##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-K 
 ANNUAL REPORT PURSUANT
TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2004
    
    Commission File Number 1-3924
 MAXXAM INC.  Delaware
(State or other jurisdiction
of incorporation or organization)
    
    95-2078752
(I.R.S. Employer
Identification Number)1330 Post Oak Blvd., Suite 2000
Houston, Texas
(Address of Principal Executive Offices)
    
    77056
(Zip Code)
 Registrants telephone number, including area code: (713) 975-7600 Securities registered pursuant to Section 12(b) of the Act: Name of each exchangeTitle of each class
    
    on which registeredCommon Stock, $.50 par value
    
    American
 Securities registered pursuant to Section 12(g) of the Act: None. Indicate by check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ Noo 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. þ Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). Yes þ Noo 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: $82.4
million. Number of shares of common stock outstanding at March 1, 2005: 5,976,487 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.




---



TABLE OF CONTENTS Part IItem 1.
    
    Business
    
    
    
    
    3General
    
    
    3Forest Products Operations
    
    
    4Real Estate Operations
    
    
    14Racing Operations
    
    
    17Kaiser Aluminum
    
    
    18Item 2.
    
    Properties
    
    
    19Item 3.
    
    Legal Proceedings
    
    
    19Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    23Part IIItem 5.
    
    Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    24Item 6.
    
    Selected Financial Data
    
    
    25Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    26Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    45Item 8.
    
    Financial Statements and Supplementary Data
    
    
    46Report of Independent Registered Public Accounting Firm
    
    
    46Consolidated Balance Sheet
    
    
    47Consolidated Statement of Operations
    
    
    48Consolidated Statement of Cash Flows
    
    
    49Consolidated Statement of Stockholders Deficit
    
    
    50Notes to Consolidated Financial Statements
    
    
    51Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    88Item 9A.
    
    Controls and Procedures
    
    
    88Item 9B.
    
    Other Information
    
    
    90Part IIIItems 10-14.
    
    To be filed with the Registrants definitive proxy statement
    
    
    90Part IVItem 15.
    
    Exhibits and Financial Statement Schedules
    
    
    90Signatures
    
    
    
    
    95Index of Exhibits
    
    
    
    
    96Glossary of Defined Terms
    
    
    
    
    100Form of Stock Option AgreementList of SubsidiariesConsent of Deloitte & Touche LLPCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  2




---



##### Table of Contents



PART I 
 ITEM 1. BUSINESS 
 General MAXXAM Inc. and its subsidiaries are collectively referred to herein as the Companyor
MAXXAMunless otherwise indicated or the context indicates otherwise. Some terms used herein are
defined in the Glossary of Defined Terms. The Company conducts the substantial portion of its
operations through its subsidiaries, which operate in three principal industries. Any reference
herein to a company includes the subsidiaries of that company unless otherwise noted or the context
indicates otherwise.  
    Forest products, through MAXXAM Group Inc. (MGI) and MGIs wholly
owned subsidiary, The Pacific Lumber Company (Palco), and Palcos
wholly owned subsidiaries, Scotia Pacific Company LLC (Scotia LLC)
and Britt Lumber Co., Inc. (Britt). MGI operates in several
principal aspects of the forest products industry  the growing and
harvesting of redwood and Douglas-fir timber, the milling of logs into
lumber and the manufacture of lumber into a variety of finished
products. Housing, construction and remodeling are the principal
markets for the Companys lumber products.
    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.
    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 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 owns approximately 63% of Kaiser Aluminum Corporation
(Kaiser). Kaiser and a number of its subsidiaries have filed for reorganization under Chapter 11
of the United States Bankruptcy Code (the Bankruptcy Code). See Kaiser Aluminum and Notes 1
and 11 to the Consolidated Financial Statements contained herein. Except as otherwise indicated,
all references herein to Notes represent the Notes to the Consolidated Financial Statements
contained herein. This Annual Report onForm 10-Kcontains statements which constituteforward-looking
statements within the meaning of the Private Securities Litigation Reform Act of 1995 (PSLRA).
These statements appear in a number of places (see Item 1.BusinessForest Products
OperationsTimber and Timberlands 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, will,
should, plans or anticipates or the negative thereof or other variations thereon or
comparable terminology, or by discussions of strategy. Readers are cautioned that any such
forward-looking statements are not guarantees of future performance and involve significant risks
and uncertainties, and that actual results may vary materially from the forward-looking statements
as a result of various factors. These factors include the effectiveness of managements strategies
and decisions, general economic and business conditions, developments in technology, new or
modified statutory or regulatory requirements, 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. No assurance can be given that these are all of the
factors that could cause actual results to vary materially from the forward-looking statements. 
 3




---



##### Table of Contents



Forest Products Operations General The Company engages in forest products operations through MGI, Palco, Britt and Scotia LLC.
Palco, which has been in continuous operation for over 130 years, engages in several principal
aspects of the forest products industrythe growing and harvesting of redwood and Douglas-fir
timber, the milling of logs into lumber products and the manufacturing of lumber into a variety of
value-added finished products. Palco has over the past three years implemented a number of changes
to allow it to operate on a more efficient and cost effective basis. These changes include
undertaking a mill improvement project that will include a new
state-of-the-art mill, installing a new planer facility, closing two of its
sawmills, eliminating certain of its operations such as its company-staffed logging operations, and
utilizing more efficient harvesting methods. See Production Facilities. The Companys forest products operations have been adversely affected by the failure of the
California North Coast Regional Water Quality Control Board to release for harvest a number of
Palcos timber harvesting plans even though the plans have already been approved by the other
government agencies which review Palcos timber harvesting plans and are in compliance with Palcos
comprehensive multi-species habitat conservation plan. See Regulatory and Environmental
FactorsWater Quality 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 and Timberlands This section contains statements which constitute forward-looking statements within the
meaning of the PSLRA. See this section and BusinessGeneral above for cautionary information
with respect to such forward-looking statements. Palco owns and manages, directly or through subsidiaries, approximately 217,000 acres of
virtually contiguous commercial timberlands located in Humboldt County along the northern
California coast, an area which has very favorable soil and climate conditions for growing timber.
These timberlands, which are located in close proximity to Palcos sawmills and have an extensive
network of roads, contain predominantly conifer timber. Palcos conifers consist (by volume) of
approximately 66% redwood, 30% Douglas-fir, and 4% other conifer timber. Approximately 204,000
acres of Palcos timberlands are owned by Scotia LLC (the Scotia LLC Timberlands), and Scotia LLC
has the exclusive right to harvest (the Scotia LLC Timber Rights) approximately 12,200 acres of
timberlands owned by Palco and its subsidiary, Salmon Creek LLC (Salmon Creek). The timber in
respect of the Scotia LLC Timberlands and the Scotia LLC Timber Rights is collectively referred to
as the Scotia LLC Timber.The Scotia LLC Timberlands and the timberlands of Palco are
collectively referred to as the Palco Timberlands.Substantially all of Scotia LLC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
(collectively, the Timber Notes). The Indenture governing the Timber Notes is referred to herein
as the Timber Notes Indenture.Under a master purchase agreement, Palco harvests and purchases
from Scotia LLC virtually all of the logs harvested from the Scotia LLC Timber. See
Relationships among the Palco Companies below for a description of this and other relationships
among the Palco Companies. In March 1999, Palco, Scotia LLC, and Salmon Creek (collectively, the Palco Companies),
consummated the Headwaters Agreement (the Headwaters Agreement) with the United States and
California. Pursuant to the agreement, approximately 5,600 acres of timberlands owned by the Palco
Companies (the Headwaters Timberlands) were transferred to the United States government in
exchange for (i) an aggregate of $300.0 million, (ii) approximately 7,700 acres of timberlands, and
(iii) approval by the federal and state governments of habitat conservation and sustained yield
plans (the Environmental Plans) in respect of substantially all of the Palco Timberlands.
California also agreed to offer to purchase other timberlands owned by Palco and Scotia LLC (which
purchases were subsequently consummated). 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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. 4




---



##### Table of Contents



Scotia LLCs foresters, wildlife and fisheries biologists, geologists, botanists and
other personnel provide a number of forest stewardship techniques, including protecting the timber
located on the Scotia LLC Timberlands from forest fires,
erosion, insects and other damage, overseeing reforestation activities, and implementing and
monitoring environmental and regulatory compliance. Scotia LLCs
personnel also prepare timber harvesting plans (THPs) and
maintain and update the information contained in the GIS. See Harvesting Practices below for a
description of the GIS updating process and the THP preparation process. Palco and Scotia LLC
engage in extensive efforts to supplement the natural regeneration of timber and increase the
amount of timber on its timberlands. Scotia LLC 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. Pursuant to the services agreement
described below (see Relationships among the Palco Companies), Palco conducts regeneration
activities on the Scotia LLC Timberlands on behalf of Scotia LLC. Reforestation of redwood timber
generally is accomplished through redwood sprouts from 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 2004, Palco planted an estimated 1,350,000 redwood and Douglas-fir
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 (CDF) for review and approval. Timber companies which do not have a
sustained yield plan are allowed to follow alternative procedures (see below). Palco is 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 is made in accordance 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, the federal and state governments approved the Environmental
Plans, which consisted of a sustained yield plan (the SYP) and a multi-species habitat
conservation plan (the HCP) in respect of substantially all of the Palco Timberlands. However,
in connection with two lawsuits filed against Palco, a California court invalidated the SYP and the
incidental take permits issued by California in connection with the Environmental Plans (the
California Permits), a decision which Palco has appealed. See Item 3, Legal ProceedingsForest
Products Litigation. As a result of these cases, Palco has since October 2002 been obtaining review and approval of
its THPs under the 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), and may be used during the review and
approval period for the Option A plan. An approved Option A plan is an alternative to obtaining
approval of a sustained yield plan. In December 2004, Palco revised and resubmitted its Option A
plan, which document (the Option A Plan) is currently under review by the CDF. In May 2002, Palco completed its first timber cruise since 1986. The results of the timber
cruise provided Palco with an estimate of the volume of merchantable timber on the Palco
Timberlands. The 2002 cruise data reflected a 0.1 million MBF decrease in estimated overall timber
volume as compared to the estimated volumes reported as of December 31, 2001 using the 1986 cruise
data (adjusted for harvest and estimated growth). The 2002 cruise data indicated that the Palco
Timberlands have significantly less old growth timber than estimated as of December 31, 2001, using
the 1986 cruise data. There was also an estimated increase in young growth timber volume almost
equal to the estimated decrease in old growth timber volume. Harvesting Practices The ability of Palco to harvest timber depends in large part upon the ability to obtain
regulatory approval of THPs prepared by Scotia LLCs foresters. Prior to harvesting timber in
California, companies are obligated to obtain the 5




---



##### Table of Contents



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 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 Scotia LLCs approved THPs and the amount of timber covered by
such THPs varies 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 Timber Notes Indenture requires Scotia LLC 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 Scotia LLC Timber adequate to pay
interest and principal amortization based on the Minimum Principal Amortization schedule (as set
forth in the Timber Notes Indenture) for the Timber Notes for the next succeeding twelve-month
period. See Item 7. Managements Discussion and Analysis of Financial Condition and Results of
OperationsFinancial Condition and Investing and
Financing ActivitiesForest Products Operations regarding delays by the North Coast Water Board in
releasing already-approved THPs for harvest. 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 in connection with timber harvesting and
other operations on its timberlands. Scotia LLC maintains a detailed geographical information system covering the Palco
Timberlands (the GIS). 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 (defined below), Palco, to the extent
necessary, assists Scotia LLC in updating, upgrading and improving the GIS and the other computer
systems owned by Scotia LLC. By carefully monitoring and updating this data base and conducting
field studies, Scotia LLCs foresters are better able to develop detailed THPs addressing the
various regulatory requirements. Scotia LLC also utilizes a Global Positioning System (GPS)
which can provide precise location of geographic features through satellite positioning. Use of
the GPS greatly enhances the quality and efficiency of the GIS data. Scotia LLC 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 harvests which can be employed. Production Facilities Palco operates three highly mechanized sawmills and related facilities located in Scotia,
Fortuna and Arcata, California. Palcos sawmills historically have been supplied almost entirely
from timber harvested from Palcos timberlands, but are supplemented from time to time by logs
purchased from third parties. Palco has over the years implemented numerous technological advances
that have increased 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 state-of-the-art
sawmill located in Scotia. The new sawmill allows more efficient processing of smaller second
growth logs (up to 24 in diameter) and reduces operating and other costs. The first phase of the
project, the processing of smaller diameter logs, has been completed and production commenced in
the third quarter of 2004. Since commencing production, Palco has made substantial progress in
refining the production process. As part of the mill improvement project, equipment from Palcos
Carlotta mill is in the process of being moved to the new mill in Scotia to be used to process
larger diameter logs. Completion of this phase of the project is, however, subject to successful
resolution of the liquidity problems being experienced by Palco. See Managements Discussion and
Analysis of Financial Condition and Results of OperationsFinancial
Condition and Investing and Financing ActivitiesForest Products Operations.
The Carlotta mill was permanently closed at the end of 2004, and management is
considering alternative uses for the property. In addition, Palco in January 2004 completed a new
$5 6




---



##### Table of Contents



million planer project in Scotia. The new high speed state-of-the-art system processes rough
sawn boards into finished lumber up to four times faster than the older planers replaced by the new
system. Britts mill in Arcata,
California, primarily processes 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 produced approximately 86, 76 and 74 million
board feet of lumber in 2004, 2003 and 2002, respectively. Palcos remaining mill, located in
Fortuna, produces primarily common grade lumber. Subject to market conditions and lumber supply, Palco dries a substantial 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 which occurs in the drying process). Palco owns and can operate up to 35 kilns having an
annual capacity of approximately 95 million board feet. Palco also operates a finishing and remanufacturing plant in Scotia which processes rough
lumber into a variety of finished products such as trim, fascia, siding and paneling.
Remanufacturing enhances the value of some grades of lumber by assembling knot-free pieces of
narrower and shorter lumber into wider or longer pieces in Palcos state-of-the-art end and edge
glue plant. The result is a standard sized upper grade product which can be sold at a significant
premium over common grade products. 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 58% of the
fuel in 2004. The power plant is capable of producing up to 35 megawatts per hour and generates
substantially all of the energy requirements of Scotia, California, the town adjacent to the Palco
Timberlands. Several of Palcos facilities are located in Scotia and a number of its employees
live there. Palco sells surplus power to Pacific Gas and Electric Company. In 2004, the sale of
surplus power accounted for approximately 5% of MGIs total revenues. Products MGI produced 298.1, 289.3 and 267.8 million board feet of lumber in 2004, 2003 and 2002,
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, 2004
    
    
    Year Ended December 31, 2003% of Total
    
    
    
    
    
    
    
    
    
    
    % of TotalLumber
    
    
    % of Total
    
    
    
    
    
    
    Lumber
    
    
    % of TotalProduction
    
    
    Lumber
    
    
    % of Total
    
    
    Production
    
    
    Lumber
    
    
    % of TotalProduct
    
    Volume
    
    
    Revenues
    
    
    Revenues
    
    
    Volume
    
    
    Revenues
    
    
    RevenuesUpper grade redwood lumber
    
    
    6
    %
    
    
    13
    %
    
    
    12
    %
    
    
    9
    %
    
    
    18
    %
    
    
    16
    %Common grade redwood lumber
    
    
    70
    %
    
    
    71
    %
    
    
    63
    %
    
    
    72
    %
    
    
    70
    %
    
    
    62
    %Total redwood lumber
    
    
    76
    %
    
    
    84
    %
    
    
    75
    %
    
    
    81
    %
    
    
    88
    %
    
    
    78
    %Upper grade Douglas-fir lumber
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %
    
    
    3
    %
    
    
    3
    %Common grade Douglas-fir lumber
    
    
    21
    %
    
    
    14
    %
    
    
    12
    %
    
    
    15
    %
    
    
    8
    %
    
    
    7
    %Total Douglas-fir lumber
    
    
    22
    %
    
    
    15
    %
    
    
    13
    %
    
    
    16
    %
    
    
    11
    %
    
    
    10
    %Other grades of lumber
    
    
    2
    %
    
    
    1
    %
    
    
    1
    %
    
    
    3
    %
    
    
    1
    %
    
    
    1
    %Total lumber
    
    
    100
    %
    
    
    100
    %
    
    
    89
    %
    
    
    100
    %
    
    
    100
    %
    
    
    89
    %Logs
    
    
    
    
    
    
    
    
    
    
    3
    %
    
    
    
    
    
    
    
    
    
    
    3
    %Wood chips
    
    
    
    
    
    
    
    
    
    
    2
    %
    
    
    
    
    
    
    
    
    
    
    2
    %
 In 2004, MGI sold 296.9 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 7




---



##### Table of Contents



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
of redwood uppers, but has some knots, sapwood and a coarser grain. Such lumber is commonly used
for construction purposes, including outdoor structures such as decks 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. MGI does not have any significant contractual relationships with third parties relating to the
purchase of logs. During 2004, MGI purchased approximately 35.3 million board feet of logs from
third parties. 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, 2004 was $50.8 million, of which it is estimated
that $18.7 million will be shipped in the first quarter of 2005. The sales backlog at December 31,
2003, was $35.2 million, of which $12.7 million was shipped in the first quarter of 2004. 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. See also
Regulatory and Environmental Factors below 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. Marketing The housing, construction and remodeling markets are the primary markets for MGIs lumber
products. MGIs goal is to maintain a wide distribution of its products geographically. 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
2004. Common grades of Douglas-fir lumber are sold primarily in California. In 2004, MGIs
largest three customers accounted for approximately 13%, 7% and 5%, respectively, of MGIs total
net lumber sales. Exports of lumber accounted for approximately 3% of MGIs total net lumber sales
in 2004. MGI markets its products through its own sales staff which focuses primarily on domestic
sales. MGI actively follows trends in the housing, construction and remodeling markets in order to
maintain an appropriate level of inventory and assortment of products. Due to its high quality
products, strong brand recognition, competitive prices and long history, MGI believes it has a
strong degree of customer loyalty. However, this customer 8




---



##### Table of Contents



loyalty would be severely tested if
product shortages result from the failure of the North Coast Water Board to release for harvest
already-approved THPs. See Item 7. Managements Discussion and Analysis of Financial Condition and
Results of OperationsFinancial Condition and
Investing and Financing ActivitiesForest Products Operations. 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, 2005, MGI had approximately 835 employees. Relationships among the Palco Companies The Palco Companies are parties to several agreements among themselves, including a master
purchase agreement, a services agreement, an additional services agreement, a reciprocal rights
agreement, and an environmental indemnification agreement. Palco and Scotia LLC are parties to a master purchase agreement (the Master Purchase
Agreement) which governs the sale to Palco of logs harvested from the Scotia LLC Timberlands. As
Palco purchases logs from Scotia LLC pursuant to the Master Purchase Agreement, Palco is
responsible, at its own expense, for harvesting and removing the standing Scotia LLC Timber covered
by approved THPs, with the purchase price being based upon stumpage prices. Title to, and the
obligation to pay for, harvested logs passes to Palco once the logs are measured. The Master
Purchase Agreement contemplates that all sales of logs by Scotia LLC 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 Timber Notes 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 Scotia LLC 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. Scotia LLC relies on Palco, pursuant to a services agreement between the companies (the
Services Agreement), to provide operational, management and related services not performed by
Scotia LLCs own employees with respect to the Scotia LLC Timberlands. These services include
protecting the Scotia LLC Timberlands from fire, disease and insects; maintaining and
rehabilitating roads on the Scotia LLC Timberlands; building new roads to permit the harvesting of
Scotia LLC Timber; providing certain timber management services, such as replanting and
reforestation, designed to
supplement the natural regeneration of, and increase the amount of, Scotia LLC Timber;
assisting Scotia LLC to comply with all applicable environmental laws; advising and consulting with
Scotia LLC regarding legislative matters; preparing and filing on behalf of Scotia LLC (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 Scotia LLCs possession and reasonably necessary for the operation and maintenance of
the Scotia LLC Timberlands and Scotia LLC Timber. Palco is required to provide all services under the Services Agreement in a manner consistent
in all material respects with prudent business practices which are consistent with then-current
applicable industry standards and are in compliance in all material respects with all applicable
timber laws. Scotia LLC pays Palco a services fee which is 9




---



##### Table of Contents



adjusted annually based on a specified
government price index relating to wood products and reimburses Palco for the cost of constructing,
rehabilitating and maintaining roads, and performing reforestation services, on the Scotia LLC
Timberlands. Certain of such reimbursable expenses vary in relation to the amount of timber to be
harvested in any given period. Scotia LLC provides certain services to Palco pursuant to an additional services
agreement between the companies. These services include (i) assisting Palco to operate, maintain
and harvest its own timber properties, (ii) updating and providing access to the GIS with respect
to information concerning Palcos own timber properties and (iii) assisting Palco with its
statutory and regulatory compliance. This agreement provides that Palco shall pay Scotia LLC a fee
for such services equal to Scotia LLCs actual cost of providing such services, as determined in
accordance with generally accepted accounting principles. The Palco Companies are also 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 Scotia LLC are parties to an
environmental indemnification agreement, pursuant to which Palco has agreed to indemnify Scotia LLC
from and against certain present and future liabilities arising with respect to hazardous
materials, hazardous materials contamination or disposal sites, or under environmental laws with
respect to the Scotia LLC Timberlands. In particular, Palco is liable with respect to any
contamination which occurred on the Scotia LLC Timberlands prior to the date of their transfer to
Scotia LLC. 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 for cautionary information
with respect to such forward-looking statements. General Palcos business 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, and air and water quality. Compliance with such laws and regulations
also plays a significant role in Palcos business. 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, to demonstrate that their proposed timber operations constitute the
maximum sustainable production of their timberlands over time. See Timber and Timberlands
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 is also
subject to the California Environmental Quality Act (the 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 (the CWA), which require that Palco conduct its
operations so as to reasonably protect the water quality of nearby rivers and streams. Compliance
with such laws, regulations and judicial and administrative interpretations,
together with other regulatory and environmental matters, have resulted in substantial
restrictions on the scope and timing of Palcos timber operations, increased operational costs
significantly, and engendered continual litigation and other challenges to its operations.
Moreover, the cash flows of Palco and Scotia LLC have recently been adversely affected by the
failure of the North Coast Water Board to release for harvest THPs which have already been approved
by the other government agencies that approve Scotia LLCs THPs. See Water Quality below. 10




---



##### Table of Contents



Environmental Plans The Environmental Plans, consisting of the HCP and the SYP, which cover the substantial
portion of the timberlands of the Palco Companies, were approved by the federal and state
governments upon the consummation of the Headwaters Agreement. In connection with approval of the
Environmental Plans, incidental take 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. On October 31, 2003, the Court
hearing the EPIC-SYP/Permits lawsuit(as defined below), entered a judgment invalidating the SYP
and the California Permits, and that decision is now on appeal. 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 (consisting of 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 acres 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 to develop proposed harvesting
prescriptions. Prescriptions for the Van Duzen watershed were approved in January 2004.
Prescriptions for a third watershed (Lower Eel  Eel Delta) were approved in March 2004. The
Freshwater, Van Duzen and Lower Eel 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 any harvesting activities on potential landslide-prone areas. This effectively
reduced both the size and operational restrictions in respect of landslide-prone areas. The
analysis for a fourth watershed, Elk River, was submitted in mid-2004 for agency and public review,
and prescriptions for Elk River have been developed and are undergoing review by the relevant
agencies. The HCP required the Palco Companies, together with the government agencies, 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 proven to require more time than originally
anticipated. Accordingly, the Palco Companies have been working with the government agencies to
establish an appropriate timeline and to streamline the process for implementation of watershed
analysis on the remaining portions of Palco Timberlands to ensure that such studies are time and
cost efficient, and that such studies continue to provide scientific results necessary to evaluate
potential changes to the harvesting restrictions on those lands. The Palco Companies have received
an extension to March 2007 of the time in which the watershed analysis process must be completed.
A proposed streamlined process is undergoing review by the relevant agencies. 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. To date, over 450 miles of roads have been stormproofed. The HCP contains an adaptive management provision, which both the state and federal
governments have clarified will be implemented on a timely and efficient basis, and in a manner
which will be both biologically and economically sound. This provision allows the Palco Companies to propose changes to many of the HCP prescriptions
based on, among other things, economic considerations. The regulatory agencies have also clarified
that in applying this adaptive 11




---



##### Table of Contents



management provision, to the extent the changes proposed do not
result in the jeopardy of a particular species, the regulatory agencies will consider the
practicality of the suggested changes, including the cost and economic feasibility and viability.
The Palco Companies and the agencies have implemented various adaptive management changes related
to wildlife and rare plants, and other changes relating to roads and streamside buffers. These
adaptive management changes have increased Palcos ability to conduct harvesting operations and/or
reduce operating costs while still meeting the obligations of the Environmental Plans. Water Quality Laws and regulations dealing with water quality are impacting the Palco Companies
primarily in four areas: efforts by the federal Environmental Protection Agency (the EPA) and 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 to
impose waste discharge reporting requirements in respect of watersheds on the Palco Timberlands and
in some cases, clean-up or prevention measures; actions by the North Coast Water Board during the
THP approval process which impose certain operational requirements on individual THPs; and a
directive of the North Coast Water Board to its staff to develop watershed-wide waste discharge
requirements (WWDRs) for the Freshwater and Elk River watersheds. Under the CWA, the EPA is required to establish TMDLs for relevant contaminants 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. On the
Palco Timberlands, the relevant contaminant 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 this process to continue into 2010. In December 1999, the EPA
issued a report dealing with TMDLs on two 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. The North Coast Water Board has begun the process of
establishing the TMDL requirements applicable to two other watercourses on the Palco Timberlands,
with a targeted completion of 2006 for these two watercourses. Scotia LLCs scientists are
actively working with North Coast Water Board staff to ensure 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. For each of the three winter periods since 2002, the North Coast Water Board has required
Palco to submit Reports of Waste Discharge 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 the three 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 delays in THP approvals. The North Coast Water Board has also issued a clean up and abatement order (the Elk River
Order) for the Elk River watershed, 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 Freshwater and Bear Creek watersheds, and is contemplating
similar actions for the Jordan and Stitz Creek watersheds. The Elk River Order has 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. Palcos appeal of
the Elk River Order to the State Water Resources Control Board (the State Water Board) was
denied. Palco has appealed the decision of the State Water Board in state court , but is holding
such appeal in abeyance until resolution of the THP No. 520 lawsuitdescribed below. See Item 3.
Legal ProceedingsForest Products Litigation. In addition to the foregoing actions, the North Coast Water Board in December 2003 directed
its staff to create WWDRs for the Freshwater and Elk River watersheds. 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 12




---



##### Table of Contents



classes of trees, that action and the other matters described above could, in addition to the
potential effects noted above, individually or collectively result in reduced harvest. In that
regard, the staff of the North Coast Water Board has not yet formulated the required WWDRs for the
Freshwater and Elk River watersheds, and has on several occasions postponed its projected date for
their completion. As a result, the North Coast Water Board has failed to release for harvest a
number of Scotia LLCs THPs that are located in the Freshwater and Elk River watersheds, even
though these THPs have already been approved by the other government agencies which review Scotia
LLCs THPs and are in compliance with the HCP. The delay in receiving the release of these THPs
has adversely impacted the cash flows of both Palco and Scotia LLC. Furthermore, it is likely that
additional delays in the development of the Freshwater and Elk River WWDRs will occur, and such
delays could have adverse impacts beyond those currently being experienced. On February 25, 2005, the Executive
Officer of the staff of the North Coast Water Boardpublicly announced approval of the release of additional THPs such that Palco would be allowed to
harvest up to 50% of the harvest limit established by the CDF for the Freshwater and Elk River
watersheds. Since this announcement, Palco and Scotia LLC have continued their efforts with the
North Coast Water Board staff to obtain the release of additional THPs
and will make a presentation to the North Coast Water Board itself on March 16, 2005, in
furtherance of these efforts. No assurance can be given that the
efforts of Palco and Scotia LLC will
be successful. See Managements Discussion and Analysis of Financial Condition and Results of
OperationsFinancial Condition and Investing and
Financing ActivitiesForest Products Operations for
further information regarding this matter, including extraordinary
actions which Palco and Scotia LLC could be forced to take if their
efforts are not successful. California Senate Bill 810, which became effective January 1, 2004, provides regional water
quality control boards with additional authority related to the approval of THPs on land within
impaired watersheds. Under this law, a THP may not be approved if the appropriate regional water
quality control board finds, based on substantial evidence, that the timber operations proposed in
the plan will result in a discharge into a watercourse that has been classified as impaired due to
sediment...that causes or contributes, to a violation of the regional water quality control plan.
The Company is uncertain of the operational and financial effects which will ultimately result
from Senate Bill 810. While this provision has not yet been invoked in respect of the Palco
Timberlands, because substantially all rivers and waterbodies on the Palco Timberlands are
classified as sediment-impaired, implementation of this law could result in delays in obtaining
approval of THPs, lower harvest levels and increased costs and additional protection measures
beyond those contained in the HCP. Also see the description of the THP No. 520 lawsuitunder Item
3. Legal ProceedingsForests Products Litigation. Impact of Future Legislation 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 Operators 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 2003,
Palco was granted a Timber Operators License for 2004-2005. 13




---



##### Table of Contents



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, 2004 are as follows: Book Value asof December 31,2004(In millions)Palmas del Mar (Puerto Rico):Undeveloped land and parcels held for sale
    
    
    
    
    1,130
    acres
    
    $
    30.9Property, plant and equipment, receivables and other, net
    
    
    
    
    
    
    
    
    
    
    7.5Total
    
    
    
    
    
    
    
    
    
    
    38.4Resort operations  Palmas Country Club(1)
    
    
    
    
    
    
    
    
    
    
    25.8Total
    
    
    
    
    
    
    
    
    
    
    64.2Fountain Hills (Arizona):Residential, commercial and industrial developed lots, and lots
under development
    
    
    
    
    227
    lots
    
    
    9.8Undeveloped residential land
    
    
    
    
    431
    acres
    
    
    4.5Property, plant, equipment and receivables, net
    
    
    
    
    
    
    
    
    
    
    1.3Total
    
    
    
    
    
    
    
    
    
    
    15.6Mirada (California):Residential developed lots and lots under development, and residential units
    
    
    
    
    47
    lots
    
    
    21.4Undeveloped land
    
    
    
    
    39
    acres
    
    
    6.7Property, plant, equipment and receivables, net
    
    
    
    
    
    
    
    
    
    
    0.8Total
    
    
    
    
    
    
    
    
    
    
    28.9Commercial lease properties:Property, plant and equipment, net:Lake Pointe Plaza (Texas)
    
    
    
    
    
    
    
    
    
    
    112.9Cooper Cameron building (Texas)
    
    
    
    
    
    
    
    
    
    
    29.9Motel 6 facilities (10 states)

    
    
    
    
    
    
    
    
    
    
    46.6Other
    
    
    
    
    
    
    
    
    
    
    3.1Total
    
    
    
    
    
    
    
    
    
    
    192.5Other, principally receivables
    
    
    
    
    
    
    
    
    
    
    4.8Total real estate properties and receivables
    
    
    
    
    
    
    
    
    
    $
    306.0
   (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 asof December 31,2004(In millions)Joint Ventures:FireRock, LLC(1):Golf course, clubhouse and other club facilities
    
    $
    15.8Other property, plant and equipment, net
    
    
    3.3Total
    
    $
    19.1Investment in FireRock, LLC
    
    $
    4.4RMCAL, LLC (1)Residential units under development
    
    $
    11.5Investment in RMCAL, LLC
    
    $
    1.9
   (1)
    
    50% owned. Amounts reflect the book value of that 50% interest. 14




---



##### Table of Contents



Revenues from real estate operations were as follows in 2004
and 2003 (see Item 7. Managements Discussion and Analysis of Financial Condition and
Results of OperationsResults of OperationsReal Estate Operations for additional details on 2004,
2003 and 2002 results): Years EndedDecember 31,2004
    
    
    2003Palmas del Mar:Real estate sales
    
    $
    30.9
    
    
    $
    16.3Commercial, resort operations and other
    
    
    10.9
    
    
    
    8.2Total
    
    
    41.8
    
    
    
    24.5Fountain Hills:Real estate sales
    
    
    12.7
    
    
    
    19.3Commercial operations and other
    
    
    6.7
    
    
    
    4.0Total
    
    
    19.4
    
    
    
    23.3Mirada:Real estate sales
    
    
    16.1
    
    
    
    5.3Commercial operations and other
    
    
    0.1
    
    
    
    0.3Total
    
    
    16.2
    
    
    
    5.6Commercial lease properties:Lake Pointe Plaza
    
    
    9.9
    
    
    
    8.6Cooper Cameron building
    
    
    2.3
    
    
    
    2.3Motel 6 facilities
    
    
    4.8
    
    
    
    4.8Other
    
    
    0.2
    
    
    
    0.2Total
    
    
    17.2
    
    
    
    15.9Other:Real estate sales
    
    
    
    
    
    
    8.8Commercial operations and other
    
    
    0.2
    
    
    
    0.2Total
    
    
    0.2
    
    
    
    9.0Total
    
    $
    94.8
    
    
    $
    78.3FireRock, LLC(1):Real estate sales
    
    $
    15.1
    
    
    $
    14.2Golf course operations
    
    
    3.0
    
    
    
    2.5Total
    
    $
    18.1
    
    
    $
    16.7
   (1)
    50% owned. Amount reflects the revenues attributable to that 50% interest.  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, Palmas now has approximately 1,130 acres of
undeveloped land remaining. The Company conducts its operations at Palmas through Palmas del Mar
Properties, Inc. (PDMPI) and PDMPIs subsidiaries. PDMPI is planning the
development and/or sale of certain of the remaining acreage at Palmas. PDMPI is also considering
various alternatives to accelerate sales of its remaining acreage as well as disposition of other
assets. In connection with this, PDMPI has retained and is in the process of working with an agent
to assist in its efforts to solicit developer and investor interest in acquiring such acreage and
other assets. No assurance can be given that these efforts will be successful. 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 at Fountain Hills, Arizona, which is located near Phoenix and adjacent to
Scottsdale, Arizona. The year-round population of Fountain Hills is over 21,000. 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 expected to be 15




---



##### Table of Contents



released
in phases, including 20 lots in the first phase that were sold in 2004. 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 three phases of custom lots, three multifamily parcels and a
private country club. The clubs championship-level private 18-hole golf course opened in
2000. The multifamily parcels were sold in 2001 and 2002. Construction of the custom lot portion
of the project is complete and 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. Three of the six parcels within the
project have been developed, one of which is the first phase of a custom lot subdivision of 46
estate lots. The Lodge at Rancho Mirage, formerly 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
recently completed custom lot subdivision comprised of 63 estate lots. In 2004, a subsidiary of
the Company sold a one-half interest in a 27-acre parcel in Mirada to a real estate developer.
This subsidiary subsequently contributed the remaining one-half interest to, and entered into and
holds a 50% interest in, a joint venture formed by the developer and the subsidiary. The joint
venture, named RMCAL, LLC (RMCAL) will construct and sell 47 villas to be built on
the parcel. The two remaining parcels encompass approximately 39 acres. Under a development
agreement with the City of Rancho Mirage which extends until 2011, this acreage may be developed
with a variety of residential and commercial uses. The Company has also obtained final regulatory
and environmental approvals for development of these two parcels and is formulating plans for
development and/or marketing of these parcels.  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. 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. See Note 14 for further information regarding these commercial properties.  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. All 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 Country Club and RMCAL projects. 16




---



##### Table of Contents



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 golfing operation at the FireRock Country Club
development competes with similar businesses in the areas in and surrounding Phoenix, Arizona. 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, 2005, the Companys real estate operations had approximately 65
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 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. The review process is only
in the preliminary stages, and there can be no assurance that the Company will obtain this
additional license as, among other things, there is a competing applicant.  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. Revenues are also earned on live and
simulcast racing as both a guest and host track (i.e. both facilities receive broadcasts of live
racing conducted from other racetracks under various guest simulcast agreements and broadcast live
racing conducted at Sam Houston Race Park and Valley Race Park to other race tracks and off track
wagering sites under various host simulcast agreements). 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 17




---



##### Table of Contents



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, an expanded outdoor
advertising campaign, radio advertising, increased marketing of items offered outside of the racing
product, a VIP program with exclusive promotional offers, and greater focus on casual customers.
Valley Race Park employs similar strategies to attract patrons. Both race parks also rent out
facilities and grounds for group events, which are often unrelated to racing but which increase
revenues and expose the facility to potential customers. Sam Houston Race Park had 167 days of
live racing in 2004, a significantly greater number than usual as Sam Houston Race Park
accommodated requests from the racing industry to alleviate 2004 scheduling issues at the two other
Texas Class 1 horse tracks. Sam Houston Race Park currently has 122 days of live racing scheduled
for 2005. Valley Race Park had 126 live racing performances (over 110 days) during 2004, and
currently has 119 live racing performances (over 99 days) scheduled for 2005. 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, increasing use of the Internet for horse wagering and
general gaming, casinos located approximately 140 miles from Houston, a greyhound racetrack located
55 miles away, a wide range of sporting events and other entertainment activities in the Houston
area, the Texas State Lottery, and charitable bingo. Live racing also faces increasing competitive
pressure from simulcast signals broadcast by racinos, which are able to offer larger purses and
competitive fields. Sam Houston Race Park could in the future also compete with other forms of
gambling in Texas, including casino gambling on Indian reservations or otherwise. 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 its January to June 2005 regular session, consider measures to enhance state
revenues through additional forms of gaming such as video lottery terminals at existing horse and
dog racing tracks, gaming on Indian reservations, and full casinos. The Company will vigorously
pursue any such legislation that is favorable to it. As any legislation expanding gaming in Texas
would likely require the approval of two-thirds of each legislative house and a majority of the
states voters, no assurance can be given that any such legislation will be enacted or become
effective. Moreover, it is not possible to determine what the provisions of any such legislation
will be or its effect on the Company.  Employees As of March 1, 2005, the Companys racing operations had approximately 600 year-round
employees and approximately 250 seasonal employees. 
 Kaiser Aluminum The
Company owns approximately 63% of Kaiser, which operated in several principal
aspects of the aluminum industry prior to the bankruptcy filings described below. Kaiser, its
principal operating subsidiary, Kaiser Aluminum & Chemical Corporation (KACC), and a
number of KACCs subsidiaries (collectively, the Debtors) have filed for
reorganization under Chapter 11 of the Bankruptcy Code (the Cases). The Cases are
being jointly administered, with the Debtors managing their businesses in the ordinary course as
debtors-in-possession subject to the control and 18




---



##### Table of Contents



supervision of the Bankruptcy Court (the
Bankruptcy Court). See Note 11 for additional information regarding the status of
the Debtors reorganization proceedings. The Company and its subsidiary, MAXXAM Group
Holdings Inc. (MGHI), collectively own 50,000,000 shares of the common stock of
Kaiser (the Kaiser Shares). See Note 11 for the description of an agreement which
the Company and MGHI have with Kaiser regarding disposition of the Kaiser Shares. The Debtors have
indicated that they believe that the equity of Kaisers stockholders, including the Company,
will likely be cancelled without consideration. For further information concerning Kaiser, see
Item 3. Legal Proceedings-Kaiser Litigation, Item 7. Managements
Discussion and Analysis of Financial Condition and Results of
OperationsResults of
OperationsConsolidated OperationsDeconsolidation of Kaiser, and Note 11. 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. Employees At March 1, 2005, MAXXAM and its subsidiaries had approximately 1,775 year-round and seasonal
employees (excluding those employed by Kaiser), none of whom are covered by a collective bargaining
agreement. 
 ITEM 2. PROPERTIES For information concerning the principal properties of the Company, see Item 1.
Business. 
 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 and Item 1.
BusinessGeneral 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 Inc. (and in some instances,
certain of its subsidiaries) is involved. The term Company, as used in this section,
refers to MAXXAM Inc., except where reference is made to the Companys consolidated financial
position, results of operations or liquidity.  USAT Matters On December 26, 1995, the United States Department of Treasurys Office of Thrift
Supervision (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 (collectively, the Respondents) and
others with 19




---



##### Table of Contents



respect to the failure of United Savings Association of Texas (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 actionwas 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
(FDIC) in August 1995 against Mr. Charles E. Hurwitz (Chairman and Chief Executive
Officer of the Company). On May 31, 2000, the Respondents filed a counterclaim to the FDIC actionin the U.S. District
Court in Houston, Texas (No. H95-3956). On November 8, 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
actionagainst 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 OTSand FDIC actions. As of December 31, 2004, such fees were in excess of
$40.4 million. The Respondents are pursuing this claim vigorously. On January 16, 2001, an action was filed against the Company, Federated Development Company
(the predecessor of a principal shareholder of the Company; Federated) and certain of
the Companys directors in the Court of Delaware Chancery Court entitled Alan Russell Kahn v.
Federated Development Co., MAXXAM Inc., et al.,Civil Action 18623NC (the Kahn
lawsuit). The plaintiff purports to bring this action as a stockholder of the Company
derivatively on behalf of the Company. The lawsuit concerns the OTSand FDIC actions, and the
Companys advancement of fees and expenses on behalf of Federated and certain of the
Companys directors in connection with these actions. It alleges that the defendants have
breached their fiduciary duties to the Company, and have wasted corporate assets, by allowing the
Company to bear all of the costs and expenses of Federated and certain of the Companys
directors related to the OTSand FDIC actions. The plaintiff seeks to require Federated and
certain of the Companys directors to reimburse the Company for all costs and expenses
incurred by the Company in connection with the OTSand FDIC actions, and to enjoin the Company from
advancing to Federated or certain of the Companys directors any further funds for costs or
expenses associated with these actions. The parties to the Kahn lawsuithave agreed to an
indefinite extension of the defendants obligations to respond to the plaintiffs
claims. Although it is impossible to assess the ultimate outcome of the Kahn lawsuit, the Company
believes that the resolution of this matter should not result in a material adverse effect on its
consolidated financial condition, results of operations or liquidity. Forest Products Litigation A California state court has invalidated the SYP in connection with two lawsuits filed against
the Palco Companies, as described below, which decision has been appealed. Other pending judicial
and administrative proceedings could affect Palcos ability to implement the HCP, implement
certain approved THPs, or carry out other operations, as discussed below. One such lawsuit was
resolved during 2004 (see below). Certain of the remaining pending cases are described below. The
Services Agreement requires Palco to prepare and file on behalf of Scotia LLC (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. The plaintiffs sought, among other things, to set aside Californias approval of
the SYP and the California Permits and injunctive relief 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/Permitsand USWA lawsuitswere
consolidated for trial. 20




---



##### Table of Contents



Following trial, the Court on October 31, 2003 entered a judgment invalidating the SYP
and the California Permits due to several deficiencies in agency procedures and the failure of
Palco to submit a complete and comprehensible SYP. The Courts decision, however, allowed
for harvesting on THPs which rely on the SYP and were approved prior to July 23, 2003. The
short-term effect of the ruling was to preclude approval, under the SYP, of a small number of THPs
which were under review but had not been approved, and a minor reduction in 2003 harvesting that
had been expected from these specific THPs. As a result of this case, Palco has since October
2002, when the Court issued a stay order preventing future reliance upon the SYP, been obtaining
review and approval of new THPs under a procedure provided for in the forest practice rules that
does not depend upon the SYP and the California Permits. Palco expects to follow this procedure
until the Option A Plan is approved. See Item 1.
BusinessForest Products
OperationsTimber and Timberlands. Palco and the State of California have appealed
the October 31, 2003, decision. In September 2004, the Court granted the plaintiffs request
for reimbursement of an aggregate of $5.8 million in attorneys fees and other expenses incurred in
connection with these matters. Palco and the State of California have also appealed this decision. In July 2001, an action entitled Environmental Protection Information Center v. The Pacific
Lumber Company, Scotia Pacific Company LLC(the Bear Creek lawsuit) was filed in the
U.S. District Court for the Northern District of California (No. C01-2821), and later amended to
add the EPA as a defendant. The lawsuit alleges that Palcos harvesting and other forestry
activities under certain 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 defendants alleged continued violation of
the CWA. On October 14, 2003, in connection with certain motions that had been filed, the Court
upheld the validity of an EPA regulation which 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 which 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. Should the
decision ultimately become final and held to apply to all Palcos timber operations, 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. Nonetheless, it is not likely that civil penalties will be awarded for
operations that occurred prior to the Courts decision due to the historical reliance by
timber companies on the regulation and the Company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 14, 2003, ruling may be adverse, the Company does not believe
that such an outcome would 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 (No.s DR020718 and DR020719,
respectively), which also name Palco and certain affiliates as defendants. On April 4, 2003, the
plaintiffs in these actions filed amended complaints and served the defendants with notice of the
actions. The Cook actionalleges, 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 actioncontains similar allegations and requests similar
relief with respect to the Elk River watershed (a portion of which is contained on the Palco
Timberlands). 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. 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 Corporationin the Humboldt County Superior Court (No. DR030070)
(the Humboldt DA action). The suit was filed under Californias 21




---



##### Table of Contents



unfair
competition law and alleges that Palco used certain unfair business practices in connection with
completion of the Headwaters Agreement, and that this resulted in Palco being able to harvest
significantly more trees under the Environmental Plans 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. In
response to motions filed by Palco for sanctions and dismissal of this suit, on April 30, 2004, the
Court issued a ruling requiring the District Attorney to amend his suit to prove that
extrinsic fraud occurred. In addition, the Court eliminated the remedies being
sought, other than for civil penalties, and suggested that it would be inappropriate to base civil
penalties on the additional trees harvested. The Court also ruled that it declined at this
juncture to impose sanctions on the District Attorney. The District Attorney subsequently
amended his suit, and Palco later filed new motions to dismiss and for sanctions. After delays
resulting from the District Attorneys efforts to disqualify the trial judge, and that
judges later self-disqualification, a hearing on these motions was held on February 18,
2005. The Court rejected the sanctions motion, but has not yet ruled on the motion for dismissal.
The Company believes that this suit is without merit and that the
April 30, 2004, ruling diminished
significantly its exposure with respect to this matter; however, there can be no assurance that
Palco will ultimately prevail, or that an adverse outcome would not be material to the
Companys consolidated financial condition, results of operations or liquidity. On December 17, 2003, an action entitled Humboldt Watershed Council, et al. v. North Coast
Regional Water Quality Board, et al.(the HWC 2003
lawsuit), naming Palco as a real
party in interest, was filed in the Humboldt County Superior Court (No. CV030961). The plaintiffs
allege that the North Coast Water Board should have required waste discharge reports in respect of
all timber harvesting activities in the Freshwater and Elk River watersheds, including those of
Palco. This action has been dismissed by the plaintiffs. On November 4, 2004, an action entitled Environmental Protection Information Center, et al. v.
California Department of Forestry and Fire Protection, et al.was filed in Humboldt County Superior
Court (No. CV04-0809). This action sought an order staying or setting aside CDFs approval
of six THPs along the Van Duzen river, and an order requiring CDF to conduct further review and
analysis of the six THPs and to refrain from reliance on information not made available for public
review and comment. Following denial by the trial judge of the plaintiffs request for
injunctive relief and various appellate proceedings which resulted in harvesting operations being
allowed to continue, the case was dismissed by the plaintiffs. On November 2, 2004, an action entitled Environmental Protection Information Center v. U.S.
Fish & Wildlife Service, NOAA Fisheries, et al.(No. C04-4647) was filed in the U.S. District Court
for the Northern District of California (the EPIC-USFWS/NOAA lawsuit). This lawsuit
alleges that two federal agencies have violated certain federal laws and related regulations in
connection with their oversight of the HCP and related incidental take permits issued by the
federal government (the Federal Permits). The
plaintiff also alleges that the Federal Permit for the northern spotted owl was unlawfully issued
and that Palco violated Californias unfair competition law by using false advertising and
making misleading environmental claims. The plaintiff seeks a variety of remedies, including
requiring additional actions by the federal agencies and precluding them from authorizing
take of the northern spotted owl, an injunction requiring Palco to cease certain alleged
unlawful activities, as well as restitution and remediation by Palco. Motions have been filed by
the federal government and Palco seeking dismissal of substantial portions of this case, but a
hearing date on this motion has not yet been set. The Company does not believe the resolution of
this action should result in a material adverse effect on its consolidated financial condition,
results of operations or liquidity. On November 16, 2001, Palco filed a case entitled The Pacific Lumber Company, et al. v.
California State Water Resources Control Board(No. DR010860) in Humboldt County Superior Court
(the THP No. 520 lawsuit) alleging that the State Water Board had no legal authority
to impose mitigation measures that were requested by the staff of the North Coast Water Board
during the THP review process and rejected by the CDF prior to approving the THP. When the staff
of the North Coast Water Board attempted to impose these mitigation measures in spite of the
CDFs decision, Palco appealed to the State Water Board, which imposed certain of the
requested mitigation measures and rejected others. Palco filed the THP No. 520 lawsuitchallenging
the State Water Boards decision, and in January 2003, the Superior Court granted
Palcos request for an order invalidating the imposition of these additional measures. The
State Water Board appealed this decision, and on March 18, 2004 the appellate court reversed the
decision of the Superior Court. The appellate courts decision could result in increased
demands by the regional and state water boards and their staffs to impose controls and limitations
upon Palcos timber harvesting beyond those provided for by the Environmental Plans or could
provide additional regulatory powers to the regional and state water boards and their staffs beyond
those provided in Senate Bill 810. Palco filed a petition for review of the appellate
courts decision by the California Supreme Court, which in June 2004 agreed to review the
decision. 22




---



##### Table of Contents



Kaiser Litigation See Note 11 for a discussion of Kaisers reorganization proceedings. Kaiser is a
defendant in a number of lawsuits, some of which involve claims of multiple persons, in which the
plaintiffs allege that certain of their injuries were caused by, among other things, exposure to
asbestos during, and as a result of, their employment or association with Kaiser or exposure to
products containing asbestos produced or sold by Kaiser. A variety of other lawsuits and claims
are pending against Kaiser. Generally, claims against Kaiser arising from actions or omissions
prior to the dates on which the Debtors filed their Cases will be settled in connection with
Kaisers plan of reorganization. Other Matters On September 2, 2004, the Company was advised that one of its former subsidiaries (which was
dissolved in 1999) is a successor to a company which manufactured munitions for the U.S. Navy
during World War II. The current owner of the underlying property, which is located in Cranbury,
New Jersey, is seeking participation by MGI, the parent of the former
subsidiary, in efforts to address contamination of the site which resulted from such operations.
The current owner estimates that the costs to determine what remedial actions are needed, and to
perform any remedial actions determined necessary, could range from $3.0 million to $8.0 million.
Costs for the investigation and remediation could exceed $8.0 million as the result of information
learned during the investigation. The Company is currently in the process of determining the
extent of its liability, which could require payment of a substantial portion of the costs, as well
as the availability of funding from the U.S. Navy and insurance coverage for these activities.
Such investigation is anticipated to take several months to complete. On December 29, 2004, the New Jersey Department of Environmental Protection
(NJDEP) issued a Directive against the current owner of the property, MGI, and the
U.S. Navy requiring these parties to conduct a remedial investigation and remedial action
(RI/RA) in respect of the property. As further required by the Directive, MGI and
the current owner on January 28, 2005, entered into an Administrative Consent Order
(ACO) providing, among other things, that MGI and the current owner begin
implementing the RI/RA within 120 days of execution of the ACO. MGI and the current owner of the
property have also entered into a Participation Agreement providing, among other things, for them
to jointly fund the RI/RA and for a mediation process to assist in equitably allocating the costs
of the RI/RA. On January 21, 2004, the owner of the Candelero Hotel located at Palmas filed a lawsuit
against PDMPI claiming an easement on certain property owned by PDMPI, as well as damages. On
September 30, 2004, this matter was settled by an agreement in which the hotel owner dismissed all
of its claims and agreed to purchase for $9.0 million a parcel of land that included the area
covered by the alleged easement. This transaction closed in November 2004. The Company is 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 23




---



##### Table of Contents



PART II 
  ITEM 5.
    MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES The Companys common stock, $.50 par value (Common Stock), is traded on the American Stock Exchange. The stock symbol is MXM. The
following table sets forth, for the calendar periods indicated, the high and low sales prices per
share of the Companys Common Stock as reported on the American Stock Exchange Consolidated
Composite Tape. 2004
    
    
    2003High
    
    
    Low
    
    
    High
    
    
    LowFirst quarter
    
    $
    28.57
    
    
    $
    18.51
    
    
    $
    9.61
    
    
    $
    8.20Second quarter
    
    
    31.60
    
    
    
    23.50
    
    
    
    15.31
    
    
    
    8.84Third quarter
    
    
    30.00
    
    
    
    25.85
    
    
    
    16.16
    
    
    
    12.90Fourth quarter
    
    
    33.50
    
    
    
    27.00
    
    
    
    19.73
    
    
    
    14.65
 The following table sets forth the number of record holders of each class of publicly owned
securities of the Company at March 1, 2005: Number ofRecordTitle of Class
    
    HoldersCommon Stock
    
    
    2,776Class A $.05 Non-cumulative Participating Convertible Preferred Stock
    
    
    20
 The Company has not declared any cash dividends on its capital stock and has no present
intention to do so. The Company may from time to time purchase shares of its Common Stock on national exchanges or
in privately negotiated transactions. No such purchases occurred during the twelve months ended
December 31, 2004, or through the date of this Report. 24




---



##### Table of Contents



ITEM 6. SELECTED FINANCIAL DATA The following summary of consolidated financial information for each of the five years ended
December 31, 2004 is not reported upon herein by independent public accountants and should be read
in conjunction with the Consolidated Financial Statements and the Notes thereto which are contained
in Item 8 herein. Years Ended December 31,2004
    
    
    2003
    
    
    2002(1)
    
    
    2001
    
    
    2000(In millions of dollars, except per share amounts)Consolidated statement of operations:Net sales
    
    $
    347.5
    
    
    $
    336.6
    
    
    $
    366.7
    
    
    $
    1,064.9
    
    
    $
    1,407.9Income (loss) before income taxes, minority interests
and discontinued operations(2)
    
    
    (46.9
    )
    
    
    (10.6
    )
    
    
    (96.0
    )
    
    
    (307.1
    )
    
    
    (161.4
    )Income (loss) from continuing operations
    
    
    (46.6
    )
    
    
    (11.6
    )
    
    
    (81.4
    )
    
    
    (780.7
    )
    
    
    (156.5
    )Income (loss) from discontinued operations, net of tax(3)
    
    
    
    
    
    
    
    
    
    
    (2.6
    )
    
    
    324.7
    
    
    
    190.4Net income (loss)
    
    
    (46.6
    )
    
    
    (11.6
    )
    
    
    (84.0
    )
    
    
    (456.0
    )
    
    
    33.9Consolidated balance sheet at end of period:Total assets (3)
    
    
    1,015.2
    
    
    
    1,060.8
    
    
    
    1,107.3
    
    
    
    3,935.3
    
    
    
    4,504.0Long-term debt, less current maturities(3)
    
    
    912.0
    
    
    
    953.5
    
    
    
    982.3
    
    
    
    1,706.8
    
    
    
    1,882.8Stockholders equity (deficit)(4)
    
    
    (657.1
    )
    
    
    (601.9
    )
    
    
    (582.5
    )
    
    
    (475.6
    )
    
    
    49.1Per share information:Basic and diluted net income (loss) per share
    
    $
    (7.79
    )
    
    $
    (1.79
    )
    
    $
    (12.87
    )
    
    $
    (69.28
    )
    
    $
    4.47
   (1)
    
    Results for the Companys aluminum operations have been included for the
period from January 1, 2002, through February 11, 2002 and for the two years ended December
31, 2001. Such results have been excluded for the subsequent periods. See Note 1 for a
discussion of the Chapter 11 filings by the Debtors (which commenced February 12, 2002).(2)
    
    Income (loss) before income taxes and minority interests includes the following
items:  
    2004 includes a $1.4 million charge for employee severance and benefit costs at Palco
(see Note 3). 2004 also includes a $1.9 million charge in connection with an environmental
matter associated with a former subsidiary of the Company (see Note 3).
    2003 includes a gain on the sale of acreage in the Grizzly Creek grove of $16.8 million
(see Note 14), $8.0 million of insurance recoveries related to the OTSand FDIC actions
(see Note 3), as well as a $1.4 million charge to write-down the Companys
casino-related assets to estimated fair value (see Note 3).
    2002 includes other items of $0.5 million attributable to Kaiser for the period from
January 1, 2002, through February 11, 2002 (see Note 3).
    2001 includes the following related to Kaiser: additional valuation allowances related
to Kaisers deferred tax assets of $505.4 million (see Note 9), business interruption
insurance recoveries of $36.6 million, a gain of $163.6 million on the sale of an
approximate 8.3% interest in Queensland Alumina Limited
(QAL), a charge of $57.2 million for asbestos-related
claims, and net gains on power sales and several other non-recurring items totaling $163.6
million. 2001 results include the following related to Palco: a gain of $16.7 million on
the sale of acreage in the Grizzly Creek grove.
    2000 includes the following related to Kaiser: estimated business interruption
insurance recoveries of $110.0 million and several other non-recurring items totaling $48.9
million. 2000 results include the following related to Palco: a gain on the sale of the
Owl Creek grove of $60.0 million.  (3)
    During 2004, Kaiser completed the sale of its interests in Alumina Partners of
Jamaica (Alpart), the alumina refinery located in Gramercy,
Louisiana (Gramercy), Kaiser Jamaica Bauxite Company
(KJBC), Volta Aluminium Company Limited
(Valco), and Kaisers Mead facility and certain related
property (the Mead Facility). In addition, Kaiser has
received confirmation from the Bankruptcy Court to proceed with the sale of its interest in
QAL. Alpart, Gramercy, KJBC, Valco, the Mead Facility, QAL and Kaisers hedging
operations are collectively referred to as Kaisers Discontinued Operations. The assets and long-term debt, less current maturities reported
as discontinued operations are included in the Consolidated Balance Sheet amounts presented
above as of December 31, 2001 and 2000. However, the results of operations of Kaisers
Discontinued Operations are reported separately as discontinued operations in the Consolidated
Statements of Operations for the period from January 1, 2002, to February 11, 2002, and for
the years ended December 31, 2001 and 2000. The assets and long-term debt of Kaisers
Discontinued Operations as of December 31, 2002, are not included in the table above due to
the deconsolidation of Kaiser on February 12, 2002.(4)
    MAXXAM Inc. did not declare or pay any cash dividends during the five year
period ended December 31, 2004. 25




---



##### Table of Contents



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 and below for
cautionary information with respect to such forward-looking statements. The Company operates in three industries: forest products, through MGI and its wholly owned
subsidiaries, principally Palco, Scotia LLC and Britt; 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. In addition, the Company owns
62% of Kaiser, a producer of fabricated aluminum products. Any reference herein to a company
includes the subsidiaries of that company unless otherwise noted or the context indicates
otherwise. Consolidated Operations Selected Operational Data The following table presents selected financial information for the years ended December 31,
2004, 2003 and 2002 for the Companys consolidated operations. Years Ended December 31,2004
    
    
    2003
    
    
    2002(In millions of dollars)Net sales
    
    $
    347.5
    
    
    $
    336.6
    
    
    $
    366.7Costs and expenses
    
    
    (333.3
    )
    
    
    (312.7
    )
    
    
    (383.5
    )Gains on sales of timberlands and other assets
    
    
    0.1
    
    
    
    17.5
    
    
    
    0.9Operating income (loss)
    
    
    14.3
    
    
    
    41.4
    
    
    
    (15.9
    )Other income
    
    
    12.8
    
    
    
    25.0
    
    
    
    12.5Interest expense
    
    
    (74.0
    )
    
    
    (77.0
    )
    
    
    (92.6
    )Loss before income taxes, minority interests and discontinued operations
    
    
    (46.9
    )
    
    
    (10.6
    )
    
    
    (96.0
    )Benefit (provision) for income taxes
    
    
    0.3
    
    
    
    (1.0
    )
    
    
    14.4Minority interests
    
    
    
    
    
    
    
    
    
    
    0.2Income (loss) from discontinued operations
    
    
    
    
    
    
    
    
    
    
    (2.6
    )Net loss
    
    $
    (46.6
    )
    
    $
    (11.6
    )
    
    $
    (84.0
    )Revenues by segment as a percentage of total:Forest products
    
    
    58.2
    %
    
    
    61.9
    %
    
    
    54.5
    %Real estate
    
    
    27.3
    %
    
    
    23.3
    %
    
    
    13.3
    %Racing
    
    
    14.5
    %
    
    
    14.8
    %
    
    
    14.3
    %Aluminum
    
    
    
    %
    
    
    
    %
    
    
    17.9
    %100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
 Deconsolidation of 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. As a
result of Kaisers filing for bankruptcy (as discussed in Note 1), Kaisers financial
results were deconsolidated beginning February 12, 2002, and the Company began reporting its
investment in Kaiser using the cost method, under which the investment is reflected as a single
amount on the Companys balance sheet of $(516.2) million, and the recording of earnings or
losses from Kaiser was discontinued after February 11, 2002. Since Kaisers results are no
longer consolidated and the Company believes that it is not probable that it will be obligated to
fund losses related to its investment in Kaiser, any adjustments reflected in Kaisers
financial statements subsequent to February 12, 2002 (relating to the recoverability and
classification of recorded asset amounts and the classification of liabilities or the effects 26




---



##### Table of Contents



on existing stockholders deficit as well as adjustments made to Kaisers financial
information for loss contingencies and other matters), are not expected to affect the
Companys financial results. The following condensed pro forma financial data reflects the results of operations of
the Company, excluding Kaiser, for the year ended December 31, 2002, the year in which Kaiser was
deconsolidated (in millions, except share data). Net sales
    
    $
    301.0Costs and expenses
    
    
    (292.5
    )Operating income
    
    
    8.5Other income
    
    
    20.7Interest expense
    
    
    (80.2
    )Loss before income taxes and minority interest
    
    
    (51.0
    )Income tax benefit (provision)
    
    
    15.2Minority interests
    
    
    0.3Net loss
    
    $
    (35.5
    )Basic and diluted net loss per share
    
    $
    (5.45
    )
 See Notes 1 and 11 for further discussion of Kaisers reorganization proceedings
and other information regarding the Companys investment in Kaiser. Kaiser Discontinued Operations As part of Kaisers plan to divest certain of its commodity-based assets, Kaiser during
2004, with the approval of the Bankruptcy Court, completed or finalized plans for the sale of its
interests in Kaisers Discontinued Operations. In accordance with Statement of Financial
Accounting Standards No. 144, Accounting for the Impairment and Disposal of Long-Lived
Assets (SFAS No. 144), the operating results of Kaisers interests in
the divested assets have been reported as discontinued operations in the accompanying Consolidated
Statement of Operations for the period from January 1, 2002, to February 11, 2002, the date that
Kaiser was deconsolidated (see discussion of the deconsolidation of Kaiser above). Combined income
statement information in respect of Kaisers Discontinued Operations for the period from
January 1, 2002, to February 11, 2002, included in income (loss) from discontinued operations is as
follows (in millions): Period fromJanuary 1, 2002, toFebruary 11, 2002Net sales
    
    $
    101.8Operating income
    
    
    0.8Income before income taxes and minority interests
    
    
    0.7Net loss
    
    
    (2.6
    )
 Overview of Consolidated Results of Operations Net Sales Net sales for 2004 totaled $347.5 million, compared to $336.6 million in 2003. Net sales for
the real estate segment increased $16.5 million due to higher sales of real estate acreage at the
Companys Palmas del Mar and Mirada developments. Net sales for the racing segment increased
$0.8 million due to more live race days being held. Net sales for the Companys forest
products segment decreased $6.4 million primarily due to lower lumber revenues. Lumber sales for
2004 were impacted by lower shipments resulting from lower harvest levels. Net sales for 2003 totaled $336.6 million, compared to $366.7 million in 2002. The decline is
primarily attributable to the deconsolidation of Kaisers financial results beginning
February 12, 2002, the date Kaiser filed for Chapter 11 reorganization. Net sales for 2002
included $65.7 million attributable to Kaiser (excluding discontinued operations) for the period
from January 1, 2002 to February 11, 2002, whereas 2003 included none of Kaisers financial
results. Net sales for the Companys forest products segment increased $9.1 million for 2003
versus 2002, reflecting favorable trends in lumber prices, while net sales for the real estate
segment increased $29.4 million for 2003 as compared to 2002, primarily due to increased sales of
real estate acreage and commercial lots. Due to a decline in attendance, 2003 net sales for the
Companys racing segment declined by $2.9 million from 2002. 27




---



##### Table of Contents



Operating Income (Loss) The Company recorded operating income of $14.3 million in 2004 compared to operating
income of $41.4 million for the prior year period. Operating results for the forest products
segment decreased by $29.1 million, primarily as a result of the decrease in net sales noted above
and an increase in cost of sales due primarily to declines in harvest, which led to higher third
party log purchases. The real estate segment recorded operating income of $29.7 million versus
operating income of $17.1 million in 2003, primarily due to the increases in net sales noted above.
The racing segments operating loss increased by $1.2 million despite the increase in live
race days noted above due primarily to an increase in marketing and development costs. The
corporate segments operating loss increased by $9.4 million due primarily to an increase in
stock-based compensation expense which is adjusted as the market value of the Companys
Common Stock changes, in addition to a $1.9 million charge for an environmental matter discussed
under Other Matters in Note 12. The Company recorded operating income of $41.4 million in 2003 compared to an operating loss
of $15.9 million in 2002. Operating income for the Companys forest products segment
increased $15.7 million for 2003, primarily due to $17.5 million in gains on sales of timberlands
and other assets, while the real estate segments operating results improved from a loss of
$0.2 million in 2002 to income of $17.1 million in 2003 as a result of the increase in net sales
discussed above. Results for the racing segment declined from operating income of $0.4 million in
2002 to an operating loss of $1.9 million in 2003 as a result of an increase in selling, general
and administrative expenses. Kaiser contributed $24.4 million (excluding discontinued operations)
to the consolidated operating loss for 2002. Loss Before Income Taxes, Minority Interests and Discontinued Operations The Companys consolidated loss before income taxes, minority interests and discontinued
operations increased by $36.3 in 2004 compared to the prior year, primarily as a result of the
decrease in operating income discussed above. Investment, interest and other income decreased by
$12.2 million, primarily because results for 2003 included income related to an $8.0 million
reimbursement from an insurer for certain costs incurred in connection with the OTSand FDIC
actions. The Companys consolidated loss before income taxes, minority interests and discontinued
operations decreased by $85.4 million in 2003 compared to the prior year, principally due to the
deconsolidation of Kaiser and the improved operating results discussed above. In addition, the
Companys investment, interest and other income for 2003 includes income related to the $8.0
million reimbursement from an insurer discussed above. Interest expense decreased $8.1 million in
2003 from the preceding year as a result of early extinguishment of MGHIs Senior Secured
Notes (the MGHI Notes). Forest Products Operations Industry Overview and Selected Operational Data 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. The Companys forest products operations are conducted through MGI and its wholly owned
subsidiaries, principally Palco, Scotia LLC and Britt. The segments business is somewhat
seasonal, and its net sales have been historically higher in the months of April through November
than in the months of December through March. Management expects that the segments revenues
and cash flows will continue to be somewhat seasonal. Accordingly, the segments results for
any one quarter are not necessarily indicative of results to be expected for the full year. Regulatory and environmental matters as well as certain pending legal matters play a
significant role in the Companys forest products operations. See Item 1.
BusinessForest Products OperationsRegulatory and Environmental Matters
and Note 12 for further discussion of these matters. Regulatory compliance and related litigation
have caused and may continue to cause delays in approval of THPs and delays in harvesting on THPs
once they are approved. This has resulted and may continue to result in a decline in harvest, an
increase in the cost of logging operations, and increased costs related to timber harvest
litigation. The cash flows of Palco and Scopac have both been adversely impacted by the failure of
the North Coast Water Board to release for harvest a number of already-approved THPs. Scotia LLC
expects that without the release of 28




---



##### Table of Contents



additional THPs, its cash flows from operations, together with funds available under
its line of credit, will be inadequate to pay the entire amount of interest
due on the July 20, 2005, payment date for its Timber Notes. Palco is in
default under the Palco Credit Agreement and estimates that, without the
prompt release of a substantial portion of these THPs and necessary
amendments to the Palco Credit Agreement, its cash flow from
operations,
together with funds available under the Palco Credit Agreement, will not
provide sufficient liquidity to fund its current level of operations.
For further information, see Financial Condition and Investing and Financing
ActivitiesForest Products Operations. Furthermore, there can be no assurance that certain other pending legal, regulatory and
environmental matters or future governmental regulations, legislation or judicial or administrative
decisions, adverse weather conditions, or low lumber or log prices, will not have a material
adverse effect on the Companys financial condition, results of operations or liquidity. See Item
1. BusinessForest Products OperationsRegulatory and Environmental Factors, Item 3. Legal
Proceedings and Note 12 for further information regarding regulatory and legislative matters and
legal proceedings relating to the Companys forest products operations. 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. Based upon these reviews, Palco implemented
a number of changes during the last quarter of 2001 and the first quarter of 2002, including
closing two of its four sawmills, eliminating certain of its operations, including its
company-staffed logging operations (now relying exclusively on contract loggers) and its soil
amendment and concrete block activities, utilizing more efficient harvesting methods and adopting
other cost saving measures. Palco has continued to examine ways in which to achieve additional
cost savings. During 2004, Palco opened a new planer facility in Scotia and began construction on
a new sawmill in Scotia, California. The project is expected to cost $27.3 million ($20.5 million
of which was expended in 2004) with the last phase scheduled for completion in the third quarter of
2005 (subject to available cash). Funds for this project are being provided from existing cash
resources and borrowings under the Palco Credit Agreement. As part of the project, the Carlotta
mill was permanently closed, and the equipment from the Carlotta mill is in the process of being
moved to the new mill in Scotia. Management is considering alternative uses for the property.
Further actions may be taken during 2005 as a result of Palcos continuing evaluation process or in
response to the financial difficulties discussed above, and writedowns of certain assets may be
required. 29




---



##### Table of Contents



The following table presents selected operational and financial information for the years
ended December 31, 2004, 2003 and 2002 for the Companys forest products operations. Years Ended December 31,2004
    
    
    2003
    
    
    2002(In millions of dollars,except shipments and prices)Shipments:Lumber: (1)Redwood upper grades
    
    
    17.4
    
    
    
    26.4
    
    
    
    27.0Redwood common grades
    
    
    209.2
    
    
    
    215.8
    
    
    
    224.3Douglas-fir upper grades
    
    
    2.5
    
    
    
    4.4
    
    
    
    4.7Douglas-fir common grades
    
    
    61.6
    
    
    
    44.4
    
    
    
    22.4Other
    
    
    6.2
    
    
    
    7.7
    
    
    
    0.1Total lumber
    
    
    296.9
    
    
    
    298.7
    
    
    
    278.5Cogeneration power (2)
    
    
    162.0
    
    
    
    163.5
    
    
    
    152.4Average sales price:Lumber: (3)Redwood upper grades
    
    $
    1,352
    
    
    $
    1,275
    
    
    $
    1,317Redwood common grades
    
    
    613
    
    
    
    601
    
    
    
    544Douglas-fir upper grades
    
    
    980
    
    
    
    1,249
    
    
    
    1,351Douglas-fir common grades
    
    
    408
    
    
    
    346
    
    
    
    342Cogeneration power (4)
    
    
    65
    
    
    
    61
    
    
    
    60Net sales:Lumber, net of discount
    
    $
    179.2
    
    
    $
    184.0
    
    
    $
    170.4Logs
    
    
    6.1
    
    
    
    6.5
    
    
    
    14.4Cogeneration power
    
    
    10.8
    
    
    
    11.4
    
    
    
    9.4Wood chips
    
    
    3.1
    
    
    
    3.4
    
    
    
    2.3Other
    
    
    2.9
    
    
    
    3.2
    
    
    
    2.9Total net sales
    
    $
    202.1
    
    
    $
    208.5
    
    
    $
    199.4Operating income (5)
    
    $
    5.4
    
    
    $
    34.5
    
    
    $
    18.8Loss before income taxes
    
    $
    (49.3
    )
    
    $
    (18.1
    )
    
    $
    (33.5
    )
 
 (1)
    
    Lumber shipments are expressed in millions of board feet.(2)
    
    Power deliveries are expressed in thousands of megawatts.(3)
    
    Dollars per thousand board feet.(4)
    
    Dollars per megawatt.(5)
    
    Operating income for 2003 includes a $16.8 million gain on the sale of timberlands in the Grizzly Creek grove. 30




---



##### Table of Contents



Net Sales Net sales for the forest products segment in 2004 were $6.4 million below the prior years net
sales. While total lumber shipments were only slightly lower than the prior year and prices in
most categories of lumber improved, the mix of products sold continued to shift from higher-priced
redwood and upper grade Douglas-fir lumber to lower-priced common grade Douglas fir, which produced
an overall decline of $4.8 million in net sales of lumber. Sales of logs, power and other
products, which accounted for 11.3% of the segments sales product mix in 2004, were down a
combined $1.6 million compared to the prior year. The forest products segments net sales for 2003 increased compared to the preceding year.
Lumber sales increased by $13.6 million primarily as a result of higher average sales prices for
redwood common grade lumber. Although lumber shipments were higher, this improvement was
unfavorably impacted by a shift in the mix of product from higher-priced redwood and upper grade
Douglas-fir lumber to lower-priced common grade Douglas-fir lumber. Net sales of logs to third
parties decreased $7.9 million or 55% in 2003. Sales of surplus power from Palcos cogeneration
power plant increased over the prior year due to increases in both volume and prices. Operating Income (Loss) Operating income for the forest products segment was $5.4 million in 2004, which was
significantly below the prior years operating income of $34.5 million. The decline was primarily
attributable to three factors: the decline in net sales discussed above, an increase in the per
unit production cost of lumber and the 2003 gain of $16.8 million on the sale of timberlands in the
Grizzly Creek grove. Per unit lumber production costs were adversely affected by the declines in
harvest, which led to increased third party log purchases approximating 35.3 mmbf in 2004, as
compared to 21.4 mmbf in 2003. The forest products segments operating income of $34.5 million reflected an increase of $15.7
million over 2002. Results for 2003 include the $16.8 million gain on the sale of timberlands in
the Grizzly Creek grove. Although gross margins on sales of lumber increased, higher harvesting
costs per unit limited the improvement to $2.4 million. Gross margins from cogeneration power
increased $1.7 million, which was more than offset by a decline of $3.2 million on log sales.
Selling, general and administrative expenses increased $3.9 million, primarily due to increases in
salaries and benefits, severance costs, expenses associated with a public relations campaign by
Palco, and costs related to various legal matters. Loss Before Income Taxes The loss before income taxes increased $31.2 million in 2004 compared to 2003, primarily due
to the decreases in operating results discussed above. In addition, earnings on cash, cash
equivalents and other investments declined due to lower investment balances and lower returns
during 2004 versus 2003. The declines on returns on investment funds was partially offset by a
decrease in interest expense. The loss before income taxes decreased $15.4 million in 2003 compared to 2002. The decrease
was principally attributable to the increase in operating income discussed above. Investment,
interest and other income (expense) and interest expense for 2003 were comparable to 2002. 31




---



##### Table of Contents



Real Estate Operations Industry Overview and Selected Operational Data The Company, principally through its wholly owned subsidiaries and joint ventures, invests in
and develops residential and commercial real estate, primarily in Arizona, California, Puerto
Rico, and Texas. The following table presents selected operational and financial information for
the years ended December 31, 2004, 2003 and 2002, respectively, for the Companys real estate
operations. Years Ended December 31,2004
    
    
    2003
    
    
    2002(In millions of dollars)Net sales:Real estate:Fountain Hills
    
    $
    12.7
    
    
    $
    19.3
    
    
    $
    8.7Mirada
    
    
    16.1
    
    
    
    5.3
    
    
    
    0.2Palmas
    
    
    30.9
    
    
    
    16.3
    
    
    
    14.2Other
    
    
    
    
    
    
    8.8
    
    
    
    1.5Total
    
    
    59.7
    
    
    
    49.7
    
    
    
    24.6Resort, commercial and other:Fountain Hills
    
    
    6.7
    
    
    
    4.0
    
    
    
    3.7Mirada
    
    
    0.1
    
    
    
    0.3
    
    
    
    Palmas
    
    
    10.9
    
    
    
    8.2
    
    
    
    11.1Commercial lease properties
    
    
    17.2
    
    
    
    15.9
    
    
    
    9.3Other
    
    
    0.2
    
    
    
    0.2
    
    
    
    0.2Total
    
    
    35.1
    
    
    
    28.6
    
    
    
    24.3Total net sales
    
    $
    94.8
    
    
    $
    78.3
    
    
    $
    48.9Operating income (loss):Fountain Hills
    
    $
    4.1
    
    
    $
    9.8
    
    
    $
    0.1Mirada
    
    
    6.0
    
    
    
    
    
    
    
    (1.9
    )Palmas
    
    
    13.3
    
    
    
    (5.4
    )
    
    
    (2.1
    )Commercial lease properties
    
    
    7.2
    
    
    
    5.9
    
    
    
    3.4Other
    
    
    (0.9
    )
    
    
    6.8
    
    
    
    0.3Total operating income (loss)
    
    $
    29.7
    
    
    $
    17.1
    
    
    $
    (0.2
    )Investment, interest and other income (expense), net:Equity in earnings from real estate joint ventures
    
    $
    2.8
    
    
    $
    0.7
    
    
    $
    2.5Other
    
    
    5.3
    
    
    
    5.2
    
    
    
    3.7$
    8.1
    
    
    $
    5.9
    
    
    $
    6.2Income (loss) before income taxes
    
    $
    19.5
    
    
    $
    4.1
    
    
    $
    (7.2
    )
 32




---



##### Table of Contents



Net Sales Net sales for the real estate segment include: revenues from sales of developed lots, bulk
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 increased $16.5 million in 2004 from the year ago
period, largely driven by acreage sales at Palmas del Mar and Mirada, an increase in lot sales at
Fountain Hills and Mirada, and increases in net sales from commercial operations at Palmas del Mar
and Fountain Hills. Acreage sales at Fountain Hills declined between periods, and Other net sales
in 2003 included $8.8 million from the sale of a parcel of real estate in Lake Havasu, Arizona. Net sales for the real estate segment increased $29.4 million in 2003 from the prior year.
Real estate sales at Fountain Hills increased $10.6 million over 2002 to $19.3 million for 2003 due
to an increase in acreage and commercial lot sales, while revenues from lot sales at Mirada
increased $5.1 million over the prior year to $5.3 million for 2003. The $8.8 million sale of the
Lake Havasu parcel during 2003 also contributed to the improvement in net sales. In addition, the
Companys commercial lease properties (several of which were acquired in the fourth quarter of
2002) had sales of $15.9 million, an increase of $6.6 million over the prior year. Real estate
sales at Palmas increased slightly in 2003; however, this was more than offset by a decline in
resort and commercial operations at Palmas, which was due in large part to closure of the Companys
casino facility at Palmas in March 2003 (see Note 3). Operating Income (Loss) Operating results increased by $12.6 million for 2004 versus 2003 primarily due to increased
sales as discussed above. In addition, operating results for 2003 include a $1.4 million charge to
recognize the impairment of Palmas casino assets related to the foreclosure of a hotel which was owned and operated by a third party from whom the casino leased space. The increase in the real estate segments operating results from 2002 to 2003 was due largely
to the increase in sales discussed above. Income (Loss) Before Income Taxes The segments income before income taxes increased by $15.4 million for 2004 versus 2003, due
to the higher operating results discussed above, as well as an increase in equity earnings from
FireRock, LLC. Income (loss) before income taxes increased $11.3 million in 2003 compared to 2002 due to the
impact of the improved operating results discussed above. Interest expense increased $5.7 million
in 2003 compared to 2002, primarily due to increased borrowings used to fund the acquisition of
several commercial lease properties in late 2002. 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. However, for 2004 only, Sam Houston Race
Park was granted 40 additional live race days. 33




---



##### Table of Contents



The following table presents selected operational and financial information for the years
ended December 31, 2004, 2003 and 2002, respectively, for the Companys racing operations. Years Ended December 31,2004
    
    
    2003
    
    
    2002(In millions of dollars)Number of live racing days:Sam Houston Race Park
    
    
    167
    
    
    
    127
    
    
    
    126Valley Race Park
    
    
    110
    
    
    
    110
    
    
    
    110Handle:Sam Houston Race Park:On-track handle
    
    $
    137.0
    
    
    $
    134.2
    
    
    $
    146.3Off-track handle
    
    
    173.7
    
    
    
    173.4
    
    
    
    188.9Total
    
    $
    310.7
    
    
    $
    307.6
    
    
    $
    335.2Valley Race Park:On-track handle
    
    $
    19.4
    
    
    $
    20.0
    
    
    $
    22.3Off-track handle
    
    
    3.6
    
    
    
    4.0
    
    
    
    3.7Total
    
    $
    23.0
    
    
    $
    24.0
    
    
    $
    26.0Net sales:Sam Houston Race Park:Gross pari-mutuel commissions
    
    $
    34.9
    
    
    $
    34.5
    
    
    $
    37.3Other revenues
    
    
    10.0
    
    
    
    9.4
    
    
    
    8.9Total
    
    
    44.9
    
    
    
    43.9
    
    
    
    46.2Valley Race Park:Gross pari-mutuel commissions.
    
    
    4.6
    
    
    
    4.7
    
    
    
    5.2Other revenues
    
    
    1.1
    
    
    
    1.2
    
    
    
    1.3Total
    
    
    5.7
    
    
    
    5.9
    
    
    
    6.5Total net sales
    
    $
    50.6
    
    
    $
    49.8
    
    
    $
    52.7Operating income (loss):Sam Houston Race Park
    
    $
    (2.1
    )
    
    $
    (1.2
    )
    
    $
    0.7Valley Race Park
    
    
    (1.0
    )
    
    
    (0.7
    )
    
    
    (0.3
    )Total operating income (loss)
    
    $
    (3.1
    )
    
    $
    (1.9
    )
    
    $
    0.4Income (loss) before income taxes
    
    $
    (3.1
    )
    
    $
    (1.7
    )
    
    $
    0.4
 34




---



##### Table of Contents



Net Sales Net sales for the racing segment for 2004 increased by $0.8 million compared to the prior year
due primarily to 40 more live racing days at Sam Houston Race Park. Net sales for Valley Race Park
for 2004 were comparable to the prior year. Average daily attendance declined at both race parks. Net sales for the Companys racing segment totaled $49.8 million for 2003, a decrease of $2.9
million from the previous year. While the number of live and simulcast racing days for 2003 was
comparable to 2002, the segments overall average daily attendance at both Sam Houston Race Park
and Valley Race Park declined for 2003. This negatively impacted pari-mutuel commissions. Operating Income (Loss) Despite an increase in net sales for 2004, the operating loss for the segment increased versus
the prior year primarily due to higher costs of sales and operations. The increase in costs of
sales and operations was due to the increase in live racing days during the year, which led to
higher utility, payroll and other operating expenses. Operating results decreased by $2.3 million in 2003. The major reasons for the decrease were
the lower net sales discussed above, in addition to the impact of a $1.1 million increase in
operating expenses. The increase in operating expenses was largely driven by an increase in
selling, general and administrative expenses including costs associated with legislative efforts. Income Before Income Taxes The decrease in income before income taxes for this segment for 2004 as compared to 2003, as
well as the decrease in income before income taxes for 2003 versus 2002, are both attributable to
the operating losses discussed above. Other Items Not Directly Related to Industry Segments Years Ended December 31,2004
    
    
    2003
    
    
    2002(In millions)Operating loss
    
    $
    (17.7
    )
    
    $
    (8.3
    )
    
    $
    (10.5
    )Income (loss) before income taxes
    
    
    (14.0
    )
    
    
    5.1
    
    
    
    (10.7
    )
 Operating Loss The operating losses represent corporate general and administrative expenses that are not
attributable to the Companys industry segments. For 2004, such losses include $1.9 million
related to an accrual for an environmental matter discussed under Other Matters in Note 12. In
addition to this accrual, results for 2004 include $6.1 million related to an increase in
stock-based compensation expense, which is adjusted as the market value of the Companys Common
Stock changes and as awards vest. The decrease in the operating loss in 2003 versus 2002 was
primarily due to certain general and administrative expenses incurred in 2002 as a result of
Kaisers Chapter 11 filing (see Note 1). The operating loss for 2002 also included severance and
moving expenses incurred as a result of reduction in Corporate staff and office space. Income (Loss) Before Income Taxes Income (loss) before income taxes includes operating losses, investment, interest and other
income (expense) and interest expense, that are not attributable to the Companys industry
segments. Results for 2003 include income related to an $8.0 million reimbursement from an insurer
for certain costs incurred in connection with the OTSand FDIC actions(see Note 12). The loss
before income taxes for 2002 includes interest expense of $8.1 million attributable to the MGHI
Notes which were extinguished in December of 2002. 35




---



##### Table of Contents



Provision for Income Taxes The Company generated a loss before income taxes of $46.9 million for 2004; however, the
Company has recorded no tax benefit associated with the loss for the period. The benefit for
income taxes of $0.3 million reflected in the Consolidated Statement of Operations consists
principally of state taxes. 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 9. Based on this evaluation, the Company provided full valuation allowances with
respect to the deferred tax assets attributable to losses and credits generated during 2004. These
valuation allowances were in addition to the valuation allowances which were provided in prior
years. 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. 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 Scotia LLC, 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. Scotia
LLC is highly leveraged and has significant debt service requirements (see Note 1). MAXXAM
Parent is used in this section to refer to the Company on a stand-alone basis without its
subsidiaries. Cash Flow Operating Activities Net cash provided by operating activities
of $29.0 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). Net cash provided by operating activities
of $15.3 million for the year ended December 31,
2003, principally reflects net loss (after adding back depreciation, depletion, amortization and
other reconciling items, totaling $6.9 million), a
$4.4 million decrease in inventories, a $1.8 million decrease
in long-term assets and an $8.0 million increase in long-term liabilities, offset by net changes to other working capital accounts
totaling $5.1 million. Investing Activities Net cash used for investing activities of $26.2 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 proceeds from the sale of marketable securities and other
short-term investments of $5.8 million. Net
cash used for investing activities of $0.8 million for the year ended December 31, 2003,
principally reflects capital expenditures of $23.8 million, partly offset by proceeds from the sale
of timberlands and other assets of $22.5 million. Financing Activities Net cash provided by financing activities of $4.8 million for the year ended December 31,
2004, principally reflects net borrowings on the Scotia LLC and Palco 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 Timber Notes, net
of restricted cash withdrawals, of $5.3 million. Net cash used for financing activities of $22.5 million for the year ended December 31, 2003,
principally reflects repayments on real estate credit facilities of $11.1 million, treasury stock
purchases of $9.0 million, principal payments on and repurchases of Timber Notes, net of restricted
cash withdrawals, of $5.1 million, offset by proceeds from borrowings on credit facilities
(primarily real estate) of $2.9 million. 36




---



##### Table of Contents



MAXXAM Parent MAXXAM Parent and MGHI own the 50,000,000 Kaiser Shares, representing an approximate 63%
interest in Kaiser. As a result of the Cases, the value of Kaiser common stock has declined
substantially, and the market value of the Kaiser Shares based on the price per share quoted at the
close of business on March 1, 2005, was $4.5 million. There can be no assurance that such value
would be realized should the Kaiser Shares be sold, and it is likely that the Companys ownership
interest in Kaiser will be cancelled without consideration. Disposition of the Kaiser Shares is
restricted under an agreement among Kaiser, MAXXAM Parent and MGHI. See also Notes 1 and 11. MAXXAM Parent expects that its general and administrative costs, net of cost reimbursements
from subsidiaries will range from $7.0 million to $9.0 million for the next year. There can be no
assurance, however, that MAXXAM Parents cash requirements for its corporate, general and
administrative expenses will not increase. 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. 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 distributions from the real
estate segment, should be sufficient to meet its working capital requirements. However, there can
be no assurance that this will be the case. See Forest
Products Operations below regarding potential adverse impacts
upon MAXXAM Parent as a result of the liquidity issues being
experienced by Palco and Scotia LLC. Forest Products Operations Substantially all of MGIs consolidated assets are owned by Palco, and a significant portion
of Palcos consolidated assets are owned by Scotia LLC. The holders of the Timber Notes have
priority over the claims of creditors of Palco with respect to the assets and cash flows of Scotia
LLC. The Palco Credit Agreement (described below) contains certain restrictive covenants which
effectively preclude the distribution of funds from Palco to MGI. Regulatory and environmental matters as well as certain pending legal matters play a
significant role in the Companys forest products operations. See Item 1. BusinessForest
Products OperationsRegulatory and Environmental Factors and Note 12 for discussion of these
matters. Regulatory compliance and related litigation have caused and may continue to cause delays
in approval of Scotia LLCs THPs and delays in harvesting on its THPs once they are approved. This
has resulted and may continue to result in a decline in harvest, an increase in the cost of logging
operations, and increased costs related to timber harvest litigation. As discussed in Item 1. BusinessForest Products OperationsRegulatory and Environmental
FactorsWater Quality, the North Coast Water Board is requiring Palco and Scotia LLC to apply
various waste discharge reporting, mitigation and erosion control requirements in respect of timber
harvesting activities in several watersheds, and may impose additional measures in the future. The
North Coast Water Board in December 2003 directed its staff to formulate WWDRs for the Freshwater
and Elk River watersheds. These requirements have not yet been formulated, and the North Coast
Water Board has failed to release for harvest a number of THPs already approved by the other
government agencies which review Scotia LLCs THPs. The failure of the North Coast Water Board to release these THPs for harvest has adversely
impacted the cash flows of both Palco and Scotia LLC. Scotia LLC estimates that, without the
prompt release of a substantial portion of these THPs, its cash flows
from operations, together with
funds available under the Scotia LLC Line of Credit described below, will be inadequate to pay the
entire amount of interest due on the July 20, 2005 Timber Notes payment date, which would
constitute an event of default under the Timber Notes Indenture. Palco is in default under the
Palco Credit Agreement described below and estimates that, without the prompt release of a
substantial portion of these THPs and necessary amendments to the Palco Credit Agreement, its cash
flow from operations, together with funds available under the Palco
Credit Agreement, will not
provide sufficient liquidity to fund its current level of operations. Palco and Scotia LLC are
continuing efforts to obtain the clearance of the North Coast Water Board of sufficient THPs.
Palco has received a limited waiver of the default through March 18, 2005, from the lender under
the Palco Credit Agreement and is seeking a more permanent solution to the default. There can be
no assurance that these efforts with the North Coast Water Board and the lender under the Palco
Credit Agreement will be successful. 37




---



##### Table of Contents



In the event of a failure to pay interest on the Timber Notes in full when due, the Trustee or
the holders of at least 25% of the aggregate outstanding principal amount of the Timber Notes may
cause all principal, interest and other amounts related to the Timber Notes to become immediately
due and payable. Also, in the event of a failure by Palco or Scotia LLC to perform its respective
covenants or agreements under the Master Purchase Agreement or by Palco to perform its covenants or
agreements under the Services Agreement that continues for 30 days after notice from the Trustee or
the holders of 25% or more of the outstanding principal amount of the Timber Notes, the holders of
a majority of the aggregate outstanding principal amount of the Timber Notes may cause all
principal, interest and other amounts related to the Timber Notes to become immediately due and
payable. In the event of any such acceleration, the Agent under the Scotia LLC Line of Credit may
also accelerate the advances then outstanding thereunder. If such accelerations of Timber Notes
and/or advances under the Scotia LLC Line of Credit occur, the Trustee may exercise all rights
under the Timber Notes Indenture and related security documents, including applying funds to pay
accelerated amounts, and selling the Scotia LLC Timberlands and other assets and using the proceeds
thereof to pay accelerated amounts. In the event that Scotia LLC were to seek protection by filing
under the Bankruptcy Code, all amounts related to the Timber Notes would become immediately due and
payable under the Timber Notes Indenture and all advances under the Scotia LLC Line of Credit
agreement could be accelerated. The foregoing rights of the Trustee and holders of Timber Notes
are subject to the rights of Scotia LLC under the Bankruptcy Code. Without an extension of the limited waiver of Palcos default under the Palco Credit Agreement
and a restructuring or replacement of that facility, Palcos lender may take any of the following
actions: reduce the amount of funds available to Palco for borrowing; refuse to make new loans to
or issue new letters of credit for the benefit of Palco; declare any or all loans and other amounts
owed under the agreement to be immediately due and payable; require Palco to cash collateralize all
outstanding letters of credit; or pursue its other rights and remedies under the Palco Credit
Agreement and related security agreements. The existence of the default also requires Palco to pay
interest on amounts borrowed under the Palco Credit Agreement at a per annum rate 2% higher than
the rate at which interest would be owed if no default existed. If any acceleration under the
Palco Credit Agreement occurs, then the agent for the lender may exercise all rights under that
agreement and related security documents, including selling Palcos assets and using the proceeds
thereof to pay the accelerated amounts. In the event that Palco were to seek protection by filing
under the Bankruptcy Code, all loans and other amounts owed under the Palco Credit Agreement would
become immediately due and payable. The foregoing rights of the lender under the Palco Credit
Agreement are subject to the rights of Palco under the Bankruptcy Code. In the event of a Scotia LLC default or a Palco liquidity shortfall, whether resulting from a
failure to extend the limited waiver past March 18, 2005, any action described above taken by
Palcos lender, or otherwise, Palco and Scotia LLC could be forced to take extraordinary actions,
which may include: reducing expenditures by laying off employees and shutting down various
operations; seeking other sources of liquidity, such as from asset sales; and considering seeking
protection by filing under the Bankruptcy Code. On December 8, 2004,
Standard & Poors Ratings Services (S&P) lowered Palcos credit rating
from B- to CCC+. As a result, Palco may be required to post a
security deposit for workers compensation liabilities in July 2005, in an
amount that has not been determined but that could be material to Palcos liquidity, capital
resources, and results of operations. If improvements in Palcos liquidity, capital resources, and
results of operations produce an upward revision in Palcos credit rating, or if a waiver of this
requirement is allowed under applicable law, then posting of such a security deposit may not be
necessary. Palco management is in the process of evaluating the potential amount of such a
security deposit, if required. There can be no assurance that such a security deposit
will not be required or that, if required, the amount will not be material. Palco management is
also evaluating whether other potential obligations or unanticipated adverse financial reports may
result from the S&P credit action described above. The liquidity issues being experienced by Palco and Scotia LLC could result in claims against
and could have adverse impacts on MAXXAM Parent, MGHI and/or MGI. For example, under ERISA law,
were Palco to terminate its pension plan, MAXXAM Parent and its wholly owned subsidiaries would be
jointly and severally liable for any unfunded pension plan obligations. The unfunded obligation
attributable to Palcos pension plan as of December 31, 2004 is estimated to have been in the range
of approximately $35 million based upon current annuity placement interest rate assumptions. In
addition, it is possible that certain transactions could be entered into in connection with a
potential restructuring or reorganization of Palco or Scotia LLC, such as a sale of all or a
portion of the equity ownership in Palco and/or Scotia LLC, a sale of a substantial portion of
Palcos and/or Scotia LLCs assets and/or a cancellation of some or all of Palcos and/or Scotia
LLCs indebtedness, which could require the utilization of all or a substantial portion of, 38




---



##### Table of Contents



or the loss of significant portion of, the Companys net operating losses for federal and state income tax purposes and could require tax payments. In addition, there can be no assurance that certain other pending legal, regulatory and
environmental matters or future governmental regulations, legislation or judicial or administrative
decisions, adverse weather conditions, or low lumber or log prices, will not have a material
adverse effect on the Companys financial condition, results of operations or liquidity. See Item
1. BusinessForest Products OperationsRegulatory and Environmental Factors, Item 3. Legal
Proceedings and Note 12 for further information regarding regulatory and legislative matters and
legal proceedings relating to the Companys forest products operations. The Scotia LLC Line of Credit allows Scotia LLC to borrow up to one years interest on the
Timber Notes (the Scotia LLC Line of Credit). On June 20, 2003, the Scotia LLC Line of Credit
was extended to July 7, 2006. At or near the completion of such extension, Scotia LLC intends to
request that the Scotia LLC Line of Credit be extended for an additional period of not less than
364 days. If not extended, Scotia LLC may draw upon the full amount available. The amount drawn
would be repayable in 12 semiannual installments on each note payment date (after the payment of
certain other items, including the Aggregate Minimum Principal Amortization Amount, as defined,
then due), commencing approximately two and one-half years following the date of the draw. At
December 31, 2004, Scotia LLC could have borrowed a maximum of $57.1 million under the Scotia LLC
Line of Credit, and there were $18.2 million in borrowings
outstanding under the facility. At January 31, 2005, the maximum
availability under the Scotia LLC Line of Credit was
$55.9 million, and there were $45.9 million in borrowings
outstanding under this facility. On the note payment date in January 2004, Scotia LLC had $4.1 million set aside in the note
payment account to pay the $27.2 million of interest due (net of $2.0 million of additional
interest due in respect of Timber Notes held by Scotia LLC). The funds available under the Scotia
LLC Line of Credit were used to pay the remaining $23.1 million of interest due. Scotia LLC repaid
$12.7 million of principal on the Timber Notes (an amount equal to Scheduled Amortization, as set
forth in the Timber Notes Indenture (Scheduled Amortization)) using funds held in the Scheduled
Amortization Reserve Account, a reserve account used to support principal payments on the Timber
Notes (SAR Account). On the note payment date in July 2004, Scotia LLC used $26.6 million (net of $2.1 million of
additional interest due in respect of Timber Notes held by Scotia LLC) of the funds available under
the Scotia LLC Line of Credit to pay the entire $26.6 million of interest due. Scotia LLC repaid
$4.5 million of principal on the Timber Notes (an amount equal to Scheduled Amortization) using
funds held in the SAR Account. On the note payment date in January 2005, Scotia LLC used $26.3 million (net of $2.2 million
of additional interest due in respect of Timber Notes held by Scotia LLC) of the funds available
under the Scotia LLC Line of Credit to pay the entire $26.3 million of interest due. Scotia LLC
repaid $10.6 million of principal on the Timber Notes (an amount equal to Scheduled Amortization)
using funds held in the SAR Account. With respect to the note payment date in July 2005, as a result of the matters discussed
above, Scotia LLC may not have adequate funds available under the Scotia LLC Line of Credit to pay
the entire $25.9 million of interest which will be due (net of $2.0 million of additional interest
which would be due in respect of Timber Notes held by Scotia LLC). Should this occur, Scotia LLC
would be in default under the Timber Notes Indenture. Should a
default not occur, Scotia LLC anticipates paying the $5.0 million of principal due on the Timber
Notes (an amount equal to Scheduled Amortization) by using funds held in the SAR Account. During 2004, $10.9 million of funds from the SAR Account were used to repurchase $11.0 million
principal amount of Timber Notes, as permitted under the Timber Notes Indenture, resulting in a
loss of $0.3 million (net of unamortized deferred financing costs) on the repurchase of debt. Due to its highly leveraged condition, Scotia LLC is more sensitive than less leveraged
companies to factors affecting its operations, including low log prices, governmental regulation
and litigation affecting its timber harvesting practices (see Results of OperationsForest
Products Operations above and Note 12), and general economic conditions. Scotia LLCs cash flows
from operations are significantly impacted by harvest volumes and log prices. The Master Purchase
Agreement between Scotia LLC and Palco (see Item 1. BusinessForest Products
OperationsRelationships among the Palco Companies) contemplates that all sales of logs by Scotia
LLC to Palco will be at fair market value (based on stumpage prices) for each species and category
of timber. The Master Purchase 39




---



##### Table of Contents



Agreement provides that if the purchase price equals or exceeds the
SBE Price and a structuring price set forth in a schedule to the Timber Notes 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 Scotia LLC is required to engage an
independent forestry consultant to confirm that the purchase price reflects fair market value. In December 2004, the State Board of Equalization adopted the new Harvest Value Schedule for
the first half of 2005. The prices published in that schedule reflected a 14.3% increase in the
SBE Price for small redwood logs and a 12.5% increase for small Douglas-fir logs from the prices
published for the second half of 2004. On January 27, 2005, S&P announced that it was placing its ratings on all classes of Timber
Notes on CreditWatch with negative implications. S&P indicated that the CreditWatch placements
reflected Palcos difficulties in obtaining approval from the North Coast Water Board to move
forward with harvesting related to certain THPs. S&P also indicated that any additional delays in
the ability to harvest on the Scotia LLC Timberlands (and the inability to generate adequate
revenue) could put into question whether Scotia LLC will have sufficient funds to make payment of
full and timely interest on the July 2005 Timber Notes note payment date. In addition, on February
7, 2005, Moodys Investors Services lowered the ratings on all classes of the Timber Notes,
reflecting concerns over continued weak cash flow from timber operations due to difficulties in
obtaining approval of THPs. The rating on the Class A-1 Timber Notes was lowered from A1 to Baa2;
the rating on the Class A-2 Timber Notes was lowered from A3 to Baa3; and the rating on the Class
A-3 Timber Notes was lowered from Baa2 to Ba1. All three ratings will remain on review for
possible downgrade, as Moodys noted that there is some risk that there will be insufficient cash
to make full payment of interest on the July 2005 note payment date. On January 23, 2004, Palco entered into an asset-based credit agreement with a bank (the
Palco Credit Agreement). This agreement provides for a three-year revolving facility after which
Palco may request a one-year extension. Borrowings under the agreement bear interest at rates
based upon (and at variable margins above) LIBOR or the prime rate, and are secured by the
substantial portion of Palcos assets. Effective February 22, 2005, the Palco Credit Agreement was
amended by, among other things: reducing the maximum amount of potential borrowings from $35.0
million to $30.0 million; decreasing the borrowing base reserve by $2.0 million (and thereby
increasing the amount able to be borrowed by the same amount); and requiring more frequent
submissions of borrowing base certificates. At December 31, 2004, $13.1 million in borrowings and $0.3 million in letters of credit were
outstanding under the Palco Credit Agreement. In accordance with the agreement, Palco is required
to maintain a certain base level of borrowings through February 12, 2005, based on certain
collateral balances. Palco is required to meet certain quarterly earnings thresholds under a
covenant of the Palco Credit Agreement. As of December 31, 2004, Palco was not in compliance with
this covenant. Capital expenditures have been made during the past three years to improve production
efficiency and reduce operating costs. In April 2004, Palco commenced a mill improvement project,
including construction of a new sawmill in Scotia, California. The project is expected to cost
$27.3 million ($20.5 million of which was expended in 2004) with the last phase scheduled for
completion in the third quarter of 2005. Funds for this project are being provided from existing
cash resources and borrowings under the Palco Credit Agreement. Palco believes that the new mill
will improve annual results from operations by at least $20.0 million, assuming an adequate supply
of logs. As part of the project, equipment from Palcos Carlotta mill is in the process of being
moved to the new mill in Scotia, and the Carlotta mill was permanently closed. The Carlotta mill
and other equipment would be used to process large diameter logs. Completion of this project is,
however, subject to successful resolution of the liquidity problems being experienced by Palco.
Management is considering alternative uses for the Carlotta property. Capital expenditures, excluding
expenditures for the new sawmill and for timberlands, are estimated to be between $5.0 million and
$7.0 million for 2005. Subject to available resources, Palco and Scotia LLC may purchase
additional timberlands from time to time as appropriate opportunities arise. The Company estimates that funding requirements for pension benefits for 2005 will range from
$2.2 million to $2.4 million. Palcos share of these amounts ranges from $1.6 million to $1.8
million. Palco will require funds available under the Palco Credit Agreement in order to meet its
working capital and capital expenditure requirements for the next year. Palcos ability to meet
such requirements could be adversely affected should Palco be unsuccessful in its efforts to obtain
a more permanent solution to the default discussed above. Furthermore, Palcos cash flows from
operations may be adversely affected by diminished availability of logs from Scotia LLC, lower 40




---



##### Table of Contents



lumber prices, adverse weather conditions, pending legal, regulatory and environmental matters or
increased funding requirements for its pension plan. See Results of OperationsForest Products
Operations above, as well as Note 12, for discussion of the regulatory, environmental and legal
matters affecting harvest levels and operating costs. With respect to long-term liquidity, until such time as Palco has adequate cash flows
from operations and/or dividends from Scotia LLC, there can be no assurance that Palco will be able
to meet its working capital, capital expenditures and debt service obligations. Liquidity, capital resources and results of operations in the long-term
may continue to be adversely affected by the same factors affecting short-term cash flows from
operations, as discussed above. Real Estate Operations Capital expenditures and real estate improvements and development costs are expected to be
approximately $32.0 million to $33.0 million in 2005. The Company expects that these expenditures
will be funded by existing cash and available credit facilities. The Company believes that the existing cash and credit facilities of its real estate
subsidiaries are sufficient to fund the working capital and capital expenditure requirements of
such subsidiaries for 2005. With respect to the long-term liquidity of such subsidiaries, the
Company believes that their ability to generate cash from the sale of their existing real estate,
together with their ability to obtain financing and joint venture partners, should provide
sufficient funds to meet their working capital and capital expenditure requirements. PDMPI and its
subsidiaries, however, have required advances from MAXXAM Parent in prior years to fund their
operations, and PDMPI may require such advances in the future. Racing Operations Capital expenditures and investments in new ventures are expected to be between $2.0 million
and $2.5 million in 2005. Subsequent to December 31, 2004, SHRP, Ltd. borrowed $4.5 million from MAXXAM Parent to fund
its 2005 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 SHRP, Ltd.s long-term liquidity. Kaisers Operations As a result of the filing of the Cases, claims against the Debtors for principal and accrued
interest on secured and unsecured indebtedness existing on the Filing Date are stayed while the
Debtors continue business operations as debtors-in-possession, subject to the control and
supervision of the Court. At this time, it is not possible to predict the effect of the Cases on
the businesses of the Debtors. With respect to the Companys interest in Kaiser, the Debtors have
indicated that the equity of Kaisers stockholders will likely be cancelled without consideration.
See Note 11 for further information. 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. 41




---



##### Table of Contents



Contractual Obligations The following table presents information with respect to the Companys contractual obligations
as of December 31, 2004 (in millions). Payments Due by PeriodLess than 1
    
    
    2-3
    
    
    4-5
    
    
    More thanContractual Obligations
    
    Total
    
    
    Year
    
    
    Years
    
    
    Years
    
    
    5 YearsLong-term debt obligations(1)
    
    $
    932.2
    
    
    $
    20.2
    
    
    $
    53.7
    
    
    $
    55.5
    
    
    $
    802.8Interest due on long-term debt obligations(2)
    
    
    659.6
    
    
    
    68.6
    
    
    
    133.1
    
    
    
    125.3
    
    
    
    332.6Operating lease obligations
    
    
    13.4
    
    
    
    3.3
    
    
    
    5.4
    
    
    
    2.6
    
    
    
    2.1Purchase obligations(3)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other long-term liabilities reflected on the
Companys balance sheet(4)(5)(6)(7)
    
    
    8.1
    
    
    
    3.6
    
    
    
    0.8
    
    
    
    3.7
    
    
    
    Total
    
    $
    1,613.3
    
    
    $
    95.7
    
    
    $
    193.0
    
    
    $
    187.1
    
    
    $
    1,137.5
   (1)
    
    Includes capital lease obligations of $1.2 million as of December 31, 2004.(2)
    
    Interest due on long-term debt obligations is net of additional interest due in
respect of Timber Notes held by the Company.(3)
    
    Excludes $1.5 million in 2005 under a contract entered into in 2004 for completion
of Palcos new sawmill project. Also excludes ordinary course of business purchase orders.(4)
    
    Excludes expected funding for pension benefits for 2005 and subsequent years.
Expected funding requirements for pension benefits for 2005 range from $2.2 million to $2.4
million. Funding requirements for pension benefits after 2005 are excluded due to the
significant variability in the assumptions required to project the timing of future cash
payments. Also excluded are reserves for litigation, environmental remediation,
self-insurance claims, and other contingent liabilities due to uncertainty as to when cash
payments will be required.(5)
    
    Includes $0.4 million in 2005 and $1.6 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.(6)
    
    Includes $0.4 million in 2005 and $2.1 million in 2008 under the terms of various
executive compensation agreements.(7)
    
    Includes $2.8 million in 2005, $0.4 million in 2006, and $0.4 million in 2007 for
contractual amounts owed under agreements with various professional services firms
(principally audit and tax compliance fees). Trends Real Estate Operations PDMPI is considering various alternatives to accelerate sales of its remaining 1,130 acres of
undeveloped land as well as disposition of other assets. In connection with this, PDMPI has
retained and is in the process of working with an agent to assist in its efforts to solicit
developer and investor interest in acquiring such acreage and other assets. No assurance can be
given that these efforts will be successful. Racing Operations The Texas legislature convenes its regular session every other year. It is expected that this
body will, during its January to June 2005 regular session, consider measures to enhance state
revenues through additional forms of gaming such as video lottery terminals at existing horse and
dog racing tracks, gaming on Indian reservations, and full casinos. The Company will vigorously
pursue any such legislation that is favorable to it. As any legislation expanding gaming in Texas
would likely require the approval of two-thirds of each legislative house and a majority of the
states voters, no assurance can be given that any such legislation will be enacted or become
effective. Moreover, it is not possible to determine what the provisions of any such legislation
will be or its effect on the Company. 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 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 42




---



##### Table of Contents



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, ongoing basis. Actual results may
differ from these estimates due to changed 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Deconsolidation of 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
principles, legal reorganization or bankruptcy represent conditions which can preclude
consolidation in instances where control rests with the bankruptcy court, rather than the majority
owner. As discussed under Results of OperationsConsolidated Operations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 deconsolidated Kaisers
financial results beginning February 12, 2002, and began reporting its investment in Kaiser using
the cost method. Through February 11, 2002, under generally accepted principles of consolidation, the Company
had recognized losses in excess of its investment in Kaiser of $516.2 million. Since Kaisers
results are no longer consolidated and the Company believes that it is not probable that it will be
obligated to fund losses related to its investment in Kaiser, any adjustments reflected in Kaisers
financial statements subsequent to February 12, 2002 (relating to the recoverability and
classification of recorded asset amounts and classification of liabilities or the effects on
existing stockholders deficit, as well as adjustments made to Kaisers financial information for
loss contingencies and other matters), are not expected to affect the Companys financial results. The Company expects to consider reversal of these losses when either: (1) Kaisers bankruptcy
is resolved and the amount of the Companys remaining investment in Kaiser is determined or (2) the
Company disposes of the Kaiser Shares. Accordingly, these consolidated financial statements do not
reflect any adjustments related to the deconsolidation of Kaiser other than presenting the
Companys investment in Kaiser using the cost method, which reflects the investment as a single
amount on its balance sheet, and discontinuing the recording of earnings or losses from Kaiser
after February 11, 2002. When either of the events described above occurs, the Company will
re-evaluate the appropriate accounting treatment of its investment in Kaiser based upon the facts
and circumstances at such time. The Debtors have indicated that the equity of Kaisers
stockholders, including the Company, will likely be cancelled without consideration as a result of
Kaisers plan of reorganization. Loss Contingencies The Company is involved in various claims, lawsuits, environmental matters and other
proceedings discussed in Note 12. Such matters involve uncertainty as to possible losses 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 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. 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 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
Notes 3 and 12 for further discussion of the Companys material legal and environmental
contingencies. 43




---



##### Table of Contents



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 9 for further discussion of the Companys income taxes. Deferred Tax Asset Valuation Allowances As of December 31, 2004, the Company had
$76.8 million of deferred tax assets (net of $78.3
million in valuation allowances) and $70.8 million of deferred tax liabilities. The deferred tax
assets and liabilities reported in the Companys 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 9 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, the salary growth rate, and the expected
return on plan assets. 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 5.875% at December 31, 2004, and 6.25% at December 31, 2003.
The assumed weighted average long-term rate of compensation increase is 4.11%. The assumed weighted
average long-term rate of return on plan assets is 8.5%. Plan assets consist principally of common
stocks and U.S. government and other fixed-income obligations. The estimated impact of a 25 basis point decrease in the discount rate (from 5.875% to 5.625%)
would increase the Companys aggregate pension obligation by approximately $5.8 million, while the
estimated impact of a 25 basis point increase in the discount rate (from 5.875% to 6.125%) would
decrease the Companys aggregate pension obligation by approximately $5.6 million. Generally accepted accounting principles are applied to determine the expense that the Company
recognizes related to pension obligations, while pension plan funding is governed by tax and labor
laws. The Company expects pension expense to be approximately $4.5 million in 2005, while cash
contributions are expected to range from $2.2 million to $2.4 million in 2005. This compared to
pension expense of $3.2 million and cash contributions of $1.0 million in 2004. At December 31, 2004, the Company had $30.6 million in accrued liabilities related to pension
benefits. This amount consists of an accrued liability of $17.4 million reflecting the cumulative
excess of the amount the Company has 44




---



##### Table of Contents



expensed over the amount the Company has funded since inception of its plans, as well as an additional
minimum liability of $13.2 million reflecting the excess of the accumulated benefit obligation over
the fair value of plan assets. See Note 10 for further discussion of the Companys 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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to changes in interest rates primarily under the Scotia LLC Line of
Credit and the Palco Credit Agreement, as well as certain other debt facilities used to finance
real estate development activities. These facilities bear interest at either the prime interest
rate or LIBOR plus a specified percentage point spread. The Scotia LLC Line of Credit was
established in conjunction with the offering of the Timber Notes. The Companys objective in
maintaining its other variable rate borrowings is flexibility in borrowing funds and making
repayments without penalties. As of December 31, 2004, there were $32.2 million in borrowings
outstanding under all variable rate facilities. Based on the amount of borrowings outstanding
under these facilities during 2004, a 1% change in interest rates effective from the beginning of
the year would have resulted in an increase or decrease in annual interest expense of $0.4 million. All of the Companys other debt is fixed-rate, and therefore, does not expose the Company to
the risk of higher interest payments due to changes in market interest rates. The Company does not
utilize interest rate swaps or similar hedging arrangements. 45




---



##### Table of Contents



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 (the
Company) as of December 31, 2004 and 2003, and the related consolidated statements of operations,
cash flows, and stockholders deficit for each of the three years in the period ended December 31,
2004. 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
14.5 percent, 14.8 percent, and 11.2 percent of consolidated total revenues for the years ended
December 31, 2004, 2003, and 2002, 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, 2004 and 2003, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2004, 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, at December 31, 2004, the cash flows of MAXXAM Inc.s wholly owned
subsidiary, The Pacific Lumber Company (Palco) and Palcos wholly owned subsidiary, Scotia
Pacific Company LLC (Scotia LLC) have been adversely affected by delays in obtaining regulatory
approvals to harvest timber. Palco was in default under an asset-based credit agreement with a
bank. Scotia LLC has estimated that without additional approvals, Scotia LLC will be unable to pay
the entire amount of interest due in July, 2005 on its timber notes. Such failure to pay interest
would constitute an event of default under the indenture governing the timber notes. The
difficulties of these subsidiaries in meeting their loan agreement covenants and paying the
interest on the timber notes raise substantial doubts about Palcos and Scotia LLCs ability to
continue as going concerns. Further, the difficulties of these subsidiaries 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, 2004, 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 14, 2005 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 14, 2005 46




---



##### Table of Contents



MAXXAM INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEET
(In millions of dollars, except share information) December 31,2004
    
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    21.4
    
    
    $
    13.8Marketable securities and other short-term investments
    
    
    131.7
    
    
    
    138.1Receivables:Trade, net of allowance for doubtful accounts of $0.6 and $0.4, respectively
    
    
    13.1
    
    
    
    12.4Other
    
    
    3.4
    
    
    
    2.6Inventories:Lumber
    
    
    17.0
    
    
    
    17.7Logs
    
    
    7.2
    
    
    
    11.8Real estate held for sale
    
    
    21.1
    
    
    
    13.7Prepaid expenses and other current assets
    
    
    16.6
    
    
    
    17.9Total current assets
    
    
    231.5
    
    
    
    228.0Property, plant and equipment, net of accumulated depreciation of $183.4 and
$164.6, respectively
    
    
    370.2
    
    
    
    367.9Timber and timberlands, net of accumulated depletion of $222.1 and $214.2, respectively
    
    
    213.6
    
    
    
    217.9Real estate
    
    
    52.5
    
    
    
    68.1Deferred income taxes
    
    
    94.8
    
    
    
    95.2Restricted cash, marketable securities and other investments
    
    
    15.6
    
    
    
    43.6Intangible assets
    
    
    3.8
    
    
    
    4.7Long-term receivables and other assets
    
    
    33.2
    
    
    
    35.4$
    1,015.2
    
    
    $
    1,060.8Liabilities and Stockholders DeficitCurrent liabilities:Accounts payable
    
    $
    14.4
    
    
    $
    10.8Accrued interest
    
    
    24.9
    
    
    
    25.8Accrued compensation and related benefits
    
    
    12.1
    
    
    
    12.8Other accrued liabilities
    
    
    27.8
    
    
    
    23.4Short-term borrowings and current maturities of long-term debt
    
    
    51.4
    
    
    
    28.5Total current liabilities
    
    
    130.6
    
    
    
    101.3Long-term debt, less current maturities
    
    
    912.0
    
    
    
    953.5Accrued pension and other postretirement benefits
    
    
    41.8
    
    
    
    32.9Losses in excess of investment in Kaiser
    
    
    516.2
    
    
    
    516.2Other noncurrent liabilities
    
    
    71.7
    
    
    
    58.8Total liabilities
    
    
    1,672.3
    
    
    
    1,662.7Commitments and contingencies (see Note 12)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; 669,019 and 669,040 shares issued, respectively; 668,174 and 668,195
shares outstanding, respectively
    
    
    0.3
    
    
    
    0.3Common stock, $0.50 par value; 13,000,000 shares authorized; 10,063,359 shares
issued; 5,976,487 and 5,976,466 shares outstanding, respectively
    
    
    5.0
    
    
    
    5.0Additional capital
    
    
    225.3
    
    
    
    225.3Accumulated deficit
    
    
    (666.4
    )
    
    
    (619.8
    )Accumulated other comprehensive loss
    
    
    (96.6
    )
    
    
    (88.0
    )Treasury stock, at cost (shares held: preferred  845; common  4,086,872 and
4,086,893, respectively)
    
    
    (124.7
    )
    
    
    (124.7
    )Total stockholders deficit
    
    
    (657.1
    )
    
    
    (601.9
    )$
    1,015.2
    
    
    $
    1,060.8
 The accompanying notes are an integral part of these financial statements. 47




---



##### Table of Contents



MAXXAM INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENT OF OPERATIONS
(In millions of dollars, except per share information) Years Ended December 31,2004
    
    
    2003
    
    
    2002Net sales:Forest products
    
    $
    202.1
    
    
    $
    208.5
    
    
    $
    199.4Real estate
    
    
    94.8
    
    
    
    78.3
    
    
    
    48.9Racing
    
    
    50.6
    
    
    
    49.8
    
    
    
    52.7Aluminum
    
    
    
    
    
    
    
    
    
    
    65.7347.5
    
    
    
    336.6
    
    
    
    366.7Cost and expenses:Cost of sales and operations:Forest products
    
    
    150.1
    
    
    
    144.4
    
    
    
    136.5Real estate
    
    
    31.7
    
    
    
    25.1
    
    
    
    19.6Racing
    
    
    42.7
    
    
    
    41.0
    
    
    
    42.4Aluminum
    
    
    
    
    
    
    
    
    
    
    66.8Selling, general and administrative expenses
    
    
    71.7
    
    
    
    63.7
    
    
    
    80.4Gains on sales of timberlands and other assets
    
    
    (0.1
    )
    
    
    (17.5
    )
    
    
    (0.9
    )Impairment of assets
    
    
    
    
    
    
    1.4
    
    
    
    Depreciation, depletion and amortization
    
    
    37.1
    
    
    
    37.1
    
    
    
    37.8333.2
    
    
    
    295.2
    
    
    
    382.6Operating income (loss):Forest products
    
    
    5.4
    
    
    
    34.5
    
    
    
    18.8Real estate
    
    
    29.7
    
    
    
    17.1
    
    
    
    (0.2
    )Racing
    
    
    (3.1
    )
    
    
    (1.9
    )
    
    
    0.4Aluminum
    
    
    
    
    
    
    
    
    
    
    (24.4
    )Corporate
    
    
    (17.7
    )
    
    
    (8.3
    )
    
    
    (10.5
    )14.3
    
    
    
    41.4
    
    
    
    (15.9
    )Other income (expense):Investment and interest income
    
    
    8.6
    
    
    
    13.8
    
    
    
    13.6Other income (expense)
    
    
    4.2
    
    
    
    11.2
    
    
    
    (1.1
    )Interest expense
    
    
    (71.8
    )
    
    
    (74.8
    )
    
    
    (88.7
    )Amortization of deferred financing costs
    
    
    (2.2
    )
    
    
    (2.2
    )
    
    
    (3.9
    )Loss before income taxes, minority interests and discontinued
operations
    
    
    (46.9
    )
    
    
    (10.6
    )
    
    
    (96.0
    )Benefit (provision) for income taxes
    
    
    0.3
    
    
    
    (1.0
    )
    
    
    14.4Minority interests
    
    
    
    
    
    
    
    
    
    
    0.2Loss from continuing operations
    
    
    (46.6
    )
    
    
    (11.6
    )
    
    
    (81.4
    )Discontinued operations:Income from Kaisers discontinued operations
    
    
    
    
    
    
    
    
    
    
    0.7Provision for income taxes
    
    
    
    
    
    
    
    
    
    
    (4.0
    )Minority interests
    
    
    
    
    
    
    
    
    
    
    0.7Loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    (2.6
    )Net loss
    
    $
    (46.6
    )
    
    $
    (11.6
    )
    
    $
    (84.0
    )Basic and diluted loss per common and common equivalent share
from continuing operations
    
    $
    (7.79
    )
    
    $
    (1.79
    )
    
    $
    (12.47
    )Basic and diluted loss per common and common equivalent share
from discontinued operations
    
    
    
    
    
    
    
    
    
    
    (0.40
    )Basic and diluted loss per common and common equivalent share
    
    $
    (7.79
    )
    
    $
    (1.79
    )
    
    $
    (12.87
    )
 The accompanying notes are an integral part of these financial statements. 48




---



##### Table of Contents



MAXXAM INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions of dollars) Years Ended December 31,2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net loss
    
    $
    (46.6
    )
    
    $
    (11.6
    )
    
    $
    (84.0
    )Adjustments to reconcile net loss to net cash provided
by (used for) operating activities:Depreciation, depletion and amortization
    
    
    37.1
    
    
    
    37.1
    
    
    
    44.8Non-cash stock-based compensation expense
    
    
    6.1
    
    
    
    0.8
    
    
    
    0.1Non-cash impairments and restructuring charges
    
    
    
    
    
    
    1.4
    
    
    
    Gains on sales of timberlands and other assets
    
    
    (0.1
    )
    
    
    (18.3
    )
    
    
    (4.7
    )Net losses (gains) on marketable securities
    
    
    2.2
    
    
    
    (5.2
    )
    
    
    3.1Minority interests
    
    
    
    
    
    
    
    
    
    
    (0.9
    )Amortization of deferred financing costs and discounts on long-term debt
    
    
    2.2
    
    
    
    2.1
    
    
    
    3.9Equity in loss of unconsolidated affiliates, net of dividends
received
    
    
    1.7
    
    
    
    1.3
    
    
    
    1.2Other
    
    
    0.3
    
    
    
    (0.7
    )
    
    
    (2.4
    )Increase (decrease) in cash resulting from changes in:Receivables
    
    
    (0.8
    )
    
    
    (0.2
    )
    
    
    25.6Inventories
    
    
    4.4
    
    
    
    4.4
    
    
    
    15.5Prepaid expenses and other assets
    
    
    1.5
    
    
    
    (2.6
    )
    
    
    46.8Accounts payable
    
    
    2.5
    
    
    
    (1.1
    )
    
    
    10.7Accrued and deferred income taxes
    
    
    0.2
    
    
    
    0.6
    
    
    
    18.9Other accrued liabilities
    
    
    1.6
    
    
    
    (1.6
    )
    
    
    (48.6
    )Accrued interest
    
    
    (0.9
    )
    
    
    (0.2
    )
    
    
    6.0Long-term assets and long-term liabilities
    
    
    17.7
    
    
    
    8.9
    
    
    
    (71.1
    )Other
    
    
    (0.1
    )
    
    
    0.2
    
    
    
    1.6Net cash provided by (used for) operating activities
    
    
    29.0
    
    
    
    15.3
    
    
    
    (33.5
    )Cash flows from investing activities:Net proceeds from dispositions of property and investments
    
    
    0.2
    
    
    
    22.5
    
    
    
    6.5Net sales (purchases) of marketable securities and other investments
    
    
    5.8
    
    
    
    0.1
    
    
    
    117.0Capital expenditures
    
    
    (32.7
    )
    
    
    (23.8
    )
    
    
    (111.3
    )Decrease in cash attributable to deconsolidation of Kaiser
    
    
    
    
    
    
    
    
    
    
    (130.4
    )Other
    
    
    0.5
    
    
    
    0.4
    
    
    
    0.7Net cash used for investing activities
    
    
    (26.2
    )
    
    
    (0.8
    )
    
    
    (117.5
    )Cash flows from financing activities:Proceeds from issuances of long-term debt
    
    
    5.4
    
    
    
    2.9
    
    
    
    92.9Redemptions and repurchases of, and principal payments on, long-term debt
    
    
    (43.1
    )
    
    
    (27.7
    )
    
    
    (105.4
    )Borrowings (repayments) under revolving and short-term credit facilities
    
    
    30.0
    
    
    
    
    
    
    
    (21.1
    )Incurrence of deferred financing costs
    
    
    (0.8
    )
    
    
    (0.1
    )
    
    
    (1.5
    )Restricted cash withdrawals, net
    
    
    13.3
    
    
    
    11.4
    
    
    
    31.6Treasury stock purchases
    
    
    
    
    
    
    (9.0
    )
    
    
    Other
    
    
    
    
    
    
    
    
    
    
    (1.2
    )Net cash provided by (used for) financing activities
    
    
    4.8
    
    
    
    (22.5
    )
    
    
    (4.7
    )Net increase (decrease) in cash and cash equivalents
    
    
    7.6
    
    
    
    (8.0
    )
    
    
    (155.7
    )Cash and cash equivalents at beginning of year
    
    
    13.8
    
    
    
    21.8
    
    
    
    177.5Cash and cash equivalents at end of year
    
    $
    21.4
    
    
    $
    13.8
    
    
    $
    21.8
 The accompanying notes are an integral part of these financial statements. 49




---



##### Table of Contents



MAXXAM INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENT OF STOCKHOLDERS DEFICIT
(In millions, except per share information) Years Ended December 31,2004
    
    
    2003
    
    
    2002Preferred Stock ($.50 Par)Balance at beginning and end of year
    
    $
    0.3
    
    
    $
    0.3
    
    
    $
    0.3Common Stock ($.50 Par)Balance at beginning and end of year
    
    $
    5.0
    
    
    $
    5.0
    
    
    $
    5.0Additional CapitalBalance at beginning and end of year
    
    $
    225.3
    
    
    $
    225.3
    
    
    $
    225.3Accumulated DeficitBalance at beginning of year
    
    $
    (619.8
    )
    
    $
    (608.2
    )
    
    $
    (524.2
    )Net loss
    
    
    (46.6
    )
    
    
    (11.6
    )
    
    
    (84.0
    )Balance at end of year
    
    $
    (666.4
    )
    
    $
    (619.8
    )
    
    $
    (608.2
    )Accumulated Other Comprehensive Income (Loss)Minimum pension liability adjustment
    
    $
    (6.9
    )
    
    $
    1.1
    
    
    $
    (7.4
    )Applicable income taxes
    
    
    
    
    
    
    (0.1
    )
    
    
    3.0Unrealized gains (losses) on available-for-sale investments
    
    
    (1.7
    )
    
    
    0.2
    
    
    
    (0.7
    )Applicable income taxes
    
    
    
    
    
    
    
    
    
    
    0.3Unrealized gains (losses) on derivatives
    
    
    
    
    
    
    
    
    
    
    (12.1
    )Reclassification for realized gains (losses) on derivatives
    
    
    
    
    
    
    
    
    
    
    (6.0
    )Other comprehensive income (loss)
    
    
    (8.6
    )
    
    
    1.2
    
    
    
    (22.9
    )Accumulated other comprehensive loss at beginning of year
    
    
    (88.0
    )
    
    
    (89.2
    )
    
    
    (66.3
    )Accumulated other comprehensive loss at end of year
    
    $
    (96.6
    )
    
    $
    (88.0
    )
    
    $
    (89.2
    )Treasury StockBalance at beginning of year
    
    $
    (124.7
    )
    
    $
    (115.7
    )
    
    $
    (115.7
    )Treasury stock purchases
    
    
    
    
    
    
    (9.0
    )
    
    
    Balance at end of year
    
    $
    (124.7
    )
    
    $
    (124.7
    )
    
    $
    (115.7
    )Comprehensive Income (Loss)Net loss
    
    $
    (46.6
    )
    
    $
    (11.6
    )
    
    $
    (84.0
    )Other comprehensive income (loss)
    
    
    (8.6
    )
    
    
    1.2
    
    
    
    (22.9
    )Total comprehensive loss
    
    $
    (55.2
    )
    
    $
    (10.4
    )
    
    $
    (106.9
    )
 The accompanying notes are an integral part of these financial statements. 50




---



##### Table of Contents



MAXXAM INC. AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Index of Notes Number
    
    Description
    
    Page1
    
    Basis of
Presentation and Summary of Significant Accounting Policies
    
    
    512
    
    New Accounting
Standards
    
    
    613
    
    Segment Information
and Other Items
    
    
    614
    
    Cash, Cash
Equivalents, Marketable Securities and Other Investments
    
    
    645
    
    Property, Plant and
Equipment
    
    
    666
    
    Investments in
Unconsolidated Affiliates
    
    
    667
    
    Short-term
Borrowings
    
    
    668
    
    Long-term Debt
    
    
    679
    
    Income Taxes
    
    
    7010
    
    Employee Benefit and
Incentive Plans
    
    
    7311
    
    Investment in Kaiser
    
    
    7612
    
    Commitments and
Contingencies
    
    
    7813
    
    Stockholders
Deficit
    
    
    8314
    
    Significant
Acquisitions and Dispositions
    
    
    8615
    
    Supplemental Cash
Flow and Other Information
    
    
    8616
    
    Quarterly Financial
Information (Unaudited)
    
    
    87
 
 1. Basis of Presentation and Summary of Significant Accounting Policies Basis of Presentation The Company The consolidated financial statements generally include the accounts of MAXXAM Inc. and its
majority and wholly owned subsidiaries. See, however, Deconsolidation of Kaiser below. All
references to the Companyinclude MAXXAM Inc. and its majority owned and wholly owned
subsidiaries, unless otherwise noted or the context indicates otherwise. Intercompany balances and
transactions have been eliminated. Investments in affiliates (20% to 50% ownership) are accounted
for using the equity method of accounting. The Company conducts the substantial portion of its operations through its subsidiaries, which
operate in three principal industries:  
    Forest products, through MAXXAM Group Inc. (MGI) and MGIs wholly
owned subsidiary, The Pacific Lumber Company (Palco). Palcos
wholly owned subsidiaries are Scotia Pacific Company LLC (Scotia
LLC), Salmon Creek LLC (Salmon Creek) and Britt Lumber Co., Inc.
(Britt). MGI operates in several principal aspects of the forest
products industry  the growing and harvesting of redwood and
Douglas-fir timber, the milling of logs into lumber and the
manufacture of lumber into a variety of finished products. Housing,
construction and remodeling are the principal markets for the
Companys lumber products.
    Real estate investment and development, through MAXXAM Property
Company (MPC) and other wholly owned subsidiaries of the Company.
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.
    Racing operations, through Sam Houston Race Park, Ltd. (SHRP, Ltd.),
a Texas limited partnership, in which the Company owns a 100%
interest. SHRP, Ltd. owns and operates a 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 owns approximately 63% of Kaiser Aluminum
Corporation (Kaiser), a producer of fabricated aluminum products. Results and activities for
MAXXAM Inc. (excluding its subsidiaries) and 51




---



##### Table of Contents



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. Financial Difficulties of Certain Forest Products Entities Regulatory and
environmental matters as well as certain pending legal matters play a
significant role in the Companys forest products operations.
See Note 12 for discussion of
these matters. Regulatory compliance and related litigation have caused and may continue to cause
delays in approval of Scotia LLCs timber harvest plans (THPs) and delays in harvesting on its
THPs once they are approved. This has resulted and may continue to result in a decline in harvest,
an increase in the cost of logging operations, and increased costs related to timber harvest
litigation. As discussed
in Note 12, the California North Coast Regional Water Quality Control Board (the North
Coast Water Board) is requiring Palco and Scotia LLC to apply various waste discharge reporting,
mitigation and erosion control requirements in respect of timber harvesting activities in several
watersheds, and may impose additional measures in the future. The North Coast Water Board in
December 2003 directed its staff to formulate watershed-wide waste discharge requirements (WWDRs)
for the Freshwater and Elk River watersheds. These requirements have not yet been formulated, and
the North Coast Water Board has failed to release for harvest a number of THPs already approved by
the other government agencies which review Scotia LLCs THPs. The failure
of the North Coast Water Board to release these THPs for harvest has adversely
impacted the cash flows of both Palco and Scotia LLC. Scotia LLC estimates that, without the
prompt release of a substantial portion of these THPs, its cash flows
from operations, together with
funds available under an agreement (the Scotia LLC Line of Credit) with a group of banks pursuant
to which Scotia LLC may borrow to pay interest on its 6.55% Class A-1, 7.11% Class A-2 and 7.71%
Class A-3 Timber Collateralized Notes due 2028 of Scotia LLC (the Timber Notes), will be
inadequate to pay the entire amount of interest due on the July 20, 2005 payment date for the
Timber Notes, which would constitute an event of default under the indenture governing the Timber
Notes (the Timber Notes Indenture). Palco is in default under a $30.0 million asset-based credit
agreement with a bank (the Palco Credit Agreement) and estimates that, without the prompt release
of a substantial portion of these THPs and necessary amendments to the Palco Credit Agreement, its
cash flow from operations, together with funds available under the
Palco Credit Agreement, will not
provide sufficient liquidity to fund its current level of operations. Palco and Scotia LLC are
continuing efforts to obtain the clearance of the North Coast Water Board of sufficient THPs.
Palco has received a limited waiver of the default through March 18, 2005, from the lender under
the Palco Credit Agreement and is seeking a more permanent solution to the default. There can be
no assurance that these efforts with the North Coast Water Board and the lender under the Palco
Credit Agreement will be successful. In the event of a failure to pay interest on the Timber Notes in full when due, the trustee
under the Timber Notes Indenture (the Trustee) or the holders of at least 25% of the aggregate
outstanding principal amount of the Timber Notes may cause all principal, interest and other
amounts related to the Timber Notes to become immediately due and payable. Also, in the event of a
failure by Palco or Scotia LLC to perform its respective covenants or agreements under the master
purchase agreement which governs the sale to Palco of logs harvested from the timberlands owned by
Scotia LLC (the Scotia LLC Timberlands) or by Palco to perform its covenants or agreements under
a services agreement between Palco and Scotia LLC relating to the provision of operational,
management and related services not performed by Scotia LLCs own employees with respect to the
Scotia LLC Timberlands, which failure continues for 30 days after notice from the Trustee or the
holders of 25% or more of the outstanding principal amount of the Timber Notes, the holders of
a majority of the aggregate outstanding principal amount of the Timber Notes may cause all
principal, interest and other amounts related to the Timber Notes to become immediately due and
payable. In the event of any such acceleration, the Agent under the Scotia LLC Line of Credit may
also accelerate the advances then outstanding thereunder. If such accelerations of Timber Notes
and/or advances under the Scotia LLC Line of Credit occur, the Trustee may exercise all rights
under the Timber Notes Indenture and related security documents, including applying funds to pay
accelerated amounts, and selling the Scotia LLC Timberlands and other assets and using the proceeds
thereof to pay accelerated amounts. In the event that Scotia LLC were to seek protection by filing
under the U. S. Bankruptcy Code (the Bankruptcy Code), all amounts related to the Timber Notes
would become immediately due and payable under the Timber Notes Indenture and all advances under
the Scotia LLC Line of Credit agreement could be accelerated. The foregoing rights of the Trustee
and holders of Timber Notes are subject to the rights of Scotia LLC under the Bankruptcy Code. 52




---



##### Table of Contents



Without an extension of the limited waiver of Palcos default under the Palco Credit
Agreement and a restructuring or replacement of that facility, Palcos lender may take any of the
following actions: reduce the amount of funds available to
Palco for borrowing; refuse to make new loans to or issue new letters of credit for the
benefit of Palco; declare any or all loans and other amounts owed under the agreement to be
immediately due and payable; require Palco to cash collateralize all outstanding letters of credit;
or pursue its other rights and remedies under the Palco Credit Agreement and related security
agreements. The existence of the default also requires Palco to pay interest on amounts borrowed
under the Palco Credit Agreement at a per annum rate 2% higher than the rate at which interest
would be owed if no default existed. If any acceleration under the Palco Credit Agreement occurs,
then the agent for the lender may exercise all rights under that agreement and related security
documents, including selling Palcos assets and using the proceeds thereof to pay the accelerated
amounts. In the event that Palco were to seek protection by filing under the Bankruptcy Code, all
loans and other amounts owed under the Palco Credit Agreement would become immediately due and
payable. The foregoing rights of the lender under the Palco Credit Agreement are subject to the
rights of Palco under the Bankruptcy Code. In the event of a Scotia LLC default or a Palco liquidity shortfall, whether resulting from a
failure to extend the limited waiver past March 18, 2005, any action described above taken by
Palcos lender, or otherwise, Palco and Scotia LLC could be forced to take extraordinary actions,
which may include: reducing expenditures by laying off employees and shutting down various
operations; seeking other sources of liquidity, such as from asset sales; and considering seeking
protection by filing under the Bankruptcy Code. On December 8, 2004, Standard & Poors Ratings Services (S&P) lowered Palcos credit rating
from B- to CCC+. As a result, Palco may be required to post a
security deposit for workers compensation liabilities in July 2005, in an
amount that has not been determined but that could be material to Palcos liquidity, capital
resources, and results of operations. If improvements in Palcos liquidity, capital resources, and
results of operations produce an upward revision in Palcos credit rating, or if a waiver of this
requirement is allowed under applicable law, then posting of such a security deposit may not be
necessary. Palco management is in the process of evaluating the potential amount of such a
security deposit, if required. There can be no assurance that such a security deposit will not be
required or that, if required, the amount will not be material. Palco management is also
evaluating whether other potential obligations or unanticipated adverse financial reports may
result from the S&P credit action described above. The liquidity issues being experienced by Palco and Scotia LLC could result in claims against
and could have adverse impacts on MAXXAM Parent, MGHI and/or MGI. For example, under ERISA law,
were Palco to terminate its pension plan, MAXXAM Parent and its wholly owned subsidiaries would be
jointly and severally liable for any unfunded pension plan obligations. The unfunded obligation
attributable to Palcos pension plan as of December 31, 2004 is estimated to have been in the range
of approximately $35 million based upon current annuity placement interest rate assumptions. In
addition, it is possible that certain transactions could be entered into in connection with a
potential restructuring or reorganization of Palco or Scotia LLC, such as a sale of all or a
portion of the equity ownership in Palco and/or Scotia LLC, a sale of a substantial portion of
Palcos and/or Scotia LLCs assets and/or a cancellation of some or all of Palcos and/or Scotia
LLCs 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 for federal and state income
tax purposes and could require tax payments. In addition, there can be no assurance that certain other pending legal, regulatory and
environmental matters or future governmental regulations, legislation or judicial or administrative
decisions, adverse weather conditions, or low lumber or log prices, will not have a material
adverse effect on the Companys financial condition, results of
operations or liquidity. See Note 12 for further information regarding regulatory and legislative matters and
legal proceedings relating to the Companys forest products operations. Under generally accepted accounting principles, 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. As discussed above, Palco and Scotia LLCs cash flows have
been adversely impacted by ongoing delays in approvals from the North Coast Water Board, and one of
the actions being considered is seeking protection by filing for bankruptcy. Were this to occur,
the financial results of the subsidiaries which file for bankruptcy would be deconsolidated on the
date of such filing, and the Company would began reporting its investment in such subsidiaries
using the cost method. If Palco and/or Scotia LLC were among the 53




---



##### Table of Contents



subsidiaries which filed for
bankruptcy, the resulting impact on the Companys financial statements would be significant The
following condensed pro forma financial information reflects MGIs results on a deconsolidated
basis, and the impact of reporting the Companys investment in MGI on the cost method (in
millions). This information is on a pro forma basis only, however, and the actual
impact of a deconsolidation at some point in the future would differ. Furthermore, this pro
forma information assumes that MGI and all of its subsidiaries file for bankruptcy, rather than the
impact of only one or more subsidiaries filing. Year EndedDecember 31,2004Revenues
    
    $
    145.4Costs and expenses
    
    
    (136.5
    )Operating income (loss)
    
    
    8.9MAXXAMs equity in MGIs losses
    
    
    (49.3
    )Other income (expenses)  net
    
    
    (6.5
    )Income tax benefit
    
    
    0.3Net loss
    
    $
    (46.6
    )
 December 31,2004Current assets
    
    $
    151.3Property, plant, and equipment (net)
    
    
    253.4Other assets
    
    
    170.5Total assets
    
    $
    575.2Current liabilities
    
    
    44.3Long-term debt, less current maturities
    
    
    224.1Other liabilities
    
    
    74.7Losses recognized in excess of investment in MGI
    
    
    373.0Losses recognized in excess of investment in Kaiser
    
    
    516.2Total liabilities
    
    
    1,232.3Stockholders deficit
    
    
    (657.1
    )Total liabilities and stockholders deficit.
    
    $
    575.2
 In the event that MGI and /or any of it subsidiaries file for bankruptcy, the Company
believes that it is not probable that it would be obligated to fund losses related to its
investment in such subsidiaries. Deconsolidation of 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. As
discussed below, 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 the Company began
reporting its investment in Kaiser using the cost method, under which the investment is reflected
as a single amount on the Companys balance sheet of $(516.2) million, and the recording of
earnings or losses from Kaiser was discontinued after February 11, 2002. Through February 11, 2002, under generally accepted principles of consolidation, the Company
had recognized losses in excess of its investment in Kaiser of $516.2 million. Since Kaisers
results are no longer consolidated and the Company believes that it is not probable that it will be
obligated to fund losses related to its investment in Kaiser, any adjustments reflected in Kaisers
financial statements subsequent to February 12, 2002 (relating to the recoverability and
classification of recorded asset amounts and the classification of liabilities or the effects on
existing stockholders deficit as well as adjustments made to Kaisers financial information for
loss contingencies and other matters), are not expected to affect the Companys financial results. The Company expects to consider reversal of its losses in excess of its investment in
Kaiser when either: (1) Kaisers bankruptcy is resolved and the amount of the Companys remaining
investment in Kaiser is determined or (2) the Company disposes of its shares of Kaiser common
stock. Accordingly, these consolidated financial statements do not reflect any adjustments related
to the deconsolidation of Kaiser other than presenting the Companys investment in 54




---



##### Table of Contents



Kaiser using the
cost method. When either of the events described above occurs, the Company will re-evaluate the
appropriate accounting treatment of its investment in Kaiser based upon the facts and circumstances
at such time. It is likely that the Companys
ownership interest in Kaiser will be cancelled. In such event, the Company will reverse the
$516.2 million of losses in excess of its investment in Kaiser, and recognize the entire amount in
income for the period. Such benefit would be reduced, however, by losses, if any, related to Kaiser
which the Company estimates it would be obligated to fund. See Note 11 for further discussion of
the Companys investment in Kaiser. The following condensed pro forma financial data
reflect the results of operations of the
Company, excluding Kaiser, for the year ended December 31, 2002, the year in which Kaiser was
deconsolidated (in millions, except share data). Net sales
    
    $
    301.0Costs and expenses
    
    
    (292.5
    )Operating income
    
    
    8.5Other income
    
    
    20.7Interest expense
    
    
    (80.2
    )Loss before income taxes and minority interests
    
    
    (51.0
    )Income tax benefit
    
    
    15.2Minority interests
    
    
    0.3Net loss
    
    $
    (35.5
    )Basic and diluted net loss per share
    
    $
    (5.45
    )
 Kaiser Discontinued Operations As part of Kaisers plan to divest certain of its commodity-based assets, Kaiser during 2004,
with the approval of the Bankruptcy Court, completed or finalized plans for the sale of its
interests in Kaisers Discontinued Operations. In accordance with Statement of Financial
Accounting Standards No. 144, Accounting for the Impairment and Disposal of Long-Lived Assets
(SFAS No. 144), the operating results of Kaisers interests in the divested assets have been
reported as discontinued operations in the accompanying Consolidated Statement of Operations for
the period from January 1, 2002, to February 11, 2002, the date that Kaiser was deconsolidated (see
discussion of the deconsolidation of Kaiser above). Combined income statement information in
respect of Kaisers Discontinued Operations for the period from January 1, 2002, to February 11,
2002, included in income (loss) from discontinued operations is as follows (in millions): Period fromJanuary 1, 2002, toFebruary 11, 2002Net sales
    
    $
    101.8Operating income
    
    
    0.8Income before income taxes and minority interests
    
    
    0.7Net loss
    
    
    (2.6
    )
 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. Adjustments made to estimates
often relate to improved information not previously available. Uncertainties regarding such
estimates and related assumptions are inherent in the preparation of the Companys consolidated
financial statements; accordingly, actual results could differ from these estimates. Risks and uncertainties are inherent with respect to the ultimate outcome of the matters
discussed in Note 12. 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 9. Estimates of future benefit
payments used to measure the Companys pension and other postretirement benefit obligations
discussed in Note 10 are 55




---



##### Table of Contents



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 financial statements or liquidity could be affected. Reclassifications Certain reclassifications have been made to prior years consolidated financial statements to
be consistent with the current years presentation. The reclassification of prior year balances
includes $21.2 million of auction rate securities which were reclassified from cash and cash
equivalents to marketable securities in the Consolidated Balance Sheet. 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 debt securities, corporate common stocks and option contracts.
These investments are managed by financial institutions. Securities Available-for-Sale 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. Inventories Inventories are stated at 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
multi-species habitat conservation plan (HCP) and the sustained yield plan (SYP) (see Note 12)
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. 56




---



##### Table of Contents



The carrying amounts of the Companys SYP and HCP intangible assets are as follows (in
millions): December 31,2004
    
    
    2003
    
    
    2002SYP/HCP
    
    $
    8.3
    
    
    $
    8.3
    
    
    $
    8.3Less: Accumulated amortization
    
    
    (4.5
    )
    
    
    (3.6
    )
    
    
    (2.7
    )$
    3.8
    
    
    $
    4.7
    
    
    $
    5.6
 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 life of intangible assets with finite lives are 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, 2004, 2003 and 2002, was
$0.9 million per year. The estimated amortization expense 2005 through 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. 57




---



##### Table of Contents



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. Revenue Recognition Revenues from the sale of logs, lumber products and by-products are recorded when the legal
ownership and the 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 noncurrent liabilities on the balance sheet.
Additionally, in certain circumstances the cost recovery or installment method is used whereby 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 the 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. Asset Impairment 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. Under certain conditions, the results of operations of a component of an entity which either
has been disposed of or is classified as held-for-sale would be reported in discontinued
operations. The Company classifies long-lived assets as held-for-sale if the following conditions
are satisfied:  
    Management commits to a plan to sell a long-term operating asset;
    The asset is available for immediate sale;
    An active effort to locate a buyer is underway; and
    It is probable that the sale will be completed within one year. Legal and Environmental Contingencies The Company is currently involved in various claims and proceedings which are reviewed for
potential financial exposure on a regular basis. If the potential loss from any claim or legal
proceeding is considered probable and is reasonably estimable as of the balance sheet date, a
liability is accrued. The Company estimates the probability of 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 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. See Note 12 for a description of
the Companys material legal proceedings and environmental matters. 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 58




---



##### Table of Contents



(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 9 for further discussion of the Companys income taxes. Stock-based Compensation The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees (APB Opinion No. 25) and related interpretations in accounting for
stock options (or stock appreciation rights, as applicable) issued to employees and outside
directors. Under APB Opinion No. 25, because the exercise price of the Companys employee stock
options equals or exceeds the market price of the underlying stock on the date of grant, no
compensation expense is recognized when stock options are granted. However, compensation expense
is recorded in each period prior to exercise based on the excess of market value at the end of each
period over the exercise price, if applicable (i.e., compensation expense is adjusted up or down as
the market value of the Companys stock changes). The following table illustrates the pro forma effect on net income and earnings per share had
the Company accounted for its stock options under the fair value method. For purposes of pro forma
disclosures, the estimated fair value of the options is amortized to expense over the options
vesting period (in millions, except per share information). Years Ended December 31,2004
    
    
    2003
    
    
    2002Net loss, as reported
    
    $
    (46.6
    )
    
    $
    (11.6
    )
    
    $
    (84.0
    )Add: Stock-based employee compensation expenses included in reported net
loss, net of related tax effects
    
    
    6.1
    
    
    
    0.8
    
    
    
    Deduct: Total stock-based employee compensation expense determined
under the fair value method for all awards, net of related tax effects
    
    
    (1.8
    )
    
    
    (1.8
    )
    
    
    (1.3
    )Pro forma net loss
    
    $
    (42.3
    )
    
    $
    (12.6
    )
    
    $
    (85.3
    )Basic and diluted loss per share:As reported
    
    $
    (7.79
    )
    
    $
    (1.79
    )
    
    $
    (12.87
    )Pro forma
    
    
    (7.06
    )
    
    
    (1.94
    )
    
    
    (13.07
    )
 The fair value of stock options granted were estimated at the grant date using a
Black-Scholes option pricing model and the following weighted average assumptions: Years Ended December 31,2004
    
    
    2003
    
    
    2002Dividend yield
    
    
    
    
    
    
    
    
    
    
    Expected volatility
    
    
    0.40
    
    
    
    0.39
    
    
    
    0.38Risk-free interest rate
    
    
    4.59
    %
    
    
    4.76
    %
    
    
    4.92
    %Expected life (years)
    
    
    6.65
    
    
    
    6.64
    
    
    
    6.63Weighted average fair value
    
    $
    8.58
    
    
    $
    9.50
    
    
    $
    10.65
 59




---



##### Table of Contents



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 of the Company (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 (the 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. 2004
    
    
    2003
    
    
    2002Weighted average shares outstanding:Common Stock
    
    
    5,976,467
    
    
    
    6,465,919
    
    
    
    6,527,671Effect of dilution:Class A Preferred Stock
    
    
    
    (1)
    
    
    
    (1)
    
    
    
    (1)Weighted average number of common and common equivalent
shares - Basic
    
    
    5,976,467
    
    
    
    6,465,919
    
    
    
    6,527,671Effect of dilution:Stock options (1)
    
    
    
    (1)
    
    
    
    (1)
    
    
    
    (1)Weighted average number of common and common equivalent
shares - Diluted
    
    
    5,976,467
    
    
    
    6,465,919
    
    
    
    6,527,671   (1)
    
    The Company had a loss for the years ended December 31, 2004, 2003 and 2002; the
Class A Preferred Stock and options were therefore not included in the computation of earnings
per share for the period.
 60




---



##### Table of Contents



2.
    New Accounting Standards Postretirement Medical Costs In May 2004, the Financial Accounting Standards Board (FASB) issued FASB Staff Position FAS
106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug
Improvement and Modernization Act of 2003 (FSP FAS 106-2). FSP FAS 106-2 applies only to
sponsors of single-employer defined benefit postretirement health care plans for which (1) the
employer has concluded that prescription drug benefits available under the plan to some or all
participants, for some or all future years, are actuarially equivalent to Medicare Part D and
thus qualify for the subsidy provided by the Prescription Drug Act, and (2) the expected subsidy
will offset or reduce the employers share of the cost of the underlying postretirement
prescription drug coverage on which the subsidy is based. FSP FAS 106-2 provides guidance on the
accounting for the effects of the Prescription Drug Act on a companys accumulated postretirement
benefit obligation. In addition, FSP FAS 106-2 addresses accounting for plan amendments and
requires certain financial statement disclosures regarding the Prescription Drug Act and its
effects FSP FAS 106-2 was effective for the first interim period beginning after June 15, 2004. The
Company believes that the benefits provided by the Companys plan are actuarially equivalent to
Medicare Part D; however, based on the proposed regulations issued to date and the Companys
understanding of the Prescription Drug Act, the Company is uncertain as to the potential future
subsidies which may be realized under the Prescription Drug Act. Therefore, measures of the
accumulated postretirement benefit obligation and net periodic benefit cost included herein do not
reflect any amount associated with potential subsidies under the Prescription Drug Act. The
Company expects to be able to determine amounts of potential subsidies when additional
clarification and final regulations are issued. Accounting for Stock Options In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS
No.123(r)). SFAS No. 123(r) will require compensation costs related to share-based payment
transactions to be measured based on the grant-date fair value of the equity or liability
instruments issued. In addition, liability awards will be remeasured each reporting period.
Compensation cost will be recognized over the period that an employee provides service in exchange
for the award. SFAS No. 123(r) is effective as of the first interim or annual reporting period
that begins after June 15, 2005. For the portion of outstanding awards for which the requisite
service has not yet been rendered, compensation cost is recognized as of the required effective
date based on the grant-date fair value of those awards. In addition, SFAS No. 123(r) applies to
all awards granted after the required effective date. The Company is in the process of evaluating
the effects of this Statements provisions on its financial position and results of operations. 
  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 which 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. 61




---



##### Table of Contents



The following table presents financial information by reportable segment (in millions). Consol-idatedReportable Segments
    
    
    
    
    
    
    Total
    
    
    
    
    
    
    Consol-Forest
    
    
    Real
    
    
    
    
    
    
    
    
    
    
    Excluding
    
    
    
    
    
    
    idatedDecember 31,
    
    
    Products
    
    
    Estate
    
    
    Racing
    
    
    Corporate
    
    
    Aluminum
    
    
    Aluminum(1)
    
    
    TotalInvestment, interest and
other income (expense), net
    
    
    2004
    
    
    $
    1.0
    
    
    $
    8.1
    
    
    $
    
    
    
    $
    3.7
    
    
    $
    12.8
    
    
    $
    
    
    
    $
    12.82003
    
    
    
    5.5
    
    
    
    5.9
    
    
    
    0.2
    
    
    
    13.4
    
    
    
    25.0
    
    
    
    
    
    
    
    25.02002
    
    
    
    7.4
    
    
    
    6.2
    
    
    
    
    
    
    
    8.0
    
    
    
    21.6
    
    
    
    (9.1
    )
    
    
    12.5Interest expense(2)
    
    
    2004
    
    
    
    55.7
    
    
    
    18.3
    
    
    
    
    
    
    
    
    
    
    
    74.0
    
    
    
    
    
    
    
    74.02003
    
    
    
    58.1
    
    
    
    18.9
    
    
    
    
    
    
    
    
    
    
    
    77.0
    
    
    
    
    
    
    
    77.02002
    
    
    
    58.8
    
    
    
    13.2
    
    
    
    
    
    
    
    8.2
    
    
    
    80.2
    
    
    
    12.4
    
    
    
    92.6Depreciation, depletion and
amortization
    
    
    2004
    
    
    
    20.6
    
    
    
    14.0
    
    
    
    1.7
    
    
    
    0.8
    
    
    
    37.1
    
    
    
    
    
    
    
    37.12003
    
    
    
    21.0
    
    
    
    14.2
    
    
    
    1.7
    
    
    
    0.2
    
    
    
    37.1
    
    
    
    
    
    
    
    37.12002
    
    
    
    22.8
    
    
    
    10.4
    
    
    
    1.6
    
    
    
    0.3
    
    
    
    35.1
    
    
    
    2.7
    
    
    
    37.8Income (loss) before income
taxes, minority interests and
discontinued operations
    
    
    2004
    
    
    
    (49.3
    )
    
    
    19.5
    
    
    
    (3.1
    )
    
    
    (14.0
    )
    
    
    (46.9
    )
    
    
    
    
    
    
    (46.9
    )2003
    
    
    
    (18.1
    )
    
    
    4.1
    
    
    
    (1.7
    )
    
    
    5.1
    
    
    
    (10.6
    )
    
    
    
    
    
    
    (10.6
    )2002
    
    
    
    (33.5
    )
    
    
    (7.2
    )
    
    
    0.4
    
    
    
    (10.7
    )
    
    
    (51.0
    )
    
    
    (45.0
    )
    
    
    (96.0
    )Income (loss) from
discontinued operations, net
of tax
    
    
    2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2.6
    )
    
    
    (2.6
    )Capital expenditures
    
    
    2004
    
    
    
    29.8
    
    
    
    2.4
    
    
    
    0.2
    
    
    
    0.3
    
    
    
    32.7
    
    
    
    
    
    
    
    32.72003
    
    
    
    19.1
    
    
    
    3.5
    
    
    
    1.0
    
    
    
    0.2
    
    
    
    23.8
    
    
    
    
    
    
    
    23.82002
    
    
    
    12.2
    
    
    
    93.6
    
    
    
    0.6
    
    
    
    0.1
    
    
    
    106.5
    
    
    
    4.8
    
    
    
    111.3Total assets
    
    
    2004
    
    
    
    440.0
    
    
    
    338.2
    
    
    
    33.2
    
    
    
    203.8
    
    
    
    1,015.2
    
    
    
    
    
    
    
    1,015.22003
    
    
    
    483.6
    
    
    
    359.5
    
    
    
    33.6
    
    
    
    184.1
    
    
    
    1,060.8
    
    
    
    
    (3)
    
    
    1,060.8
   (1)
    
    For 2002, amounts attributable to the aluminum segment are for the period from
January 1, 2002, through February 11, 2002. Kaisers results were deconsolidated commencing
February 12, 2002 (see Notes 1 and 11).(2)
    
    Interest expense also includes amortization of deferred financing costs.(3)
    
    As a result of the deconsolidation of Kaiser, the aluminum segments balance sheet
amounts are not included in the consolidated total as of December 31, 2004 and 2003. Other Items Forest Products 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. Based upon these reviews, Palco implemented
a number of changes during the last quarter of 2001 and the first quarter of 2002, including
closing two of its four sawmills, eliminating certain of its operations, including its
company-staffed logging operations (now relying exclusively on contract loggers) and its soil
amendment and concrete block activities, utilizing more efficient harvesting methods and adopting
other cost saving measures. In connection with these changes, the Company in 2001 recorded a
charge to operating costs of $2.2 million for impaired assets. As a result of the operational reviews conducted during 2001, Palco identified machinery and
equipment that it no longer needed for its current or future operations and in 2001 committed to a
plan for disposal of these assets during 2002. During 2002, machinery and equipment with a
carrying value of $2.2 million was sold, resulting in a gain of $1.0 million. 62




---



##### Table of Contents



Palco has continued to examine ways in which to achieve additional cost savings. During 2004,
Palco opened a new planer facility in Scotia and began construction on a new sawmill in Scotia,
California. The project is expected to cost $27.3 million ($20.5 million of which was expended in
2004), with the last phase scheduled for completion in the third quarter of 2005 (subject to
available cash). Funds for this project are being provided from existing cash resources and
borrowings under the Palco Credit Agreement. As part of the project, the Carlotta mill was
permanently closed, and the equipment from the Carlotta mill is in the process of being moved to
the new mill in Scotia. Management is considering alternative uses for the property. Palco implemented a voluntary reduction in workforce related to the closure of the Carlotta
mill. In connection with the reduction, Palco charged $1.4 million against earnings for employee
severance and benefit costs. This amount is reflected in selling, general and administrative
expenses in the Consolidated Statement of Operations for 2004. The employee severance and benefit
costs were related to the termination of approximately 107 regular employees, the majority of whom
were engaged in direct manufacturing activities at Palcos sawmill facilities. As of December 31,
2004, all of the $1.4 million in severance and benefits had been paid. Further actions may be
taken during 2005 as a result of Palcos continuing evaluation process or in response to the
financial difficulties discussed in Note 1, and writedowns of certain assets may be required. Additionally, the Company recorded an environmental remediation charge of $3.4 million in
2001. 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
$0.4 million, $0.7 million and $0.5 million of costs related to this remediation liability during
2004, 2003 and 2002, respectively. Based on managements best estimates given the current facts
and circumstances, the remaining $1.8 million is expected to be incurred in 2005. The forest products segments operating income (loss) included gains on sales of timberlands
in the Grizzly Creek grove of $16.8 million in November 2003. Real Estate Investment, interest and other income (expense) for the real estate segment includes equity in
earnings from real estate joint ventures of $2.8 million, $0.7 million and $2.5 million for the
years ended December 31, 2004, 2003 and 2002, respectively. Investment, interest and other income
(expense) for the real estate segment also includes $0.8 million in 2003 for the gain realized on
the sale of the Companys investment in the Sunridge Canyon real estate joint venture. In April 2004, a subsidiary of the Company and a third party real estate development company
formed a joint venture 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. In connection with the 2003 termination of the Companys casino facility lease at its Palmas
del Mar operation in Puerto Rico (Palmas), the Company recorded a charge to operating expenses of
$1.4 million related to the write-down casino-related assets to estimated fair value. Corporate The Company recorded a charge to operating expense of $1.9 million in 2004 in connection with
an environmental matter associated with a former subsidiary of the Company. See Note 12 for
further discussion. In addition to this accrual, results for 2004 include $6.1 million related to
an increase in stock-based compensation expense, which is adjusted as the market value of the
Companys Common Stock changes and awards vest. Corporate investment, interest and other income (expense) for 2003 includes $8.0 million of
insurance recoveries related to the OTSand FDIC actions. During 2002, the Company repurchased $56.6 million principal amount of the Senior Secured
Notes of MGHI (the MGHI Notes), resulting in a gain of $2.4 million (net of tax). The Company
redeemed the remaining $31.6 million principal amount of MGHI Notes in December 2002. 63




---



##### Table of Contents



Aluminum For the period from January 1, 2002 to February 11, 2002 the aluminum segments operating loss
includes the impact of restructuring charges of $1.3 million which are included in cost of sales
and operations, in addition to the net impact of certain non-recurring amounts totaling $1.8
million included in investment, interest and other income in the Consolidated Statement of
Operations. Product Sales The following table presents segment sales by primary products (in millions). Years Ended December 31,2004
    
    
    2003
    
    
    2002(1)Forest products:Lumber, net of discount
    
    $
    179.2
    
    
    $
    184.0
    
    
    $
    170.4Logs
    
    
    6.1
    
    
    
    6.5
    
    
    
    14.4Wood chips
    
    
    3.1
    
    
    
    3.4
    
    
    
    2.3Cogeneration power
    
    
    10.8
    
    
    
    11.4
    
    
    
    9.4Other
    
    
    2.9
    
    
    
    3.2
    
    
    
    2.9Total forest products sales
    
    $
    202.1
    
    
    $
    208.5
    
    
    $
    199.4Real estate:Real estate and development
    
    $
    59.7
    
    
    $
    49.7
    
    
    $
    24.6Resort, commercial and other operations
    
    
    17.9
    
    
    
    12.7
    
    
    
    15.0Commercial lease properties
    
    
    17.2
    
    
    
    15.9
    
    
    
    9.3Total real estate sales
    
    $
    94.8
    
    
    $
    78.3
    
    
    $
    48.9Racing:Gross pari-mutuel commissions
    
    $
    39.5
    
    
    $
    39.2
    
    
    $
    42.5Other
    
    
    11.1
    
    
    
    10.6
    
    
    
    10.2Total racing sales
    
    $
    50.6
    
    
    $
    49.8
    
    
    $
    52.7
   (1)
    
    As a result of the deconsolidation of Kaiser, amounts for the aluminum segment are
not presented in this table for the period from January 1, 2002, to February 11, 2002. 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, 2004, $2.3 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, 2004, 2003 and 2002, sales to any one customer did not exceed
10% of consolidated revenues. Export sales were less than 10% of total revenues in 2004, 2003 and
2002. 
  4.
    Cash, Cash Equivalents, Marketable Securities and Other Investments Cash equivalents consist of highly liquid money market instruments with original maturities of
three months or less. As of December 31, 2004 and 2003, carrying amounts of the Companys cash
equivalents approximated fair value. The fair value of substantially all marketable equity and debt securities is determined by
quoted market prices. The following is a summary of available-for-sale securities (in millions): December 31,2004
    
    
    2003Cost
    
    $
    75.0
    
    
    $
    130.6Estimated fair value
    
    
    74.5
    
    
    
    134.1
 64




---



##### Table of Contents



During 2003, marketable debt securities classified as held-to-maturity were sold to
generate funds for principal payments on long-term debt and for the repurchase of Timber Notes.
The amortized cost of the securities sold was $22.2 million, and the realized gain on the sale of
such securities was $0.1 million. At December 31, 2003, management re-evaluated the classification of its investment securities
in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities
(SFAS No. 115). As a result, marketable debt securities previously classified as
held-to-maturity were transferred to the available-for-sale category. The amortized cost and fair
value of the transferred securities was $14.3 million and $14.4 million, respectively, at December
31, 2003. There were no investments classified as held-to-maturity at December 31, 2004 and 2003. Investment, interest and other income (expense), net, includes gross realized gains and losses
on sales of available-for-sale securities as follows (in millions): Years Ended December 31,2004
    
    
    2003
    
    
    2002Gross realized gains
    
    $
    0.6
    
    
    $
    0.4
    
    
    $
    2.4Gross realized losses
    
    
    (0.4
    )
    
    
    
    
    
    
    (0.1
    )
 The net adjustment to unrealized holding gains (losses) on available-for-sale securities
included as a separate component of shareholders deficit totaled $(1.7) million, $0.2 million, and
$(0.7) million in 2004, 2003, and 2002, respectively. The fair value of investment securities in a
continuous unrealized loss position for less than twelve months and for twelve months or more as of
December 31, 2004, was $6.5 million and $11.9 million, respectively. Gross unrealized losses on
investment securities at December 31, 2004, were not material. Available-for-sale 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. 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 31,2004
    
    
    2003Current assets:Restricted cash and cash equivalents
    
    $
    3.1
    
    
    $
    4.0Marketable securities, restricted:Amounts held in SAR Account
    
    
    25.1
    
    
    
    22.2Long-term restricted cash, cash equivalents, marketable securities and other investments:Amounts held in SAR Account
    
    
    68.5
    
    
    
    87.7Other amounts restricted under the Timber Notes Indenture
    
    
    2.5
    
    
    
    2.5Other long-term restricted amounts
    
    
    6.4
    
    
    
    8.2Less: Amounts attributable to Timber Notes held in SAR Account
    
    
    (61.8
    )
    
    
    (54.8
    )15.6
    
    
    
    43.6Total restricted cash, cash equivalents, marketable securities and other investments
    
    $
    43.8
    
    
    $
    69.8
 Amounts in the Scheduled Amortization Reserve Account (SAR Account) are being held by
the trustee under the Timber Notes Indenture to support principal payments on the Timber Notes.
See Note 8 for further discussion of the SAR Account. Other Investments Cash, cash equivalents, marketable securities and other investments include interests 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. The following table shows the Companys investment in these partnerships,
including restricted amounts held in the SAR Account (in millions). December 31,2004
    
    
    2003Restricted
    
    $
    16.0
    
    
    $
    15.5Unrestricted
    
    
    47.6
    
    
    
    19.3$
    63.6
    
    
    $
    34.8
 65




---



##### Table of Contents



Investment, interest and other income (expense), net, includes income from the Companys
investment in these partnerships for each of the three years in the period ended December 31, 2004,
as follows (in millions): Years Ended December 31,2004
    
    
    2003
    
    
    2002Earnings from investments in partnerships
    
    $
    1.8
    
    
    $
    4.8
    
    
    $
    3.0
 
  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): Estimated Useful
    
    
    December 31,Lives
    
    
    2004
    
    
    2003Land and improvements
    
    5  30 years
    
    $
    135.4
    
    
    $
    128.4Buildings
    
    5  40 years
    
    
    260.9
    
    
    
    257.3Machinery and equipment
    
    3  15 years
    
    
    135.3
    
    
    
    132.5Construction in progress
    
    
    
    
    
    
    22.0
    
    
    
    14.3553.6
    
    
    
    532.5Less: accumulated depreciation
    
    
    
    
    
    
    (183.4
    )
    
    
    (164.6
    )$
    370.2
    
    
    $
    367.9
 Depreciation expense for the years ended December 31, 2004, 2003 and 2002 was $27.9
million, $26.3 million, and $31.7 million, respectively. As discussed in Note 3, the Company in 2003 recorded a charge of $1.4 million for asset
impairments related to real estate operations. 
  6.
    Investments in Unconsolidated Affiliates RMCAL,
LLC (Mirada Villas) In April 2004, a subsidiary of the Company and a third party real estate development company
formed a joint venture 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. 
  7.
    Short-term Borrowings During 2004 and 2003, the Company had average short-term borrowings outstanding of $36.5
million and $16.1 million, respectively, under the credit facilities described below. The weighted
average interest rate for these facilities during 2004 and 2003 was 3.4% and 2.2%, respectively. Palco Credit Agreements On January 23, 2004, Palco entered into the Palco Credit Agreement, an asset-based
credit agreement with a bank. The Palco Credit Agreement provides for a three-year revolving
facility after which Palco may request a one-year 66




---



##### Table of Contents



extension. Borrowings under the agreement bear
interest at rates based upon (and at variable margins above) LIBOR or the prime rate, and are
secured by the substantial portion of Palcos assets. Effective February 22, 2005, the Palco
Credit Agreement was amended by, among other things: reducing the maximum amount of potential
borrowings from $35.0 million to $30.0 million; decreasing the borrowing base reserve by $2.0
million (and thereby increasing the amount able to be borrowed by the same amount); and requiring
more frequent submissions of borrowing base certificates. At December 31, 2004, $0.3 million in
letters of credit and $13.1 million in borrowings were outstanding under the Palco Credit
Agreement. In accordance with the agreement, Palco is required to maintain a certain base level of
borrowings through February 12, 2005 based on certain collateral balances. Palco is required to
meet certain quarterly earnings
thresholds under a covenant of the Palco Credit Agreement. As of December 31, 2004, Palco was
not in compliance with this covenant. Palco has received a limited waiver, through March 18, 2005,
of the default and is seeking a more permanent solution to the default. However, there can be no
assurance that such efforts will be successful. See Note 1 for further discussion. Scotia LLC Line of Credit The maximum amount Scotia LLC may borrow under the Scotia LLC Line of Credit is equal to one
years interest on the aggregate outstanding principal balance of the Timber Notes (the Required
Liquidity Amount). On June 20, 2003, the Scotia LLC Line of Credit was extended to July 7, 2006.
At or near the completion of such extension, Scotia LLC intends to request that the Scotia LLC Line
of Credit be extended for an additional period of not less than 364 days. If not extended, Scotia
LLC may draw upon the full amount available. The amount drawn would be repayable in 12 semiannual
installments on each note payment date (after the payment of certain other items, including the
Aggregate Minimum Principal Amortization Amount, as defined, then due), commencing approximately
two and one-half years following the date of the draw. Borrowings under the Scotia LLC Line of
Credit generally bear interest at the Base Rate (as defined in the agreement) plus 0.25% or at
LIBOR plus 1.0% (at any time the borrowings have not been continually outstanding for more than six
months). At December 31, 2004, Scotia LLC could have borrowed a maximum of $57.1 million under the
Scotia LLC Line of Credit, and there was $18.2 million outstanding under the Scotia LLC Line of
Credit. At January 31, 2005, the maximum availability under the
Scotia LLC Line of Credit was $55.9 million, and there were
$45.9 million in borrowings outstanding under this facility. As discussed further in Note 1, Scotia LLC is experiencing
financial difficulties due to regulatory restrictions on its ability to harvest. As a result,
Scotia LLC may not have adequate availability under the Scotia LLC Line of Credit to pay the entire
amount of interest due on the Timber Notes in July 2005. Such a failure to pay interest would
constitute an event of default under the Timber Notes Indenture. 
  8.
    Long-term Debt Principal amounts of long-term debt consist of the following (in millions): December 31,2004
    
    
    20036.55% Scotia LLC Class A-1 Timber Notes due July 20, 2028
    
    $
    61.7
    
    
    $
    83.97.11% Scotia LLC Class A-2 Timber Notes due July 20, 2028
    
    
    243.2
    
    
    
    243.27.71% Scotia LLC Class A-3 Timber Notes due July 20, 2028
    
    
    463.3
    
    
    
    463.37.56% Lakepointe Notes due June 8, 2021
    
    
    115.8
    
    
    
    117.27.03% Motel Notes due May 1, 2018
    
    
    47.3
    
    
    
    48.56.08% Beltway Notes due November 9, 2024
    
    
    29.8
    
    
    
    30.47.12% Palmas Notes due December 20, 2030
    
    
    29.6
    
    
    
    30.0Other notes and contracts, primarily secured by receivables, buildings, real estate
and equipment
    
    
    6.4
    
    
    
    24.4997.1
    
    
    
    1,040.9Less: current maturities
    
    
    (20.2
    )
    
    
    (28.5
    )Timber Notes held in SAR Account
    
    
    (64.9
    )
    
    
    (58.9
    )$
    912.0
    
    
    $
    953.5
 The amount attributable to the Timber Notes held in the SAR Account of $61.8 million at
December 31, 2004, reflected in Note 4 represents the amount paid to acquire $64.9 million
principal amount of Timber Notes. The Companys publicly traded debt instruments (the Timber Notes and the Palmas Notes) are
thinly traded financial instruments; accordingly, their market prices at any balance sheet date may
not be representative of the prices which would be derived from a more active market. 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, 2004, the estimated fair value of current and long-term debt was $809.3 million.
At December 31, 2003, the estimated fair value of the Companys current and long-term debt was
$801.2 million. 67




---



##### Table of Contents



Scotia LLC Timber Notes Scotia LLC issued $867.2 million aggregate principal amount of Timber Notes on July 20, 1998.
The Timber Notes and the Scotia LLC Line of Credit are secured by a lien on (i) Scotia LLCs
timber, timberlands and timber rights and (ii) substantially all of Scotia LLCs other property.
The Timber Notes Indenture permits Scotia LLC to have outstanding up to $75.0 million of
non-recourse indebtedness to acquire additional timberlands, as well as to issue additional timber
notes provided certain conditions are met (including repayment or redemption of the remaining $61.7 million of Class A-1 Timber Notes
and that the remaining Timber Notes meet certain ratings standards). The Timber Notes were structured to link, to the extent of cash available, the deemed
depletion of Scotia LLCs timber (through the harvest and sale of logs) to the required
amortization of the Timber Notes. The required amount of amortization on any Timber Notes payment
date is determined by various mathematical formulas set forth in the Timber Notes Indenture.
Principal and interest are payable semi-annually, generally on January 20 and July 20 of each year.
The minimum amount of principal which Scotia LLC must pay (on a cumulative basis and subject to
available cash) through any Timber Notes payment date is referred to as Minimum Principal
Amortization. If the Timber Notes were amortized in accordance with Minimum Principal
Amortization, the final installment of principal would be paid on July 20, 2028. The minimum
amount of principal which Scotia LLC must pay (on a cumulative basis) through any Timber Notes
payment date in order to avoid payment of prepayment or deficiency premiums is referred to as
Scheduled Amortization.If all payments of principal were made in accordance with Scheduled
Amortization, Scotia LLC would pay the final installment of principal on January 20, 2014. Such
final installment would include a single bullet principal payment of $463.3 million related to
the Class A-3 Timber Notes. In November 1999, $169.0 million of funds from the sale of 5,600 acres of timberlands (the
Headwaters Timberlands) were contributed to Scotia LLC and set aside in the SAR Account. Amounts
in the SAR Account are part of the collateral securing the Timber Notes and are used to make
principal payments to the extent that cash flows from operations are insufficient to pay Scheduled
Amortization on the Class A-1 and Class A-2 Timber Notes. In addition, during the six years
beginning January 20, 2014, any amounts then remaining in the SAR Account would be used to amortize
the Class A-3 Timber Notes. Funds may from time to time be released to Scotia LLC from the SAR
Account if the amount in the account at that time exceeds the Required Scheduled Amortization
Reserve Balance (as defined and set forth in the Timber Notes Indenture). If the balance in the
SAR Account falls below the Required Scheduled Amortization Reserve Balance, up to 50% of any
Remaining Funds (funds that could otherwise be released to Scotia LLC free of the lien securing the
Timber Notes) are required to be used on each monthly deposit date to replenish the SAR Account.
As of December 31, 2004, the amount held in the SAR Account was $27.6 million below the Required
Scheduled Amortization Reserve Balance. On the note payment date in January 2004, Scotia LLC had $4.1 million set aside in the note
payment account to pay the $27.2 million of interest due (net of $2.0 million of additional
interest due in respect of Timber Notes held by Scotia LLC). The funds available under the Scotia
LLC Line of Credit were used to pay the remaining $23.1 million of interest due. Scotia LLC repaid
$12.7 million of principal on the Timber Notes (an amount equal to Scheduled Amortization) using
funds held in the SAR Account. On the note payment date in July 2004, Scotia LLC used $26.6 million (net of $2.1 million of
additional interest due in respect of Timber Notes held by Scotia LLC) of the funds available under
the Scotia LLC Line of Credit to pay the entire $26.6 million of interest due. Scotia LLC repaid
$4.5 million of principal on the Timber Notes (an amount equal to Scheduled Amortization) using
funds held in the SAR Account. On the note payment date in January 2005, Scotia LLC used $26.3 million (net of $2.2 million
of additional interest due in respect of Timber Notes held by Scotia LLC) of the funds available
under the Scotia LLC Line of Credit to pay the entire $26.3 million of interest due. Scotia LLC
repaid $10.6 million of principal on the Timber Notes (an amount equal to Scheduled Amortization)
using funds held in the SAR Account. During 2004, $10.9 million of funds from the SAR Account were used to repurchase $11.0 million
principal amount of Timber Notes, as permitted under the Timber Notes Indenture, resulting in a
loss of $0.3 million (net of unamortized deferred financing costs) on the repurchase of debt. As discussed further in Note 1, Scotia LLC is experiencing financial difficulties due to
regulatory restrictions on its ability to harvest. As a result, Scotia LLC may not have adequate
funds to pay the entire amount of interest due on the Timber Notes in July 2005. Such an event
would constitute an event of default under the Timber Notes Indenture. 68




---



##### Table of Contents



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
(the Lakepointe Notes). The Lakepointe Notes are secured by operating leases, Lake Pointe Plaza
and a $60.0 million residual value insurance contract. 69




---



##### Table of Contents



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 (the Motel Notes). The Motel Notes are secured by an operating lease (see Note 14), the
properties, and an $11.2 million residual value insurance contract. 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 (the Beltway Notes).
The Beltway Notes are secured by an operating lease (see Note 14), the building, and an $11.2
million residual value insurance contract. 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 (the Palmas Notes). The Palmas Notes are secured by
the country club assets and a letter of credit. Maturities Scheduled maturities of long-term debt outstanding at December 31, 2004, are as follows (in
millions): Years Ending December 31,2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    ThereafterTimber Notes
    
    $
    15.6
    
    
    $
    18.2
    
    
    $
    26.5
    
    
    $
    25.0
    
    
    $
    19.6
    
    
    $
    598.4Lakepointe Notes
    
    
    1.0
    
    
    
    1.3
    
    
    
    1.7
    
    
    
    1.8
    
    
    
    2.0
    
    
    
    108.0Motel Notes
    
    
    1.3
    
    
    
    1.3
    
    
    
    1.4
    
    
    
    1.8
    
    
    
    2.2
    
    
    
    39.3Beltway Notes
    
    
    0.6
    
    
    
    0.6
    
    
    
    0.7
    
    
    
    0.7
    
    
    
    0.8
    
    
    
    26.4Palmas Notes
    
    
    0.4
    
    
    
    0.4
    
    
    
    0.5
    
    
    
    0.5
    
    
    
    0.6
    
    
    
    27.2Other
    
    
    1.3
    
    
    
    0.6
    
    
    
    0.5
    
    
    
    0.4
    
    
    
    0.1
    
    
    
    3.5$
    20.2
    
    
    $
    22.4
    
    
    $
    31.3
    
    
    $
    30.2
    
    
    $
    25.3
    
    
    $
    802.8
 The scheduled maturities for the Timber Notes reflected in the table above are based on
Scheduled Amortization (subject to available cash). Capitalized Interest Interest capitalized during the years ended December 31, 2004, 2003 and 2002 was $0.8 million,
$0.1 million and 0.9 million, respectively. Interest capitalized on Palcos new Scotia sawmill
amounted to $0.7 million for the year ended December 31, 2004. Loan Covenants Certain 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. 
  9.
    Income Taxes The Company files consolidated federal income tax returns together with its domestic
subsidiaries, other than Kaiser and its subsidiaries. Kaiser and its domestic subsidiaries are
members of a separate consolidated return group that files its own consolidated federal income tax
returns. Loss before income taxes, minority interests and discontinued operations by geographic area is
as follows (in millions): Years Ended December 31,2004
    
    
    2003
    
    
    2002Domestic
    
    $
    (46.9
    )
    
    $
    (10.6
    )
    
    $
    (96.0
    )Foreign
    
    
    
    
    
    
    
    
    
    
    $
    (46.9
    )
    
    $
    (10.6
    )
    
    $
    (96.0
    )
 70




---



##### Table of Contents



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 (provision) for income taxes on loss before income taxes, minority interests and
discontinued operations consists of the following (in millions): Years Ended December 31,2004
    
    
    2003
    
    
    2002Current:Federal
    
    $
    
    
    
    $
    
    
    
    $
    State and local
    
    
    (1.3
    )
    
    
    
    
    
    
    (0.1
    )Foreign
    
    
    (0.2
    )
    
    
    
    
    
    
    (0.5
    )(1.5
    )
    
    
    
    
    
    
    (0.6
    )Deferred:Federal
    
    
    
    
    
    
    
    
    
    
    4.6State and local
    
    
    1.8
    
    
    
    (1.0
    )
    
    
    10.4Foreign
    
    
    
    
    
    
    
    
    
    
    1.8
    
    
    
    (1.0
    )
    
    
    15.0$
    0.3
    
    
    $
    (1.0
    )
    
    $
    14.4
 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 31,2004
    
    
    2003
    
    
    2002Loss before income taxes, minority interests and discontinued
operations
    
    $
    (46.9
    )
    
    $
    (10.6
    )
    
    $
    (96.0
    )Amount of federal income tax benefit based upon the statutory rate
    
    $
    16.4
    
    
    $
    3.7
    
    
    $
    33.6Changes in valuation allowances and revision of prior years tax estimates
    
    
    (16.0
    )
    
    
    (4.9
    )
    
    
    (24.1
    )Foreign taxes, net of federal tax benefit
    
    
    (0.2
    )
    
    
    
    
    
    
    (0.5
    )State and local taxes, net of federal tax effect
    
    
    0.4
    
    
    
    0.5
    
    
    
    8.1Adjustments due to deconsolidation of Kaiser
    
    
    
    
    
    
    
    
    
    
    (3.1
    )Other
    
    
    (0.3
    )
    
    
    (0.3
    )
    
    
    0.4$
    0.3
    
    
    $
    (1.0
    )
    
    $
    14.4
 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. Changes in valuation allowances and revision of
prior years tax estimates includes $15.8 million for 2002, which is attributable to additional
valuation allowances on Kaisers loss and credit carryforwards (see Kaisers Income Taxes
below). Generally, the other reversal of reserves relates to the expiration of the relevant
statute of limitations with respect to certain income tax returns or the resolution of specific
income tax matters with the relevant tax authorities. 71




---



##### Table of Contents



The components of the Companys net deferred income tax assets (liabilities) are as
follows (in millions): December 31,2004
    
    
    2003Deferred income tax assets:Postretirement benefits other than pensions
    
    $
    5.1
    
    
    $
    5.0Loss and credit carryforwards
    
    
    141.3
    
    
    
    136.0Other liabilities
    
    
    20.6
    
    
    
    21.4Real estate
    
    
    17.3
    
    
    
    20.2Timber and timberlands
    
    
    14.9
    
    
    
    9.5Other
    
    
    34.2
    
    
    
    33.0Valuation allowances
    
    
    (78.3
    )
    
    
    (67.5
    )Total deferred income tax assets, net
    
    
    155.1
    
    
    
    157.6Deferred income tax liabilities:Property, plant and equipment
    
    
    (60.3
    )
    
    
    (57.4
    )Deferred gains on sales of timber and timberlands
    
    
    
    
    
    
    (6.6
    )Other
    
    
    (10.5
    )
    
    
    (11.2
    )Total deferred income tax liabilities
    
    
    (70.8
    )
    
    
    (75.2
    )Net deferred income tax assets
    
    $
    84.3
    
    
    $
    82.4
 The Company evaluated all appropriate factors in determining the realizability of the
$141.3 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 2004 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 $19.0 million and $5.0
million in 2004 and 2003, respectively. With respect to the $64.5 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 Kaiser shares. For federal tax purposes, the
Companys basis is estimated to be $379.3 million (as compared to $(516.2) million reflected in
these financial statements), which would result in a federal tax benefit at current federal
statutory income tax rates of approximately $132.8 million. Should the Company dispose of its
investment in Kaiser or should the Companys investment in Kaiser be determined to be worthless,
the Company can give no assurance that any tax benefit could be realized from the losses due to
limitations imposed under the Internal Revenue Code relating to capital losses. As of December 31, 2004 and 2003, $0.2 million and $0.1 million, respectively, of the net
deferred income tax assets listed above are included in prepaid expenses and other current assets.
Certain other portions of the deferred income tax liabilities listed above are included in other
accrued liabilities and other noncurrent liabilities. The following table presents the estimated tax attributes for federal income tax purposes at
December 31, 2004, attributable to the Company (in millions). The utilization of certain of these
tax attributes is subject to limitations. ExpiringRegular tax attribute carryforwards:Current year net operating loss
    
    $
    37.3
    
    
    
    2024Prior year net operating losses
    
    
    325.8
    
    
    
    2006-2023Alternative minimum tax credits
    
    
    1.8
    
    
    IndefinitePassive activity losses
    
    
    7.3
    
    
    IndefiniteAlternative minimum tax attribute carryforwards:Current year net operating loss
    
    $
    40.1
    
    
    
    2024Prior year net operating losses
    
    
    347.4
    
    
    
    2006-2023
 72




---



##### Table of Contents



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 related tax laws, regulations, judicial
decisions and administrative interpretations of the local tax authority. 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 liquidity issues being experienced by Palco and Scotia LLC
could result in claims against and could have adverse impacts on MAXXAM Parent, MGHI and/or MGI.
It is possible that certain transactions could be entered into in connection with a potential
restructuring or reorganization of Palco or Scotia LLC, such as a sale of all or a portion of the
equity ownership in Palco and/or Scotia LLC, a sale of a substantial portion of Palcos and/or
Scotia LLCs assets and/or a cancellation of some or all of Palcos and/or Scotia LLCs
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 for federal and state income tax
purposes and could require tax payments. Kaisers Income Taxes Kaiser and its domestic subsidiaries are members of a separate consolidated return group which
files its own consolidated federal income tax return. During the period from October 28, 1988,
through June 30, 1993, Kaiser and its domestic subsidiaries were included in the consolidated
federal income tax returns of the Company. The tax allocation agreements of Kaiser and KACC with
the Company terminated pursuant to their terms, effective for taxable periods beginning after June
30, 1993. However, payments or refunds for periods prior to July 1, 1993 related to certain
jurisdictions could still have been required pursuant to Kaisers and KACCs respective tax
allocation agreements with the Company. In January 2003, the Company and Kaiser entered into a
settlement agreement providing that no further payments would be due by either party to the other
party under the tax allocation agreements. On February 24, 2003, the Bankruptcy Court approved
this agreement. The Company had a reserve of $35.3 million related to the tax allocation
agreements which was reversed in 2002 since this matter was resolved with no payment to Kaiser.
See Note 11. 
 10. Employee Benefit and Incentive Plans Pension and Other Postretirement Benefit Plans The Company has various retirement plans which cover essentially all employees. Most of the
Companys employees are covered by defined benefit plans. The benefits are determined under
formulas based on the employees years of service, age and compensation. The Company has unfunded postretirement medical benefit plans which 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 over the period the 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 operations. 73




---



##### Table of Contents



The funded status of the Companys pension and other postretirement benefit plans and the
accrued benefit liability included in other long-term liabilities as of December 31, 2004 and 2003,
respectively, were as follows (in millions): Pension Benefits
    
    
    Medical/Life BenefitsYears Ended December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Change in projected benefit obligation:Projected benefit obligation at beginning of year
    
    $
    84.2
    
    
    $
    74.6
    
    
    $
    11.4
    
    
    $
    10.0Service cost
    
    
    2.9
    
    
    
    2.7
    
    
    
    0.5
    
    
    
    0.4Interest cost
    
    
    5.4
    
    
    
    5.1
    
    
    
    0.7
    
    
    
    0.6Plan participants contributions
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.4Actuarial (gain) loss
    
    
    8.3
    
    
    
    5.3
    
    
    
    0.8
    
    
    
    2.4Curtailments, settlements and amendments
    
    
    0.1
    
    
    
    (1.1
    )
    
    
    
    
    
    
    (1.3
    )Benefits paid
    
    
    (2.9
    )
    
    
    (2.4
    )
    
    
    (0.8
    )
    
    
    (2.1
    )Projected benefit obligation at end of year
    
    $
    98.0
    
    
    $
    84.2
    
    
    $
    12.6
    
    
    $
    11.4Change in plan assets:Fair value of plan assets at beginning of year
    
    $
    56.8
    
    
    $
    43.2
    
    
    $
    
    
    
    $
    Actual return on assets
    
    
    5.4
    
    
    
    11.3
    
    
    
    
    
    
    
    Employer contributions
    
    
    1.0
    
    
    
    4.6
    
    
    
    0.8
    
    
    
    0.8Plan participants contributions
    
    
    
    
    
    
    
    
    
    
    1.7
    
    
    
    1.3Benefits paid
    
    
    (2.9
    )
    
    
    (2.3
    )
    
    
    (2.5
    )
    
    
    (2.1
    )Fair value of plan assets at end of year
    
    $
    60.3
    
    
    $
    56.8
    
    
    $
    
    
    
    $
    Funded status:Projected benefit obligation in excess of plan assets
    
    $
    (37.7
    )
    
    $
    (27.5
    )
    
    $
    (12.6
    )
    
    $
    (11.4
    )Unrecognized actuarial loss (gain)
    
    
    20.5
    
    
    
    12.6
    
    
    
    2.9
    
    
    
    2.1Unrecognized prior service costs
    
    
    (0.2
    )
    
    
    (0.2
    )
    
    
    (1.8
    )
    
    
    (2.1
    )Net amount recognized
    
    $
    (17.4
    )
    
    $
    (15.1
    )
    
    $
    (11.5
    )
    
    $
    (11.4
    )Amounts recognized in the Consolidated Balance Sheet:Accrued benefit liability
    
    $
    (30.6
    )
    
    $
    (21.4
    )
    
    $
    (11.5
    )
    
    $
    (11.4
    )Intangible asset
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accumulated other comprehensive income
    
    
    13.2
    
    
    
    6.3
    
    
    
    
    
    
    
    Net amount recognized
    
    $
    (17.4
    )
    
    $
    (15.1
    )
    
    $
    (11.5
    )
    
    $
    (11.4
    )
 A minimum pension liability adjustment is required when the actuarial present value of
the accumulated benefit obligation exceeds the fair value of plan assets and accrued pension
liability. In 2004, a minimum liability pre-tax adjustment of $6.9 million was reflected as an
increase in accrued benefit liability with an offsetting pre-tax charge to stockholders deficit
recorded as a component of other comprehensive income (loss). In 2003, the partial reversal of a
minimum liability pre-tax adjustment of $1.9 million was recorded as a reduction of the accrued
benefit liability with an offsetting reduction of stockholders deficit as a component of other
comprehensive income (loss). The aggregate accumulated benefit obligation and fair value of plan assets for pension plans
with accumulated benefit obligations in excess of plan assets were $90.9 million and $60.3 million,
respectively, as of December 31, 2004, and $78.2 million and $56.8 million, respectively, as of
December 31, 2003. 74




---



##### Table of Contents



The components of pension and other postretirement medical benefits expense for the three
years ended December 31, 2004, were as follows (in millions): Pension Benefits
    
    
    Medical/Life BenefitsYears Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Components of net periodic benefit costs:Service cost
    
    $
    2.9
    
    
    $
    2.7
    
    
    $
    2.5
    
    
    $
    0.5
    
    
    $
    0.4
    
    
    $
    0.4Interest cost
    
    
    5.4
    
    
    
    5.1
    
    
    
    4.8
    
    
    
    0.7
    
    
    
    0.6
    
    
    
    0.7Expected return on assets
    
    
    (5.1
    )
    
    
    (4.6
    )
    
    
    (4.5
    )
    
    
    
    
    
    
    
    
    
    
    Amortization of prior service costs
    
    
    
    
    
    
    0.1
    
    
    
    0.1
    
    
    
    (0.2
    )
    
    
    (0.2
    )
    
    
    Recognized net actuarial (gain) loss
    
    
    
    
    
    
    
    
    
    
    (0.1
    )
    
    
    
    
    
    
    
    
    
    
    (0.1
    )Net periodic benefit costs
    
    
    3.2
    
    
    
    3.3
    
    
    
    2.8
    
    
    
    1.0
    
    
    
    0.8
    
    
    
    1.0Curtailments, settlements and other
    
    
    
    
    
    
    0.1
    
    
    
    0.2
    
    
    
    (0.1
    )
    
    
    0.3
    
    
    
    (0.5
    )Adjusted net periodic benefit costs
    
    $
    3.2
    
    
    $
    3.4
    
    
    $
    3.0
    
    
    $
    0.9
    
    
    $
    1.1
    
    
    $
    0.5
 The measurement date used for the Companys pension and postretirement benefit plans was
December 31, 2004. The underlying assumptions of the Companys pension and other postretirement
benefit plans for the three years ended December 31, 2004, were as follows: Pension Benefits
    
    
    Medical/Life BenefitsYears Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Weighted-average assumptions:Discount rate used to determine benefit obligation
    
    
    5.875
    %
    
    
    6.25
    %
    
    
    6.75
    %
    
    
    5.875
    %
    
    
    6.25
    %
    
    
    6.75
    %Discount rate used to determine net periodic benefit cost
    
    
    6.25
    %
    
    
    6.75
    %
    
    
    6.75
    %
    
    
    6.25
    %
    
    
    6.75
    %
    
    
    6.75
    %Expected return on plan assets
    
    
    8.50
    %
    
    
    8.00
    %
    
    
    8.00
    %
    
    
    
    
    
    
    
    
    
    
    Rate of compensation increase
    
    
    4.11
    %
    
    
    4.20
    %
    
    
    5.00
    %
    
    
    
    
    
    
    
    
    
    
    
 The average annual assumed rate of increase in the per capita cost of covered benefits
(i.e. health care cost trend rate) for 2005 is 10.0% for all participants. The rate
of increase is assumed to decline gradually to 5.0% in 2010 for all participants and remain at that
level thereafter. Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plan. A one-percentage-point change in assumed health care cost trend
rates as of December 31, 2004 would have the following effects (in millions): 1-Percentage-
    
    
    1-Percentage-Point Increase
    
    
    Point DecreaseEffect on total of service and interest cost components
    
    $
    0.2
    
    
    $
    (0.1
    )Effect on the postretirement benefit obligations
    
    
    1.5
    
    
    
    (1.2
    )
 The plans investments are held under a trust agreement with an independent trustee. The
plans Investment Committees establish the investment policies for the plans assets and have
selected certain investment funds maintained by the trustee for investment of plan assets. The
Investment Committees also determine the portion of plan assets to be invested in such funds. The
trustee selects third party 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, 2004, the Investment Committees target asset allocations were
70% for equity securities and 30% for fixed income securities. 75




---



##### Table of Contents



The weighted-average asset allocations for the Companys pension plans at December 31, 2004
and 2003, by asset category are as follows: Years Ended December 31,2004
    
    
    2003Asset Category:Equity securities
    
    
    71
    %
    
    
    70
    %Debt securities
    
    
    29
    
    
    
    30Total
    
    
    100
    %
    
    
    100
    %
 The expected rate of return on plan assets assumption, used in the determination of net
periodic pension cost, will be increased from 8.50% to 8.75% for 2005. The Companys expected 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, 2004. The Companys funding policy is to make annual contributions to the plans 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 8.0% was used in the determination of the
ERISA minimum funding requirements for the plan years ended December 31, 2004 and 2003. Expected
funding requirements for pension benefits for 2005 range from $2.2 million to $2.4 million.
Expected funding requirements for postretirement medical benefits for 2005 range from $0.8 million
to $0.9 million. The Company also has unfunded Supplemental Executive Retirement Plans that provide certain key
employees defined pension benefits that supplement those provided by the Companys other retirement
plans. The Company had $3.2 million and $2.8 million accrued as projected benefit obligations in
the Consolidated Balance Sheet for such plans at December 31, 2004 and 2003, respectively. 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 Benefits2005
    
    $
    3.0
    
    
    $
    0.92006
    
    
    3.2
    
    
    
    0.82007
    
    
    3.5
    
    
    
    0.92008
    
    
    3.7
    
    
    
    1.02009
    
    
    4.1
    
    
    
    1.0Years 2010-2014
    
    
    27.6
    
    
    
    6.0
 Savings and Incentive Plans The Company has various defined contribution savings plans designed to enhance the existing
retirement programs of participating employees. Expenses incurred by the Company for all of these
plans were $0.7 million, $0.7 million and $0.5 million for the years ended December 31, 2004, 2003
and 2002, respectively. 
 11. Investment in Kaiser Reorganization Proceedings Kaiser, its wholly owned subsidiary, Kaiser Aluminum and Chemical Corporation (KACC), and 24
of KACCs subsidiaries have filed separate voluntary petitions in the United States Bankruptcy
Court for the District of Delaware (the Bankruptcy Court) for reorganization under Chapter 11 of
the Bankruptcy Code. Kaiser, KACC and the 15 subsidiaries of KACC that filed petitions on February
12, 2002, are collectively referred to herein as the Original Debtors.Additional subsidiaries
of KACC filed petitions in the first quarter of 2003. The Original Debtors and the additional
debtors are collectively referred to herein as the Debtors,and the Chapter 11 proceedings of
these entities are collectively referred to herein as the Cases.For purposes of these financial
statements, the term Filing Datemeans, with respect to any particular Debtor, the date on which
such Debtor filed its Case. The Cases are being jointly 76




---



##### Table of Contents



administered. The Debtors are managing their businesses in the ordinary course as debtors-in-possession subject to the
control and administration of the Bankruptcy Court. The necessity for filing the Cases by the Original Debtors was attributable to the
liquidity and cash flow problems of Kaiser and its subsidiaries arising in late 2001 and early
2002. Kaiser was facing significant near-term debt maturities at a time of unusually weak aluminum
industry business conditions, depressed aluminum prices and a broad economic slowdown that was
further exacerbated by the events of September 11, 2001. In addition, Kaiser had become
increasingly burdened by asbestos litigation and growing legacy obligations for retiree medical and
pension costs. The confluence of these factors created the prospect of continuing operating losses
and negative cash flows, resulting in lower credit ratings and an inability to access the capital
markets. Kaiser has indicated that its objective in the Cases is to achieve the highest possible
recoveries for all stakeholders, consistent with the Debtors abilities to pay, and to continue the
operation of their businesses. However, there can be no assurance that the Debtors will be able to
attain these objectives or achieve a successful reorganization. While valuation of the Debtors
assets and estimates of pre-Filing Date claims at this stage of the Cases is subject to inherent
uncertainties, Kaiser has indicated that the Debtors believe that, in the aggregate, it is likely
that their liabilities will be found to significantly exceed the fair value of their assets. The
Debtors therefore currently believe that it is likely that substantially all pre-Filing Date claims
will be settled at less than 100% of their face value. With respect to the Companys interest in
Kaiser, the Debtors have indicated that the equity of Kaisers stockholders, including the Company,
will likely be cancelled without consideration. As provided by the Bankruptcy Code, the Debtors had the exclusive right to propose a plan of
reorganization for 120 days following the initial Filing Date. The Bankruptcy Court has
subsequently approved several extensions of the exclusivity period for the Debtors. Most recently,
the Bankruptcy Court approved an extension of exclusivity as to certain Debtors to April 30, 2005,
and through June 30, 2005, for the remaining Debtors. Kaiser has indicated that additional
extensions may be sought. However, no assurance can be given that any such future extension
requests will be granted by the Bankruptcy Court. If the Debtors fail to file a plan of
reorganization during the exclusivity period, or if such plan is not accepted by the requisite
number of creditors and equity holders entitled to vote on the plan, other parties in interest in
the Cases may be permitted to propose their own plan(s) of reorganization for the Debtors. In March 2002, the Company filed a suit requesting the Bankruptcy Court to find that it has no
further obligations to the Debtors under certain tax allocation agreements. The Companys suit was
based on the assertion that the agreements are personal contracts and financial accommodations
which cannot be assumed under the Bankruptcy Code. Kaiser and the Company subsequently settled
this suit, which settlement was approved by the Bankruptcy Court on February 24, 2003. Pursuant to
the settlement, the parties agreed to release each other from all present and future claims or
obligations under the tax allocation agreements. The Company had a reserve of $35.3 million
related to the tax allocation agreements which was reversed in 2002 since this matter was resolved
with no payment to Kaiser. In April 2002, Kaiser filed a motion seeking an order of the Bankruptcy Court prohibiting the
Company (or MGHI), without first seeking Bankruptcy Court relief, from disposing of its Kaiser
stock (the Kaiser Shares), including any sale, transfer, or exchange of such stock or treating
any of the Kaiser Shares as worthless for federal income tax purposes. Kaiser indicated in its
Bankruptcy Court filing that it was concerned that such a transaction could have the effect of
depriving Kaiser of the ability to utilize the full value of its net operating losses, foreign tax
credits and minimum tax credits. In July 2002, the Company and MGHI agreed with Kaiser that they
would not dispose of any of their Kaiser shares prior to a hearing on the April 2002 motion. The
parties also agreed that the Company (or MGHI) may upon 10 days written notice to Kaiser (a)
request the Bankruptcy Court to hear the matter at a special hearing or (b) have the matter heard
at one of Kaisers scheduled monthly bankruptcy hearings. Kaisers common stock is publicly traded on the OTC Bulletin Board under the trading symbol
KLUCQ.OB. The market value for the 50,000,000 Kaiser Shares, based on the price per share quoted
at the close of business on March 1, 2005, was $4.5 million. There can be no assurance that such
value would be realized should the Kaiser Shares be sold. 77




---



##### Table of Contents



12. Commitments and Contingencies Commitments The Company leases certain facilities and equipment under operating leases. Minimum rental
commitments under operating leases at December 31, 2004, are as follows: Years Ended December 31,
    
    (In millions)2005
    
    $
    3.32006
    
    
    2.92007
    
    
    2.52008
    
    
    1.72009
    
    
    0.9Thereafter
    
    
    2.1Total minimum lease payments
    
    $
    13.4
 Rental expense for operating leases was $4.7 million, $4.3 million and $5.1 million for
the years ended December 31, 2004, 2003 and 2002, 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)2005
    
    $
    17.12006
    
    
    17.32007
    
    
    17.52008
    
    
    17.82009
    
    
    18.0Thereafter
    
    
    208.1Total minimum rentals
    
    $
    295.8
 Contingencies Forest Products Operations Regulatory and environmental matters play a significant role in 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, and air and water quality. Environmental Plans From March 1999 until October 2002, Scotia LLC 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 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 a 100-year planning period would not exceed
the average annual growth level during the last decade of the 100-year planning period. The forest
practice rules allow companies which do not have a sustained yield plan to follow an alternative
procedure to document compliance with the sustained yield requirements. As discussed below, on
October 31, 2003, the Court hearing the EPIC-SYP/Permits lawsuit(as defined below) entered a
judgment invalidating the SYP and the incidental take permits issued by California pursuant to the
HCP (California Permits), and that decision is now on appeal. As a result of an earlier stay
order issued in this case, Scotia LLC has since October 2002 been obtaining review and
approval of THPs under this alternative procedure and expects to follow this procedure until
approval of its pending Option A plan (Option A Plan), which is an alternative to a sustained
yield plan. The HCP and related incidental take permits issued by the federal government pursuant
to the HCP (Federal Permits) allow incidental take of certain federally listed species located
on the Companys 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 78




---



##### Table of Contents



Permits have terms of 50 years. Since the consummation of the Headwaters Agreement in March 1999, there
has been a significant amount of work required in connection with the implementation of the HCP and
SYP (together, the Environmental Plans), and this work is expected to continue for several more
years. Water Quality Laws and regulations dealing with water quality are impacting the Company primarily in four
areas: efforts by the federal Environmental Protection Agency (EPA) and 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 to impose waste
discharge reporting requirements in respect of watersheds on Palcos timberlands and in some cases,
clean-up or prevention measures; actions by the North Coast Water Board during the THP approval
process which impose certain operational requirements on individual THPs; and a directive of the
North Coast Water Board to its staff to develop WWDRs for the Freshwater and Elk River watersheds. Under the federal Clean Water Act (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 Companys timberlands. The
Company expects this process to continue into 2010. The final TMDL requirements applicable to the
Companys 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. Beginning with the 2002-2003 winter operating period, Palco has been required to submit
Reports of Waste Discharge to the North Coast Water Board each year in order to conduct winter
harvesting activities in the Elk River and Freshwater watersheds. After consideration of these
reports, the North Coast Water Board imposed requirements on Palco to implement additional
mitigation and erosion control practices in these watersheds for these winter operating periods.
In addition, the North Coast Water Board has extended the requirements for certain mitigation and
erosion control practices to the Bear, Jordan and Stitz watersheds. Reporting and mitigation
requirements imposed by the North Coast Water Board have significantly increased operating costs
and may in the future further increase costs or cause delays in THP approvals. The North Coast Water Board has also issued a clean up and abatement order (the Elk River
Order) which is aimed at addressing existing sediment production sites in the Elk River watershed
through clean up actions. The North Coast Water Board has also initiated the process which could
result in similar orders for the Freshwater and Bear Creek watersheds, and is contemplating similar
actions for the Jordan and Stitz Creek watersheds. The Elk River Order has 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. Palcos appeal of the Elk River
Order to the State Water Resources Control Board (the State Water Board) was denied. Palco has
appealed the decision of the State Water Board but is holding such
appeal in abeyance
until resolution of the THP 520 lawsuitdiscussed below. In addition to the foregoing actions, the North Coast Water Board in December 2003 directed
its staff to create WWDRs for the Freshwater and Elk River watersheds. As harvesting activities on
the Companys timberlands cannot readily be moved between watersheds due to, among other things,
historic harvest patterns, adjacency restrictions, and the age classes of trees, that action and
the other matters described above could, in addition to the potential effects noted above,
individually or collectively result in reduced harvest. In that regard, the staff of the North
Coast Water Board has not yet formulated the required WWDRs for the Freshwater and Elk River
watersheds. As a result, the North Coast Water Board has failed to release for harvest a number of
the Companys THPs which have already been approved by the other government agencies which review
the Companys THPs. The unreleased THPs represent a significant portion of the Companys planned
harvest for the first half of 2005. The ongoing delay in receiving the approval of the North Coast
Water Board has adversely impacted the cash flows of both the Company and Palco. See Note 1 for
further discussion. The above matters could individually or collectively result in reduced harvest levels as Palco
is not able to readily move its harvesting activities between watersheds due to, among other
things, historic harvest patterns, adjacency restrictions, and the age classes of trees. 79




---



##### Table of Contents



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 Companys
timberlands are classified as sediment-impaired, implementation of this law could result in delays in obtaining approvals of THPs, lower
harvest levels and increased costs and additional protection measures beyond those contained in the
HCP. Also see the description of a case entitled The Pacific Lumber Company, et al. v. California
State Water Resources Control Board(the THP No. 520 lawsuit) below. Timber Harvest Litigation A California state court has invalidated the SYP in connection with two lawsuits filed against
Palco, as described below, which decision has been appealed. Other pending judicial and
administrative proceedings, as discussed below, could affect Palcos ability to implement the HCP,
implement certain approved THPs, or carry out other operations, as discussed below. 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. This action alleged, among other things, various violations
of the CESA and the California Environmental Quality Act, and challenged, among other things, the
validity and legality of the SYP and the California Permits. The plaintiffs sought, among other
things, to set aside Californias approval of the SYP and the California Permits and injunctive
relief 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 challenging the validity
and legality of the SYP. The EPIC-SYP/Permitsand USWA lawsuitswere consolidated for trial. Following trial, the Court on October 31, 2003, entered a judgment invalidating the SYP and
the California Permits due to several deficiencies in agency procedures and the failure of Palco to
submit a complete and comprehensible SYP. The Courts decision, however, allowed for harvesting on
THPs which rely on the SYP and were approved prior to July 23, 2003. The short-term effect of the
ruling was to preclude approval, under the SYP, of a small number of THPs which were under review
but had not been approved, and a minor reduction in 2003 harvesting that had been expected from
these specific THPs. As a result of this case, Palco has since October 2002, when the Court issued
a stay order preventing future reliance upon the SYP, been obtaining review and approval of new
THPs under a procedure provided for in the forest practice rules that does not depend upon the SYP
and the California Permits. Palco expects to follow this procedure until the Option A plan is
approved. Palco and the State of California have appealed the October 31, 2003, decision. In
September 2004, the Court granted the plaintiffs request for reimbursement of an aggregate of $5.8
million in attorneys fees and other expenses incurred in connection with these matters. Palco and
the State of California have also appealed this decision. In July 2001, an action entitled Environmental Protection Information Center v. The Pacific
Lumber Company, Scotia Pacific Company LLC(the Bear Creek lawsuit) was filed and later amended
to add the EPA as a defendant. The lawsuit alleges that Palcos harvesting and other forestry
activities under certain of its 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 defendants alleged continued violation of the
CWA. On October 14, 2003, in connection with certain motions that had been filed, the Court upheld
the validity of an EPA regulation which 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 which 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. Should the
decision ultimately become final and held to apply to all Palcos timber operations, 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 80




---



##### Table of Contents



in the HCP. Nonetheless, it is not likely that civil penalties will be awarded for
operations that occurred prior to the Courts decision due to the historical reliance by timber
companies on the regulation and the Companys belief that the requirements under the HCP are
adequate to ensure that sediment and pollutants from harvesting activities on Palcos timberlands
will not reach levels harmful to the environment. While the impact of a conclusion to this case that upholds the October 14, 2003,
ruling may be adverse, the Company does not believe that such an outcome would 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, which also name Palco and certain affiliates as defendants. On April 4, 2003, the
plaintiffs in these actions filed amended complaints and served the defendants with notice of the
actions. The Cook actionalleges, among other things, that defendants logging practices have
contributed to an increase in flooding along Freshwater Creek (which runs through Palcos
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 actioncontains similar allegations and requests similar relief with respect to
the Elk River watershed (a portion of which is contained on the Companys timberlands). 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. 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(the Humboldt DA action). The suit was filed under Californias unfair
competition law and alleges that Palco used certain unfair business
practices in connection with completion of the Headwaters Agreement, and that this resulted in
these companies being able to harvest significantly more trees under the Environmental Plans 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. In response to motions filed by Palco for sanctions and
dismissal of this suit, on April 30, 2004, the Court issued a ruling requiring the District
Attorney to amend his suit to prove that extrinsic fraud occurred. In addition, the Court
eliminated the remedies being sought, other than for civil penalties, and suggested that it would
be inappropriate to base civil penalties on the additional trees harvested. The Court also ruled
that it declined at this juncture to impose sanctions on the District Attorney. The District
Attorney subsequently amended his suit, and Palco later filed new motions to dismiss and for
sanctions. After delays resulting from the District Attorneys efforts to disqualify the trial
judge, and that judges later self-disqualification, a hearing on these motions was held on
February 18, 2005. The Court rejected the sanctions motion, but has not yet ruled on the motion
for dismissal. The Company believes that this suit is without merit
and that the April 30, 2004,
ruling diminished significantly its exposure with respect to this matter; however, there can be no
assurance that Palco will ultimately prevail or that an adverse outcome would not be material to
the Companys consolidated financial condition, results of operations and/or liquidity. On December 17, 2003, an action entitled Humboldt Watershed Council, et al. v. North Coast
Regional Water Quality Board, et al. (the HWC 2003 lawsuit), naming Palco as a real party in
interest, was filed. The plaintiffs allege that the North Coast Water Board should have required
waste discharge reports in respect of all timber harvesting activities in the Freshwater and Elk
River watersheds, including those of Palco. This action has been dismissed by the plaintiffs. On November 2, 2004, an action entitled Environmental Protection Information Center v. U.S.
Fish & Wildlife Service, NOAA Fisheries, et al.was filed. This lawsuit alleges that two federal
agencies have violated certain federal laws and related regulations in connection with their
oversight of the HCP and Federal Permits. The plaintiff also alleges that the Federal Permit for
the northern spotted owl was unlawfully issued and that Palco violated Californias unfair
competition law by using false advertising and making misleading environmental claims. The
plaintiff seeks a variety of remedies including requiring additional actions by the federal
agencies and precluding them from authorizing take of the northern spotted owl, an injunction
requiring Palco to cease certain alleged unlawful activities, as well as restitution and
remediation by Palco. The Company does not believe 81




---



##### Table of Contents



the resolution of this action should result in a material adverse effect on its consolidated financial condition, results of operations or liquidity. On November 16, 2001, Palco filed the THP No. 520 lawsuitalleging that the State Water
Board had no legal authority to impose mitigation measures that were requested by the staff of the
North Coast Water Board during the THP review process and rejected by the CDF prior to approving
the THP. When the staff of the North Coast Water Board attempted to impose these mitigation
measures in spite of the CDFs decision, Palco appealed to the State Water Board, which imposed
certain of the requested mitigation measures and rejected others. Palco filed the THP No. 520
lawsuitchallenging the State Water Boards decision, and in January 2003, the Superior Court granted Palcos request for an
order invalidating the imposition of these additional measures. The State Water Board appealed
this decision, and on March 18, 2004, the appellate court reversed the decision of the Superior
Court. The appellate courts decision could result in increased demands by the regional and state
water boards and their staffs to impose controls and limitations upon Palcos timber harvesting
beyond those provided for by the Environmental Plans or could provide additional regulatory powers
to the regional and state water boards and their staffs beyond those provided in Senate Bill 810.
Palco filed a petition for review of the appellate courts decision by the California Supreme
Court, which in June 2004 agreed to review the decision. OTS Contingency and Related Matters On December 26, 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 (collectively, the Respondents) and others with respect to the failure of United Savings
Association of Texas (USAT). The OTS sought damages ranging from $326.6 million to $821.3
million under various theories. On October 17, 2002, the OTS actionwas settled for $0.2 million
with no admission of wrongdoing on the part of the Respondents. As a result of the dismissal of OTS action, a related civil action, alleging damages in excess
of $250.0 million, was subsequently dismissed. This action, entitled the 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 (FDIC) in August 1995, against Mr.
Charles E. Hurwitz (Chairman and Chief Executive Officer of the Company). On May 31, 2000, the Respondents filed a counterclaim to the FDIC action. On November 8,
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 actionagainst 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 OTSand FDIC actions. As of December 31, 2004, such fees were in
excess of $40.4 million. The Respondents are pursuing this claim vigorously. 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. On January 16, 2001, an action entitled Alan Russell Kahn v. Federated Development Co., MAXXAM
Inc., et al.(the Kahn lawsuit) was filed. The plaintiff purports to bring this action as a
stockholder of the Company derivatively on behalf of the Company. The lawsuit concerns the OTSand
FDIC actions, and the Companys advancement of fees and expenses on behalf of Federated and certain
of the Companys directors in connection with these actions. It alleges that the defendants have
breached their fiduciary duties to the Company, and have wasted corporate assets, by allowing the
Company to bear all of the costs and expenses of Federated and certain of the Companys directors
related to the OTS and FDIC actions. The plaintiff seeks to require Federated and certain of the
Companys directors to reimburse the Company for all costs and expenses incurred by the Company in
connection with the OTSand FDIC actions, and to enjoin the Company from advancing to Federated or
certain of the Companys directors any further funds for costs or expenses associated with these
actions. The parties to the Kahn lawsuithave agreed to an indefinite extension of the defendants
obligations to respond to the plaintiffs claims. Although it is impossible to assess the ultimate
outcome of 82




---



##### Table of Contents



the Kahn lawsuit, the Company believes that the resolution of this matter should not
result in a material adverse effect on its consolidated financial condition, results of operations
or liquidity. Other Matters On September 2, 2004, the Company was advised that one of its former subsidiaries is a
successor to a company which manufactured munitions for the U.S. Navy during World War II. The
current owner of the underlying property, which is located in Cranbury, New Jersey, is seeking the
Companys participation in efforts to address contamination of the site which resulted from such
operations. The current owner estimates that the costs to determine what remedial actions are
needed, and to perform any remedial actions determined necessary, could range from $3.0 million to
$8.0 million. Costs for the investigation and remediation could exceed $8.0 million as the result
of information learned during the investigation. The Company is currently in the process of determining the extent of its liability, which could
require payment of a substantial portion of the costs, as well as the availability of funding from
the U.S. Navy and insurance coverage for these activities. Such investigation is anticipated to
take several months to complete. Selling, general and administrative expenses for the year ended
December 31, 2004, included $1.9 million related to this matter. On January 21, 2004, the owner of the Candelero Hotel located at Palmas filed a lawsuit
against PDMPI claiming an easement on certain property owned by PDMPI as well as damages. On
September 30, 2004, this matter was settled by an agreement in which the hotel owner dismissed all
of its claims and agreed to purchase for $9.0 million a parcel of land that included the area
covered by the alleged easement. This transaction closed in November 2004. The Company is 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. 
 13. Stockholders Deficit Preferred Stock The holders of the Companys 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 In 2002, the Company adopted the MAXXAM 2002 Omnibus Employee Incentive Plan (the 2002
Omnibus Plan). Up to 700,000 shares of common stock and 70,000 shares of Class A Preferred Stock
were reserved for awards pursuant to the 2002 Omnibus Plan, of which 198,220 and 70,000 shares,
respectively, were available to be awarded at December 31, 2004. The 2002 Omnibus Plan replaced
the MAXXAM 1994 Omnibus Plan (the 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. 83




---



##### Table of Contents



The options (or rights, as applicable) granted in 2004, 2003 and 2002 generally vest at the
rate of 20% per year commencing one year from the date of grant. The following table summarizes
the options or rights outstanding and exercisable relating to the Companys stock option plans.
The prices shown are the weighted average price per share for the respective number of underlying
shares. 2004
    
    
    2003
    
    
    2002Shares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    PriceOutstanding at
beginning of year
    
    
    1,145,390
    
    
    $
    24.16
    
    
    
    992,650
    
    
    $
    25.58
    
    
    
    800,100
    
    
    $
    30.12Granted
    
    
    111,400
    
    
    
    33.00
    
    
    
    176,240
    
    
    
    19.72
    
    
    
    215,850
    
    
    
    9.40Exercised
    
    
    (10,110
    )
    
    
    15.76
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Expired or forfeited
    
    
    (72,480
    )
    
    
    29.93
    
    
    
    (23,500
    )
    
    
    51.12
    
    
    
    (23,300
    )
    
    
    31.40Outstanding at end of year
    
    
    1,174,200
    
    
    
    24.71
    
    
    
    1,145,390
    
    
    
    24.16
    
    
    
    992,650
    
    
    
    25.58Exercisable at end of year
    
    
    666,118
    
    
    $
    28.73
    
    
    
    570,890
    
    
    $
    31.74
    
    
    
    431,620
    
    
    $
    36.15
 84




---



##### Table of Contents



The following table summarizes information about stock options outstanding as of December 31,
2004: Weighted AverageRange of
    
    
    
    
    
    Remaining
    
    
    Weighted Average
    
    
    Options
    
    
    Weighted AverageExercise Prices
    
    Shares
    
    
    Contractual Life
    
    
    Exercise Price
    
    
    Exercisable
    
    
    Exercise Price$  9.40-$15.88
    
    
    330,340
    
    
    
    7.26
    
    
    $
    11.68
    
    
    
    177,590
    
    
    $
    12.79$16.38-$19.72
    
    
    459,160
    
    
    
    7.58
    
    
    
    18.49
    
    
    
    215,228
    
    
    
    17.98$30.38-$45.50
    
    
    245,700
    
    
    
    6.32
    
    
    
    38.76
    
    
    
    134,300
    
    
    
    43.55$46.80-$56.00
    
    
    139,000
    
    
    
    2.93
    
    
    
    51.40
    
    
    
    139,000
    
    
    
    51.401,174,200
    
    
    
    6.68
    
    
    
    24.71
    
    
    
    666,118
    
    
    
    28.73
 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. Concurrent with the adoption of the 1994 Omnibus Plan, the Company adopted the MAXXAM 1994
Non-Employee Director Plan (the 1994 Director Plan). Up to 35,000 shares of Common Stock are
reserved for awards under the 1994 Director Plan. Options were granted to non-employee directors
to purchase 2,400 shares of common stock in 2004, 2003 and 2002, respectively. The weighted
average exercise prices of these options are $24.90, $12.15 and $11.00 per share, respectively,
based on the quoted market price at the date of grant. The options vest at the rate of 25% per
year commencing one year from the date of grant. At December 31, 2004, options for 19,100 shares
were outstanding, 13,100 of which were exercisable. Shares Reserved for Issuance At December 31, 2004, the Company had 2,976,898 common shares and 160,000 Class A Preferred
shares reserved for future issuances in connection with various options, convertible securities and
other rights as described above. 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 (the Series A Right)
for each outstanding share of the Companys Class A Preferred Stock and (ii) one Series B Preferred
Stock Purchase Right (the 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 (the 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 shall 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. 85




---



##### Table of Contents



Voting Control As of December 31, 2004, 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 99.1% of the
Companys Class A Preferred Stock and 47.9% of the Companys Common Stock (resulting in combined
voting control of approximately 74.9% 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. 
 14. Significant Acquisitions and Dispositions Motel Six Properties In December 2002, Motel Assets acquired two business trusts which own a portfolio of sixteen
motel properties located in ten different states. These properties secure the Motel Notes which
had an outstanding principal balance of $47.3 million at December 31, 2004. Upon closing of the
transaction, Motel Assets made a cash payment of $3.5 million. The Motel Notes have an interest
rate of 7.03% with a May 1, 2018, maturity date. Motel Assets acquired the properties 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. Motel
Assets is accounting for the lease as an operating lease. The Motel Notes are secured by the
lease, the properties, and an $11.2 million residual value insurance contract. Cooper Cameron Building In November 2002, Beltway Assets acquired an office building located in Houston, Texas, for a
purchase price of $32.7 million. The transaction was financed with a cash payment of $3.0 million
and proceeds of $29.7 million (net of $1.3 million of deferred financing costs) from the issuance
of the Beltway Notes, which had an outstanding principal balance of $29.8 million at December 31,
2004. The Beltway Notes have an interest rate of 6.08% and a November 9, 2024 maturity date. At
the time of the acquisition, Beltway Assets simultaneously leased the property back to the seller
for a period of 22 years. Beltway Assets is accounting for the lease as an operating lease. The
Beltway Notes are secured by the building, the lease, and an $11.2 million residual value insurance
contract. Timberland Transactions In November 2003, Palco and Scotia LLC sold approximately 681 acres of timberlands within an
area known as the Grizzly Creek grove. Palco received $10.0 million in cash, while Scotia LLC
received $8.2 million in cash. The Company recognized a gain of $16.8 million in 2003 related to
this sale. 
 15. Supplemental Cash Flow and Other Information Years Ended December 31,2004
    
    
    2003
    
    
    2002(In millions)Supplemental information on non-cash investing and financing activities:Transfer of marketable debt securities from held-to-maturity to available-for-sale
    
    $
    
    
    
    $
    14.4
    
    
    $
    Repurchases of debt using restricted cash and marketable securities
    
    
    10.9
    
    
    
    5.4
    
    
    
    Supplemental disclosure of cash flow information:Interest paid, net of capitalized interest
    
    $
    72.7
    
    
    $
    75.0
    
    
    $
    83.3Income taxes paid, net
    
    
    0.4
    
    
    
    0.4
    
    
    
    0.2
 86




---



##### Table of Contents



16. Quarterly Financial Information (Unaudited) Summary quarterly financial information for the years ended December 31, 2004 and 2003 is as
follows (in millions, except share information): Three Months EndedMarch 31
    
    
    June 30
    
    
    September 30
    
    
    December 312004:Net sales
    
    $
    68.9
    
    
    $
    92.5
    
    
    $
    81.5
    
    
    $
    104.6Loss before income taxes
    
    
    (20.3
    )
    
    
    (5.3
    )
    
    
    (20.1
    )
    
    
    (1.2
    )Net loss
    
    
    (20.3
    )
    
    
    (5.3
    )
    
    
    (20.2
    )
    
    
    (0.8
    )Basic and diluted loss per common and common
equivalent share
    
    $
    (3.40
    )
    
    $
    (0.89
    )
    
    $
    (3.37
    )
    
    $
    (0.13
    )2003:Net sales
    
    $
    74.9
    
    
    $
    78.5
    
    
    $
    89.4
    
    
    $
    93.8Income (loss) before income taxes
    
    
    (10.5
    )
    
    
    (8.1
    )
    
    
    (6.3
    )
    
    
    14.3Net income (loss)
    
    
    (10.5
    )
    
    
    (8.1
    )
    
    
    (6.3
    )
    
    
    13.3Basic earnings (loss) per common and common
equivalent share
    
    $
    (1.61
    )
    
    $
    (1.24
    )
    
    $
    (0.96
    )
    
    $
    1.91Diluted earnings (loss) per common and common
equivalent share
    
    $
    (1.61
    )
    
    $
    (1.24
    )
    
    $
    (0.96
    )
    
    $
    1.88
 87




---



##### Table of Contents



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 
 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, 2004. Changes in Internal Control over Financial Reporting Since September 30, 2004, 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 issuer;(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 issuer are being made only in
accordance with authorizations of management and directors of the issuer; and(3)
    Provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the issuers assets that could have a material effect
on the financial statements. (§240.13a-15(f) of the Securities and Exchange Commissions
Regulation S-K). 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. 88




---



##### Table of Contents



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
(COSO). 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, 2004. Dated: March 14, 2005
 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 (the Company) maintained
effective internal control over financial reporting as of December 31, 2004, 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 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, 2004, 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,
2004, based on the criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. 89




---



##### Table of Contents



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,
2004 and 2003, and the related consolidated statements of operations, cash flows, and stockholders
deficit for each of the three years in the period ended December 31, 2004. Our audits also
included the financial statement schedules listed in the Index at Item 15(a)(2). Our report dated
March 14, 2005 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 14, 2005 
 ITEM 9B. OTHER INFORMATION Not applicable. 
 PART III Certain information required under Part III (Items 10 through 14) has been omitted from this
Report since the Company intends to file with the Securities and Exchange Commission, not later
than 120 days after the close of its fiscal year, a definitive proxy statement pursuant to
Regulation 14A which involves the election of directors. 
 PART IV 
 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES Page(a) Index to Financial Statements1. Financial Statements (included under Item 8):Report of Independent Registered Public Accounting Firm
    
    
    46Consolidated Balance Sheet at December 31, 2004 and 2003
    
    
    47Consolidated Statement of Operations for the Years Ended December 31, 2004, 2003 and 2002
    
    
    48Consolidated Statement of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002
    
    
    49Consolidated Statement of Stockholders Deficit for the Years Ended December 31, 2004, 2003 and 2002
    
    
    50Notes to Consolidated Financial Statements
    
    
    512. Financial Statement Schedules:Schedule I  Condensed Financial Information of Registrant at December 31, 2004
and 2003 and for the Years Ended December 31, 2004, 2003 and 2002
    
    
    91All other schedules are inapplicable or the required information is included in the
Consolidated Financial Statements or the Notes thereto.(b) Exhibits
 Reference is made to the Index of Exhibits at the end of this Report, which index is
incorporated herein by reference. 90




---



##### Table of Contents



SCHEDULE I  CONDENSED FINANCIAL INFORMATION OF REGISTRANT MAXXAM INC. BALANCE SHEET (Unconsolidated)
(In millions of dollars, except share information) December 31,2004
    
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    8.7
    
    
    $
    2.1Marketable securities and other investments
    
    
    100.9
    
    
    
    86.7Other current assets
    
    
    7.0
    
    
    
    7.3Total current assets
    
    
    116.6
    
    
    
    96.1Deferred income taxes
    
    
    58.4
    
    
    
    61.2Other assets
    
    
    0.4
    
    
    
    1.0$
    175.4
    
    
    $
    158.3Liabilities and Stockholders DeficitCurrent liabilities:Accounts payable and other accrued liabilities
    
    $
    4.7
    
    
    $
    4.5Total current liabilities
    
    
    4.7
    
    
    
    4.5Payables to subsidiaries, net of receivables and advances
    
    
    190.9
    
    
    
    188.9Losses recognized in excess of investment in Kaiser
    
    
    516.2
    
    
    
    516.2Losses recognized in excess of investments in subsidiaries
    
    
    87.1
    
    
    
    25.9Other noncurrent liabilities
    
    
    33.6
    
    
    
    24.7Total liabilities
    
    
    832.5
    
    
    
    760.2Stockholders deficit:Preferred stock, $0.5 par value; $0.75 liquidation preference; 2,500,000
shares authorized; Class A $0.05 Non-Cumulative Participating Convertible
Preferred
Stock; 669,019 and 669,040 shares issued, respectively; 668,174 and
668,195 shares outstanding, respectively
    
    
    0.3
    
    
    
    0.3Common stock, $0.50 par value; 13,000,000 shares authorized; 10,063,359
shares issued; 5,976,487 and 5,976,466 shares outstanding, respectively
    
    
    5.0
    
    
    
    5.0Additional capital
    
    
    225.3
    
    
    
    225.3Accumulated deficit
    
    
    (666.4
    )
    
    
    (619.8
    )Accumulated other comprehensive loss
    
    
    (96.6
    )
    
    
    (88.0
    )Treasury stock, at cost (shares held: preferred  845; common  4,086,872
and 4,086,893, respectively)
    
    
    (124.7
    )
    
    
    (124.7
    )Total stockholders deficit
    
    
    (657.1
    )
    
    
    (601.9
    )$
    175.4
    
    
    $
    158.3
 See notes to consolidated financial statements and accompanying notes. 91




---



##### Table of Contents



SCHEDULE I  CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued) MAXXAM INC. STATEMENT OF OPERATIONS (Unconsolidated)
(In millions of dollars) Years Ended December 31,2004
    
    
    2003
    
    
    2002Investment, interest and other income (expense), net
    
    $
    3.7
    
    
    $
    13.4
    
    
    $
    4.1Intercompany interest income (expense), net
    
    
    (9.9
    )
    
    
    (16.1
    )
    
    
    (26.9
    )Interest expense
    
    
    (0.1
    )
    
    
    
    
    
    
    (0.3
    )General and administrative expenses
    
    
    (16.0
    )
    
    
    (8.4
    )
    
    
    (9.4
    )Equity in losses of subsidiaries
    
    
    (28.9
    )
    
    
    (8.9
    )
    
    
    (56.4
    )Loss before income taxes
    
    
    (51.2
    )
    
    
    (20.0
    )
    
    
    (88.9
    )Credit for income taxes
    
    
    4.6
    
    
    
    8.4
    
    
    
    4.9Net loss
    
    $
    (46.6
    )
    
    $
    (11.6
    )
    
    $
    (84.0
    )
 See notes to consolidated financial statements and accompanying notes. 92




---



##### Table of Contents



SCHEDULE I  CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued) MAXXAM INC. STATEMENT OF CASH FLOWS (Unconsolidated)
(In millions of dollars) Years Ended December 31,2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net loss
    
    $
    (46.6
    )
    
    $
    (11.6
    )
    
    $
    (84.0
    )Adjustments to reconcile net income (loss) to net cash provided
by (used for) operating activities:Equity in losses of subsidiaries
    
    
    28.9
    
    
    
    8.9
    
    
    
    56.4Non-cash stock-based compensation expense
    
    
    6.1
    
    
    
    0.8
    
    
    
    0.1Net (gains) losses on marketable securities and other investments
    
    
    2.2
    
    
    
    (5.2
    )
    
    
    2.2Decrease in payable to affiliates
    
    
    
    
    
    
    
    
    
    
    (35.3
    )Decrease in receivables, prepaids and other assets
    
    
    0.7
    
    
    
    10.9
    
    
    
    1.2Decrease (increase) in deferred income tax assets
    
    
    3.2
    
    
    
    (8.1
    )
    
    
    30.3(Increase) decrease in accounts payable and other liabilities
    
    
    1.0
    
    
    
    (2.3
    )
    
    
    (2.3
    )Net cash used for operating activities
    
    
    (4.5
    )
    
    
    (6.6
    )
    
    
    (31.4
    )Cash flows from investing activities:Net sales (purchases) of marketable securities and other investments
    
    
    (17.5
    )
    
    
    (7.6
    )
    
    
    48.1Dividends received from subsidiaries
    
    
    5.9
    
    
    
    4.3
    
    
    
    Investments in and net advances from (to) subsidiaries
    
    
    23.0
    
    
    
    19.6
    
    
    
    (19.7
    )Capital expenditures
    
    
    (0.3
    )
    
    
    (0.1
    )
    
    
    (0.1
    )Net cash provided by investing activities
    
    
    11.1
    
    
    
    16.2
    
    
    
    28.3Cash flows from financing activities:Treasury stock repurchases
    
    
    
    
    
    
    (9.0
    )
    
    
    Net cash used for financing activities
    
    
    
    
    
    
    (9.0
    )
    
    
    Net increase (decrease) in cash and cash equivalents
    
    
    6.6
    
    
    
    0.6
    
    
    
    (3.1
    )Cash and cash equivalents at beginning of year
    
    
    2.1
    
    
    
    1.5
    
    
    
    4.6Cash and cash equivalents at end of year
    
    $
    8.7
    
    
    $
    2.1
    
    
    $
    1.5Supplementary schedule of non-cash investing and financing activities:Deferral of interest payment on intercompany note payable
    
    $
    11.3
    
    
    $
    11.4
    
    
    $
    20.7Distribution of assets from subsidiaries
    
    
    
    
    
    
    
    
    
    
    1.0Non-cash dividends received from subsidiaries
    
    
    21.6
    
    
    
    14.7
    
    
    
    60.0Supplemental disclosure of cash flow information:Interest paid
    
    $
    0.5
    
    
    $
    0.4
    
    
    $
    7.0
 See notes to consolidated financial statements and accompanying notes. 93




---



##### Table of Contents



SCHEDULE I  CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued) MAXXAM INC. NOTES TO FINANCIAL STATEMENTS 1. Investment in Kaiser On February 12, 2002, Kaiser Aluminum Corporation (Kaiser) and certain of its subsidiaries
(the Debtors) filed for reorganization under Chapter 11 of the United States Bankruptcy Code. As
a result, Kaisers financial results were deconsolidated beginning February 12, 2002, and MAXXAM
Inc. (the Company) began reporting its investment in Kaiser using the cost method. Since
Kaisers results are no longer consolidated and the Company believes that it is not probable that
it will be obligated to fund losses related to its investment in Kaiser, any adjustments made in
Kaisers financial statements subsequent to February 12, 2002 (relating to the recoverability and
classification of recorded asset amounts and classification of liabilities or the effects on
existing stockholders deficit as well as adjustments made to Kaisers financial information for
loss contingencies and other matters discussed in the notes to the Consolidated Financial
Statements) are not expected to impact the Companys financial results. While valuation of the
Debtors assets and pre-filing date claims at this stage of the bankruptcy cases is subject to
inherent uncertainties, Kaiser has indicated that the Debtors believe that it is likely that their
liabilities will be found to exceed the fair value of their assets. The Debtors therefore believe
that it is likely that pre-filing date claims will be settled at less than 100% of their face value
and the equity of Kaisers stockholders, including the Company, will be cancelled without
consideration. 2. Deferred Income Taxes The deferred income tax assets and liabilities reported in the accompanying unconsolidated
balance sheet are determined by computing such amounts on a consolidated basis for the Company and
members of its consolidated federal income tax return group, and then reducing such consolidated
amounts by the amounts recorded by the Companys subsidiaries pursuant to their respective tax
allocation agreements with the Company. The Companys net deferred income tax assets relate
primarily to loss and credit carryforwards, net of valuation allowances. The Company evaluated all
appropriate factors to determine the proper valuation allowances for these carryforwards, including
any limitations concerning their use, the year the carryforwards expire and the levels of taxable
income necessary for utilization. Based on this evaluation, the Company has concluded that it is
more likely than not that it will realize the benefit of the carryforwards for which valuation
allowances were not provided. 3. Notes Payable to Subsidiaries, Net of Notes Receivable and Advances The Companys indebtedness to its subsidiaries, which includes accrued interest, consists of
the following (in millions): December 31,2004
    
    
    2003Note payable to MAXXAM Group Holdings Inc. (MGHI)
    
    $
    182.3
    
    
    $
    170.9Net advances
    
    
    8.6
    
    
    
    18.0$
    190.9
    
    
    $
    188.9
 94




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized. MAXXAM INC.Date: March 16, 2005
    
    By:
    
    PAUL N. SCHWARTZPaul N. SchwartzPresident
 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated. Date: March 16, 2005
    
    By:
    
    CHARLES E. HURWITZCharles E. HurwitzChairman of the Board and Chief Executive OfficerDate: March 16, 2005
    
    By:
    
    J. KENT FRIEDMANJ. Kent FriedmanVice Chairman of the Board andGeneral CounselDate: March 16, 2005
    
    By:
    
    ROBERT J. CRUIKSHANKRobert J. CruikshankDirectorDate: March 16, 2005
    
    By:
    
    EZRA G. LEVINEzra G. LevinDirectorDate: March 16, 2005
    
    By:
    
    STANLEY D. ROSENBERGStanley D. RosenbergDirectorDate: March 16, 2005
    
    By:
    
    MICHAEL J. ROSENTHALMichael J. RosenthalDirectorDate: March 16, 2005
    
    By:
    
    PAUL N. SCHWARTZPaul N. SchwartzPresident, Chief Financial Officer and Director(Principal Financial Officer andInterim Principal Accounting Officer)
 95




---



##### Table of Contents



INDEX OF EXHIBITS ExhibitNumber
    
    Description3.1
    
    Restated certificate of incorporation of the Company (conformed to
include all amendments and certificates of designation thereto and
incorporated herein by reference to Exhibit 3.1 to the Companys
Quarterly Report on Form 10-Q for the quarter ended June 30, 2004)3.2
    
    Certificate of Powers, Designations, Preferences and Relative,
Participating, Optional and Other Rights of the Companys Class B Junior
Participating Preferred Stock (incorporated herein by reference to
Exhibit 3.2 to the Companys Annual Report on Form 10-K for the year
ended December 31, 1989)3.3
    
    Certificate of Designations of Class A $.05 Non-Cumulative Participating
Convertible Preferred Stock of the Company (incorporated by reference to
Exhibit 3.3 to the Companys Annual Report on Form 10-K for the year
ended December 31, 1999; the Company 1999 Form 10-K)3.4
    
    Amended and Restated By-laws of the Company, dated March 30, 2000
(incorporated herein by reference to Exhibit 3.1 to the Companys
Quarterly Report on Form 10-Q for the quarter ended March 31, 2000)4.1
    
    Rights Agreement, dated December 15, 1999, by and between the Company and
American Stock Transfer & Trust Company (incorporated herein by reference
to Exhibit 4.1 to the Companys Report on Form 8-K dated December 15,
1999)4.2
    
    Palco Credit Agreement, dated January 23, 2004, among Palco, Britt, Bank
of America, N.A., as Agent, and the Lenders from time to time party
thereto (incorporated herein by reference to Exhibit 4.2 to the Companys
Annual Report on Form 10-K for the year ended December 31, 2003)4.3
    
    Amendment No. 1 to the Palco Credit Agreement, dated May 7, 2004
(incorporated herein by reference to Exhibit 10.1 to the Companys
Quarterly Report on Form 10-Q for the quarter ended March 31, 2004)4.4
    
    Amendment No. 2 to the Palco Credit Agreement, dated October 20, 2004
(incorporated by reference to Exhibit 10.1 to the Companys Quarterly
Report on Form 10-Q for the quarter ended September 30, 2004)4.5
    
    Amendment No. 3 to the Palco Credit Agreement, dated February 22, 2005
(incorporated herein by reference to Exhibit 10.1 to the Companys Report
on Form 8-K dated February 25, 2005)4.6
    
    [Reserved]4.7
    
    Timber Notes Indenture (the Timber Notes Indenture), dated July 20,
1998, between Scotia LLC and State Street Bank and Trust Company
regarding Scotia LLCs Class A-1, Class A-2 and Class A-3 Timber
Collateralized Notes (incorporated herein by reference to Exhibit 4.1 to
the Companys Quarterly Report on Form 10-Q for the quarter ended June
30, 1998; the Company June 1998 Form 10-Q)4.8
    
    First Supplemental Indenture, dated July 16, 1999, to the Timber Notes
Indenture (incorporated herein by reference to Exhibit 4.1 to Scotia
LLCs Quarterly Report on Form 10-Q for the quarter ended June 30, 1999;
File No. 333-63825; the Scotia LLC June 1999 Form 10-Q)4.9
    
    Second Supplemental Indenture, dated November 18, 1999, to the Timber
Notes Indenture (incorporated herein by reference to Exhibit 99.3 to
Scotia LLCs Report on Form 8-K dated November 19, 1999; File No.
333-63825)4.10
    
    Deed of Trust, Security Agreement, Financing Statement, Fixture Filing
and Assignment of Proceeds, dated July 20, 1998 (incorporated herein by
reference to Exhibit 4.2 to the Company June 1998 Form 10-Q)
 96




---



##### Table of Contents



ExhibitNumber
    
    Description4.11
    
    Credit Agreement (the Scotia LLC Line of Credit), dated July 20, 1998,
among Scotia LLC, the financial institutions party thereto and Bank of
America, N.A., as Agent (incorporated herein by reference to Exhibit 4.3
to the Company June 1998 Form 10-Q)4.12
    
    First Amendment, dated July 16, 1999, to the Scotia LLC Line of Credit
(incorporated herein by reference to Exhibit 4.2 to the Scotia LLC June
1999 Form 10-Q)4.13
    
    Second Amendment, dated June 15, 2001, to the Scotia LLC Line of Credit
(incorporated herein by reference to Exhibit 4.1 to Scotia LLCs
Quarterly Report on Form 10-Q for the quarter ended June 30, 2001; File
No. 333-63825)4.14
    
    Third Amendment, dated June 30, 2003, to the Scotia LLC Line of Credit
(incorporated herein by reference to Exhibit 4.1 to Scotia LLCs
Quarterly Report on Form 10-Q for the quarter ended June 30, 2003; File
No. 333-63825)4.15
    
    Loan Agreement, dated June 28, 2001, between Lakepointe Assets LLC and
Legg Mason Real Estate Services, Inc. (incorporated herein by reference
to Exhibit 4.2 to MGHIs Quarterly Report on Form 10-Q for the quarter
ended June 30, 2001; File No. 333-18723; the MGHI June 2001 Form 10-Q)4.16
    
    Promissory Note, dated June 28, 2001, between Lakepointe Assets LLC and
Legg Mason Real Estate Services, Inc. (incorporated herein by reference
to Exhibit 4.3 to the MGHI June 2001 Form 10-Q)4.17
    
    Lease Agreement, dated June 28, 2001, between Lakepointe Assets LLC and
Fluor Enterprises Inc. (incorporated herein by reference to Exhibit 10.1
to the MGHI June 2001 Form 10-Q)4.18
    
    Guarantee of Lease dated June 28, 2001, between Fluor Corporation and
Lakepointe Assets LLC (incorporated herein by reference to Exhibit 10.2
to the MGHI June 2001 Form 10-Q)Note: Pursuant to Regulation § 229.601, Item 601(b)(4)(iii) of Regulation
S-K, upon request of the Securities and Exchange Commission, the Company
hereby agrees to furnish a copy of any unfiled instrument which defines
the rights of holders of long-term debt of the Company and its
consolidated subsidiaries (and for any of its unconsolidated subsidiaries
for which financial statements are required to be filed) wherein the
total amount of securities authorized thereunder does not exceed 10
percent of the total consolidated assets of the Company10.1
    
    Tax Allocation Agreement (MGHI Tax Allocation Agreement), dated
December 23, 1996, between the Company and MGHI (incorporated herein by
reference to Exhibit 10.1 to MGHIs Registration Statement on Form S-4;
Registration No. 333-18723)10.2
    
    Amendment of MGHI Tax Allocation Agreement, dated December 31, 2001
(incorporated herein by reference to Exhibit 10.2 to MGHIs Annual Report
on Form 10-K for the year ended December 31, 2001; File No. 333-18723;
the MGHI 2001 Form 10-K)10.3
    
    Tax Allocation Agreement (MGI Tax Allocation Agreement), dated August
4, 1993, between the Company and MGI (incorporated herein by reference to
Exhibit 10.6 to Amendment No. 2 to MGIs Registration Statement on Form
S-2; Registration No. 33-56332)10.4
    
    Amendment of MGI Tax Allocation Agreement, dated December 31, 2001,
between the Company and MGI (incorporated herein by reference to Exhibit
10.4 to the MGHI 2001 Form 10-K)10.5
    
    Tax Allocation Agreement, dated May 21, 1988, among the Company, MGI,
Palco and the corporations signatory thereto (incorporated herein by
reference to Exhibit 10.8 to Palcos Annual Report on Form 10-K for the
year ended December 31, 1988; File No. 1-9204)
 97




---



##### Table of Contents



ExhibitNumber
    
    Description10.6
    
    Tax Allocation Agreement (Palco Tax Allocation Agreement), dated March
23, 1993, among Palco, Scotia Pacific Holding Company, Salmon Creek
Corporation and the Company (incorporated herein by reference to Exhibit
10.1 to Amendment No. 3 to the Registration Statement on Form S-1 of
Scotia Pacific Holding Company; Registration No. 33-55538)10.7
    
    Amendment of Palco Tax Allocation Agreement, dated December 31, 2001
(incorporated herein by reference to Exhibit 10.7 to the MGHI 2001 Form
10-K)10.8
    
    Tax Allocation Agreement, dated February 9, 2004, among Britt, Palco, MGI
and the Company (incorporated herein by reference to Exhibit 10.8 to the
Companys Annual Report on Form 10-K for the year ended December 31,
2003)10.9
    
    [Reserved]10.10
    
    New Master Purchase Agreement, dated July 20, 1998, between Scotia LLC
and Palco (incorporated herein by reference to Exhibit 10.1 to MGHIs
Quarterly Report on Form 10-Q for the quarter ended June 30, 1998; File
No. 333-18723; the MGHI June 1998 Form 10-Q)10.11
    
    New Services Agreement, dated July 20, 1998, between Palco and Scotia LLC
(incorporated herein by reference to Exhibit 10.2 to the MGHI June 1998
Form 10-Q)10.12
    
    New Additional Services Agreement, dated July 20, 1998, between Scotia
LLC and Palco (incorporated herein by reference to Exhibit 10.3 to the
MGHI June 1998 Form 10-Q)10.13
    
    New Reciprocal Rights Agreement, dated July 20, 1998, among Palco, Scotia
LLC and Salmon Creek Corporation (incorporated herein by reference to
Exhibit 10.4 to the MGHI June 1998 Form 10-Q)10.14
    
    New Environmental Indemnification Agreement, dated July 20, 1998, between
Palco and Scotia LLC (incorporated herein by reference to Exhibit 10.5 to
the MGHI June 1998 Form 10-Q)10.15
    
    Implementation Agreement with Regard to Habitat Conservation Plan for the
Properties of Palco, Scotia LLC and Salmon Creek Corporation, dated March
1, 1999, by and among The United States Fish and Wildlife Service, the
National Marine Fisheries Service, the California Department of Fish and
Game (CDF&G), the CDF and Palco, Salmon Creek Corporation and Scotia
LLC (incorporated herein by reference to Exhibit 99.3 to Scotia LLCs
Report on Form 8-K dated March 19, 1999; File No. 333-63825; the Scotia
LLC March 19, 1999 Form 8-K)10.16
    
    Agreement Relating to Enforcement of AB 1986, dated February 25, 1999, by
and among The California Resources Agency, CDF&G, CDF, The California
Wildlife Conservation Board, Palco, Salmon Creek Corporation and Scotia
LLC (incorporated herein by reference to Exhibit 99.4 to the Scotia LLC
March 19, 1999 Form 8-K)10.17
    
    Habitat Conservation Plan, dated March 1, 1999, for the Properties of
Palco, Scotia LLC and Salmon Creek Corporation (incorporated herein by
reference to Exhibit 99.5 to the Scotia LLC March 19, 1999 Form 8-K)10.18
    
    Letter, dated February 25, 1999, from the CDF to Palco (incorporated
herein by reference to Exhibit 99.8 to the Scotia LLC March 19, 1999 Form
8-K)10.19
    
    Letter, dated March 1, 1999, from the CDF to Palco (incorporated herein
by reference to Exhibit 99.9 to the Scotia LLC March 19, 1999 Form 8-K)10.20
    
    Letter, dated March 1, 1999, from the U.S. Department of the Interior
Fish and Wildlife Service and the U.S. Department of Commerce National
Oceanic and Atmospheric Administration to Palco, Salmon Creek Corporation
and Scotia LLC (incorporated herein by reference to Exhibit 99.10 to the
Scotia LLC March 19, 1999 Form 8-K)10.21
    
    [Reserved]
 98




---



##### Table of Contents



ExhibitNumber
    
    DescriptionExecutive Compensation Plans and Arrangements10.22
    
    MAXXAM 2002 Omnibus Employee Incentive Plan (incorporated hereby
reference to Exhibit 99 to the Companys Schedule 14A dated April 30,
2002)10.23
    
    Form of Stock Option Agreement under the MAXXAM 2002 Omnibus Employee
Incentive Plan (incorporated herein by reference to Exhibit 10.22 to the
Companys Annual Report on Form 10-K for the year ended December 31,
2002)10.24
    
    MAXXAM 1994 Omnibus Employee Incentive Plan (incorporated herein by
reference to Exhibit 99 to the Companys Schedule 14A dated April 29,
1994)10.25
    
    Form of Stock Option Agreement under the MAXXAM 1994 Omnibus Employee
Incentive Plan (incorporated herein by reference to Exhibit 10.30 to the
Companys Annual Report on Form 10-K for the year ended December 31,
1994; the Company 1994 Form 10-K)10.26
    
    MAXXAM Amended and Restated Non-Employee Director Stock Plan
(incorporated herein by reference to Exhibit 99.1 to the Companys
Schedule 14A dated April 20, 2004)*10.27
    
    Form of Stock Option Agreement under the Amended and Restated
Non-Employee Director Plan10.28
    
    Form of deferred fee agreement for Company directors (incorporated herein
by reference to Exhibit 10.26 to the Companys Annual Report on Form 10-K
for the fiscal year ended December 31, 1996)10.29
    
    MAXXAM 1994 Executive Bonus Plan (Amended and Restated 2003)
(incorporated herein by reference to Exhibit 99 to the Companys Schedule
14A dated April 5, 2004)10.30
    
    MAXXAM Revised Capital Accumulation Plan of 1988, as amended December 12,
1988 (incorporated herein by reference to Exhibit 10.1 to the Companys
Quarterly Report on Form 10-Q for the quarter ended June 30, 1995)10.31
    
    MAXXAM Supplemental Executive Retirement Plan (incorporated herein by
reference to Exhibit 10(ii) to MGIs Registration Statement on Form S-4
on Form S-2; Registration No. 33-42300)10.32
    
    Form of Company deferred compensation agreement (incorporated herein by
reference to Exhibit 10.35 to the Companys Annual Report on Form 10-K
for the year ended December 31, 1995)10.33
    
    Executive Employment Agreement between the Company and J. Kent Friedman
dated November 29, 1999 (incorporated herein by reference to Exhibit
10.52 to the Company 1999 Form 10-K)10.34
    
    Restricted Stock Agreement (Restricted Stock Agreement), dated December
13, 1999, between the Company and Charles E. Hurwitz (incorporated herein
by reference to Exhibit 10.53 to the Company 1999 Form 10-K)10.35
    
    Amendment, dated December 16, 2003, to the Restricted Stock Agreement
(incorporated herein by reference to Exhibit 10.35 to the Companys
Annual Report on Form 10-K for the year ended December 31, 2003)10.36
    
    Retention Agreement, dated September 9, 2004, between the Company and
Diane Dudley (incorporated herein by reference to Exhibit 10.1 to the
Companys Report on Form 8-K dated September 9, 2004)10.37
    
    Consulting Agreement, dated December 30, 2004, between Diane Dudley and
the Company (incorporated herein by reference to Exhibit 10.1 the
Companys Report on Form 8-K dated December 30, 2004)*21.1
    
    List of the Companys Subsidiaries*23.1
    
    Consent of Deloitte & Touche LLP*31.1
    
    Section 302 Certification of Chief Executive Officer
 99




---



##### Table of Contents



ExhibitNumber
    
    Description*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
   *
    
    Included with this filing 
 Glossary of Defined Terms Set forth below is a list of all terms used and defined in this Report (other than the Exhibit
Index) and the Consolidated Financial Statements 1994 Director Plan:The MAXXAM 1994 Non-Employee Director Plan 1994 Omnibus Plan:The MAXXAM 1994 Employee Incentive Omnibus Plan 2002 Omnibus Plan:The MAXXAM 2002 Employee Incentive Omnibus Plan ACO:Administrative Consent Order concerning the RI/RA in respect of a property in Cranbury, New
Jersey Acquiring Person:A person or group of affiliated or associated persons who acquire beneficial
ownership, or the right to acquire beneficial ownership, of 15% or more of the Companys Common
Stock (or announces a tender offer which would have this result) Alpart:Alumina Partners of Jamaica APB Opinion No. 25:Accounting Principles Board Opinion 25, Accounting for Stock Issued to
Employees Bankruptcy Code:The United States Bankruptcy Code Bankruptcy Court:The United States Bankruptcy Court for the District of Delaware Bear Creek lawsuit:An action entitled Environmental Protection Information Association v. Pacific
Lumber, Scotia Pacific Company LLC(No. C01-2821) filed in the U.S. District Court for the Northern
District of California Beltway Assets:Beltway Assets LLC, an indirect wholly owned subsidiary of the Company Beltway Notes:The 6.08% notes of Beltway Assets due in November 2024 BOF:California Board of Forestry and Fire Protection Britt:Britt Lumber Co., Inc., a wholly owned subsidiary of Palco California Permits:The Permits issued by California pursuant to the HCP Cases:The Chapter 11 proceedings of the Debtors Cave action:An action entitled Steve Cave, et al. v. Gary Clark, et al.(No. DR020719) filed in
the Superior Court of Humboldt County, California CDF:California Department of Forestry and Fire Protection 100




---



##### Table of Contents



CEQA:California Environmental Quality Act CESA:California Endangered Species Act Class A Preferred Stock:The Companys Class A $.05 Non-Cumulative Participating Convertible
Preferred Stock Common Stock:The Companys $0.50 par value common stock Company:MAXXAM Inc., including its subsidiaries Cook action:An action entitled Alan Cook, et al. v. Gary Clark, et al.(No. DR020718)
filed in the Superior Court of Humboldt County, California COSO:Committee of Sponsoring Organizations of the Treadway Commission CWA:Federal Clean Water Act Debtors:Kaiser, KACC and the subsidiaries of KACC which have filed petitions for reorganization Elk River Order:Clean up and abatement order issued to Palco by the North Coast Water Board for
the Elk River watershed Environmental Plans:The HCP and the SYP EPA:Federal Environmental Protection Agency EPIC-SYP/Permits lawsuit: 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.
filed in the Superior Court of Humboldt County, California (No. CV990445) EPIC-USFWS/NOAA lawsuit:An action entitled Environmental Protection Information Center v. U.S.
Fish & Wildlife Service, NOAA Fisheries, et al.(No. C04-4647), filed in U.S. Court for the
Northern District of California ESA:The Federal Endangered Species Act FASB:Financial Accounting Standards Board FDIC:Federal Deposit Insurance Corporation FDIC action:An action entitled Federal Deposit Insurance Corporation, as manager of the FSLIC
Resolution Fund v. Charles E. Hurwitz(No. H-95-3956) filed by the FDIC on August 2, 1995 in the
U.S. District Court for the Southern District of Texas Federal Permits:The Permits issued by the federal government pursuant to the HCP Federated:Federated Development Company, a principal stockholder of the Company now known as
Giddeon Holdings, Inc. Filing Date:With respect to any particular Debtor, the date on which such Debtor filed its Case FireRock, LLC:A 50% owned joint venture which develops and manages a real estate project in
Arizona Forest Practice Act:The California Forest Practice Act FSP FAS 106-2:FASB Staff Position FAS 106-2, Accounting and Disclosure Requirements Related to
the Medicare Prescription Drug, Improvement and Modernization Act of 2003 101




---



##### Table of Contents



GIS:Scotia LLCs Geographical information system GPS:Scotia LLCs Global Positioning System Gramercy:Kaisers alumina refinery located in Gramercy, Louisiana Harvest Value Schedule:A schedule setting forth SBE Prices which is published biannually by the
California State Board of Equalization for purposes of computing yield taxes on timber sales HCP:The habitat conservation plan covering multiple species approved in March 1999 in
connection with the consummation of the Headwaters Agreement Headwaters Agreement:The agreement among Palco, Scotia LLC, Salmon Creek, the United States and
California pursuant to which the Palco Companies transferred to the United States government 5,600
acres of timberlands in exchange for $300 million, approximately 7,700 acres of timberlands, and
federal and state government-approved habitat conservation and sustained yield plans Headwaters Timberlands:Approximately 5,600 acres of Palco timberlands transferred to the United
States government as part of the Headwaters Agreement Humboldt DA action:A civil suit entitled The People of the State of California v. Pacific Lumber,
Scotia Pacific Holding Company and Salmon Creek Corporation(No. DR030070) filed in the Superior
Court of Humboldt County, California, by the District Attorney of Humboldt County HWC 2003 lawsuit:An action entitled Humboldt County Watershed Council, et al. v. North Coast
Regional Water Quality Control Board, et al.(No. CV030961), naming Palco as real party in
interest, filed in the Superior Court of Humboldt County, California Junior Preferred Stock:$0.50 par value Class B Junior Participating Preferred Stock of the Company KACC:Kaiser Aluminum & Chemical Corporation, Kaisers principal operating subsidiary Kahn lawsuit:An action entitled Alan Russell Kahn v. Federated Development Co., MAXXAM Inc., et.
al.(Civil Action 18623NC) filed in the Delaware Court of Chancery Kaiser:Kaiser Aluminum Corporation, a subsidiary of the Company engaged in aluminum operations Kaisers Discontinued Operations:Discontinued operations of Kaiser which includes Alpart,
Gramercy, KJBC, Valco, Mead Facility, QAL and Kaisers hedging operations Kaiser Shares:50,000,000 shares of the common stock of Kaiser owned by the Company and MGHI KJBC:Kaiser Jamaica Bauxite Company Lakepointe Assets:Lakepointe Assets Holdings LLC, an indirect wholly owned subsidiary of the
Company Lakepointe Notes:The 7.56% notes of Lakepointe Assets and its subsidiaries due June 8, 2021 LIBOR:London Inter Bank Offering Rate Master Purchase Agreement:The agreement between Palco and Scotia LLC that governs all purchases
of logs by Palco from Scotia LLC MAXXAM:MAXXAM Inc., including its subsidiaries 102




---



##### Table of Contents



MAXXAM Parent:MAXXAM Inc., excluding its subsidiaries Mead Facility:Kaisers Mead facility and certain related property MBF:Million board feet MGHI:MAXXAM Group Holdings Inc., a wholly owned subsidiary of the Company MGHI Notes:12% Senior Secured Notes of MGHI MGI:MAXXAM Group Inc., a wholly owned subsidiary of MGHI Motel Assets:Motel Assets Holdings LLC, an indirect wholly owned subsidiary of the Company Motel Notes:The 7.03% notes of Motel Assets and its subsidiaries due May 1, 2018 MPC:MAXXAM Property Company, a wholly owned subsidiary of the Company NJDEP:New Jersey Department of Environmental Protection North Coast Water Board:California North Coast Regional Water Quality Control Board Old growth:Trees which have been growing for approximately 200 years or longer Option A Plan:Palcos Option A Plan under review by the CDF Original Debtors:Kaiser, KACC and the 15 subsidiaries of KACC that filed petitions for
reorganization on February 12, 2002 OTS:The United States Department of Treasurys Office of Thrift Supervision OTS action:A formal administrative proceeding initiated by the OTS against the Company and others
on December 26, 1995 Palco:The Pacific Lumber Company, a wholly owned subsidiary of MGI Palco Companies:Palco, Scotia LLC and Salmon Creek, collectively Palco Credit Agreement:January 2004 revolving credit facility between Palco and a bank which
provides for borrowings up to $35.0 million, based upon certain collateral balances Palco Timberlands:The Scotia LLC Timberlands and the timberlands owned by Palco Palmas:Palmas del Mar, a master-planned residential community and resort located on the
southeastern coast of Puerto Rico near Humacao Palmas Notes:The 7.12% notes due December 20, 2030 of Palmas Country Club Inc., an indirect
wholly owned subsidiary of the Company PDMPI:Palmas del Mar Properties, Inc., a wholly owned subsidiary of the Company Permits:The incidental take permits issued by the United States and California pursuant to the
HCP Prescription Drug Act:Medicare Prescription Drug, Improvement, and Modernization Act of 2003 PSLRA:Private Securities Litigation Reform Act of 1995 103




---



##### Table of Contents



QAL:Queensland Alumina Limited Racing Act:Texas Racing Act and related regulations Racing Commission:Texas Racing Commission Required Liquidity Amount:One years interest on the aggregate outstanding balance of the Timber
Notes Respondents:The Company, Federated, Mr. Charles Hurwitz and the other respondents in the OTS
action Rights:The Series A and B Rights RI/RA:Remedial investigation and remedial action RMCAL:A 50% owned joint venture formed to construct and sell 47 villas on a parcel in the Mirada
development Salmon Creek:Salmon Creek LLC, a wholly owned subsidiary of Palco Sanctions Motion:A counterclaim and motion for sanctions filed by the Respondents on November 8,
2002, in connection with the FDIC action SAR Account:Funds held in a reserve account titled the Scheduled Amortization Reserve Account and
used to support principal payments on the Timber Notes SBE Price:The applicable stumpage price for a particular species and size of log, as set forth in
the most recent Harvest Value Schedule Scheduled Amortization:The amount of principal which Scotia LLC must pay through each Timber Note
payment date in order to avoid prepayment or deficiency premiums Scotia LLC:Scotia Pacific Company LLC, a limited liability company wholly owned by Palco Scotia LLC Line of Credit:The agreement between a group of lenders and Scotia LLC pursuant to
which Scotia LLC may borrow in order to pay up to one years interest on the Timber Notes Scotia LLC Timber:The timber in respect of the Scotia LLC Timberlands and the Scotia LLC Timber
Rights Scotia LLC Timberlands:Approximately 204,000 acres of timberlands owned by Scotia LLC Scotia LLC Timber Rights:Scotia LLCs exclusive right to harvest on approximately 12,200 acres of
timberlands owned by Palco and Salmon Creek Series A Right:The Companys Series A Preferred Stock Purchase Right Series B Right:The Companys Series B Preferred Stock Purchase Right Services Agreement:The agreement between Palco and Scotia LLC regarding services to be provided
to Scotia LLC by Palco SFAS:Statement of Financial Accounting Standards SFAS No. 66:SFAS No. 66, Accounting for Sales of Real Estate SFAS No. 115:SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities SFAS No. 123(r):SFAS No. 123 (revised 2004), Share-Based Payment 104




---



##### Table of Contents



SFAS No. 144:SFAS No. 144 Accounting for Impairment and Disposal of Long-Lived Assets SHRP, Ltd.:Sam Houston Race Park, Ltd., a wholly owned subsidiary of the Company State Water Board:California State Water Resources Control Board SYP:The sustained yield plan approved in March 1999, as part of the Headwaters Agreement take:Adverse impacts on species which have been designated as endangered or threatened THP:Timber harvesting plan required to be filed with and approved by the CDF prior to the
harvesting of timber THP No. 520 lawsuit:An action entitled The Pacific Lumber Company, et al. v. California
State Water Resources Control Board(No. DR010860) filed in the Superior Court of Humboldt County,
California Timber Notes:Scotia LLCs 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 due
July 20, 2028 Timber Notes Indenture:The indenture governing the Timber Notes TMDLs:Total maximum daily load limits USAT:United Savings Association of Texas USWA lawsuit:An 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(No. CV990452) filed in the Superior Court of
Humboldt County, California Valco:Volta Aluminium Company Limited WWDRs:Watershed-wide discharge requirements young growth:Trees which have been growing for less than 200 years 105