingent  assets and liabilities known to
exist as of the date the  financial  statements  are  published,  and  (iii) the
reported  amount  of  revenues  and  expenses   recognized  during  each  period
presented.   The  Company  reviews  all  significant   estimates  affecting  its
consolidated financial statements on a recurring basis and records the effect of
any necessary adjustments prior to filing the consolidated  financial statements
with the Securities and Exchange  Commission  (the "SEC").  Adjustments  made to
estimates  often  relate  to  improved  information  not  previously  available.
Uncertainties   are  inherent  in  such   estimates  and  related   assumptions;
accordingly, actual results could differ materially from these estimates.

     Risks and  uncertainties  are inherent with respect to the ultimate outcome
of Bankruptcy Cases and the matters  discussed in Note 11. Scopac's  estimate of
its future harvest  levels is based on a number of  assumptions  that may or may
not  prove  to  be  accurate  and,   accordingly,   is  subject  to  significant
uncertainty.  The results of a  resolution  of such  uncertainties  could have a
material effect on the Company's  consolidated  financial  position,  results of
operations or liquidity. In addition, uncertainties related to the projection of
future taxable income could affect the realization of the Company's deferred tax
assets discussed in Note 8. Estimates of future benefit payments used to measure
the Company's pension and other postretirement  benefit obligations discussed in
Note 9 are subject to a number of assumptions  about future  experience,  as are
the estimated future cash flows projected in the evaluation of long-lived assets
for possible  impairment.  To the extent there are material  differences between
these  estimates  and  actual  results,  the  Company's  consolidated  financial
position, results of operations and/or liquidity could be affected.

     Reclassifications

     Certain  reclassifications  totaling  $0.9  million have been made to prior
years'  consolidated  financial  statements  to be  consistent  with the current
year's presentation.

     Summary of Significant Accounting Policies

     Concentrations of Credit Risk
     Cash  equivalents  and  restricted   marketable   securities  are  invested
primarily in short to medium-term  investment  grade debt instruments as well as
other types of corporate and government debt obligations.  The Company mitigates
its  concentration of credit risk with respect to these investments by generally
purchasing  investment  grade products  (ratings of A1/P1 short-term or at least
BBB/Baa3 long-term). No more than 5% is invested in the same issue. Unrestricted
marketable   securities  are  invested  primarily  in  debt  securities.   Other
investments consist of interests in limited  partnerships which invest in a wide
variety of investment  options,  including  debt  securities,  corporate  common
stocks and option contracts.  These investments are managed by various financial
institutions.

     Available-for-Sale Securities
     Management   determines  the  appropriate   classification   of  investment
securities at the time of purchase and re-evaluates  such designation as of each
balance  sheet  date.  Available-for-sale  securities  are stated at fair market
value,  with the  unrealized  gains and  losses,  net of tax,  reported in other
comprehensive  income  (loss),  a separate  component of  shareholders'  equity.
Realized   gains   and   losses   and   declines   in   value   judged   to   be
other-than-temporary on available-for-sale securities are included in investment
and  interest  income.  Interest  and  dividends  on  securities  classified  as
available-for-sale are also included in investment and interest income. The cost
of securities sold is determined using the first-in,  first-out method. The fair
value of substantially all securities is determined by quoted market prices. The
fair value of marketable debt securities includes accrued interest.

     Investments in Limited Partnerships
     The Company invests in limited partnerships that acquire,  hold, and sell a
variety of investment options. Investments in limited partnerships are accounted
for using the equity method of accounting.

     Inventories
     Inventories  are stated at the lower of cost or market.  Cost is  primarily
determined  using the last-in,  first-out  method.  Inventory  costs  consist of
material,   labor  and  manufacturing   overhead,   including  depreciation  and
depletion.

     Real Estate
     Real  estate  inventories  are stated at cost.  In the event that facts and
circumstances  indicate  that  the  value  of  real  estate  inventories  may be
impaired,  an evaluation of recoverability  would be performed.  This evaluation
would include the  comparison of the future  estimated  undiscounted  cash flows
associated  with the assets to the carrying  amount of these assets to determine
if a writedown to fair value is required.

     Timber Harvest and Other Long-Term Assets
     Direct costs  associated  with the  preparation of THPs are capitalized and
reflected in prepaid  expenses and other  current  assets on the balance  sheet.
These costs are expensed as the timber  covered by the related THP is harvested.
Costs  associated  with the  preparation  of the Company's HCP and its sustained
yield plan ("SYP," and together  with the HCP, the  "Environmental  Plans") (see
Note 11) were  capitalized and are reflected in long-term  receivables and other
assets. These costs are being amortized on a straight-line basis over 10 years.

     The carrying amounts of the Company's SYP and HCP intangible  assets are as
follows (in millions):

                                                         December 31,
                                       ---------------------------------------
                                           2006         2005          2004
                                       ---------- -------------- -------------

SYP/HCP                                $ 8.3      $    8.3         $  8.3
Less: Accumulated amortization          (6.3)         (5.4)          (4.5)
                                       ---------- -------------- -------------
                                       $ 2.0      $    2.9         $  3.8
                                       ========== ============== =============

     The  Company   evaluates  its  intangible  assets  with  finite  lives  for
impairment whenever events or changes in circumstances indicate that such assets
might be impaired. The remaining useful subject of intangible assets with finite
lives is evaluated annually to determine whether events or circumstances warrant
changes in the estimated useful lives of such assets.

     Amortization  of intangible  assets for the years ended  December 31, 2006,
2005 and 2004, was $0.9 million per year. The estimated amortization expense for
2007 and 2008 is $0.9  million per year,  and $0.2  million for 2009.  Estimated
amortization  will change if events or  circumstances  warrant  the  revision of
estimated useful lives.

     Timber and Timberlands
     Timber and  timberlands  are stated at cost, net of accumulated  depletion.
Depletion  is  computed  utilizing  the  units-of-production  method  based upon
estimates  of timber  quantities.  Periodically,  the  Company  will  review its
depletion rates considering  currently  estimated  merchantable  timber and will
adjust the depletion rates prospectively.

     Capital  expenditures  related  to  Scopac's  timber  properties  were $1.9
million,  $2.4 million and $3.0  million for the years ended  December 31, 2006,
2005 and 2004, respectively.  Depletion expense for the years ended December 31,
2006,  2005  and  2004,  was  $5.8  million,  $6.1  million  and  $8.2  million,
respectively.

     Revenue Recognition
     Revenues  from  the sale of  logs,  lumber  products  and  by-products  are
recorded when the legal ownership and risk of loss passes to the buyer, which is
generally at the time of shipment.

     The Company  recognizes income from land sales in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 66, "Accounting for Sales of Real
Estate"  ("SFAS No. 66").  In accordance  with SFAS No. 66,  certain real estate
sales are accounted for under the percentage of completion  method,  under which
income is recognized  based on the  estimated  stage of completion of individual
contracts.  The unrecognized income associated with such sales has been recorded
as deferred real estate sales and is reflected in other  current and  noncurrent
liabilities on the balance sheet.  Additionally,  in certain  circumstances  the
cost  recovery  or  installment  method is used  under  which  the gross  profit
associated with these  transactions is deferred and recognized when appropriate.
The unrecognized  income  associated with such sales is reflected as a reduction
of long-term receivables and other assets in the balance sheet.

      The Company recognizes revenues from pari-mutuel commissions received on
live and simulcast horse and greyhound racing in the period in which the
performance occurred. The Company also receives revenues in the form of fees
paid by other racetracks for the broadcast of the Company's live races to
offsite locations. Other sources of revenue include food and beverage sales,
admission and parking fees, corporate sponsorships and advertising, club
memberships, suite rentals and other miscellaneous items.

     Deferred Financing Costs
     Costs  incurred  to obtain  debt  financing  are  deferred  and  amortized,
generally  on a  straight-line  basis,  over the  estimated  term of the related
borrowing.  If debt with deferred  financing costs is retired early, the related
deferred finance costs are written off.

     Long-Lived Assets
     The Company reviews  long-lived  assets and identifiable  intangible assets
for impairment  whenever  events or changes in  circumstances  indicate that the
carrying  amount of these assets may not be recoverable.  Impairment  losses are
recorded on assets used in operations  when indicators of impairment are present
and the  undiscounted  cash flows to be  generated by those assets are less than
the carrying amount.  Impairment  losses are also recorded for long-lived assets
which are expected to be disposed of.

     The  Company  classifies   long-lived  assets  as  held-for-sale  when  the
following  conditions are satisfied:  (i) management commits to a plan to sell a
long-term operating asset, (ii) the asset is available for immediate sale, (iii)
an active effort to locate a buyer is underway, and (iv) it is probable that the
sale will be completed  within one year. The assets  classified as held-for-sale
at December 31, 2006 and 2005 related  primarily to real estate  properties that
are expected to be sold within a year.

     Gain and Loss Contingencies
     The Company is involved in various claims, lawsuits,  environmental matters
and other  proceedings,  including  those  discussed  in Note 11.  Such  matters
involve  uncertainty as to reasonably  possible  losses and potential  gains the
Company may  ultimately  realize when one or more future events occur or fail to
occur.  The Company accrues and charges to income  estimated  losses  (including
related  estimated  legal fees) from  contingencies  when it is probable (at the
balance  sheet date) that an asset has been  impaired or liability  incurred and
the amount of loss can be  reasonably  estimated.  The Company  recognizes  gain
contingencies  when  realization  is considered  probable.  Differences  between
estimates  recorded and actual  amounts  determined  in  subsequent  periods are
treated as changes in  accounting  estimates  (i.e.,  they are  reflected in the
financial  statements  in the period in which they are  determined to be losses,
with no retroactive restatement).

     Environmental Remediation Obligations
     In 2001, Palco recorded an environmental remediation charge of $3.4 million
(of which $1.4  million is accrued at  December  31,  2006).  The  environmental
accrual represents Palco's estimate of costs reasonably  expected to be incurred
based on presently  enacted laws and  regulations,  currently  available  facts,
existing technology, and Palco's assessment of the likely remediation actions to
be taken.  Palco  incurred $0.1 million,  $0.2 million and $0.4 million of costs
related to this remediation liability during 2006, 2005 and 2004,  respectively.
Based on management's best estimates given the current facts and  circumstances,
$1.0 million is expected to be incurred in 2007 and the  remaining  $0.4 million
in future years.

     Income Taxes
     Deferred income taxes are computed using the liability  method.  Under this
method,  deferred tax assets and liabilities are determined based on differences
between financial  reporting and tax bases of assets and liabilities  (temporary
differences)  and are  measured  using the  enacted  tax rates and laws that are
expected to be in effect when the differences are expected to reverse.

     The Company records  valuation  allowances to reduce deferred tax assets to
the amount of future tax benefit  that is more  likely than not to be  realized.
The Company considers future taxable income and ongoing tax planning  strategies
in  assessing  the  need  for a  valuation  allowance.  See  Note 8 for  further
discussion of the Company's income taxes.

     Stock-Based Compensation
     Under the  Company's  stock-based  compensation  plans,  stock  options and
similar instruments may be granted to employees and outside directors at no less
than the fair market value of the Company's common stock ("Common Stock") on the
date of grant.  Grants generally vest ratably over a five-year period for grants
to employees  and over a four-year  period for grants to outside  directors  and
expire ten years after the grant date.  Grants have  generally  been  settled in
cash upon exercise.

     Grants issued to employees and outside directors were previously  accounted
for under the intrinsic value method of accounting as defined by APB Opinion No.
25  and  related  interpretations.   Effective  January  1,  2006,  the  Company
prospectively  adopted the fair value-based method of accounting for stock-based
employee  compensation  as prescribed by SFAS No.  123(R),  Share Based Payments
("SFAS No. 123(R)") issued by the Financial Accounting Standards Board ("FASB"),
and  recognized  a  $0.7  million  charge  in  January  2006,  representing  the
cumulative  effect of the  accounting  change.  For the year ended  December 31,
2006,  the  Company  recognized  a  benefit  of $2.0  million  for  stock  based
compensation  and for the years ended  December  31, 2005 and 2004,  the Company
recognized  stock  compensation  expense  of  $3.7  million  and  $6.1  million,
respectively. The 2006 benefit is the result of a decline in the market value of
the  Company's  Common  Stock.  The 2005  expense  is  primarily  the  impact of
additional  options  vesting during the fourth  quarter of 2005,  while the 2004
expense is the result of  additional  options  vesting  and an  increase  in the
market  value of the  Company's  Common  Stock.  Stock  compensation  expense is
adjusted as the market value of the  Company's  Common Stock  changes and awards
vest.  Included in the  Consolidated  Balance  Sheet at  December  31, 2006 is a
liability for stock compensation of $7.2 million.

     The following  table  illustrates the pro forma effect on net loss and loss
per share for the years ended December 31, 2005 and 2004, respectively,  had the
Company  accounted for its grants under the fair value method of accounting  (in
millions, except per share information).

                                                                                   Years ended December 31,
                                                                            ----------------------------------------
                                                                                    2005                2004
                                                                            --------------------  ------------------
Net income (loss), as reported                                              $       (4.0)         $    (46.6)
  Add: Non-cash stock-based employee compensation expenses
    included in reported net income (loss), net of related tax effects               3.7                 6.1

  Deduct: Total stock-based employee compensation expense
    determined under the fair value method for all awards, net of
    related tax effects                                                             (3.7)               (6.5)
                                                                            -------------------  ------------------
Pro forma net income (loss)                                                 $       (4.0)        $     (47.0)
                                                                            ===================  ==================

Basic and diluted loss per share:
  As reported                                                               $      (0.66)        $     (7.79)
  Pro forma                                                                        (0.67)              (7.84)

     The fair value of grants  were  estimated  at each  reporting  date using a
Black-Scholes option-pricing model and the following assumptions:

                                                 Years Ended
                                                 December 31,
                                           -------------------------
                                               2005        2004
                                           ------------ ------------
Expected volatility                             38%          41%
Expected dividends                               -            -
Expected term (in years)                      6.44         6.63
Risk-free rate                                4.35%        3.63%
Weighted average fair value                $ 15.40      $ 13.47

     Per Share Information
     Basic earnings (loss) per share is calculated by dividing net income (loss)
by the weighted average number of common shares  outstanding  during the period,
including the weighted  average  impact of any shares of Common Stock issued and
treasury stock acquired  during the year from the date of issuance or repurchase
and  the  dilutive  effect  of  the  Company's  Class  A  $0.05   Non-Cumulative
Participating  Convertible Preferred Stock ("Class A Preferred Stock"), which is
convertible  into Common Stock.  Diluted  earnings per share  calculations  also
include the dilutive effect of common and preferred stock options.

                                                                   2006          2005         2004
                                                               ------------- ------------- -----------
Weighted average number of common shares outstanding-basic      5,534,981     5,972,180      5,976,467
  Effect of dilution(1):
  Conversion of Class A Convertible Preferred Stock               668,119             -(1)           -(1)
  Exercise of stock options                                        67,104             -(1)           -(1)
                                                               ------------- ------------- -----------
Weighted average number of common shares outstanding-diluted    6,270,204     5,972,180      5,976,467
                                                               ============= ============= ===========

     (1) The Company had a loss for the years ended  December 31, 2005 and 2004;
the Class A  Preferred  Stock and options  were  therefore  not  included in the
computation  of  earnings  per  share  for the  period  as the  effect  would be
anti-dilutive.

     Accumulated Other Comprehensive Income (loss)

     Accumulated  Other  Comprehensive  Income (loss)  ("AOCI")  consists of the
following (in millions):

                                                                                                December 31,
                                                                                         ---------------------------
                                                                                             2006           2005
                                                                                         ------------- -------------
AOCI related to Kaiser                                                                   $     -       $   (85.3)
Minimum pension liability, net of related income tax effects of $2.9 million                 0.8           (10.3)
Unrealized gains (losses) on available-for-sale investments                                  0.6            (0.7)
Other                                                                                       (0.4)           (0.3)
                                                                                         ------------- -------------
                                                                                         $   1.0       $   (96.6)
                                                                                         ============= =============

2. New Accounting Standards

     Accounting for Stock Options
     The Company  adopted SFAS No. 123(R)  effective  January 1, 2006.  SFAS No.
123(R)  requires  compensation  costs  related  to  share-based  payments  to be
determined  by the fair value of the equity or liability  instruments  issued on
the grant date.  Compensation  cost is required to be recognized over the period
that an employee provides service in exchange for the award and these awards are
required to be re-measured each reporting period.  The adoption of this standard
resulted in an expense of $0.7 million in the first quarter of 2006 representing
the cumulative impact of awards exercisable on January 1, 2006.

     Exchanges of Nonmonetary Assets
     In December  2004,  the FASB issued SFAS No. 153,  Exchanges of Nonmonetary
Assets,  an  amendment of APB Opinion No. 29 ("SFAS No.  153").  SFAS No. 153 is
based on the principle that  exchanges of nonmonetary  assets should be measured
based on the fair value of the assets exchanged. The adoption of SFAS No. 153 on
January 1, 2006, did not have an impact on the Company's  consolidated financial
statements.

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

     Accounting for Uncertainty in Income Taxes
     In June 2006, the FASB issued FASB  Interpretation  No. 48, "Accounting for
Uncertainty in Income Taxes" ("FIN No. 48"),  which clarifies the accounting for
uncertainty in income tax positions. FIN 48 requires that a company recognize in
its  consolidated  financial  statements  the impact of a tax position that will
more likely than not be sustained upon examination based on the technical merits
of the position.  FIN 48 is effective for the Company's  calendar year beginning
January 1, 2007. Any cumulative  effect  recorded as a result of adopting FIN 48
will be recorded as an adjustment to opening retained earnings. The Company does
not expect the impact of adoption of this statement to have a material impact on
its consolidated financial statements.

     Fair Value Measurements
     In September  2006,  the FASB issued SFAS No. 157, Fair Value  Measurements
("SFAS No. 157"), which is intended to increase consistency and comparability in
fair value  measurements  by defining fair value,  establishing  a framework for
measuring fair value, and expanding  disclosures about fair value  measurements.
SFAS No. 157 is  effective  for  financial  statements  issued for fiscal  years
beginning  after  November 15,  2007,  and interim  periods  within those fiscal
years.  The Company will adopt SFAS No. 157 on January 1, 2008,  and has not yet
determined the impact, if any, on its consolidated financial statements.

     Employers'  Accounting for Defined Benefit Pension and Other Postretirement
Plans
     In September 2006, the FASB issued SFAS No. 158, Employers'  Accounting for
Defined  Benefit Pension and Other  Postretirement  Plans," an amendment of FASB
Statements  No. 87, 88, 106,  and 132(R)  ("SFAS No.  158"),  which  requires an
employer to recognize the overfunded or underfunded  status of a defined benefit
postretirement  plan as an asset or  liability  in its  statement  of  financial
position,  and to recognize through  comprehensive  income changes in the funded
status in the year in which the  changes  occur.  Additionally,  it  requires an
employer  to measure  the  funded  status of a plan as of the date of its fiscal
year-end, with limited exceptions. SFAS 158 is effective as of the end of fiscal
years ending after December 15, 2006;  however,  the requirement to measure plan
assets and benefit  obligations as of the fiscal year-end is not effective until
fiscal  years  ending  after  December  15,  2008.   The  Company   adopted  all
requirements  of SFAS 158 on December  31, 2006 and  recognized  a $2.1  million
reduction of its liability.

     The Fair Value Option for  Financial  Assets and Financial  Liabilities  --
Including an  amendment of FASB  Statement  No. 115 In February  2007,  the FASB
issued SFAS No. 159, The Fair Value Option for  Financial  Assets and  Financial
Liabilities  --  Including an  amendment  of FASB  Statement  No. 115 ("SFAS No.
159").  SFAS No. 159 permits entities to measure eligible assets and liabilities
at fair  value.  Unrealized  gains and  losses on items for which the fair value
option has been elected are reported in earnings.  SFAS No. 159 is effective for
fiscal years  beginning after November 15, 2007. The Company will adopt SFAS No.
159 on January 1, 2008, and has not yet  determined  the impact,  if any, on its
consolidated financial statements.

3. Segment Information and Other Items

     Reportable Segments
     As discussed in Note 1, the Company's  operations are organized and managed
as distinct  business units that offer  different  products and services and are
managed separately through the Company's subsidiaries.

     The Company has three reportable  segments,  and the accounting policies of
the  segments are the same as those  described in Note 1. The Company  evaluates
segment performance based on net sales, operating income excluding depreciation,
depletion  and  amortization,  and  income  before  income  taxes  and  minority
interests.

     Net sales and  operating  income  (loss)  for each  reportable  segment  is
presented in the Consolidated  Statement of Operations.  Operating income (loss)
for  "Corporate"  represents  general and  administrative  expenses not directly
attributable  to  the  reportable   segments.   The  amounts  reflected  in  the
"Corporate" column also serve to reconcile the total of the reportable segments'
amounts to totals in the Company's consolidated financial statements.

     The following table presents  financial  information by reportable  segment
(in millions):

                                                                          Reportable Segments
                                                         ----------------------------------------------------------
                                                                                                            Consol-
                                                                    Forest     Real                         idated
                                                      December 31, Products   Estate  Racing   Corporate    Total
                                                      ------------ --------- ------- -------- ----------- ---------
Selling, general and administrative expenses               2006    $ 24.4(1) $  7.7  $ 8.8    $  5.4(2)   $  56.3
                                                           2005      24.8(3)   23.1    8.6      15.8(2)      72.3
                                                           2004      26.1(4)   19.4    9.3      16.9(2)      71.7

Investment, interest and other income (expense), net       2006       1.7       5.1    0.2       2.6          9.6
                                                           2005       4.1(5)    2.4      -      12.1(6)      18.6
                                                           2004       1.0       8.1      -       3.7         12.8

Interest expense(7)                                        2006      70.5      17.3      -      (0.1)        87.7
                                                           2005      60.6      17.4      -       0.2         78.2
                                                           2004      55.7      18.3      -         -         74.0

Depreciation, depletion and amortization                   2006      18.5      13.4    1.5       0.2         33.6
                                                           2005      19.9      14.2    1.6       0.2         35.9
                                                           2004      20.6      14.0    1.7       0.8         37.1

Income (loss) before income taxes                          2006     (78.0)(8)  25.2   (4.4)    428.1(9)     370.9
                                                           2005     (69.9)     74.0   (4.1)     (4.1)        (4.1)
                                                           2004     (49.3)     19.5   (3.1)    (14.0)       (46.9)

Capital expenditures                                       2006      13.3       1.7    0.6         -         15.6
                                                           2005      14.7       1.2    3.4       0.4         19.7
                                                           2004      29.8       2.4    0.2       0.3         32.7

Total assets                                               2006     441.9     299.5   36.4     232.1      1,009.9
                                                           2005     421.4     345.3   36.4     245.2      1,048.3
-------------------
(1)  Includes  severance  costs  of  $1.5  million  related  to a  reduction  in
     workforce.
(2)  Includes  stock-based  compensation expense of $(2.0) million in 2006, $3.7
     million in 2005 and $6.1  million  in 2004.  Also  includes a $1.9  million
     charge  in  2005  and  2004 in  connection  with  an  environmental  matter
     associated with a former subsidiary of the Company. See Note 11 for further
     information.
(3)  Includes  severance costs of $0.7 million related to the closure of Palco's
     Fortuna mill and a $4.6 million asset impairment charges (see Note 5).
(4)  Includes  $1.4 million  charge for  employee  severance  and benefit  costs
     related to the closure of Palco's Carlotta mill.
(5)  Includes  $3.1 million for  settlement  of a lawsuit filed by Palco against
     several insurance  companies seeking  reimbursement of settlement  payments
     and defense costs related to a legal matter which was settled in 2002.
(6)  Includes a $4.3  million  benefit to correct  the  cumulative  effect of an
     overstatement  of  intercompany  interest from 1995 to 2000 and income from
     investments in limited partnerships of $7.3 million. See Note 4.
(7)  Interest expense also includes amortization of deferred financing costs.
(8)  Includes a $11.6  million gain from the sale of certain  properties as part
     of the  Scopac  Land  Sale  Program.  (9) 2006  includes  a $430.9  million
     reversal of net investment in Kaiser (see Notes 1 and 10).

     Product Sales
     The  following  table  presents  segment  sales  by  primary  products  (in
millions):

                                                      Years Ended December 31,
                                               ---------------------------------------
                                                   2006         2005         2004
                                               ------------ ------------ -------------
Forest products:
  Lumber, net of discount                      $   121.6    $   155.9    $   179.2
  Logs                                               3.5          8.2          6.1
  Wood chips                                         2.7          3.5          3.1
  Cogeneration power                                 8.5         10.9         10.8
  Other                                              3.7          3.3          2.9
                                               ------------ ------------ -------------
     Total forest products sales               $   140.0    $   181.8    $   202.1
                                               ============ ============ =============

Real estate:
  Real estate and development                  $    69.8    $   142.2    $    59.7
  Resort, commercial and other operations           16.7         17.8         17.9
  Commercial lease properties                       18.4         18.3         17.2
                                               ------------ ------------ -------------
     Total real estate sales                   $   104.9    $   178.3    $    94.8
                                               ============ ============ =============

Racing:
  Gross pari-mutuel commissions                $    37.1    $    36.5    $    39.5
  Other                                              9.5          9.8         11.1
                                               ------------ ------------ -------------
     Total racing sales                        $    46.6    $    46.3    $    50.6
                                               ============ ============ =============

     Geographical Information
     The  Company's  forest  products and racing  operations  are located in the
United States.  The Company's  real estate  operations are located in the United
States and Puerto Rico.  For the year ended  December 31, 2006,  $0.7 million of
net sales  attributable to the Company's  forest  products  segment were made to
foreign customers.

     Major Customers and Export Sales
     For the years ended  December  31,  2006,  2005 and 2004,  sales to any one
customer  did not exceed 10% of  consolidated  revenues.  Export sales were less
than 1% of total revenues in 2006, 2005 and 2004.  Approximately 40% of the real
estate segment's 2005 revenue was attributable to five transactions.

4. Cash,  Cash  Equivalents,  Marketable  Securities and  Investments in Limited
Partnerships

     The following table presents cash, cash equivalents,  marketable securities
and other investments, in the aggregate (in millions):

                                                               December 31,
                                                        ---------------------------
                                                            2006           2005
                                                        ------------- -------------

Cash and cash equivalents                               $   44.0      $    84.4
Marketable securities                                      141.4          128.9
Investments in limited partnerships                         26.9           31.2
                                                        ------------- -------------
                                                           212.3          244.5
Less:  restricted cash and marketable securities           (51.3)         (37.0)
                                                        ------------- -------------
Unrestricted cash and marketable securities             $  161.0      $   207.5
                                                        ============= =============

     Cash Equivalents
     Cash  equivalents  consist of highly liquid money market  instruments  with
maturities  of three  months or less.  As of  December  31,  2006 and 2005,  the
carrying amounts of the Company's cash equivalents approximated fair value.

     Marketable Securities
     Marketable  securities generally consist of U.S. corporate debt securities,
U.S. treasury obligations, and other debt securities with contractual maturities
ranging  from one year to five years and are  classified  as  available-for-sale
securities.  The fair  value  of  substantially  all  marketable  securities  is
determined  by quoted  market  prices.  As of December  31,  2006 and 2005,  the
carrying amounts of the Company's marketable securities approximated fair value.
Investment,  interest and other income  (expense),  net, includes gross realized
gains  (losses)  on  sales  of  available-for-sale  securities  as  follows  (in
millions):

                                   Years Ended December 31,
                              ------------------------------------
                                 2006        2005        2004
                              ----------- ----------- ------------

Gross realized gains         $    -      $    -      $     0.6
Gross realized losses          (0.1)       (0.4)          (0.4)

     The   net   adjustment   to   unrealized    holding   gains   (losses)   on
available-for-sale  securities included as a separate component of shareholders'
deficit totaled $1.3 million,  $(0.1) million, and $(1.7) million in 2006, 2005,
and 2004, respectively.

     As of December 31, 2006, there were no occurrences  where the fair value of
investment  securities  were in a continuous  unrealized  loss position for less
than twelve months and for twelve  months or more.  Gross  unrealized  losses on
investment securities at December 31, 2006, were not material.

     Investments in Limited Partnerships
     The Company has an equity  interest in several limited  partnerships  which
invest in  diversified  portfolios  of common stocks and equity  securities,  in
addition  to  exchange-traded   options,   futures,   forward  foreign  currency
contracts,   and  other  arbitrage   opportunities.   The  Company's   ownership
percentages in these partnerships are not significant.  Investment, interest and
other income (expense),  net,  includes income from the Company's  investment in
these  partnerships  for the years ended  December 31, 2006,  2005, and 2004 was
$(0.6) million, $7.3 million and $1.8 million, respectively.

     Restricted  Cash,  Cash  Equivalents,   Marketable   Securities  and  Other
Investments  Cash,  marketable  securities  and other  investments  include  the
following amounts which are restricted (in millions):

                                                                                  December 31,
                                                                          --------------------------
                                                                              2006         2005
                                                                          ------------ -------------

Current:
  Restricted cash and cash equivalents                                    $    3.6     $    6.1
  Restricted marketable securities, held in SAR Account                       39.5         23.0
                                                                          ------------ -------------
                                                                              43.1         29.1
                                                                          ------------ -------------

Non Current:
  Restricted Scopac Timber Notes and other amounts held in SAR Account         2.8         52.9
  Other amounts restricted under the Scopac Indenture                          2.5          2.5
  Other long-term restricted amounts                                           5.7          5.4
  Less: Amounts attributable to Scopac Timber Notes held in SAR Account       (2.8)       (52.9)
                                                                          ------------ -------------
                                                                               8.2          7.9
                                                                          ------------ -------------

Total restricted cash and cash equivalents and marketable securities      $   51.3     $   37.0
                                                                          ============ =============

     Amounts in the SAR  Account  are held by the  Trustee to support  principal
payments on the Scopac  Timber Notes.  See Note 7 for further  discussion of the
SAR Account.

5. Property, Plant and Equipment

     Property, plant and equipment, including capitalized interest, is stated at
cost,  net of accumulated  depreciation.  Depreciation  is computed  principally
utilizing  the  straight-line  method at rates based upon the  estimated  useful
lives of the various  classes of assets.  The carrying value of property,  plant
and  equipment  is  assessed  when  events and  circumstances  indicate  that an
impairment might exist.

     The major classes of property,  plant and equipment are as follows  (dollar
amounts in millions):

                                                               December 31,
                                    Estimated Useful    --------------------------
                                          Lives             2006         2005
                                  --------------------- ------------ -------------
Land and improvements                 5 - 30 years      $  145.3     $  140.6
Buildings                             5 - 40 years         267.6        269.8
Machinery and equipment               3 - 15 years         157.6        144.8
Construction in progress                                     1.0          7.7
                                                        ------------ -------------
                                                           571.5        562.9
Less:  accumulated depreciation                           (234.5)      (207.9)
                                                        ------------ -------------
                                                        $  337.0     $  355.0
                                                        ============ =============

     Capital expenditures for property,  plant and equipment were $13.7 million,
$17.3 million and $29.7 million for the years ended December 31, 2006,  2005 and
2004, respectively.  Depreciation expense for the years ended December 31, 2006,
2005 and 2004 was $28.7 million, $28.8 million, and $27.9 million, respectively.

     In 2005, as part of Palco's on-going  evaluation of its sawmill activities,
Palco's  long-lived assets were subject to impairment  reviews due to changes in
their  expected  use and revised  estimates  of  undiscounted  cash flows.  As a
result,  impairment  charges of $4.6 million were  recognized in 2005  primarily
related  to two  sites,  the  Carlotta  mill  site and  Palco's  remanufacturing
facility in Scotia.  There was an additional  impairment  change of $0.7 million
recognized  in 2006  resulting  from Palco's  regular  evaluation of its sawmill
activities.

6. Investments in Unconsolidated Affiliates

     RMCAL Development LP (Mirada Villas)
     In April 2004,  a  subsidiary  of the Company and a third party real estate
development company formed a joint venture named RMCAL Development LP to develop
a  residential  parcel  located  in  the  Mirada  development.  The  Company  is
accounting for the joint venture under the equity method. In connection with the
formation  of the joint  venture,  the Company sold a 50% interest in the parcel
for $4.5  million  and  contributed  the  remainder  of the  parcel to the joint
venture in return for a 50% interest in the venture.

     FireRock, LLC
     A  subsidiary  of the Company  continues  to hold a 50% interest in a joint
venture  named  FireRock,  LLC,  which was formed to develop an 808-acre area in
Fountain Hills called FireRock.  The Company is accounting for the joint venture
under the  equity  method.  The  development  is a  residential,  golf-oriented,
upscale master-planned  community.  Lot sales concluded in 2004, but the venture
continues to own and operate the country club located in the development.

7. Debt

     Principal  amounts  of  outstanding  debt  consist  of  the  following  (in
millions):

                                                                                                 December 31,
                                                                                         --------------------------
                                                                                              2006         2005
                                                                                         ------------- -------------

Prior Palco-Britt Facilities                                                             $     -       $   58.7
Palco Revolving Credit Facility due July 18, 2011                                           24.1              -
Palco Term Loan due July 18, 2011                                                           84.3              -
Scopac Line of Credit, due July 2006                                                        36.2           31.3
6.55% Scopac Class A-1 Scopac Timber Notes due July 20, 2028                                 7.3           36.6
7.11% Scopac Class A-2 Scopac Timber Notes due July 20, 2028                               243.2          243.2
7.71% Scopac Class A-3 Scopac Timber Notes due July 20, 2028                               463.3          463.3
7.56% Lakepointe Notes due June 8, 2021                                                    113.5          114.8
7.03% Motel Notes due May 1, 2018                                                           44.7           46.1
6.08% Beltway Notes due November 9, 2024                                                    28.6           29.2
7.12% Palmas Notes due December 20, 2030                                                    28.7           29.2
Other notes and contracts, primarily secured by receivables, buildings, real estate
  and equipment                                                                              5.3            5.1
                                                                                         ------------- -------------
  Total Principal Outstanding                                                            1,079.2        1,057.5
Less: short term borrowings and current maturities                                        (180.7)        (112.5)
  Class A-1 Scopac Timber Notes held in the SAR Account, at par value(1)                    (2.8)         (13.9)
  Class A-2 Scopac Timber Notes held in the SAR Account, at par value(1) (2)                   -          (41.5)
  Discount on sale of Class A-2 Scopac Timber Notes held in SAR Account                    (10.3)             -
                                                                                         ------------- -------------
                                                                                         $ 885.4       $  889.6
                                                                                         ============= =============

(1)  The Scopac  Indenture  provides that a Scopac Timber Note does not cease to
     be outstanding because Scopac holds the instrument. Consequently, Scopac is
     required to pay and has paid  interest and  principal on the Scopac  Timber
     Notes repurchased and held in the SAR Account.
(2)  The Class A-2  Scopac  Timber  Notes held in the SAR  Account  were sold in
     October 2006.

     On  January  18,  2007,  the  Debtors  (Palco  and its  five  wholly  owned
subsidiaries,  including  Scopac),  filed for protection under Chapter 11 of the
Bankruptcy  Code. As a result of the  commencement of the Bankruptcy  Cases, the
operative  documents  provide  that the  outstanding  principal  of, and accrued
interest on, all  obligation  debts of the Debtors  became  immediately  due and
payable.  However,  claims for  principal  and accrued  interest on the Debtors'
indebtedness  are stayed  (deferred)  while the Debtors  continue to operate the
businesses as debtors-in-possession. The automatic stay provisions of Chapter 11
of the Bankruptcy Code make it unnecessary to reclassify  prepetition  long-term
liabilities as of the Filing Date even though prepetition creditors might demand
payment  or  there  is  a  violation  of  a  covenant  in  the  debt  agreement.
Accordingly, the Debtors' long-term debt obligations,  except for the Palco Term
Loan, where the Borrowers did not meet the required  minimum EBITDA  maintenance
covenant for the three months ended December 31, 2006,  have been  classified in
accordance  with  their  contractual  terms  in  the  accompanying  consolidated
financial statements.

     Short Borrowings and Current Maturities
     Short term  borrowings and current  maturities  include the Palco Revolving
Credit Facility and the Scopac Line of Credit, as well as the current maturities
of long-term indebtedness.

     Also included in short-term  borrowings and current  maturities at December
31, 2006,  is the Palco Term Loan  resulting  from the Borrowers not meeting the
required minimum EBITDA maintenance covenant for the three months ended December
31, 2006.

     Palco Credit Agreements
     At December  31, 2005,  and June 30, 2006,  Palco and Britt were in default
under the Prior Palco-Britt  Facilities due to financial covenant breaches.  The
existence of the  defaults  required  Palco to pay interest on amounts  borrowed
under the Prior  Palco-Britt  Facilities  at a per annum rate 2% higher than the
rate at which interest would have been owed had no default existed.

     On July 18, 2006,  Palco and Britt, as Borrowers,  closed on the Palco Term
Loan,  a five-year  $85.0  million  secured term loan,  and the Palco  Revolving
Credit Facility, a five-year $60.0 million secured asset-based  revolving credit
facility, and terminated the Prior Palco-Britt  Facilities.  The Palco Term Loan
was fully funded at closing.  The Palco Term Loan and the Palco Revolving Credit
Facility  required  MGI to  provide  a $10.0  million  subordinated  loan to the
Borrowers,  which was also funded at closing.  The Borrowers used  approximately
(i)  $56.5  million  of the Palco  Term  Loan to pay off the  Prior  Palco-Britt
Facilities and cash  collateralize  previously-existing  letters of credit;  and
$6.0 million to pay  transaction  costs.  The  remaining  $32.5  million of loan
proceeds  were used for general  corporate  purposes.  As of December  31, 2006,
$84.3  million was  outstanding  under the Palco Term Loan and $24.1  million of
borrowings  were  outstanding and $13.7 million of letters of credit were issued
under the Palco Revolving Credit Facility.

     The  amount  available  for  borrowings  under the Palco  Revolving  Credit
Facility  was  normally  the  sum of 85% of  the  Borrowers'  eligible  accounts
receivable  plus the lesser of (i) 80% of the book value of Borrowers'  eligible
inventory or (ii) 85% of the net orderly  liquidation  value of such  inventory.
However,  during  each  period  from  October 15 through  January 15, the amount
available for borrowing under the Palco Revolving Credit Facility was the sum of
95% of Borrowers' eligible accounts receivable plus the lesser of (i) 90% of the
book  value of  Borrowers'  eligible  inventory  or (ii) 95% of the net  orderly
liquidation  value of such  inventory.  The  amount  available  under  the Palco
Revolving Credit Facility could not exceed $60.0 million.

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

     Both the Palco Term Loan and the Palco Revolving Credit Facility  contained
substantially  identical  restrictive  covenants  that  limited  the  Borrowers'
ability to incur debt,  grant  liens,  make  investments,  pay  dividends,  make
capital  expenditures  or merge or  consolidate,  and required the  Borrowers to
maintain  specified  minimum  levels  of  EBITDA  throughout  the  life  of  the
facilities  and  specified  minimum  fixed  charge  coverage  ratios and maximum
leverage ratios commencing  December 31, 2007. The Palco Term Loan also required
the Borrowers to repay a substantial portion of the outstanding principal of the
Palco  Term  Loan with the net  proceeds  from  various  required  asset  sales,
including the real property  associated with Palco's former Fortuna and Carlotta
sawmills,  and Palco-owned homes in Scotia,  California to be sold after certain
milestones had been met. Any remaining  principal balance of the Palco Term Loan
was due on the maturity date. The Palco Term Loan and the Palco Revolving Credit
Facility  contained  customary  events of default and  customary  remedies  with
respect  to the  occurrence  of an event of  default  and each was  secured by a
security  interest in the stock of Palco held by MGI, and  substantially  all of
the assets of the Borrowers (other than Palco's equity interest in Scopac).

     The Borrowers did not meet the required minimum EBITDA maintenance covenant
for the  three-month  period  ended  September  30,  2006,  due to an  unplanned
severance charge and a legal  settlement.  On November 20, 2006, MGI made a loan
to Palco, enabling the Borrowers to exercise their cure right under the two debt
facilities.  The  Borrowers  also  notified  the lenders  that  changing  market
conditions  and other  factors  would  likely  adversely  affect the  Borrowers'
ability to comply  with the  financial  covenants  at  December  31, 2006 and in
future periods.

     The Borrowers did not meet the required minimum EBITDA maintenance covenant
for the three-month period ended December 31, 2006. Accordingly,  the Palco Term
Loan has been reclassified as a current liability in the Company's  consolidated
balance sheet.

     In January 2007, Palco did not have sufficient  liquidity to pay all of the
interest  due on the Palco  Term Loan.  Based upon a review of its  alternatives
under the circumstance, and consultation with its legal advisors, on January 18,
2007,  Palco  elected to file for voluntary  protection  under Chapter 11 of the
Bankruptcy Code. As a result of the commencement of the Bankruptcy Cases, lender
claims  are  stayed  (deferred)  while  the  Debtors  continue  to  operate  the
businesses as debtors-in-possession.

     The Palco  Term Loan and Palco  Revolving  Credit  Facility  each  included
prepayment  premiums of 3%, 2% and 1% that would have been payable in connection
with any  prepayment of the Palco Term Loan or reduction or  termination  of the
Palco  Revolving  Credit  Facility  during  the first,  second and third  years,
respectively.

     Scopac Credit Agreements
     Scopac's  indebtedness  consists of the Scopac Timber Notes ($713.8 million
principal  outstanding  as of December  31,  2006) and the Scopac Line of Credit
($36.2  million  principal  outstanding  as of December  31,  2006),  each being
secured by (i) Scopac's  timberlands  and timber rights,  (ii) certain  contract
rights and other assets, (iii) the proceeds of the foregoing, and (iv) the funds
held by the Trustee in various accounts related to the Scopac Timber Notes.

     Scopac Line of Credit
     The  Scopac  Line of Credit  allowed  Scopac  to  borrow  up to one  year's
interest on the  aggregate  outstanding  principal  balance of the Scopac Timber
Notes. On May 18, 2006, the Scopac Line of Credit was extended to July 6, 2007.

     Borrowings  under the Scopac Line of Credit  generally bore interest at the
Base Rate (as defined in the agreement) plus 0.25% or at LIBOR plus 1.0% (at any
time that  borrowings  have not been  continually  outstanding for more than six
months).

     Scopac Timber Notes

     General
     In July 1998,  Scopac issued $867.2 million  aggregate  principal amount of
Scopac  Timber Notes,  which are due July 20, 2028.  The Scopac Timber Notes are
senior secured  obligations of Scopac and do not constitute  obligations of, and
are not guaranteed  by, Palco or any other person.  The Scopac Timber Notes were
issued in three  classes:  Class A-1  Scopac  Timber  Notes  aggregating  $160.7
million, Class A-2 Scopac Timber Notes aggregating $243.2 million, and Class A-3
Scopac Timber Notes aggregating $463.3 million.

     The Scopac  Timber  Notes were  structured  to link,  to the extent of cash
available,  the deemed  depletion of Scopac Timber (through the harvest and sale
of logs) to the required  amortization of the Scopac Timber Notes.  The required
amount of amortization on any Scopac Timber Notes payment date was determined by
various mathematical  formulas set forth in the Scopac Indenture.  The amount of
principal  Scopac was  required  to pay (on a  cumulative  basis and  subject to
available  cash)  through any Scopac Timber Notes payment date is referred to as
"Minimum  Principal  Amortization." If the Scopac Timber Notes were amortized in
accordance  with  Minimum  Principal  Amortization,  the  final  installment  of
principal  would have been paid on January 20, 2010,  July 20, 2017 and July 20,
2028  for  the  Class  A-1,  Class  A-2  and  Class  A-3  Scopac  Timber  Notes,
respectively. Scheduled Amortization is the amount of principal which Scopac was
required to pay (on a cumulative  basis) through any Scopac Timber Notes payment
date in order to avoid  prepayment  or deficiency  premiums.  If all payments of
principal were made in accordance with Scheduled Amortization, Scopac would have
paid the final  installment  of  principal  on  January  20,  2014.  Such  final
installment  would have included a single "bullet"  principal  payment of $463.3
million related to the Class A-3 Scopac Timber Notes.

     Scopac Timber Note Payment Dates
     Amounts  payable  on  the  Scopac  Timber  Notes  were  due  semi-annually,
generally on January 20 and July 20 of each year).

     On the note payment date in January 2005,  Scopac used the funds  available
under the Scopac Line of Credit to pay the $28.5  million of interest due ($26.3
million net of interest  due in respect of Scopac  Timber  Notes held in the SAR
Account).  Using funds held in the SAR Account, Scopac also repaid $17.1 million
of  principal  on  the  Scopac  Timber  Notes,  an  amount  equal  to  Scheduled
Amortization  ($10.6) million net of principal in respect of Scopac Timber Notes
held in the SAR Account).  See "-SAR Account" for information  regarding the SAR
Account.

     On the note  payment  date in July  2005,  Scopac  used its  existing  cash
resources,  all of the remaining funds available under the Scopac Line of Credit
and a $2.2 million  early log payment by Palco,  to pay all of the $27.9 million
of interest due ($25.9  million net of interest due in respect of Scopac  Timber
Notes held in the SAR Account). Using funds held in the SAR Account, Scopac also
repaid $8.0 million of principal on the Scopac Timber Notes,  an amount equal to
Scheduled  Amortization  ($5.0  million  net of  principal  in respect of Scopac
Timber Notes held in the SAR Account).

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

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

     As the January 2007 Scopac Timber Notes payment date approached,  it became
apparent  that Scopac would not have  sufficient  liquidity to make the interest
payment.  The failure of Scopac to pay all of the interest on the Scopac  Timber
Notes when due  constitutes an event of default under the Scopac  Indenture.  In
the event of a failure to pay  interest on the Scopac  Timber Notes in full when
due,  the Trustee  under the Scopac  Indenture or the holders of at least 25% of
the  aggregate  outstanding  principal  amount of the Scopac  Timber  Notes were
entitled  to cause all  principal,  interest  and other  amounts  related to the
Scopac Timber Notes to become  immediately due and payable.  In the event of any
such  acceleration,  the Agent under the Scopac Line of Credit was also entitled
to accelerate the advances then outstanding thereunder. If such accelerations of
Scopac  Timber  Notes  and/or  advances  under the Scopac Line of Credit were to
occur,  the  Trustee  was  entitled  to  exercise  all  rights  under the Scopac
Indenture  and  related  security  documents,  including  applying  funds to pay
accelerated  amounts,  and selling  the Scopac  Timberlands,  the Scopac  Timber
Rights  and  Scopac's  other  assets  and  using  the  proceeds  thereof  to pay
accelerated  amounts.  Based  upon  a  review  of  its  alternatives  under  the
circumstance  and  consultation  with its legal  advisors,  on January 18, 2007,
Scopac  elected  to  file  for  voluntary  protection  under  Chapter  11 of the
Bankruptcy Code. As a result of the commencement of the Bankruptcy Cases, lender
claims  are  stayed  (deferred)  while  the  Debtors  continue  to  operate  the
businesses as debtors-in-possession.

     Trustee
     U.S. Bank, the Trustee under the Scopac Indenture,  resigned  effective May
1, 2006.  Scopac  appointed  Deutsche Bank  National  Trust Company as successor
Trustee,  which appointment became effective May 1, 2006. Deutsche Bank National
Trust Company  resigned  effective  August 25, 2006 and Scopac appointed Bank of
New York as successor  Trustee,  which  appointment  became effective August 25,
2006.

     SAR Account
     In November  1999,  $169.0 million of funds from the sale of 5,600 acres of
timberlands  owned  principally  by Salmon Creek and Palco were  contributed  to
Scopac  and  set  aside  in the  SAR  Account  (Scheduled  Amortization  Reserve
Account).  Amounts in the SAR Account are part of the  collateral  securing  the
Scopac Timber Notes and were used to make principal  payments to the extent that
cash flows from operations are insufficient to pay Scheduled Amortization on the
Scopac Timber Notes. In addition, on or after January 20, 2014, any amounts then
remaining  in the SAR Account  were to be used to amortize  the Class A-3 Scopac
Timber  Notes.  Funds  could be  released  to Scopac from the SAR Account if the
amount in the account at that time exceeded the Required Scheduled  Amortization
Reserve  Balance  (as  defined  and set forth in the Scopac  Indenture).  If the
balance  in the SAR  Account  fell  below the  Required  Scheduled  Amortization
Reserve Balance, up to 50% of any Remaining Funds (funds that could otherwise be
released  to Scopac  free of the lien  securing  the Scopac  Timber  Notes) were
required to be used on each monthly  deposit date to replenish  the SAR Account.
As of December  31, 2006,  the amount held in the SAR Account was $79.5  million
below the Required Scheduled Amortization Reserve Balance.

     If the  amount on  deposit  in the SAR  Account  on a Scopac  Timber  Notes
payment  date was less than what was needed to reduce  outstanding  principal in
accordance  with Scheduled  Amortization,  only the amount on deposit in the SAR
Account  was  required to be paid as a  principal  payment on the Scopac  Timber
Notes.  At  December  31,  2006,  the SAR  Account  balance  was  $42.3  million
(consisting  of $2.8  million of Class A-1 Scopac  Timber  Notes held in the SAR
Account and $39.5 million in marketable securities). On October 11, 2006, Scopac
completed a private  placement  of the $41.5  million  par value of  repurchased
Class A-2 Scopac  Timber  Notes held in the SAR Account at a sales price of $750
per $1,000 principal  amount,  plus accrued interest from July 20, 2006. The net
proceeds of approximately $30.2 million were deposited into the SAR Account. The
difference between the net proceeds and the par value of the Scopac Timber Notes
that were sold is recorded as a  contra-debt  account and will be  amortized  to
principal over the remaining contractual term of the notes.

     Letters of Credit
     At December 31, 2006,  Palco had $13.7  million of letters of credit issued
in the aggregate,  principally a $9.9 million letter of credit with the State of
California  to secure its workers  compensation  liabilities  and a $3.5 million
letter of credit to satisfy certain liability insurance obligations.

     At December  31, 2006,  the  Company's  real estate  segment had letters of
credit  outstanding in the amount of $3.5 million to satisfy  certain  liability
insurance policy requirements.

     Lakepointe Notes
     In June 2001,  Lakepointe  Assets Holdings LLC  ("Lakepointe  Assets"),  an
indirect wholly owned  subsidiary of the Company,  financed the purchase of Lake
Pointe Plaza, an office complex located in Sugarland, Texas, with $122.5 million
principal  amount of 7.56%  non-recourse  notes  due June 8,  2021  ("Lakepointe
Notes").  The  Lakepointe  Notes are secured by  operating  leases,  Lake Pointe
Plaza, a $60.0 million residual value insurance contract,  and a guaranty of all
lease payments by the parent company of the current tenant.

     Beltway Notes
     In November 2002, Beltway Assets LLC ("Beltway Assets"), an indirect wholly
owned  subsidiary  of the Company,  financed the purchase of an office  building
located  in  Houston,  Texas,  with  $30.9  million  principal  amount  of 6.08%
non-recourse notes due November 9, 2024 ("Beltway Notes"). The Beltway Notes are
secured by an operating lease, the building, and an $11.2 million residual value
insurance contract.

     Motel Notes
     In December 2002, Motel Assets Holdings LLC ("Motel  Assets"),  an indirect
wholly owned subsidiary of the Company,  financed the purchase of a portfolio of
sixteen  motel  properties  located in ten  different  states with $49.4 million
principal  amount of 7.03%  non-recourse  notes due May 1, 2018 ("Motel Notes").
The Motel Notes are secured by an  operating  lease,  the  properties,  an $11.2
million  residual value insurance  contract and a guaranty of all lease payments
by the parent company of the current tenant.

     Palmas Country Club, Inc. Notes
     In October 2000, Palmas Country Club, Inc., which owns two golf courses and
other related  assets,  financed the  construction  and  refurbishment  of these
assets with $30.0 million  principal amount of 7.12% notes due December 20, 2030
("Palmas Notes").  The Palmas Notes are secured by the entity's assets, a letter
of credit, and cash reserves being held by the lender.

     Contractual Maturities
     Contractual  maturities of outstanding  indebtedness  at December 31, 2006,
are as follows (in millions):

                                                                  Years Ending December 31,
                                          --------------------------------------------------------------------------
                                              2007         2008          2009        2010       2011     Thereafter
                                          ------------- ------------ ------------ ------------ ----------- ---------
Palco Term Loan                           $    84.3     $      -     $      -     $      -     $     -     $     -
Palco Revolving Credit Facility                24.1            -            -            -           -           -
Scopac Line of Credit                          36.2            -            -            -           -           -
Scopac Timber Notes(1)                         33.8         30.2          23.7        27.5        31.7       566.9
Lakepointe Notes                                1.7          1.8           2.0         2.1         2.5       103.4
Motel Notes                                     1.4          1.8           2.2         2.3         2.5        34.5
Beltway Notes                                   0.7          0.7           0.8         0.8         0.8        24.8
Palmas Notes                                    0.5          0.5           0.6         0.6         0.6        25.9
Other                                           0.8          0.6           0.2         0.3         0.3         3.1
                                          ------------- ------------ ------------ ------------ ----------- ---------                                          -------------------------- -----------------------------------------------
                                          $   183.5     $   35.6     $    29.5    $   33.6     $  38.4     $ 758.6
                                          ============= ============ ============ ============ =========== =========

(1)  The Scopac  Indenture  provides that a Scopac Timber Note does not cease to
     be  outstanding  because  Scopac  holds the  instrument.  Accordingly,  the
     amounts  shown  in the  table  above  reflect  total  amounts  outstanding,
     including amounts related to Scopac Timber Notes held in the SAR Account.

     Capitalized Interest
     There was no interest  capitalized during 2006. Interest capitalized during
the years ended  December  31,2005 and 2004 was $0.4  million and $0.8  million,
respectively.  Interest  capitalized  related to Palco's new sawmill amounted to
$0.4 million for the year ended December 31, 2005.

     Loan Covenants
     In addition to the previously discussed Palco Term Loan and Palco Revolving
Credit  Facility,  certain  other debt  instruments  restrict the ability of the
Company's  subsidiaries  to  transfer  assets,  make loans and  advances  or pay
dividends to the Company, and require certain subsidiaries to maintain a minimum
net worth.

     Estimated Fair Value
     The Company's  publicly traded debt  instruments  (the Scopac Timber Notes)
are thinly traded financial instruments; accordingly, their market prices at any
balance sheet date may not be representative of the prices that would be derived
from a more active market.  The fair value of publicly traded debt is determined
based on quoted  market  prices.  The fair value of debt  which is not  publicly
traded is estimated using cash flows  discounted at current  borrowing rates. At
December 31, 2006,  the estimated  fair value of current and long-term  debt was
$791.6 million.  At December 31, 2005, the estimated fair value of the Company's
current and long-term debt was $864.5 million.

     Weighted Average Interest on Short-Term Borrowings
     During  2006 and  2005,  the  Company  had  average  short-term  borrowings
outstanding of $114.9 million and $67.2 million, respectively,  under the credit
facilities  described  above.  The  weighted  average  interest  rate for  these
facilities during 2006 and 2005 was 10.0% and 7.6%, respectively.

8. Income Taxes

     The Company files a consolidated  federal  income tax return  together with
its domestic subsidiaries.

     Income  (loss)  before  income  taxes,  minority  interests,   discontinued
operations and cumulative  effect of accounting  change by geographic area is as
follows (in millions):

                            Years Ended December 31,
                     --------------------------------------
                         2006        2005         2004
                     ----------- ------------- -------------
Domestic             $  365.8    $   (23.9)    $  (58.6)
Foreign                   5.1         19.8         11.7
                     ----------- ------------- -------------
                     $  370.9    $    (4.1)    $  (46.9)
                     =========== ============= =============

     Income taxes are classified as either  domestic or foreign based on whether
payment is made or due to the United States or a foreign country. Certain income
classified as foreign is subject to domestic income taxes.

     The benefit for income  taxes on loss before  income  taxes and  cumulative
effect of an accounting change consists of the following (in millions):

                                          Years Ended December 31,
                                 -----------------------------------------
                                      2006         2005          2004
                                 ------------- ------------- -------------
Current:
  Federal                         $   -        $     -       $      -
  State and local                     -            1.1           (1.3)
  Foreign                          (1.8)          (0.6)          (0.2)
                                 ------------- ------------- -------------
                                   (1.8)           0.5           (1.5)
                                 ------------- ------------- -------------
Deferred:
  Federal                             -              -              -
  State and local                   4.2           (1.1)           1.8
  Foreign                           1.8            0.7              -
                                 ------------- ------------- -------------
                                    6.0           (0.4)           1.8
                                 ------------- ------------- -------------
                                 $  4.2        $   0.1       $    0.3
                                 ============= ============= =============

     A  reconciliation  between the  provision  for income  taxes and the amount
computed by applying the federal statutory income tax rate to loss before income
taxes,  minority  interests  and  discontinued  operations  is  as  follows  (in
millions):

                                                                                    Years Ended December 31,
                                                                            ----------------------------------------
                                                                                2006          2005         2004
                                                                            ------------- ------------ -------------
Income (loss) before income taxes and cumulative effect of accounting
change                                                                      $  370.9      $   (4.1)    $  (46.9)
                                                                            ============= ============ =============
Amount of federal income tax benefit based upon the statutory rate          $ (129.8)     $    1.4     $   16.4
Gain on reversal of net investment in Kaiser                                   150.8             -            -
Changes in valuation allowances and revision of prior years' tax estimates     (20.9)         (1.3)       (16.0)
Foreign taxes, net of federal tax benefit                                          -           0.1         (0.2)
State and local taxes, net of federal tax effect                                   -             -          0.4
Effect of change in state tax code                                               4.2             -            -
Other                                                                           (0.1)         (0.1)        (0.3)
                                                                            ------------- ------------ -------------
                                                                            $    4.2      $    0.1     $    0.3
                                                                            ============= ============ =============

     Changes in valuation allowances and revision of prior years' tax estimates,
as shown in the table  above,  include  changes  in  valuation  allowances  with
respect to  deferred  income tax assets,  amounts  for the  reversal of reserves
which the Company no longer  believes are necessary,  and other changes in prior
years' tax estimates.  The other reversals of reserves  generally  relate to the
expiration of the relevant statute of limitations with respect to certain income
tax returns or the  resolution of specific  income tax matters with the relevant
tax authorities.

     The   components  of  the   Company's   net  deferred   income  tax  assets
(liabilities) are as follows (in millions):

                                                                     December 31,
                                                            ------------------------------
                                                                 2006           2005
                                                            ---------------- --------------
Deferred income tax assets:
  Postretirement benefits other than pensions               $     4.8        $   5.3
  Loss and credit carryforwards                                 181.0          146.5
  Other liabilities                                              20.1           24.4
  Real estate                                                     9.3           11.1
  Timber and timberlands                                         25.9           22.0
  Other                                                          15.6           28.0
  Valuation allowances                                         (125.1)        (102.7)
                                                            ---------------- --------------
    Total deferred income tax assets, net                       131.6          134.6
                                                            ---------------- --------------
Deferred income tax liabilities:
  Property, plant and equipment                                 (33.3)         (41.4)
  Other                                                          (8.4)          (9.3)
                                                            ---------------- --------------
    Total deferred income tax liabilities                       (41.7)         (50.7)
                                                            ---------------- --------------
Net deferred income tax assets                              $    89.9        $  83.9
                                                            ================ ==============

     The  Company   evaluated  all   appropriate   factors  in  determining  the
realizability of the $181.0 million in deferred tax assets  attributable to loss
and credit  carryforwards.  These factors included any limitations on the use of
loss and credit  carryforwards,  results of operations for 2006 and prior years,
the  reversal of  deferred  gains,  other  temporary  differences,  the year the
carryforwards   expire,   and  the  levels  of  taxable  income   necessary  for
utilization.  The Company  also  considered  the  potential  recognition  of the
deferred gains on sales of timber and timberlands. Based on this evaluation, the
Company provided valuation allowances of $26.4 million and $13.4 million related
to loss and credit carryforwards in 2006 and 2005, respectively. With respect to
the $64.4  million  of  deferred  tax  assets  attributable  to loss and  credit
carryforwards for which a valuation allowance has not been provided, the Company
believes  that it is more likely  than not that it will  realize the benefit for
these carryforwards.

     The net  deferred  income tax assets in the above  table do not include any
potential tax benefit attributable to the Company's investment in its 50,000,000
Kaiser Shares. For federal tax purposes,  the Company's basis is estimated to be
$388.0  million,  which  results in a federal  tax  benefit  at current  federal
statutory income tax rates of approximately  $135.8 million.  As a result of the
cancellation of the Company's Kaiser Shares in 2006, the Company expects it will
take a worthless  stock  deduction on its 2006  consolidated  federal income tax
return.  However,  it is uncertain  whether the deduction meets certain criteria
required  for asset  recognition  purposes.  Accordingly,  the  Company  has not
recorded  the  resulting  tax  asset  of  approximately  $135.8  million  in its
consolidated balance sheet as of December 31, 2006.

                                                                      Expiring
                                                                   ------------
Regular tax attribute carryforwards:
  Net operating loss carryforwards                  $  444.8         2007-2026
  Alternative minimum tax credits                        4.4         Indefinite
  General business tax credits                           1.6         2025
Alternative minimum tax attribute carryforwards:
  Net operating losses                                 466.6         2007-2026

     The Company's  operations are subject to the  jurisdiction  of multiple tax
authorities  and their review of taxable income as reported in the Company's tax
filings.  Determination  of  taxable  income in any  jurisdiction  requires  the
interpretation  of tax laws,  regulations  and related  judicial  decisions  and
administrative  interpretations  of local  tax  authorities.  As a  result,  the
Company  is subject  to tax  assessments  in such  jurisdictions  including  the
re-determination  of taxable income by tax  authorities  that may not agree with
the Company's  interpretations and positions taken. The Company believes that it
has adequately provided for any such potential assessments under the guidance of
Statement  of   Financial   Accounting   Standards   No.  5,   "Accounting   for
Contingencies"  ("SFAS No. 5"). Further,  the Company believes amounts currently
provided for any such potential  assessments will not be settled within the next
twelve months and settlement of such amounts would not have a significant impact
on the Company's consolidated  financial position,  results of operations and/or
liquidity.

     As discussed in Note 1, the Bankruptcy Cases could result in claims against
and could have adverse  impacts on MAXXAM Parent and its  affiliates,  including
MGHI and/or MGI. For example, it is possible that certain  transactions could be
completed in connection with a potential  restructuring or reorganization of the
Debtors,  such as a sale of all or a  portion  of the  equity  ownership  in the
Debtors,  a sale of a  substantial  portion  of the  Debtors'  assets  and/or  a
cancellation  of some or all of the Debtors'  indebtedness,  which could require
the utilization of all or a substantial portion of, or the loss of a significant
portion of, the  Company's  net  operating  losses or other tax  attributes  for
federal  and state  income tax  purposes  and could  require  tax  payments.  In
addition,  the  Company  may be  required  to  establish  certain  deferred  tax
liabilities  as a result of loss of control of the Debtors  effective  as of the
Filing Date.

9. Employee Benefit and Incentive Plans

     Pension and Other Postretirement Benefit Plans
     The Company has three defined benefit plans:  MAXXAM Parent's  pension plan
(the "MAXXAM Pension Plan"),  Palco's pension plan (the "Palco Retirement Plan")
and MAXXAM's Supplemental Employee Retirement Plan (collectively,  the "Plans").
The benefits are determined  under  formulas  based on the  employee's  years of
service,  age and  compensation.  The Plans were frozen  effective  December 31,
2005;  as a result,  it is  expected  that  these  plans will  continue,  but no
additional benefits will accrue to participants subsequent to December 31, 2005.

     The Company has unfunded  postretirement  medical  benefit plans that cover
most of its employees.  Under the plans,  employees are eligible for health care
benefits upon retirement.  Retirees make contributions for a portion of the cost
of their health care  benefits.  The expected  costs of  postretirement  medical
benefits  are  accrued by each  participating  employer  over the  period  their
employees  provide  services  to the date of  their  full  eligibility  for such
benefits.  Postretirement  medical  benefits are  generally  provided  through a
self-insured  arrangement.  The Company has not funded the  liability  for these
benefits,  which  are  expected  to be  paid  out  of  cash  generated  by  each
participating employer's operations.

     The funded status of the MAXXAM Pension Plan and the Palco  Retirement Plan
and  other  postretirement  benefit  plans  and the  accrued  benefit  liability
included  in other  long-term  liabilities  as of  December  31,  2006 and 2005,
respectively, were as follows (in millions):

                                                                    Pension Benefits        Medical/Life Benefits
                                                               -------------------------- --------------------------
                                                                             Years Ended December 31,
                                                               -----------------------------------------------------
                                                                   2006         2005          2006         2005
                                                               ------------ ------------- ------------ -------------
Change in projected benefit obligation:
  Projected benefit obligation at beginning of year            $  98.2      $   101.3     $    10.3    $    12.6
  Service cost                                                       -            2.8           0.3          0.4
  Interest cost                                                    5.4            5.6           0.5          0.5
  Actuarial (gain) loss                                           (6.2)           0.4          (0.8)        (1.9)
  Curtailments, settlements and amendments                           -           (8.1)            -         (1.0)
  Benefits paid                                                   (3.3)          (3.8)         (0.7)        (0.3)
                                                               ------------ ------------- ------------ -------------
    Projected benefit obligation at end of year                $  94.1      $    98.2     $     9.6    $    10.3
                                                               ========================== ============ =============
Change in plan assets:
  Fair value of plan assets at beginning of year                  63.4           60.3             -            -
  Actual return on assets                                          8.1            4.6             -            -
  Employer contributions                                          11.0            2.3           0.7          0.3
  Plan participants' contributions                                   -              -           0.3          1.7
  Benefits paid                                                   (3.3)          (3.8)         (1.0)        (2.0)
                                                               -------------------------- ------------ -------------
  Fair value of plan assets at end of year                     $  79.2           63.4             -            -
                                                               ========================== ============ =============
Funded status:
  Projected benefit obligation in excess of plan assets        $ (15.0)         (34.8)    $    (9.6)       (10.3)
                                                               =============              ============
  Unrecognized actuarial loss                                                    13.2                          -
  Unrecognized prior service costs                                                  -                       (1.4)
                                                                            -------------              -------------
    Net amount recognized                                                   $   (21.6)                 $   (11.7)
                                                                            =============              =============
Amounts recognized in the Consolidated Balance Sheet:
  Accrued benefit liability                                    $ (15.0)     $   (34.8)    $    (9.6)   $   (11.7)
  Accumulated other comprehensive income                           4.2           13.2          (2.1)           -
                                                               -------------------------- ------------ -------------
    Net amount recognized                                      $ (10.8)     $   (21.6)    $   (11.7)   $   (11.7)
                                                               ========================== ============ =============

     The MAXXAM Pension Plan and the Palco  Retirement Plan each had accumulated
benefit  obligations  in excess of its plan assets as of December 31, 2006 and
2005.

     The components of pension and other postretirement medical benefits expense
for the three years ended December 31, 2006, were as follows (in millions):

                                                           Pension Benefits              Medical/Life Benefits
                                                   -------------------------------- --------------------------------
                                                                       Years Ended December 31,
                                                   -----------------------------------------------------------------
                                                      2006       2005       2004       2006       2005       2004
                                                   ---------- ----------- --------- ---------- ---------- ----------
Components of net periodic benefit costs:
  Service cost                                     $     -    $    2.8    $   3.1   $   0.3    $   0.4    $   0.5
  Interest cost                                        5.4         5.6        5.6       0.5        0.5        0.7
  Expected return on assets                           (5.7)       (5.3)      (5.1)        -          -          -
  Recognized net actuarial loss                        0.3         0.7          -         -          -          -
  Amortization of prior service costs                    -           -          -      (0.2)      (0.2)      (0.2)
                                                   ---------- ----------- --------- ---------- ---------- ----------
  Net periodic benefit costs                           0.0         3.8        3.6       0.6        0.7        1.0
  Curtailments, settlements and other                    -        (0.2)         -         -       (0.1)      (0.1)
                                                   ---------- ----------- --------- ---------- ---------- ----------
    Adjusted net periodic benefit costs            $   0.0    $    3.6    $   3.6   $   0.6    $   0.6    $   0.9
                                                   ========== =========== ========= ========== ========== ==========

     Amounts  recognized in the  consolidated  statements of financial  position
consist of:

                                                          Pension Benefits        Medical/Life Benefits
                                                     -------------------------- --------------------------
                                                                   Years Ended December 31,
                                                     -----------------------------------------------------
                                                         2006         2005          2006         2005
                                                     ------------ ------------- ------------- -------------

Current liabilities                                  $    0.3     $      -      $    0.4      $      -
Noncurrent liabilities                                   14.7            -           9.1             -
                                                     ------------ ------------- ------------- -------------
                                                     $   15.0     $      -      $    9.5      $      -
                                                     ============ ============= ============= =============

     Amounts recognized in consolidated  accumulated other comprehensive  income
consist of:

                                                          Pension Benefits        Medical/Life Benefits
                                                     -------------------------- --------------------------
                                                                   Years Ended December 31,
                                                     ------------ ------------- ------------- -------------
                                                         2006         2005          2006         2005
                                                     -------------------------- ------------ -------------
Net actuarial (gain) loss                            $    4.2     $      -      $   (0.9)     $      -
Prior service cost                                          -            -          (1.2)            -
                                                     ------------ ------------- ------------- -------------
                                                     $    4.2     $      -      $   (2.1)     $      -
                                                     ============ ============= ============= =============

(1)  It is expected  that none of this amount will be  amortized  into income in
     2007.
(2)  It is expected that $0.2 million will be amortized into income in 2007.

     The incremental effect of applying SFAS No. 158 on individual line items on
the consolidated balance sheet, were as follows (in millions):

                                                           Before                                    After
                                                       Application of                            Application of
                                                        SFAS No. 158          Adjustment          SFAS No. 158
                                                   -----------------------------------------------------------------
Liability for pension and postretirement medical   $       26.6                 (2.1)            $     24.5
Accumulated other comprehensive income                     (4.2)                 2.1                   (2.1)
Total stockholders' equity                               (211.8)                  -                  (211.8)

     The  measurement  date  used for the  MAXXAM  Pension  Plan  and the  Palco
Retirement Plan and the Company's  postretirement benefit plans was December 31,
2006.  The  underlying  assumptions  of these  plans for the three  years  ended
December 31, 2006, were as follows (in millions):

                                                                    Pension Benefits        Medical/Life Benefits
                                                                ------------------------- --------------------------
                                                                                  Years Ended December 31,
                                                                ----------------------------------------------------
                                                                 2006    2005     2004     2006     2005     2004
                                                                ---------------- -------- -------- -------- --------
Weighted-average assumptions:
  Discount rate used to determine benefit obligation              6.0%    5.625%  5.875%     6.0%   5.625%   5.875%
  Discount rate used to determine net periodic benefit cost     5.625%    5.875%   6.25%   5.625%   5.875%    6.25%
  Expected return on plan assets                                 8.75%     8.75%   8.50%       -        -        -
  Rate of compensation increase                                     -(1)      -(1) 4.11%       -        -        -

--------------------
(1)  Not applicable as the Plans were frozen effective December 31, 2005

     The  average  annual  assumed  rate of  increase  in the per capita cost of
covered benefits under the Company's  postretirement medical plans (i.e., health
care  cost  trend  rate)  for  2007 is 9.0%  for all  participants.  The rate of
increase is assumed to decline  gradually  to 5.0% in 2011 for all  participants
and remain at that level thereafter. Assumed health care cost trend rates have a
significant  effect on the amounts reported.  A  one-percentage-point  change in
assumed  health  care cost trend  rates as of  December  31, 2006 would have the
following effects (in millions):

                                                                                 1-Percentage-     1-Percentage-
                                                                                 Point Increase    Point Decrease
                                                                                 ----------------- -----------------
Effect on total of service and interest cost components                          $      0.1        $     (0.1)
Effect on the postretirement benefit obligations                                        1.1              (1.0)

     The MAXXAM Pension Plan's and the Palco Retirement  Plan's  investments are
held under separate trust  agreements  with an independent  trustee.  The MAXXAM
Pension Plan's and the Palco Retirement  Plan's separate  Investment  Committees
establish  the  investment  policies  for the plans'  assets  and have  selected
certain  investment funds maintained by the trustee (or its affiliates and third
parties) for investment of plan assets. The Investment Committees also determine
the  portion  of plan  assets  to be  invested  in  such  funds.  The  trustee's
affiliates or third parties select the  investment  managers for these funds and
the portion of each fund to be managed by the  respective  investment  managers.
The  investment  managers in turn  determine in which equity,  debt and/or other
securities the assets under their direction will be invested.  Actual investment
results  achieved  by the  investment  funds  are  reviewed  by  the  Investment
Committees  on a  regular  basis.  As  of  December  31,  2006,  the  Investment
Committees'  target asset allocations were 70% for equity securities and 30% for
fixed income  securities  for the MAXXAM  Pension Plan and the Palco  Retirement
Plan.

     The  weighted-average  asset  allocations  for each of the pension plans at
December 31, 2006 and 2005, by asset category are as follows:

                                     Years Ended December 31,
                                     -------------------------
                                        2006         2005
                                     ----------- -------------
Asset Category:
  Equity securities                       70%          70%
  Debt securities                         30           30
                                     ----------- -------------
    Total                                100%         100%
                                     =========== =============

     The  expected  rate  of  return  on  plan  assets  assumption,  used in the
determination  of net  periodic  pension  cost,  will be  8.75%  for  2007.  The
Company's  rate of return  assumption  is based on  historical  returns  on plan
assets and the expected  long-term  returns for the asset allocation  targets in
place at December 31, 2006.

     Each  company's  funding  policy  is to make  annual  contributions  to its
respective plan which equal or exceed the minimum funding requirements of ERISA.
The Company is in  compliance  with this policy.  An assumed  long-term  rate of
return  on plan  assets  of 8.75%  was used in the  determination  of the  ERISA
minimum  funding  requirements  for the plan years ended  December  31, 2006 and
2005.  Expected  funding  requirements  for the MAXXAM  Pension Plan for 2007 is
approximately  $0.9  million and  expected  funding  requirements  for the Palco
Retirement Plan for 2007 is approximately $3.6 million.. As discussed in Note 1,
Palco may not be successful in obtaining additional liquidity sufficient to fund
its  operating  cash needs for 2007.  The  failure of Palco to meet its  minimum
pension  funding  requirements  could  result  in a  termination  of  the  Palco
Retirement  Plan.  See  Note  1  for  further   information.   Expected  funding
requirements for postretirement medical benefits for 2007 are approximately $0.4
million.

     The Company also has an unfunded  Supplemental  Executive  Retirement  Plan
that provides  certain key employees  defined  pension  benefits that supplement
those provided by the MAXXAM Pension Plan and Palco Retirement Plan. The Company
had $3.5 million and $3.4 million  accrued as projected  benefit  obligations in
the  Consolidated  Balance  Sheet for such plan at  December  31, 2006 and 2005,
respectively. This plan was frozen effective December 31, 2005.

     The following benefit payments,  which reflect expected future service,  as
appropriate,  are  expected to be paid in respect of the  Company's  pension and
postretirement benefit plans (in millions):

                                               Pension         Medical/
Years Ended December 31,                       Benefits      Life Benefits
------------------------------------------- --------------- ----------------
2007                                        $         3.8   $         0.4
2008                                                  3.9             0.5
2009                                                  4.2             0.5
2010                                                  4.5             0.6
2011                                                  4.7             0.7
Years 2012-2016                                      27.5             4.2

     Savings and Incentive Plans
     The Company has two defined  contribution  savings plan designed to enhance
the existing retirement programs of participating  employees.  Effective January
1,  2006,  new  company-paid  benefits  were added to the  defined  contribution
savings  plans.   The  new  company  paid  benefits,   when  combined  with  the
participating   employer   matching   contribution,   provided   up  to  17%  of
participants'   eligible   compensation  in  the  form  of  additional  employer
contributions. Effective January 1, 2006, the Company established a Supplemental
Savings  Plan  ("SSP") in order to provide  certain  participants  in the MAXXAM
Savings Plan with certain retirement benefits they would have received under the
MAXXAM  Savings  Plan were it not for the limits on benefits  imposed by section
415(c)  and  section   401(a)(17)  of  the  Internal   Revenue  Code.   Employer
contributions  for all of these plans were $3.0  million,  $0.8 million and $0.7
million for the years ended December 31, 2006, 2005 and 2004, respectively.

10. Investment in Kaiser

     Under generally accepted  accounting  principles for entities  consolidated
through voting interests, consolidation is generally required for investments of
more  than 50% of the  outstanding  voting  stock of an  investee,  except  when
control  is  not  held  by  the  majority  owner.   Under  these  rules,   legal
reorganization   or   bankruptcy   represent   conditions   which  can  preclude
consolidation in instances where control rests with the bankruptcy court, rather
than the  majority  owner.  On  February  12,  2002,  Kaiser and  certain of its
subsidiaries filed for  reorganization  under Chapter 11 of the Bankruptcy Code.
As a result, the Company discontinued  consolidating  Kaiser's financial results
beginning  February 12, 2002, and began reporting its investment in Kaiser using
the cost method.

     In  February  2002,  Kaiser  and  certain  of its  subsidiaries  filed  for
reorganization  under  Chapter  11 of the  Bankruptcy  Code.  Kaiser's  plan  of
reorganization  provided for the cancellation of Kaiser's equity,  including the
Company's Kaiser Shares,  without consideration or obligation.  Kaiser's plan of
reorganization  became  effective  on July 6,  2006,  and  Kaiser  emerged  from
bankruptcy.  As a result, the Company no longer has any ownership interest in or
affiliation  with  Kaiser.  Since the  Company's  Kaiser  Shares were  cancelled
without obligation,  the Company reversed the $516.2 million of losses in excess
of its  investment  in Kaiser  along with the  accumulated  other  comprehensive
losses of $85.3  million  related to Kaiser,  resulting  in a net gain of $430.9
million,  recognized  in  the  third  quarter  of  2006.  As  a  result  of  the
cancellation of the Company's Kaiser Shares in 2006, the Company expects it will
take a worthless  stock  deduction on its 2006  consolidated  federal income tax
return.  However,  it is uncertain  whether the deduction meets certain criteria
required  for asset  recognition  purposes.  Accordingly,  the  Company  has not
recorded  the  resulting  tax  asset  of  approximately  $135.8  million  in its
consolidated balance sheet as of December 31, 2006.

     Also see "Deconsolidation of Kaiser" in Note 1.

11. Commitments, Regulatory and Environmental Factors and Contingencies

     Commitments
     The Company leases certain facilities and equipment under operating leases.
Minimum rental  commitments  under operating leases at December 31, 2006, are as
follows:

Years Ended December 31,                     (In millions)
------------------------------------------- ---------------

2007                                        $         3.1
2008                                                  2.7
2009                                                  1.9
2010                                                  0.8
2011                                                  0.7
Thereafter                                            1.4
                                            ---------------
Total minimum lease payments                $        10.6
                                            ===============

     Rental expense for operating leases was $3.8 million, $4.2 million and $4.7
million for the years ended December 31, 2006, 2005 and 2004, respectively.

     The Company owns certain commercial  properties which are leased to tenants
under  operating  leases.  Lease  terms  average  20 years.  Minimum  rentals on
operating leases are contractually due as follows:

            Years Ended December 31,                    (In millions)
            ----------------------------------------------------------

            2007...................................... $         17.5
            2008......................................           17.8
            2009......................................           18.0
            2010......................................           18.0
            2011......................................           18.3
            Thereafter................................          171.8
                                                       ---------------
            Total minimum rentals..................... $        261.4
                                                       ===============

     Regulatory and Environmental Factors

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

     Environmental Plans
     In March  1999,  Palco,  Scopac and Salmon  Creek (the  "Palco  Companies")
consummated  their 1996 Headwaters  Agreement (the "Headwaters  Agreement") with
the  United  States  and  California.  Pursuant  to  the  Headwaters  Agreement,
approximately  5,600  acres of  timberlands  owned by the Palco  Companies  were
transferred  to the United  States  government  in exchange for $300.0  million,
approximately 7,700 acres of timberlands,  and approval by the federal and state
governments  of the  Environmental  Plans.  In  connection  with approval of the
Environmental  Plans,   California  incidental  take  permits  (the  "California
Permits")  and federal  incidental  take permits  (the  "Federal  Permits,"  and
together with the California Permits,  the "Permits"),  were issued with respect
to certain  threatened,  endangered  and other species found on the  timberlands
covered by the Environmental Plans.

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

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

     Water Quality
     Laws and  regulations  dealing with water quality are impacting or have the
potential to impact the Palco Companies primarily in three areas: efforts by the
federal Environmental Protection Agency (the "EPA") and the North Coast Regional
Water Quality  Control  Board  ("North  Coast Water  Board") to establish  total
maximum daily load limits  ("TMDLs") in watercourses  that have been declared to
be water quality impaired; actions by the North Coast Water Board imposing waste
discharge reporting  requirements,  and various mitigation,  erosion control and
clean-up  measures;  and the  development by the North Coast Water Board and its
staff of  special  permitting  requirements  for the  Freshwater  and Elk  River
watersheds known as watershed-wide waste discharge requirements ("WWDRs").

     Under the CWA, the EPA is required to establish TMDLs in watercourses  that
have been declared to be "water  quality  impaired." The EPA and the North Coast
Water  Board  are in  the  process  of  establishing  TMDLs  for  many  northern
California rivers and certain of their tributaries,  including nine watercourses
that flow within the Palco  Timberlands.  The relevant  contaminant on the Palco
Timberlands,  is simple  sediment - dust,  dirt and gravel - that is abundant in
watercourses  largely as a function of the area's  normally  heavy  rainfall and
soil that erodes easily.  The Company expects the process of establishing  TMDLs
to continue into 2010.  The EPA has issued a report  dealing with TMDLs on three
of the nine  watercourses.  The agency indicated that the requirements under the
HCP would  significantly  address  the  sediment  issues  that  resulted in TMDL
requirements for these watercourses.  Presently,  the North Coast Water Board is
in the process of  establishing  the TMDL  requirements  applicable to two other
watercourses on the Palco Timberlands, Freshwater and Elk River, with a targeted
completion of 2008 for these two watercourses.  Scopac's scientists are actively
working with North Coast Water Board staff to ensure that these TMDLs  recognize
and incorporate the environmental protection measures of the HCP. The final TMDL
requirements  applicable to the Palco Timberlands may require aquatic protection
measures  that are  different  from or in  addition  to those in the HCP or that
result from the prescriptions to be developed pursuant to the watershed analysis
process  provided for in the HCP.  These  requirements  could  further  restrict
harvesting on the Palco Timberlands.

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

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

     On May 8,  2006,  the  North  Coast  Water  Board  adopted  WWDRs  for  the
Freshwater  and  Elk  River.  The  decision  allows   harvesting  in  these  two
watersheds,  up to  approximately  50% of the  applicable  annual  harvest limit
established by the CDF for each watershed ("CDF Harvest Limit"),  once the staff
of the North Coast Water Board reviews and enrolls THPs submitted by Scopac. The
North Coast Water  Board's  decision  also allowed the  enrollment of additional
THPs, bringing the total to approximately 75% of the CDF Harvest Limit for these
two  watersheds,  upon  approval of a monitoring  and  reporting  program by the
Executive  Officer of the North Coast  Water Board  staff.  The  monitoring  and
reporting program was approved on September 29, 2006, allowing enrollment by the
staff of the  North  Coast  Water  Board of the  additional  THPs for  these two
watersheds  planned for harvest in 2006. This  monitoring and reporting  program
will also govern future THPs in these two watersheds.  However,  there can be no
assurance  that  additional  THPs in these two  watersheds  will  ultimately  be
enrolled or harvested as planned in 2006 or future years.  The North Coast Water
Board's  adoption of these WWDRs has been appealed to the State Water Board, but
the appeals are being held in abeyance pending  implementation  of the WWDRs. As
harvesting  activities on the Palco Timberlands  cannot readily be moved between
watersheds  due to, among other things,  historic  harvest  patterns,  adjacency
restrictions, and the age classes of trees, development of WWDRs and the various
other matters  described herein are expected to result in reduced harvest levels
in 2006 and beyond.

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

     Contingencies

     Certain  present  and former  directors  and  officers  of the  Company are
defendants  in certain of the actions  described  below.  The  Company's  bylaws
provide for  indemnification of its officers and directors to the fullest extent
permitted by Delaware law. The Company is obligated to advance  defense costs to
its officers and directors, subject to the individual's obligation to repay such
amount if it is ultimately  determined  that the  individual was not entitled to
indemnification.  In addition,  the Company's  indemnity  obligation  can, under
certain  circumstances,  include  amounts  other than defense  costs,  including
judgments and settlements.

Forest Products Reorganization Proceedings

     On January 18, 2007, Palco and its five wholly owned subsidiaries, including
Scopac,  filed separate voluntary petitions for reorganization  under Chapter 11
of the Bankruptcy  Code. See Note 1,  "-Reorganization  Proceedings of Palco and
its Subsidiaries" for further information  regarding the bankruptcy  proceedings
of Palco and its  subsidiaries,  including  potential  adverse impacts on MAXXAM
Parent and its affiliates. Also see Item 1A. "Risk Factors->Risks Related to the
Bankruptcy Cases" and Item 7. "Management's Discussion and Analysis of Financial
Condition  and  Results of  Operations-Financial  Condition  and  Investing  and
Financing Activities-Forest Products Operations."

     Timber Harvest Litigation
     A California  state court had  invalidated  the SYP in connection  with two
lawsuits filed against Palco,  as described  below,  which decision was appealed
and was reversed  December 12, 2005. Other pending  judicial and  administrative
proceedings, as described below, could affect the ability of Palco and Scopac to
implement  the  HCP,  implement  certain  approved  THPs,  or  carry  out  other
operations.

     In March 1999,  an action  entitled  Environmental  Protection  Information
Association,   Sierra  Club  v.  California  Department  of  Forestry  and  Fire
Protection,  California Department of Fish and Game, The Pacific Lumber Company,
Scotia Pacific Company LLC, Salmon Creek Corporation,  et al. ("EPIC-SYP/Permits
lawsuit")  was filed in  Superior  Court in  Humboldt  County,  California  (No.
CV-990445).  This action alleged,  among other things, various violations of the
California Endangered Species Act and the California  Environmental Quality Act,
and challenged, among other things, the validity and legality of the SYP and the
California Permits and sought, among other things, to prevent  implementation of
THPs approved in reliance upon these documents. In March 1999, a similar action,
entitled  United  Steelworkers  of America,  AFL-CIO,  CLC, and Donald Kegley v.
California  Department  of Forestry  and Fire  Protection,  The  Pacific  Lumber
Company,  Scotia  Pacific  Company  LLC  and  Salmon  Creek  Corporation  ("USWA
lawsuit"),   was  filed  in  Humboldt  County  Superior  Court  (No.  CV-990452)
challenging the validity and legality of the SYP. The  EPIC-SYP/Permits and USWA
lawsuits were consolidated for trial.

     Following  the  trial,  the  Court  in  October  2003  entered  a  judgment
invalidating  the SYP and the  California  Permits and in September 2004 granted
the  plaintiffs'  request for  reimbursement  of an aggregate of $5.8 million in
attorneys'  fees and  other  expenses.  The  Palco  Companies  and the  State of
California  appealed both  decisions.  In December  2005,  the  appellate  court
reversed the trial  court's  decision  invalidating  the SYP and the  California
Permits.  The  plaintiffs  have appealed the appellate  court's  decision to the
California  Supreme  Court,  which has  accepted  the  appeal  for  review.  The
defendants'  appeal of the trial court's award of attorneys fees and expenses is
still pending at the appellate  court.  Due to the  Bankruptcy  Cases,  both the
California Supreme Court and the appellate court have entered orders staying the
proceedings pending before each court.

     In July  2001,  an action  entitled  Environmental  Protection  Information
Association v. Pacific Lumber,  Scotia Pacific Company LLC (No. C01-2821) ("Bear
Creek lawsuit") was filed in the U.S.  District Court for the Northern  District
of  California,  and later  amended to add the EPA as a  defendant.  The lawsuit
alleges that harvesting and other forestry  activities under certain of Scopac's
approved  THPs will result in  discharges of pollutants in violation of the CWA.
The  plaintiff  asserts that the CWA requires the  defendants to obtain a permit
from the North Coast Water Board before  beginning  timber  harvesting  and road
construction  activities  and is seeking to enjoin these  activities  until such
permit has been  obtained.  The  plaintiff  also seeks civil  penalties of up to
$27,500 per day for the alleged continued violation of the CWA. In October 2003,
the Court upheld the validity of an EPA regulation  that exempts  harvesting and
other forestry  activities from certain discharge  requirements.  Both state and
federal agencies, along with Palco and other timber companies,  have relied upon
this  regulation  for more than 25 years.  However,  the Court  interpreted  the
regulation in such a way as to narrow the forestry operations that are exempted,
thereby  limiting the  regulation's  applicability  and subjecting  culverts and
ditches to permit requirements.  This ruling has widespread implications for the
timber industry in the United States. The case is not yet final as the trial has
not yet been held, and there are many unresolved issues involving interpretation
of the Court's  decision and its application to actual  operations.  On June 30,
2006,  the  plaintiff  filed a motion for partial  summary  judgment  seeking to
establish the Palco Companies'  liability and the Palco Companies filed a motion
for summary judgment asserting that the plaintiff lacks standing to maintain the
lawsuit.  A hearing on these motions was held on October 3, 2006,  and the Court
took the matter under  submission.  Due to the Bankruptcy  Cases,  the Court has
entered an order staying this matter.

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

     On November 20, 2002,  two similar  actions  entitled  Alan Cook, et al. v.
Gary Clark,  et al. ("Cook action") and Steve Cave, et al. v. Gary Clark, et al.
("Cave action") were filed in Humboldt County Superior Court (No.'s DR020718 and
DR020719,  respectively),  which  also name  Palco  and  certain  affiliates  as
defendants.  The Cook action  alleges,  among  other  things,  that  defendants'
logging  practices have  contributed to an increase in flooding along Freshwater
Creek (which runs through the Palco  Timberlands),  resulting in personal injury
and damage to the  plaintiffs'  properties.  Plaintiffs  further  allege that in
order to have THPs approved in the affected  areas,  the  defendants  engaged in
certain unfair  business  practices.  The plaintiffs  seek,  among other things,
compensatory  and exemplary  damages,  injunctive  relief,  and appointment of a
receiver to ensure that the  watershed  is  restored.  The Cave action  contains
similar  allegations  and requests  similar relief with respect to the Elk River
watershed (a portion of which is contained on the Palco Timberlands). On October
13, 2005, an action  entitled  Edyth Johnson,  et al. v. Charles E. Hurwitz,  an
individual;  MAXXAM Inc.,  et al. (No.  DR040720)  was filed in Humboldt  County
Superior Court ("Johnson action") and contains  allegations  similar to the Cave
and Cook actions.  The Company does not believe the  resolution of these actions
should  result  in a  material  adverse  effect  on its  consolidated  financial
condition,  results of operations or liquidity. Notices have been filed with the
Court to stay these matters due to the Bankruptcy Cases.

     On February 25,  2003,  the  District  Attorney of Humboldt  County filed a
civil suit entitled The People of the State of California v. The Pacific  Lumber
Company,  Scotia  Pacific  Holding  Company and Salmon Creek  Corporation in the
Humboldt County Superior Court (No. DR030070)  ("Humboldt DA action").  The suit
was filed under  California's  unfair competition law and alleges that the Palco
Companies used certain unfair  business  practices in connection with completion
of  the  Headwaters  Agreement,  and  that  this  resulted  in  the  harvest  of
significantly  more  trees than would  have  otherwise  been the case.  The suit
sought a variety  of  remedies  including  a civil  penalty  of $2,500  for each
additional tree that has been or will be harvested due to this alleged  increase
in  harvest,  as  well  as  restitution  and an  injunction  in  respect  of the
additional  timber harvesting  allegedly being conducted.  On June 14, 2005, the
Court dismissed this matter in its entirety. On September 19, 2005, the District
Attorney  appealed  this  decision,  however,  the  Company  believes  that  the
dismissal  ruling  has  substantially  diminished  the  exposure  of  the  Palco
Companies with respect to this matter.  Due to the Bankruptcy  Cases,  the Court
has entered an order staying this matter.

     In  December  2005,  Palco  and  Scopac  filed a claim  ("Claim")  with the
California  Victim  Compensation  and Government  Claims Board ("Claims  Board")
against  the North  Coast  Water  Board,  the State Water Board and the State of
California  (Claim No.  G558159).  The Claim  alleges that the  defendants  have
substantially  impaired  the  contractual  and legal  rights of Palco and Scopac
under the  Headwaters  Agreement  and the related  permits,  authorizations  and
approvals. The Claim also alleges that the actions of the defendants have caused
the companies  substantial  damages,  but does not specify an amount.  While the
Claims Board has indicated  that it is  investigating  the matter,  it failed to
approve or deny the claim by the statutory  deadline.  As a result, the Claim is
by  operation  of law  treated as having been  denied,  and Palco may now file a
claim for damages in  California  state court.  This suit was filed by Palco and
Scopac on December 20, 2006 in Superior  Court in Fresno,  California  (No. CECG
0422).

     While  the  above-described  legal  proceedings  are in  general  stayed as
against the Debtors  while the  companies are in  bankruptcy,  such  proceedings
could be  dismissed  as  against  the  Debtors  as the stay is  modified  by the
Bankruptcy  Court,  if  the  Bankruptcy  Cases  are  dismissed,  or  in  certain
circumstances,  upon the emergence of the companies  from  bankruptcy.  Also see
Item 1A.  "Risk  Factors-Risk  Factors  Related  to Forest  Products  Regulatory
Matters."

     OTS Contingency and Related Matters
     On December 26, 1995, the United States  Department of Treasury's Office of
Thrift Supervision  ("OTS") initiated a formal  administrative  proceeding ("OTS
action") against the Company and others alleging, among other things, misconduct
by the Company and certain of its affiliated persons  ("Respondents") and others
with respect to the failure of United Savings Association of Texas (the "USAT").
The OTS sought  damages  ranging  from $326.6  million to $821.3  million  under
various theories. Following 110 days of proceedings before an administrative law
judge during 1997-1999,  and over two years of post-trial briefing, on September
12, 2001, the administrative law judge issued a recommended decision in favor of
the  Respondents  on each claim made by the OTS.  On October 17,  2002,  the OTS
action was settled for $0.2 million with no admission of  wrongdoing on the part
of the Respondents.

     As a result of the  dismissal of the OTS action,  a related  civil  action,
alleging  damages in excess of $250 million,  was subsequently  dismissed.  This
action, entitled Federal Deposit Insurance Corporation,  as manager of the FSLIC
Resolution Fund v. Charles E. Hurwitz ("FDIC  action"),  was originally filed by
the Federal Deposit  Insurance  Corporation  (the "FDIC") in August 1995 against
Mr. Charles E. Hurwitz (Chairman and Chief Executive Officer of the Company).

     In May 2000, the Respondents filed a counterclaim to the FDIC action in the
U.S.  District  Court in Houston,  Texas (No.  H95-3956).  In November 2002, the
Respondents  filed an amended  counterclaim  and an amended motion for sanctions
(collectively,  the "Sanctions  Motion").  The Sanctions  Motion states that the
FDIC illegally paid the OTS to bring the OTS action against the  Respondents and
that the FDIC illegally sued for an improper  purpose (i.e., in order to acquire
timberlands held by a subsidiary of the Company). The Respondents are seeking as
a  sanction  to be made  whole for the  attorneys'  fees  they  have paid  (plus
interest) in connection with the OTS and FDIC actions.  As of December 31, 2006,
such fees were in excess of $40.9 million.  On August 23, 2005, a U.S.  District
Court ruled on the Sanctions  Motion,  ordering the FDIC to pay the  Respondents
$72.3  million.  The FDIC has appealed the District  Court  decision to the U.S.
Fifth  Circuit  Court of  Appeals.  The U.S.  District  Court award has not been
accrued as of December 31, 2006 and December 31, 2005. There can be no assurance
that the Company will ultimately collect this award.

     Other Matters
     On September 2, 2004,  MGI was advised  that the New Jersey  Department  of
Environmental  Protection  ("NJDEP") alleged that one of its former subsidiaries
is a successor to a company that manufactured munitions for the U.S. Navy during
World  War II.  The  owner  of the  underlying  property,  which is  located  in
Cranbury,  New Jersey,  was seeking  MGI's  participation  in efforts to address
contamination of the site which resulted from such operations.  In January 2005,
MGI and the owner of the property entered into an  Administrative  Consent Order
with the NJDEP  providing for, among other things,  cleanup of the facility.  In
April 2005, MGI filed a Complaint against the United States of America, the U.S.
Navy,  and the U.S.  Army for cost  recovery and  contribution;  the  defendants
subsequently  denied all of the claims. In early 2006, the property was sold and
MGI entered into an amendment to the  Administrative  Consent Order substituting
the new owner for the original property owner. MGI has also reached an agreement
with several potentially  responsible parties regarding cleanup at the site, the
terms of which the Company believes will not result in a material adverse effect
on the  Company's  consolidated  financial  position,  results of  operations or
liquidity  and  under  which  MGI  retained  its  cause of  action  against  the
government parties noted above.

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

12. Stockholders' Deficit

     Preferred Stock
     The holders of the Class A Preferred Stock are entitled to receive,  if and
when  declared,  preferential  cash dividends at the rate of $0.05 per share per
annum and participate  thereafter on a share-for-share basis with the holders of
Common  Stock in any cash  dividends,  other than cash  dividends  on the Common
Stock in any  fiscal  year to the extent not  exceeding  $0.05 per share.  Stock
dividends  declared on the Common Stock would result in the holders of the Class
A Preferred  Stock  receiving an identical  stock dividend  payable in shares of
Class A  Preferred  Stock.  At the option of the  holder,  the Class A Preferred
Stock is  convertible at any time into shares of Common Stock at the rate of one
share of Common Stock for each share of Class A Preferred Stock.  Each holder of
Class A  Preferred  Stock is  generally  entitled  to ten votes per share on all
matters presented to a vote of the Company's stockholders.

     Stock Option Plans
     Under the  Company's  stock-based  compensation  plans,  stock  options and
similar instruments may be granted to employees and outside directors at no less
than the fair market value of the  Company's  Common Stock on the date of grant.
Grants  generally  vest ratably over a five-year  period for grants to employees
and over a  four-year  period for grants to  outside  directors,  and expire ten
years after the grant  date.  Grants have  generally  been  settled in cash upon
exercise.

     In 2002,  the Company  adopted the MAXXAM 2002 Omnibus  Employee  Incentive
Plan ("2002 Omnibus Plan").  700,000 shares of Common Stock and 70,000 shares of
Class A Preferred  Stock are  reserved  for awards  pursuant to the 2002 Omnibus
Plan, of which 148,687 and 70,000  shares,  respectively,  were  available to be
awarded at December  31, 2006.  The 2002  Omnibus Plan  replaced the MAXXAM 1994
Omnibus Plan ("1994 Omnibus  Plan").  Any shares which were not then already the
subject of grants  under the 1994  Omnibus  Plan are no longer  available  to be
awarded.

     Concurrent  with the adoption of the 1994 Omnibus Plan, the Company adopted
the MAXXAM 1994 Non-Employee Director Plan ("1994 Director Plan"). 35,000 shares
of Common Stock are reserved for awards under the 1994  Director  Plan, of which
12,900 were available to be awarded at December 31, 2006.

     Grants issued to employees and outside directors were previously  accounted
for under the intrinsic value method of accounting as defined by APB Opinion No.
25  and  related  interpretations.   Effective  January  1,  2006,  the  Company
prospectively  adopted the fair value-based method of accounting for stock-based
employee  compensation  as prescribed  by SFAS No. 123(R) and  recognized a $0.7
million  charge in  January  2006,  representing  the  cumulative  effect of the
accounting change.

      The fair value of grants is determined using a Black-Scholes
option-pricing model. The following assumptions apply to the options granted
through the periods presented.

                                        Years Ended December 31,
                              -------------------------------------
                                  2006        2005         2004
                              ------------------------ ------------
Expected volatility                33%         38%          41%
Expected dividends                  -           -            -
Expected term (in years)         6.20        6.44         6.63
Risk-free rate                   4.70%       4.35%        3.63%

     Expected  volatilities are based on historical  volatility of the Company's
Common Stock.  The dividend yield on the Company's Common Stock is assumed to be
zero since the Company has not paid  dividends in the past five years and has no
current plans to do so. The expected term represents the period of time that the
options  granted  are  expected  to  remain   outstanding  based  on  historical
experience.  The  risk-free  interest rate is based on the U.S.  Treasury  yield
curve in effect for the expected term of the option at the reporting date.

     A summary of activity under the Company's stock option plans during 2006 is
presented below:

                                                                                            Weighted
                                                                            Weighted        Average      Aggregate
                                                                            Average        Remaining     Intrinsic
                                                                            Exercise      Contractual    Value
                                                             Options         Price      Term (in years) (in millions)
                                                           ------------- ------------- ---------------- ------------
Balance at January 1, 2006                                  1,114,306    $   25.06
Granted                                                        94,300        27.93
Exercised                                                     (42,744)       16.76
Forfeited or expired                                          (84,009)       26.65
                                                          --------------
Balance at December 31, 2006                                1,081,853    $   25.52           5.50       $    8.5
                                                          ============== ============= ================ ==============
Exercisable at December 31, 2006                              796,261    $   25.38           4.52       $    7.1
                                                          ============== ============= ================ ==============

     Total compensation cost for share-based  payment  arrangements for the year
ended  December  31,  2006,  was a benefit of $2.0  million due  primarily  to a
reduction in the per share market price of the  Company's  Common  Stock.  As of
December 31, 2006, total estimated compensation related to non-vested grants not
yet recognized is $3.5 million and the weighted  average period over which it is
expected to be recognized is 2.0 years,  although the Company may ultimately not
have to pay all of such amount.  During the year ended December 31, 2006,  there
were $0.5 million in options  exercised and $1.3 million,  based on the weighted
average fair value, in options were vested.

     The following table summarizes  information about stock options outstanding
as of December 31, 2006:

                                 Weighted Average
    Range of                         Remaining         Weighted Average         Options          Weighted Average
 Exercise Prices      Shares     Contractual Life       Exercise Price         Exercisable        Exercise Price
------------------ ------------- ------------------    -----------------       -----------      ------------------
 $ 9.40 - $15.88       283,230         5.14               $12.09                 248,970              $12.46
 $16.38 - $19.72       333,608         5.77                18.64                 277,496               18.42
 $26.50 - $45.50       367,415         6.56                34.82                 172,195               39.64
 $50.50 - $62.00        97,600         1.62                52.95                  97,600               52.95
                   -------------                                               -----------
                     1,081,853         5.50                25.52                 796,261               25.38
                   =============                                               ===========

     In addition to the options reflected in the table above,  256,808 shares of
restricted  Common Stock  granted  under the 1994 Omnibus Plan are  outstanding.
These shares are subject to certain restrictions that lapse in 2014.

     Rights
     On December  15, 1999,  the Board of  Directors  of the Company  declared a
dividend to its  stockholders  consisting  of (i) one Series A  Preferred  Stock
Purchase  Right  ("Series A Right")  for each  outstanding  share of the Class A
Preferred  Stock and (ii) one Series B Preferred Stock Purchase Right ("Series B
Right") for each outstanding  share of the Common Stock. The Series A Rights and
the Series B Rights are  collectively  referred to herein as the  "Rights."  The
Rights are  exercisable  only if a person or group of  affiliated  or associated
persons (an "Acquiring Person") acquires beneficial  ownership,  or the right to
acquire beneficial  ownership,  of 15% or more of the Company's Common Stock, or
announces a tender  offer that would  result in  beneficial  ownership of 15% or
more of the  outstanding  Common  Stock.  Any person or group of  affiliated  or
associated  persons who, as of December 15, 1999, was the beneficial owner of at
least 15% of the outstanding  Common Stock will not be deemed to be an Acquiring
Person unless such person or group acquires  beneficial  ownership of additional
shares of Common  Stock  (subject to certain  exceptions).  Each Series A Right,
when  exercisable,  entitles the registered  holder to purchase from the Company
one share of Class A  Preferred  Stock at an  exercise  price of  $165.00.  Each
Series B Right,  when  exercisable,  entitles the registered  holder to purchase
from the  Company  one  one-hundredth  of a share of the  Company's  new Class B
Junior  Participating  Preferred  Stock,  with a par  value of $0.50  per  share
("Junior Preferred Stock"), at an exercise price of $165.00 per one-hundredth of
a share.  The Junior  Preferred  Stock has a variety of rights and  preferences,
including a liquidation preference of $75.00 per share and voting,  dividend and
distribution rights which make each one-hundredth of a share of Junior Preferred
Stock equivalent to one share of Common Stock.

     Under certain  circumstances,  including if any person becomes an Acquiring
Person other than through certain offers for all outstanding  shares of stock of
the  Company,  or if an  Acquiring  Person  engages  in  certain  "self-dealing"
transactions,  each  Series A Right  would  enable  its  holder  to buy  Class A
Preferred  Stock  (or,  under  certain  circumstances,  preferred  stock  of  an
acquiring  company)  having a value equal to two times the exercise price of the
Series A Right,  and each Series B Right  would  enable its holder to buy Common
Stock of the  Company  (or,  under  certain  circumstances,  common  stock of an
acquiring  company)  having a value equal to two times the exercise price of the
Series B Right. Under certain circumstances,  Rights held by an Acquiring Person
will be null and void. In addition,  under certain  circumstances,  the Board is
authorized to exchange all outstanding and exercisable  Rights for stock, in the
ratio of one share of Class A  Preferred  Stock per Series A Right and one share
of  Common  Stock  per  Series B Right.  The  Rights,  which do not have  voting
privileges,  expire on December 11,  2009,  but may be redeemed by action of the
Board prior to that time for $0.01 per right, subject to certain restrictions.

     Shares Reserved for Issuance
     At December 31, 2006, the Company had 2,740,707  shares of Common Stock and
808,119  shares of Class A Preferred  Stock  reserved  for future  issuances  in
connection with various  options,  convertible  securities and other rights,  as
described above.

     Voting Control
     As of  December  31,  2006,  Mr.  Charles  E.  Hurwitz  beneficially  owned
(exclusive of securities acquirable upon exercise of stock options but inclusive
of securities as to which Mr. Hurwitz disclaims  beneficial  ownership) directly
and through various entities (principally Gilda Investments, LLC, a wholly owned
subsidiary  of Giddeon  Holdings,  Inc.) an aggregate of 99.2% of the  Company's
Class A Preferred  Stock and 54.4% of the Company's  Common Stock  (resulting in
combined voting control of approximately  79.5% of the Company).  Mr. Hurwitz is
the  Chairman  of the Board and  Chief  Executive  Officer  of the  Company  and
President  and Director of Giddeon  Holdings,  Inc.  Giddeon  Holdings,  Inc. is
wholly owned by Mr. Hurwitz,  members of his immediate family and trusts for the
benefit thereof.

13. Significant Acquisitions and Dispositions

     Real Estate Transactions
     During  2005,  the  Company  realized  substantial  revenues  from sales of
properties at its Mirada development. Sales at Mirada were $26.9 million in 2006
as compared to $57.0 million in 2005.

     Additionally,  the Company  during 2006 sold 12 lots at its Fountain  Hills
development.  Sales at Fountain  Hills were $19.3 million in 2006 as compared to
$48.3 million in 2005.

     At the  Company's  Palmas  development,  there  were two sales in 2006 that
generated revenues aggregating $16.0 million. Sales at Palmas were $40.1 million
in 2006, as compared to $54.4 million in 2005.

14. Supplemental Cash Flow and Other Information

                                                                                     Years Ended December 31,
                                                                                ------------------------------------
                                                                                   2006        2005        2004
                                                                                ----------- ----------- ------------
                                                                                           (In millions)
Supplemental information on non-cash investing and financing activities:
  Repurchases of debt using restricted cash and marketable securities           $     -     $     -     $  10.9
Supplemental disclosure of cash flow information:
  Interest paid, net of capitalized interest                                    $  81.1     $  73.5     $  72.7
  Income taxes paid, net
                                                                                    1.5         0.3         0.4

15. Quarterly Financial Information (Unaudited)

     Summary  quarterly  financial  information for the years ended December 31,
2006 and 2005 is as follows (in millions, except share information):

                                                                              Three Months Ended
                                                          ----------------------------------------------------------
                                                            March 31      June 30    September 30      December 31
                                                          ------------ ----------- ----------------  ---------------
2006:
  Net sales                                               $  80.2      $  63.5     $     77.8        $    70.0
  Operating income (loss)                                     6.3          2.0          443.5(1)          (2.8)
  Income (loss) before income taxes                          (9.5)       (15.4)         418.7(1)         (22.9)
  Net income (loss)                                         (10.2)       (11.2)         418.7(1)         (22.9)

  Basic earnings (loss), after cumulative effect of accounting
    change, per common and common stock equivalent
    share(2)                                              $ (1.59)     $ (1.97)    $    79.61        $   (4.36)
                                                          ============ =========== ================= ===============
  Diluted earnings (loss), after cumulative effect of
    accounting change, per common and common
    stock equivalent share(2)                             $ (1.59)     $ (1.97)    $    69.32        $   (4.36)
                                                          ============ =========== ================= ===============

2005:
  Net sales                                               $  83.0      $  87.2     $    105.8        $   130.4
  Operating income                                            2.8          6.5           19.7             26.5
  Income (loss) before income taxes                         (14.2)        (9.6)           4.3             15.4
  Net income (loss)                                         (14.2)        (9.6)           4.3             15.5
  Basic earnings (loss) per common and
    common equivalent share(2)                            $ (2.38)     $ (1.60)    $     0.72        $    2.60
                                                          ============ =========== ================= ===============
  Diluted earnings (loss) per common and common
    stock equivalent share(2)                             $ (2.38)     $ (1.60)    $     0.62        $    2.22
                                                          ============ =========== ================= ===============
------------------------
(1)   Includes gain of $430.9 million related to reversal of net investment in Kaiser.

(2) The sum of the quarterly income per share amounts may not equal the annual
   amount reported, as per share amounts are computed independently for each
   quarter and for the full year based on the respective weighted average common
   shares outstanding.

ITEM 9A. CONTROLS AND PROCEDURES

     Conclusion   Regarding  the   Effectiveness  of  Disclosure   Controls  and
Procedures

     Our management is responsible for establishing  and maintaining  disclosure
controls and procedures that are designed to ensure that information required to
be disclosed in the Company's reports under the Securities  Exchange Act of 1934
is  recorded,  processed,  summarized  and  reported  within  the  time  periods
specified in the rules and forms of the Securities and Exchange Commission,  and
that  such  information  is  accumulated  and  communicated  to our  management,
including  our  Chief  Executive  Officer  and  Chief  Financial   Officer,   as
appropriate,  to  allow  timely  decisions  regarding  required  disclosure.  In
designing and  evaluating  the disclosure  controls and  procedures,  management
recognized  that any controls and  procedures,  no matter how well  designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives,  and  management  necessarily  was required to apply its judgment in
evaluating the  cost-benefit  relationship of possible  controls and procedures.
Also, the Company has  investments in certain  unconsolidated  entities.  As the
Company does not control or manage these entities,  its disclosure  controls and
procedures  with respect to such  entities are  necessarily  substantially  more
limited than those it maintains with respect to its consolidated subsidiaries.

     As of the end of the period covered by this report,  our management carried
out an evaluation, under the supervision and with the participation of our Chief
Executive  Officer and Chief  Financial  Officer,  of the  effectiveness  of the
design and operation of the Company's disclosure controls and procedures.  Based
on the  evaluation,  our management,  including our Chief Executive  Officer and
Chief Financial Officer,  concluded that the Company's  disclosure  controls and
procedures were effective as of December 31, 2006.

Changes in Internal Control over Financial Reporting

     Since  September  30,  2006,  there have been no  changes in the  Company's
internal  controls over  financial  reporting  that  materially  affected or are
reasonably  likely to materially  affect the internal  controls  over  financial
reporting.

Management's Annual Report on Internal Control over Financial Reporting

     Our management is responsible for  establishing  and  maintaining  adequate
internal  control over  financial  reporting.  Internal  control over  financial
reporting is a process designed to provide  reasonable  assurance  regarding the
reliability of financial  reporting and the preparation of financial  statements
for  external  purposes  in  accordance  with  generally   accepted   accounting
principles and includes those policies and procedures that:

     (1)  Pertain  to the  maintenance  of  records  that in  reasonable  detail
          accurately and fairly reflect the transactions and dispositions of the
          assets of the registrant;
     (2)  Provide  reasonable   assurance  that  transactions  are  recorded  as
          necessary to permit preparation of financial  statements in accordance
          with generally accepted accounting  principles,  and that receipts and
          expenditures  of the registrant are being made only in accordance with
          authorizations of management and directors of the registrant; and
     (3)  Provide reasonable  assurance regarding prevention or timely detection
          of unauthorized  acquisition,  use or disposition of the  registrant's
          assets that could have a material effect on the financial statements.

     In designing and evaluating the internal control over financial  reporting,
management  recognized  that any  controls  and  procedures,  no matter how well
designed and operated,  can provide only  reasonable  assurance of achieving the
desired control objectives, and management necessarily was required to apply its
judgment in evaluating the  cost-benefit  relationship of possible  controls and
procedures.   Also,  the  Company  has  investments  in  certain  unconsolidated
entities.  As the  Company  does not  control  or  manage  these  entities,  its
disclosure controls and procedures with respect to such entities are necessarily
substantially  more  limited  than  those  it  maintains  with  respect  to  its
consolidated subsidiaries.

      As of the end of the period covered by this report, our management carried
out an evaluation, under the supervision and with the participation of our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures. This
evaluation was based on the framework in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on the evaluation, our management, including our Chief Executive Officer
and Chief Financial Officer, concluded that the Company's internal control over
financial reporting was effective as of December 31, 2006.

Dated: March 30, 2007

Attestation Report of the Registered Public Accounting Firm

To the Board of Directors and Stockholders of
MAXXAM Inc., Houston, Texas

We have audited  management's  assessment,  included in the accompanying  Annual
Report on Internal  Controls  over  Financial  Reporting,  that MAXXAM Inc.  and
subsidiaries  ("Company")  maintained  effective internal control over financial
reporting  as of December 31, 2006,  based on criteria  established  in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of  the  Treadway  Commission.  The  Company's  management  is  responsible  for
maintaining  effective  internal  control over  financial  reporting and for its
assessment of the  effectiveness of internal  control over financial  reporting.
Our  responsibility  is to express an opinion on management's  assessment and an
opinion on the  effectiveness  of the Company's  internal control over financial
reporting based on our audit.

We conducted  our audit in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain  reasonable  assurance  about whether  effective
internal  control  over  financial  reporting  was  maintained  in all  material
respects. Our audit included obtaining an understanding of internal control over
financial reporting,  evaluating management's assessment, testing and evaluating
the design and operating  effectiveness of internal control, and performing such
other  procedures as we considered  necessary in the  circumstances.  We believe
that our audit provides a reasonable basis for our opinions.

A company's internal control over financial  reporting is a process designed by,
or under the  supervision  of, the company's  principal  executive and principal
financial officers, or persons performing similar functions, and effected by the
company's  board of  directors,  management,  and  other  personnel  to  provide
reasonable  assurance  regarding the reliability of financial  reporting and the
preparation  of financial  statements for external  purposes in accordance  with
generally  accepted  accounting  principles.  A company's  internal control over
financial  reporting  includes those policies and procedures that (1) pertain to
the  maintenance  of records that, in reasonable  detail,  accurately and fairly
reflect  the  transactions  involving,  and  dispositions  of, the assets of the
company;  (2) provide  reasonable  assurance that  transactions  are recorded as
necessary to permit  preparation  of financial  statements  in  accordance  with
generally accepted accounting principles,  and that receipts and expenditures of
the company are being made only in accordance with  authorizations of management
and directors of the company;  and (3) provide  reasonable  assurance  regarding
prevention or timely detection of unauthorized acquisition,  use, or disposition
of the  company's  assets  that could have a  material  effect on the  financial
statements.

Because  of  the  inherent   limitations  of  internal  control  over  financial
reporting,  including  the  possibility  of  collusion  or  improper  management
override of controls,  material  misstatements  due to error or fraud may not be
prevented or detected on a timely basis. Also,  projections of any evaluation of
the  effectiveness  of the internal  control over financial  reporting to future
periods are subject to the risk that the controls may become inadequate  because
of changes in conditions,  or that the degree of compliance with the policies or
procedures may deteriorate.

In our opinion,  management's  assessment that the Company maintained  effective
internal  control over  financial  reporting as of December 31, 2006,  is fairly
stated, in all material respects,  based on the criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission. Also, in our opinion, the Company maintained, in all
material  respects,  effective  internal control over financial  reporting as of
December   31,   2006,   based  on  the   criteria   established   in   Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission.

We have also  audited,  in accordance  with the standards of the Public  Company
Accounting  Oversight Board (United States),  the consolidated balance sheets of
the Company as of  December  31,  2006, and 2005,  and the  related  consolidated
statements of operations,  cash flows, and stockholders' deficit for each of the
three years in the period ended  December 31, 2006. Our audits also included the
financial statement  schedules listed in the Index at Item 15(a)(2).  Our report
dated  March 30,  2007  expressed  an  unqualified  opinion  on those  financial
statements and financial  statement  schedules based on our audit and the report
of other auditors and included an explanatory paragraph regarding the ability of
MAXXAM  Inc.  and  subsidiaries  to  realize  their  timber-related  assets  and
discharge their timber related  liabilities in the normal course of business and
to continue as a going concern.

                                                      DELOITTE & TOUCHE LLP
Houston, Texas
March 30, 2007

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(b) Exhibits

     The following exhibits are filed in connection with this Amendment No.1:

     23.1 Consent of Deloitte & Touche LLP

     31.1 Section 302 Certification of Chief Executive Officer

     31.2 Section 302 Certification of Chief Financial Officer

     32.1 Section 906 Certification of Chief Executive Officer

     32.2 Section 906 Certification of Chief Financial Officer

                                SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the udnersigned, thereunto duly authorized.

Date:  April 5, 2007                            MAXXAM Inc.

                                      By: __________________________________
                                      M. Emily Madison, Vice President, Finance

                             INDEX OF EXHIBITS

The following exhibits are filed in connection with this Amendment No.1:

     23.1 Consent of Deloitte & Touche LLP

     31.1 Section 302 Certification of Chief Executive Officer

     31.2 Section 302 Certification of Chief Financial Officer

     32.1 Section 906 Certification of Chief Executive Officer

     32.2 Section 906 Certification of Chief Financial Officer
```