Item 1. Business.
General The business of U.S. Timberlands Klamath Falls, LLC a Delaware limited liability company formed in 1996 (the "Company"), consists of the growing of trees and the sale of logs and standing timber. The Company owns approximately 553,000 fee acres of timberland and cutting rights on approximately 3,000 acres of timberland (collectively the "Timberlands") containing total merchantable timber volume estimated as of January 1, 2001 to be approximately 1.5 billion board feet ("BBF") in Oregon east of the Cascade Range (the "Timberlands"). Logs harvested from the Timberlands are sold to unaffiliated domestic conversion facilities. These logs are processed for sale as lumber, plywood and other wood products, primarily for use in new residential home construction, home remodeling and repair and general industrial applications. The Company also owns and operates its own seed orchard and produces approximately five million conifer seedlings annually from its nursery, approximately half of which are used for its own internal reforestation programs, with the balance sold to other forest products companies. Except as the context otherwise requires, references herein to, or descriptions of, assets and operations of the Company include the assets and operations of U.S. Timberlands Company, LP (the "Master Partnership") and the predecessors of the Company and the Master Partnership.
The Timberlands' merchantable timber consists of Ponderosa Pine (approximately 47%) and Douglas fir (approximately 13%), species which have historically commanded premium prices over other softwood species, with the balance consisting of Lodgepole Pine, White Fir and other softwood species. The Timberlands have stands of varying ages and are unique in the forests east of the Cascade Range in Oregon in that approximately 155,000 acres are actively managed tree farms (the "Plantations"). The Plantations were first established by Weyerhaeuser Company ("Weyerhaeuser") in the early 1960s and acreage has been planted each year since then. Currently, the Plantations contain age classes ranging generally from one to 39 years old. Initial thinning or harvesting of the Plantation stands is expected to begin within the next three years. The balance of the Timberlands are composed of natural stands. For a more complete description of the Company's properties, see "Properties."
In August 1996, the Company and U.S. Timberlands Management Company, LLC, formerly known as U.S. Timberlands Services Company, LLC ("Old Services"), acquired approximately 604,000 fee acres of timberland (the "Klamath Falls Timberlands"), containing an estimated merchantable timber volume of approximately 1.9 BBF and related assets from Weyerhaeuser (the "Weyerhaeuser Acquisition"). In July 1997, the Company, which is now the Master Partnership's subsidiary operating company, acquired approximately 42,000 fee acres of timberland and cutting rights on approximately 3,000 acres of timberland (the "Ochoco Timberlands"), containing an estimated merchantable timber volume of approximately 280 million board feet ("MMBF") from Ochoco Lumber Company ("Ochoco") (the "Ochoco Acquisition"). At the date of acquisition, over 40% of the merchantable timber on the Ochoco Timberlands was at least 80 years old. As of December 31, 2000, the Company has harvested substantially all of the Old Growth timber on the Ochoco Timberlands. The average age of the remaining merchantable timber on the Ochoco Timberlands is approximately 40 - 50 years in age. During October 1999, the Company contributed primarily non-income producing, pre-merchantable pine plantation timberlands in exchange for an investment in an affiliate (See Item 13 Certain Relationships and Related Transactions and Notes 3 and 9 to the Consolidated Financial Statements).
During the period from January 1, 1994 through the acquisition of the Klamath Falls Timberlands by the Company, approximately 58% of the logs harvested from the Klamath Falls Timberlands were delivered to a plywood mill owned by Weyerhaeuser at Klamath Falls, Oregon. Similarly, prior to the Ochoco Acquisition, substantially all of the timber harvested from the Ochoco Timberlands was delivered to Ochoco's mills. The Company does not currently own any conversion facilities nor does it presently intend to own any such facilities on a long-term basis; consequently the Company's sales are made to unaffiliated third parties. Concurrent with the Company's acquisition of the Klamath Falls Timberlands, the Company arranged for Collins Products LLC ("Collins"), a privately owned forest products company located within the Klamath Falls Timberlands area, to purchase Weyerhaeuser's Klamath Falls mill facilities. The Company entered into a 10-year log supply agreement with Collins (the "Collins Supply Agreement") providing for the purchase by the plywood mill and delivery by the Company of a minimum of 34 million board feet ("MMBF") of logs each year at market prices. The Collins Supply Agreement is extendable by Collins for two additional five-year terms. In addition to its sales under the Collins Supply Agreement, the Company sells logs to conversion facilities located in the area surrounding the Timberlands. There are currently more than 50 primary conversion facilities located within a 150-mile radius of the Company's Timberlands.
Formation of the Company
On November 19, 1997, the Master Partnership acquired substantially all of the equity interests in the Company and the business and assets of Old Services (the "Acquisition") and completed its initial public offering (the "MLP Offering") of common units representing limited partner interests ("Common Units"). Upon the closing of the Acquisition, Old Services contributed all of its assets, including its timber operations, to U.S. Timberlands Services Company, LLC, a newly formed Delaware limited liability company and the Company's manager (the "Manager" or "New Services"), in exchange for interests therein. Immediately thereafter, the Company assumed certain indebtedness (the "Holdings Debt") of U.S. Timberlands Holdings, LLC, an affiliate of the Company ("Holdings"), and the Manager contributed its timber operations to the Company in exchange for a member interest in the Company. Then the Manager contributed all but a 1% member interest in the Company to the Master Partnership in exchange for a general partner interest in the Master Partnership, the right to receive Incentive Distributions (as defined herein) and 1,387,963 subordinated units representing limited partner interests in the Master Partnership ("Subordinated Units"), and Holdings contributed all of its interest in the Company to the Master Partnership in exchange for 2,894,157 Subordinated Units. The Manager then distributed the Subordinated Units to Old Services. Approximately 143,398 Subordinated Units were used by Old Services to redeem interests in Old Services held by certain founding directors of the Manager (the "Founding Directors"). As a result of such transactions, the Company became the Operating Company and the Manager owns an aggregate 2% interest in the Master Partnership and the Company on a combined basis, and the right to receive Incentive Distributions; Old Services owns 1,244,565 Subordinated Units; Holdings owns 2,894,157 Subordinated Units; and the Founding Directors own an aggregate of 143,398 Subordinated Units. The 4,282,120 Subordinated Units owned by Old Services, Holdings and the Founding Directors represent an aggregate 32.6% interest in the Master Partnership. The Common Units and the Subordinated Units are referred to herein collectively as "Units" and the holders of Units are referred to herein as "Unitholders." Concurrent with the closing of the Initial Offering, the Company and its wholly owned subsidiary, U.S. Timberlands Finance Corp. ("Finance Corp."), consummated the public offering (the "Public Note Offering") of $225.0 million aggregate principal amount of unsecured senior notes (the "Notes). See "Management's Discussion and Analysis Liquidity and Capital Resources."
Finance Corp., a Delaware corporation, was formed on August 18, 1997, and is a wholly-owned subsidiary of the Company. Finance Corp. serves as the co-obligor for the Notes. It has nominal assets and does not conduct any operations. Accordingly, a discussion of the results of operations, liquidity and capital resources of Finance Corp. is not presented.
Company Structure and Management
The operations of the Master Partnership are conducted through, and the operating assets are owned by, the Company, as the Master Partnership's operating subsidiary. The Master Partnership owns a 98.9899% member interest in the Company and the Manager owns a 1% general partner interest in the Master Partnership and a 1.0101% managing member interest in the Company. The Manager therefore owns an aggregate 2% interest in the Master Partnership and the Company on a combined basis.
The Company's business is managed by the Manager. The Manager does not receive any management fee or other compensation in connection with its management of the Company, but is reimbursed for all direct and indirect expenses incurred on behalf of the Company (including wages and salaries of employees, officers and directors of the Manager) and all other necessary or appropriate expenses allocable to the Company or otherwise reasonably incurred by the Manager in connection with the operation of the Company's business.
Conflicts of interest may arise between the Manager and its affiliates, on the one hand, and the Master Partnership, the Company and the Unitholders, on the other, including conflicts relating to the compensation of the directors, officers and employees of the Manager and the determination of fees and expenses that are allocable to the Company. The Manager has a conflicts committee (the "Conflicts Committee"), consisting of two independent members of its Board of Directors, that is available at the Manager's discretion to review matters involving conflicts of interest.
The principal executive offices of the Company and the Manager are located at 625 Madison Avenue, Suite 10-B, New York, New York 10022. The telephone number at such offices is (212) 755-1100.
The Timberlands
Timber Growth
Timber growth rates reflect timberland productivity and the rate of return on a timber investment. Growth rate is an important factor in determining when to harvest timber and the harvest potential of timberlands over the long term. Merchantable timber is economically mature for harvesting when its current growth rate falls below the desired rate of return on the investment in the standing trees. The average growth rate from regeneration to economic maturity measures the capacity of the land for timber production. The Company's older and natural stands on the Timberlands that are expected to provide the near term harvest have a current average growth rate of approximately 160 board feet per acre per annum. The younger plantations, that presently have less merchantable volume, are growing at a rate that is expected to average at least 315 board feet per acre per annum to economic maturity in 50 to 60 years. This growth rate is based on calculated volumes at the time of maturity. The Company has achieved higher growth rates on the Plantations by planting high quality seedlings, by eliminating competing non-timber growth from the Timberlands and by applying modern forestry practices to assist the growth of the timber. Currently, nearly all of the seedlings planted are grown from superior seed produced in the Company's seed orchard. Management does take action to enhance the growth rate in the natural stands as well. For example, selective harvesting in the slower growing natural stands opens up the timber stand allowing for more vigorous growth of the remaining trees. When it is no longer possible to maintain acceptable growth rates in these stands they will be harvested entirely and converted to faster growing plantations.
Harvest Plans
The Company strives to manage all of its Timberlands, including the Plantations, in an economically prudent and environmentally sensitive manner in order to maximize their value over time. Integral to this management process are the Company's long-term harvest plans. The Company prepares its harvest plans annually based on analyses of the size and age class distribution of the Timberlands and the economic maturity of each harvest tract. The factors the Company considers in determining its long-term harvest plans include, among other things, current and expected market conditions, competition, customer requirements, the age, size and species distribution of the Company's timber, assumptions about timber growth rates which are improving over time as a result of technological, biological and genetic advances that improve forest management practices, expected acquisitions and dispositions, access to the Timberlands, availability of contractors, sales contracts and environmental and regulatory constraints. The Company's harvest plans reflect the Company's expectations for each year's harvest, including the sites to be harvested, the manner of harvesting such sites, the volume of each species to be harvested, the prices expected to be received for the Company's timber, the amount of stumpage sales, logging and other costs, thinning operations and other relevant information. The Company has the flexibility to update its harvest plans during the year to take into consideration changes in these factors. The Company harvested or committed to harvest from log, stumpage and timber deed sales 244 million board feet (MMBF) in 2000 and plans to harvest, or commit to harvest, approximately 150 MMBF in 2001. The Company also sold approximately 14 MMBF through property sales in 2000 and intends to sell up to 90 MMBF through property sales in 2001. Under the current harvest plans, the Company intends to harvest its current Timberlands aggressively over approximately the next six to eight years after which time the harvest level is expected to decline to a level which the Company considers to be more sustainable over the long term. Since harvest plans are based on certain assumptions, many of which are beyond the Company's control, there can be no assurance that the Company will be able to harvest the volumes projected in its harvest plans. While the Company's debt obligations place certain limitations on the harvest plans, the Company believes that it has sufficient flexibility to permit modifications in response to fluctuations in the market for logs and lumber and the other factors described above. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." If the Company's current harvest plans are pursued unaltered for the next ten years, if it consummates the land sales contemplated by its strategic plan and if its other strategic assumptions prove to be accurate, the Company expects that its timber inventory will decline through 2010 and Ponderosa Pine volume will increase as a percentage of its total timber inventory by such date. The Company expects that its inventory would remain relatively stable thereafter. Long term harvest plans, growth rates and forest inventory levels will be reviewed during 2001. Such harvest plans, land sales and other strategic assumptions do not take into account any acquisition that the Company may consummate during such period.
Access
The Timberlands are accessible by a system of approximately 5,000 miles of Company-owned and established roadways or low-maintenance roads. The Company uses third-party road crews to conduct construction and maintenance on the Timberlands. The Company regularly enters into reciprocal road-use agreements with the United States Department of Agriculture - Forest Service ("USFS") and the United States Department of Interior Bureau of Land Management ("BLM") and cooperates with such agencies in numerous cost-sharing arrangements regarding jointly used roads.
Sales and Markets
The Company sells its timber through log sales, stumpage sales and deed sales. Under a log sale, the Company identifies a block of timberland that is ready to be harvested and solicits offers from its customers for delivery of logs. After a price and volume have been agreed among the parties, the Company contracts a third party to harvest the acreage and deliver to a roadside site on the Timberlands, where a contracted trucking company picks up the logs and delivers them to the customer. A stumpage sale is similar to a log sale in that the Company solicits offers from its customers for timber on a block of timberland that is ready to be harvested. However, under a stumpage contract, the Company sells the customer the right to harvest the timber, or stumpage, and the customer arranges to harvest and deliver the logs. Under a stumpage contract, revenue recognition occurs as the timber is harvested by the customer, as the Company retains the risk of loss until the timber is harvested. A timber deed sale is similar to a stumpage sale, except revenue recognition occurs when the contract is executed, as the Company passes the risk of loss to the customer when the contract is executed.
The Company currently sells its sawlogs or stumpage to unaffiliated wood products manufacturers and sells its chips to unaffiliated pulp mills or hardboard plants. The percentage of logs which are sold as sawlogs/stumpage or pulp logs is dependent upon, among other things, the species mix and quality of the inventory harvested and the market dynamics affecting the region. Most of the timber on the Timberlands is softwood, which, due to its long fiber, strength, flexibility and other characteristics, is generally preferred over hardwood for construction lumber and plywood. Once processed, sawlogs are suitable for use as structural grade lumber, appearance grade boards, plywood and laminated veneer and can also be manufactured for such end uses as window trim, molding and door jambs. During 2000, sawlogs, stumpage sales and timber deed sales accounted for approximately 49.9%, 0.3% and 45.3%, respectively, of the Company's revenue. Chips, which can be used to make hardboard or pulp, accounted for approximately 0.5% of the Company's revenues in 2000. The market price of chips has historically been volatile, rising and falling with the price of pulp. Sales of seedlings accounted for 0.2% of the Company's revenues in 2000. Timber and property sales accounted for the remaining 3.8% of the Company's revenue in 2000.
The Company's customers include numerous unaffiliated operators of conversion facilities. Since its acquisition of the Klamath Falls Timberlands in August 1996, the Company has sold logs and chips from such timberlands to over 25 different customers. Concurrent with the Weyerhaeuser Acquisition, the Company arranged for Collins, a privately owned forest products company located within the Klamath Falls Timberlands, to purchase Weyerhaeuser's Klamath Falls mill facilities. At such time, the Company entered into the Collins Supply Agreement, a 10-year log supply agreement with Collins providing for purchase by the plywood mill and delivery by the Company of a minimum of 34 MMBF of logs each year at market prices. The Collins Supply Agreement is extendable by Collins for two additional five-year terms. In 2000, timber sales to Collins, Crown Pacific Partners, Boise Cascade Corporation and Ochoco Lumber Company, combined, accounted for approximately 58% of the Company's revenue. No other single customer accounted for more than 10% of the Company's net revenues for 2000. Collins made its purchases pursuant to the Collins Supply Agreement, while the other purchases were made pursuant to short-term arrangements. Although the loss of one or more of such customers or other significant customers could have a material adverse effect on the Company's results of operations, the Company believes that the capacity for processing wood fiber in the Company's markets currently exceeds the supply and that, therefore, such customers could readily be replaced. There are currently more than 50 primary conversion facilities located within a 150-mile radius of the Company's Timberlands.
Seasonality
Log and stumpage sales volumes are generally at their lowest levels in the first and second quarters of each year. Heavy snowfalls in higher elevations prevent access to many areas of the Company's timberlands in the first quarter. This limited access, along with spring break-up conditions in March or April (when warming weather thaws and softens roadbeds), restricts logging operations to lower elevations and areas with rockier soil types. The result of these constraints is that sales volumes are typically at their lowest in the first quarter, improving in the second quarter and at their high during the third and fourth quarters. Most customers in the region react to this seasonality by carrying high log inventories at the end of the calendar year at a level that provides sufficient inventory to carry them to the second quarter of the following year.
Contributing to this seasonality of log volumes is the market demand for lumber and related products which is typically lower in the first or winter quarter when activity in the construction industry is slow, but increasing during the spring, summer and fall quarters. Log and stumpage prices generally increase in the spring with this build up of construction activity matching the timing of re-entry to all forested areas and increased logging activity.
Competition
Due to transportation costs, domestic conversion facilities in the Pacific Northwest tend to purchase raw materials within relatively confined geographic areas, generally within a 200-mile radius. It is generally recognized that log suppliers such as the Company provide their market with a commodity product. The Company and its competitors all benefit from the same competitive advantages in the region--namely, excess of demand, close proximity to numerous mills, and positive demographic trends of the Pacific Northwest and the West Coast. Therefore, the Company and its competitors are currently able to sell all the logs they are able to produce. Additional competitive factors within a market area generally will include species and grade, quality, ability to supply logs which consistently meet the customers' specifications and ability to meet delivery requirements. The Company believes that it has a reputation as a stable and consistent supplier of well merchandised, high-quality logs. The Company has no conversion facilities and therefore does not compete with its customers for logs. The Company believes that this gives it an advantage over certain of its competitors that also own conversion facilities.
The Company competes with numerous private land and timber owners in the northwestern United States and the state agencies of Oregon, as well as immaterial amounts of foreign imports, primarily from Canada and New Zealand. In addition, the Company competes with the USFS, the BLM and the Bureau of Indian Affairs. Certain of the Company's competitors have significantly greater financial resources than the Company.
The Company believes that it competes successfully in the timber business for the following reasons: (i) the Company has substantial holdings of timber properties which include approximately 1.5 BBF of merchantable, good quality timber, approximately 155,000 acres of plantation timberland and a full-scale seed orchard and nursery operation located in a region where conversion facilities have been experiencing shortages in the supply of wood fiber; (ii) the Company focuses on owning timberlands rather than operating conversion facilities, which minimizes the Company's cost structure and capital expenditures, allows the Company to seek the most favorable markets for its timber rather than being committed to supply its own facilities, and ensures that the Company will not compete with its customers; (iii) the Company's lean operating structure allows it to efficiently manage its Timberlands, and should enable it to acquire additional timberlands without commensurate increases in overhead; and (iv) the Company's computerized geographic information system ("GIS") enables the Company to evaluate the optimal timing and patterns of the harvest of its Timberlands and evaluate and integrate acquisitions of additional timberlands.
Resource Management
Timber Resource Management
All of the silvicultural activities on the Timberlands and the harvesting and delivery of logs are conducted by independent contractors. The Company's operations involve intensive timber management and harvesting operations, which include road construction and reforestation, as well as wildlife and watershed management, all of which are carefully monitored using the Company's GIS. See "Geographic Information System." The Company employs a number of traditional and recently developed harvesting techniques on its lands based on site-specific characteristics and other resource considerations. The topography of the Timberlands allows over 95% of the Timberlands to be harvested using lower-cost mechanical methods as opposed to higher-cost cable systems.
Harvesting on the Timberlands is conducted using both selective and regeneration harvesting. In selective harvesting, a partial harvest provides merchantable timber and opens up the stand for supplemental growth on the remaining stand. Harvest entries are separated by approximately 5 to 15 years and each entry is prescribed for volume to be removed, spacing to be provided, and diameter limits to be harvested. In regeneration harvesting, which is used to harvest approximately 60% of the Company's timber, all merchantable volume is removed in a single harvest. After an area has been regeneration harvested, the Company employs a reforestation contractor to plant two-year-old seedlings at an optimal density of approximately 300 trees per acre. The Company also attempts to protect and maintain the ecosystem within the Timberlands while providing for a reasonable harvest. For example, the Company typically leaves a mix of green and dead trees at the harvest site, including some large trees, snags and downed logs to provide habitats for a variety of wildlife species while enriching the soil for successive generations of trees.
Particular forestry practices vary by geographic region and depend upon factors such as soil productivity, weather, terrain, tree size, age and stocking. The climate, site and soil conditions on the east side of the Cascade Range, for example, permit management to harvest on an optimal rotation, or harvest cycle, of 50 to 60 years. Forest stands are thinned periodically to improve growth and stand quality until harvested. The Company actively utilizes commercial thinning as a timber management practice. Pre-commercial thinning, which occurs only in the Plantation stands, is utilized when the timber harvested is not merchantable. The Company believes that such thinning improves the overall productivity of the Timberlands by enhancing the growth of the remaining trees. Occasionally, revenues are generated from pre-merchantable thinning due to strong markets for wood chips.
The Company's policy is to ensure that every acre harvested is reforested in order to enhance the long-term value of its timberlands. Based on the geographic and climatic conditions of a given harvest site, harvested areas may be regenerated naturally, by leaving mature trees to reseed the area, or replanted with seedlings. Natural regeneration methods are widely used on approximately 40% of the Company's harvested land. Approximately 27% of the Timberlands acreage currently consist of Plantations. The Company expects to convert an average of 14,000 acres of natural stands per year over the next three years to Plantations. The seed orchard produces seed from trees selected because they were the best genotype in their respective environments. During 2000, the Company planted approximately 1.7 million seedlings. Similar planting levels are expected for 2001. The Company uses the seed collected from its orchard (representing approximately 90% of seedlings planted) to grow trees with desirable traits such as superior growth characteristics, good form and disease resistance, resulting in greater wood volume over a rotation than that generated by naturally regenerated seedlings. The seedlings are grown in the Company's nursery, which uses seeds from the Company's seed orchard, which was established by Weyerhaeuser in 1973.
Geographic Information System ("GIS")
The GIS is a computer software program that the Company acquired from Weyerhaeuser as part of the Klamath Falls Acquisition. The GIS data, which has been compiled over a period of at least five years, includes detailed topographical field maps for every stand within the Timberlands including data for the Ochoco Timberlands, setting forth the characteristics, including age, species, size and other characteristics for the timber growing on each stand. Using the data in the GIS, the Company can use a computer model to "grow" the timber over time, enabling it to generate long-term harvest plans and to update its inventory annually. To maintain the integrity of the data in the GIS, the Company performs a detailed ground survey of the remaining timber inventory on a tract after each harvest and updates the data in the GIS for that tract. With the aid of the GIS, the Company is able to actively manage the Timberlands, track its inventory and develop site-specific harvest plans on multiple scales, adding additional layers of detail, such as the location of roadways or wildlife nesting areas, as required. The GIS also permits the Company to analyze the impact that new legislation may have on its Timberlands by inputting the proposed constraints imposed by such legislation in light of the particular field characteristics of its Timberlands. The Company believes the GIS may be used to the Company's advantage to evaluate potential acquisition opportunities.
Federal and State Regulation
Endangered Species
The Federal Endangered Species Act and counterpart state legislation protect species threatened with possible extinction. Protection of endangered species may include restrictions on timber harvesting, road building and other silvicultural activities in areas containing the affected species. A number of species indigenous to the Pacific Northwest have been protected under the Endangered Species Act, including the northern spotted owl, marbled murrelet, Columbian white-tail deer, mountain caribou, grizzly bear, bald eagle and various anadromous fish species. Currently, the Company has identified several spotted owl and bald eagle nesting areas affecting the Timberlands and the presence of bull trout in certain of its streams, which may affect harvesting on approximately 26,000 acres.
The United States Fish and Wildlife Service (the "USFWS") listed the American Bald Eagle in 1976 and the Northern Spotted Owl in 1990 as threatened species throughout its range in Washington, Oregon and California. The Oregon Forest Practices Act and related regulations also protect endangered species and has specific provisions governing habitat protection for the spotted owl, the bald eagle and other threatened species.
Based on the 2000 survey year, there were approximately 70 bald eagle sites on the Klamath Falls Timberlands. The Company observes harvesting restrictions around the eagle sites. Due in part to efforts of the Company and its Predecessor, the bald eagle is expected to be removed from the endangered species list in the near future.
In addition, the Company conducts surveys to determine the presence of northern spotted owls. The surveys have been conducted every year in order to (i) meet the regulatory requirements for timber harvest and other management activities, (ii) monitor existing sites and determine the current status of such sites, (iii) determine if areas identified as containing suitable habitat are supporting owls and (iv) investigate other spotted owl or other species sightings. The most recent of such surveys was completed in August 2000, and identified approximately 31 northern spotted owl sites affecting the Klamath Falls Timberlands, three of which are located on the Klamath Falls Timberlands.
The Company believes that it is managing its harvesting operations in the areas affected by protected species in substantial compliance with applicable federal and state regulations. Based on certain consultants' reports, and on management's knowledge of the Timberlands, the Company does not believe that there are any species protected under the Endangered Species Act or similar state laws that, under current regulations and Court interpretation, would have a material adverse effect on the Company's ability to harvest the Timberlands in accordance with current harvest plans. There can be no assurance, however, that species within the Timberlands may not subsequently receive protected status under the Endangered Species Act or that currently protected species may not be discovered in significant numbers within the Timberlands. Additionally, there can be no assurance that future legislative, administrative or judicial activities related to protected species will not adversely affect the Company or its ability to continue its activities and operations as currently conducted.
Timberlands
The operation of the Timberlands is subject to specialized statutes and regulations in the State of Oregon, which has enacted laws which regulate forestry operations, including the Forest Practices Act, which addresses many growing, harvesting and processing activities on forest lands. Among other requirements, these laws restrict the size and spacing of regeneration harvest units, and impose certain reforestation obligations on the owners of forest lands. The State of Oregon requires a company to provide prior notification before beginning harvesting activity. The Forest Practices Act and other state laws and regulations control timber slash burning, operations during fire hazard periods, logging activities which may affect water courses or in proximity to certain ocean and inland shore lines, water protection and enhancement and certain grading and road construction activities. The Company believes it is in substantial compliance with these regulations.
Environmental Laws and Superfund
The Company's operations are subject to federal, state and local environmental laws and regulations relating to the protection of the environment. Although the Company believes that it is in material compliance with these requirements, there can be no assurance that significant costs, civil and criminal penalties, and liabilities will not be incurred, including those relating to claims for damages to property or natural resources resulting from the Company's operations.
Environmental laws and regulations have changed substantially and rapidly over the last 20 years, and the Company anticipates there will be continuing changes. The trend in environmental regulations is to place more restrictions and limitations on activities that may affect the environment, such as emissions of pollutants and the generation and disposal of wastes. Increasingly strict environmental restrictions and limitations have resulted in increased operating costs for the Company and it is possible that the costs of compliance with environmental laws and regulations will continue to increase.
Access to Timberlands May be Limited by Federal Regulation
A substantial portion of the Timberlands consists of sections of land that are intermingled with or adjacent to sections of federal land managed by the USFS and the BLM. Removal of trees from those portions of the Timberlands requires transportation of the logs by truck across logging and general purpose roads. The Company has entered into road use agreements with the USFS and the BLM. The majority of the Company's timberland management activities to include the transportation of timber products across federal land and roads fall under such agreements, which describe the Company's exclusive rights to transport timber products across federal lands and roads without USFWS consultation. In many cases, access is only, or most economically, achieved through a road or roads built across adjacent federal land pursuant to a reciprocal right-of-way ("RROW"). Removal of federal timber often requires similar access across the Timberlands. Recent litigation (not involving the Company) before the United States Court of Appeals for the Ninth Circuit held that the BLM was not required to consult with the USFWS, which administers the Endangered Species Act, prior to approving a private landowner's proposal to build an access road across federal land pursuant to an existing RROW entered into prior to the enactment of the Endangered Species Act. A reversal on appeal or a rehearing of that case, or future federal law or regulation requiring the BLM to consult with the USFWS in connection with an RROW, could materially adversely affect the Company's ability to harvest the affected portion of the Timberlands. Certain of the Company's RROW agreements contain provisions that require compliance with state and federal environmental laws and regulations. To the extent that the Company acquires new Timberlands that require access through federal lands, the Company may enter into new RROW agreements with the BLM or other federal agencies which would require consultation with the USFWS. In addition, the BLM has published advance notice of its intent to revise regulations governing RROW agreements entered into the future to, among other things, expand the BLM's consideration of environmental and cultural factors in granting, issuing or renewing rights-of-way, provide the BLM with regulatory authority to object to the location of roads because of potential effects on threatened or endangered species and allow for the abandonment of rights-of-way under certain circumstances.
Safety and Health
The operations of the Timberlands are subject to the requirements of the Federal Occupational Safety and Health Act ("OSHA") and comparable state statutes relating to the health and safety of employees. The Company believes that it is in compliance with OSHA regulations, including general industry standards, permissible exposure levels for toxic chemicals and record-keeping requirements.
Employees
As of March 15, 2001, the Company had 29 salaried employees, including employees of the Manager that manage the business of the Company. The employees are not unionized, and the Company believes that its employee relations are good. All of the silvicultural activities on the Timberlands and the harvesting and delivery of logs are conducted by independent contractors who are not employees of the Company.
Item 2.
Item 2. Properties
Timber Inventory
The Company currently owns and manages approximately 553,000 fee acres of timberland and cutting rights on approximately 3,000 acres of timberland containing total merchantable timber volume estimated as of January 1, 2001 to be approximately 1.5 BBF in Oregon east of the Cascade Range. A merchantable tree is a tree of sufficient size that will produce a sound log 16 feet in length and at least 4.6 inches in diameter, inside bark, at the small end. The Company's merchantable timber inventory consists of a substantial percentage of premium species of softwood, consisting of Ponderosa Pine and Douglas fir, species which have historically commanded premium prices over other softwood species, as well as Lodgepole Pine, White Fir and other species. The Company believes that the Timberlands are suitable for current operations.
The Timberlands have stands of varying sizes and ages and are unique in the forests east of the Cascade Range in Oregon in that approximately 155,000 acres of the 553,000 acre total consist of actively managed pine Plantations with stands ranging in age from one to 39 years. The Plantations are stocked with high quality Ponderosa Pine (approximately 78%) and Lodgepole Pine (approximately 22%). Initial thinning of the Plantation stands, including the thinning of commercial quantities of merchantable timber, is expected to begin within the next three years. See "The Timberlands--Harvest Plans."
Merchantable Timber Inventory by Species
The Company maintains data regarding the estimated merchantable timber inventory by species within the Timberlands. All volumes are based on information developed by Company personnel. As of January 1, 2001, the total timber inventory amounted to 1.5 BBF. The Company's combined timber inventory by MMBF and percentage is Ponderosa Pine (692.2 (47%)), Lodgepole Pine (253.2 (17%)), White Fir (286.3 (20%)), Douglas fir (181.6 (13%)) and other species (47.2 (3%)). Other species include Cedar, Sugar Pine, Western Larch and Grand Fir.
Size and Species Distribution of Merchantable Timber
The Company's Timberlands are diversified by species mix and, to a lesser extent, by size distribution. Timber on the Timberlands generally reaches merchantable size between 40 and 50 years in natural stands and between 25 and 35 years in the Plantations. The Company maintains data as to the estimated volume distribution of merchantable timber on the Timberlands by species and by diameter at breast-height ("DBH"). As of January 1, 2001, approximately 343 MMBF, or 23%, of the merchantable timber had a DBH of 16 or more inches.
Acreage Distribution by Age Class on Plantations
The Company also maintains data as to the acreage distribution of timber on the Plantations by age class. As of January 1, 2001, the Plantations totaled 155,000 acres. Of the total acreage, 62,000 acres range from 1 to 15 years of age, 73,000 acres range from 16 to 25 years of age, and 20,000 acres are 26 years of age or older.
Item 3.
Item 3. Legal Proceedings
In November 2000, six purported class action lawsuits were filed against the Manager and the Board of Directors of the Manager (the "Board") alleging breach of fiduciary duty and self-dealing by the Manager and the Board in connection with an announcement on November 2, 2000 that a group led by senior management has begun the process to explore taking the Master Partnership private (the "Going-Private Transaction").
All six lawsuits were filed in the Court of Chancery of the State of Delaware for the County of New Castle. Each lawsuit was filed by a unitholder of the Master Partnership, on behalf of all other unitholders of the Master Partnership who are similarly situated, and seeks to have the class certified and the unitholder bringing the lawsuit named as representative of the class. In addition, the lawsuits seek to enjoin the Going-Private Transaction, to rescind the Going-Private Transaction if it is consummated, and to recover damages and attorneys' fees. In addition to naming the Manager and the Board as defendants, all six lawsuits name the Master Partnership as a defendant.
In the opinion of management, after consultation with outside counsel, the pending lawsuits are not expected to have a material adverse effect on the Master Partnership or the Company's financial position or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of the Company's members or the Master Partnership's Unitholders during the fourth quarter of 2000.
PART II
Item 5.
Item 5. Market for Registrant's Common Units and Related Security Holder Matters
In connection with the consummation of the Initial Public Offering for the Master Partnership and the Public Note Offering for the Company (hereafter the "Transactions"), a 98.9899% member interest in the Company was issued to the Master partnership and a 1.0101% member interest was issued to the Manager. There is no public trading market for the Company's equity securities. The Company distributes all of its Available Cash (as defined in the Company's partnership agreement) on a quarterly basis.
The Company made its first cash distribution to the Master Partnerhip for distribution to holders of the Common Units and the Subordinated Units on May 15, 1998, of $0.73, representing the sum of $0.50, the Minimum Quarterly Distribution (as defined in the Master Partnership Agreement) for the first quarter of 1998, plus $0.23, the pro rata portion of the Minimum Quarterly Distribution for the period from November 19, 1997 through December 31, 1997. The Company made the Minimum Quarterly Distributions of $0.50 per Unit for each subsequent quarter on August 14, 1998, November 13, 1998, February 12, 1999, May 14, 1999, August 13, 1999, November 15, 1999, February 14, 2000, May 15, 2000, August 14, 2000, November 14, 2000 and February 14, 2001, respectively.
Item 6.
Item 6. Selected Financial Data
(1) Due to the Weyerhaeuser Acquisition on August 30, 1996, the financial and operating data after August 30, 1996 are not comparable to financial and operating data of the Predecessor. In 1996, the Company and Old Services were formed and subsequently entered into the agreement to consummate the Weyerhaeuser Acquisition. As legal entities, the Company and Old Services were not consolidated. However, due to common ownership and management, the financial statements of the Company and Old Services prior to the Transactions have been presented on a combined basis. (2) Revenues in 2000 consist of $72.3 million of log, stumpage and deed sales, $2.9 million of timber and property sales and $0.5 million of by-products and other sales. Revenues in 1999 consist of $76.6 million of log, stumpage and deed sales and $0.4 million of by-products and other sales. Revenues in 1998 consist of $63.6 million of log and stumpage sales, $6.3 million of timber and property sales and $1.4 million of by-products and other sales. Revenues in 1997 consist of $60.4 million of log and stumpage sales, $15.2 million of timber and property sales and $1.7 million of by-products and other sales. Revenues prior to 1997 consist primarily of log sales. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (3) In July 1997, the Company acquired the Ochoco Timberlands for $110 million from Ochoco Lumber Company. In August 1996, the Company acquired the Klamath Falls Timberlands for $283.5 million from Weyerhaeuser. (4) See effect of interest expense and amortization of deferred financing fees and debt guarantee fees in "Management's Discussion and Analysis of Financial Condition and Results of Operations." (5) On July 14, 1997 the Company retired certain borrowings under its then existing revolving credit facility term loan which resulted in an extraordinary loss on extingjuishment of debt of $3.6 million. Additionally, in conjunction with the issuance of the Notes, the Company retired all existing debt under certain pre-existing long-term financing arrangements resulting in an extraordinary loss on extinguishment of debt of $5.7 million. Such extraordinary losses were due principally to the write-off of existing unamortized deferred financing fees. (6) Modified EBITDDA is defined as operating income plus depreciation, depletion, and road amortization and cost of timber and property sales. Modified EBITDDA should not be considered as an alternative to net income, operating income, cash flows from operating activities or any other measure of financial performance presented in accordance with generally accepted accounting principles. Modified EBITDDA is not intended to represent cash flow and does not represent the measure of cash available for distribution, but provides additional information for evaluating the Company's ability to make the Minimum Quarterly Distribution. In addition, Modified EBITDDA does not necessarily represent funds available for management's discretionary use as it is calculated prior to debt service obligations and capital expenditures. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (7) See discussion of long-term debt at Note 7 of the Notes to Consolidated Financial Statements. (8) The Weyerhaeuser Acquisition in August of 1996 was accounted for as a purchase. Therefore, the financial statements as of and for the periods ending prior to the date of the Weyerhaeuser Acquisition are accounted for under the pre-Weyerhaeuser Acquisition basis of accounting. Because the Klamath Timberlands did not legally exist as a stand-alone entity, there are no separate meaningful equity accounts of the Predecessor prior to the Weyerhaeuser Acquisition.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
Certain information contained in this report may constitute forward-looking statements within the meaning of the federal securities laws. Although the Company believes that expectations reflected in such forward-looking statements are based upon reasonable assumptions, it can give no assurance that its expectations will be achieved. Forward-looking information is subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected. Such risks, trends and uncertainties include the highly cyclical nature of the forest products industry, general economic conditions, competition, price conditions or trends for the Company's products, the possibility that timber supply could be affected if governmental, environmental or endangered species policies change, and limitations on the Company's ability to harvest its timber due to adverse natural conditions or increased governmental restrictions. The results of the Company's operations and its ability to pay quarterly distributions to its Unitholders depend upon a number of factors, many of which are beyond its control. These factors include general economic and industry conditions, domestic and export prices, supply and demand for logs, seasonality, government regulations affecting the manner in which timber may be harvested, and competition from other supplying regions and substitute products. These and other risks are described in the Company's other reports and registration statements, which are available from the United States Securities and Exchange Commission.
General
The Company's primary business is the growing and harvesting of timber (see Item 1. Business).
The Company's results of operations are affected by various factors, many of which are beyond its control, including general industry conditions, domestic and international prices and supply and demand for logs, lumber and other wood products, seasonality and competition from other domestic and international supplying regions and substitute products.
Supply and Demand Factors
Supply
The supply of logs available for purchase has been most affected in recent years by significant reductions in timber harvested from public timberlands, principally as a result of efforts to preserve the habitat of certain endangered species, as well as a change in the emphasis of government policy toward habitat preservation, conservation and recreation and away from timber management. Since the early 1970s, environmental and other similar concerns and governmental policies have substantially reduced the volume of timber under contract to be harvested from public lands. The pace of regulatory activity accelerated in the late 1980s. The resulting supply decrease caused prices for logs to increase significantly, reaching peak levels during 1993. The low supply of timber from public lands, which is expected to continue for the foreseeable future, has benefited private timber holders such as the Company through higher stumpage and log prices. Certain market conditions for finished products, however, have negatively impacted stumpage and log prices in 2000.
Industry participants do not expect environmental restrictions to ease materially within any reasonable planning horizon. Consequently, many producers of lumber and wood products are attempting to adapt to the new supply environment by increasing their emphasis on raw material yields, entering into long term timber supply arrangements and value added manufacturing, and accessing previously untapped supplies (such as private wood lot owners, timber with difficult access, alternative species and imports). These factors have tended to restrict prices from significant increases. While raw material supply is expected to be an ongoing challenge for the lumber and wood products industry, such conditions would likely be favorable for timber owners such as the Company.
In response to an increase in timber prices in the early 1990s, imports of logs and lumber from abroad (from countries such as Canada and New Zealand) increased. These imports, however, only partially offset the lost volume of timber from public timberlands and did not replace the mature, high-quality timber found in greater quantities on public timberlands. Imports are likely to continue to increase over the next few years and could significantly affect the raw material supplies in the domestic lumber and wood products industry.
Demand
Changes in general economic and demographic factors, including the strength of the economy, unemployment rates and interest rates for home mortgages and construction loans, have historically caused fluctuations in housing starts and, in turn, demand and prices for lumber and commodity wood products. United States housing starts for 2000 were down significantly from 1999 levels. Because of the growth of the home center distribution business, the repair and remodeling markets have become a significant factor in terms of the demand for lumber and commodity wood products and have dampened the wide fluctuations that occurred when new housing starts were the primary factor. A large portion of the Company's property consists of Pine species, which are used in the finishing market, for molding trim, doors and windows. This market is more affected by repair and remodeling than new housing construction. Prices for these species, primarily Ponderosa Pine, reached a peak in the spring of 1993 and as a result attracted imports of Radiata Pine from New Zealand and Chile. Given the strong, growing economy of the past several years, domestic markets have been able to absorb the increasing quantities of imported Radiata pine lumber. With the current slowing of our domestic economy, decreasing demand for repair and remodeling markets and over supply of finished products in the industry, the level of imports could have a negative impact on pricing for Pine lumber. The demand for logs in the United States is also affected by the level of lumber imports. In response to increasing lumber imports from Canada, the United States and Canada signed an agreement in 1996 which restricted the availability of Canadian softwood lumber in the United States. The Company believes that this agreement, which expires on March 31, 2001, has not had a material impact on the price or demand for logs in the United States although its long-term effect, as well as the effect of its termination, is uncertain.
Due to transportation costs, domestic conversion facilities in the Pacific Northwest tend to purchase raw materials within relatively confined geographic areas, generally within a 200-mile radius. The conversion facilities in the vicinity of the Timberlands need more wood supply to run at capacity than can be produced by nearby timberlands. As a result, the demand from this region is relatively steady, although prices fluctuate with market conditions.
Current Market Conditions
Log prices in the Northwest drastically declined during 2000 as compared to 1999 due to the slowing United States economy and supply and demand factors.
During 2000, the United States economy began experiencing an economic slow-down. Mortgage interest rates were climbing to levels significantly higher than those experienced over the past few years and as such created weakening conditions for new home construction, home repair and remodeling, and industrial and other construction, which weakened the demand for finished lumber and plywood products. As a result of the decreased demand and excess production capacity within the industry the markets for finished lumber and plywood products dropped to their lowest levels in the last ten years. As a result of the weakening in the finished products markets, the prices being realized for the Company's logs and timber declined significantly from 1999 levels. Prices for the Company's logs and stumpage are also at or near ten year lows.
Prices for the fourth quarter of 2000 remained weak continuing a trend started near the end of the second quarter. For the fourth quarter of 2000, the Company's average delivered log prices for Ponderosa Pine, Douglas Fir, Lodgepole Pine, and White Fir were down approximately 16%, 8%, 17%, and 10%, respectively, from the same period in 1999.
The excess production levels of 2000 are expected to continue into the first half of 2001, reducing the chances of a near-term recovery of wood product prices. In addition, the impact of the expiration of the agreement between Canada and United States limiting the Canadians lumber imports into the United States through March 31, 2001 is yet to be determined and could add to the over supply of finished wood products. As a result of the above conditions, the Company does not expect a significant increase in prices during 2001.
Results of Operations
The following table sets forth sales volume for each of 2000, 1999 and 1998 from the sale of logs, stumpage and timber deeds by thousand board feet ("MBF") and price per thousand board feet and the sales of property.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Revenues. Revenues decreased $1.3 million, or 1.7%, from $77.0 million in 1999 to $75.7 million in 2000. The decrease is primarily attributable to a decrease in log sales of $4.5 million and a $1.3 million decrease in stumpage sales, partially offset by a $1.5 million increase in timber deed sales and the fact that the Company had a $2.9 million dollar timber and property sale in 2000. To meet its working capital requirements, the Company harvested and sold logs and stumpage in 2000 at rates in excess of both 1999 levels and the estimated current annual board footage growth on the Timberlands.
Log sales for 2000 were $37.8 million on volumes of 96,112 MBF, compared to log sales of $42.3 million on volumes of 97,170 in 1999. The average log sales price for 2000 was $393 compared to an average log sales price of $436 in 1999, a 9.9% decrease, reflecting weaker markets for the Company's log sales.
Timber deed sales for 2000 were $34.3 million on volumes of 147,083 MBF, compared to timber deed revenue of $32.8 million on volumes of 86,463 MBF in 1999. The average timber deed sales price per MBF for 2000 was $246 compared to an average timber deed sales price of $379 in 1999, a 35.1% decrease. The significant decrease in timber deed sales realization is due to overall declines in market conditions as well as a reduction in the quality of the timber mix being sold in timber sales. During 2000 there were less timber deed sales containing larger, old growth timber which commands a premium, than in 1999. In addition the Company's timber deed sales in the second quarter represented substantially all of the remaining old growth timber on the Ochoco Timberlands. and was of a lower grade species mix than sales of timber on the Ochoco Timberlands in previous years.
Stumpage sales for 2000 were $0.2 million on volumes of 503 MBF, compared with stumpage sales of $1.5 million on volumes of 3,645 MBF in 1999. The reduction in stumpage volumes is a result of the Company's strategic decision to utilize log sales and timber deed sales as its primary source of revenue.
The Company had $2.9 million in revenue from planned timber and property sales in 2000 compared to no revenue from timber and property sales during 1999.
Gross Profit. Gross profit decreased $12.2 million from $36.6 million in 1999 to $24.4 million in 2000 and gross margin decreased from 47.6% in 1999 to 32.3% in 2000. The decrease in gross margin was primarily from three factors. First, contracted log and haul costs on a per MBF basis were approximately 20% higher during 2000 as compared to 1999 due to longer hauls for delivered logs and higher fuel costs. Second, the Company's timber deed sales were composed of a lower value grade mix as compared to 1999. Finally continued declines in the timber markets have resulted in lower realizations on delivered log and stumpage values.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $8.4 million in 2000, consistent with selling, general and administrative expenses of $8.5 million in 1999. Within selling, general and administrative expenses salaries and wages were up $0.3 million and professional services were up $0.5 million over 1999. Those increases were offset by a settlement with previous employees of $0.7 million in 1999.
Equity in Net Income (Loss) of Affiliate. The equity in net income of affiliate was $2.1 million during 2000 as compared to equity in net loss of affiliate of $0.6 million in 1999. The income in 2000 reflects the recapture of $0.6 million in losses absorbed from its preferred investment in U.S. Timberlands Yakima, LLC, and the Company's accrued return of $1.4 million on its preferred investment.
Interest Expense. Interest expense was $21.9 million in 2000 and 1999 consisting primarily of interest expense on the Company's $225.0 million of Senior Notes.
Other Income (Expense), net. Other income, net, was $0.2 million for 2000, compared to $1.1 million for 1999, representing a decrease in income of $0.9 million. The decrease is primarily attributable to a mark-to-market gain on an interest rate collar of approximately $1.0 million during 1999 and no such gains in 2000.
Cash Flow From Operations. During 2000, cash flow from operations increased $3.4 million or 13.3% over 1999 primarily because of a $10.4 million decrease in net income, which was more than offset by the addback of non-cash items and changes in assets and liabilities.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Revenues. Revenues increased $5.7 million, or 8.0%, from $71.3 million in 1998 to $77.0 million in 1999. The increase is primarily attributable to an increase in timber deed sales of $32.8 million and a $3.0 million increase in log sales, partially offset by a $22.8 million reduction in stumpage sales, a $1.0 million decrease in by-products and other revenues and the fact that the Company had no land sales in 1999 compared to approximately $6.3 million in land sales in 1998. To meet its working capital requirements, the Company harvested and sold logs and stumpage in 1999 at rates in excess of both 1998 levels and the estimated current annual board footage growth on the Timberlands. Timber deed sales for 1999 were $32.8 million on volumes of 86,463 MBF, compared to no timber deed revenue for 1998.
Log sales for 1999 were $42.3 million on volumes of 97,170 MBF, compared to log sales of $39.3 million on volumes of 93,557 MBF in 1998. The average log sales price per MBF for 1999 was $436 compared to an average log sales price per MBF of $420 for 1998, a 3.8% increase, reflecting stronger markets, primarily for White Fir and Douglas Fir logs.
Stumpage sales for 1999 were $1.5 million on volumes of 3,645 MBF, compared with stumpage sales of $24.4 million on volumes of 50,894 MBF in 1998. The average stumpage sales price per MBF for 1999 was $419 compared to an average stumpage sales price per MBF of $479 for 1998, a 12.5% reduction. The decrease in average stumpage sales prices from 1998 to 1999 was primarily due to a reduction in the grade of timber harvested from the Ochoco Timberlands. The overall reduction in stumpage sales volume is due to the increased use of timber deed sales in 1999.
The Company had no revenue from timber and property sales during 1999 as compared to approximately $6.3 million in planned timber and property sales during 1998.
Gross Profit. Gross profit increased by $9.8 million from $26.8 million in 1998 to $36.6 million in 1999 and gross margin increased from 37.6% in 1998 to 47.6% in 1999. The increase in gross margin was primarily from three factors. First, the Company's normal annual review of its standing timber inventory and depletion rate during the first quarter of 1999 resulted in a reduction of the Company's depletion rate, and a savings of approximately $4.9 million in 1999. Also, the Company did not have any land sales during 1999, which have typically resulted in lower margins than log, stumpage and deed sales. In addition to the above items, the Company benefited from an overall increase in log prices during 1999.
Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased by $2.0 million from $10.5 million in 1998 to $8.5 million in 1999. This expense also decreased as a percentage of net sales from 14.7% in 1998 to 11.0% in 1999. The decrease was primarily attributable to one-time expenses of $1.7 million related to severance costs and the repurchase of member interests in the General Partner that were incurred during the first and fourth quarters of 1998, combined with the provision in 1998 for the closure of the Seattle office.
Interest Expense. Interest expense for 1999 was $21.9 million as compared to $22.2 million for 1998, representing a $0.3 million or 1.4% reduction. Interest expense for both 1999 and 1998 was incurred primarily on the $225.0 million of Notes issued in the November 1997 Public Note Offering. The slight decrease in interest expense in 1999 can be attributed to a reduced level of borrowing against the available revolving credit facilities during 1999 as compared to 1998.
Interest Income. Interest income for 1999 was $0.6 million, an increase of $0.1 million or 20.0% from interest income for 1998 of $0.5 million. The increase is primarily attributable to imputed interest from deed sales with a term of more than one year. Imputed interest income from deed sales was approximately $0.3 million in 1999. The increase in interest from timber deed sales was partially offset by a reduction in other interest income due to a decrease in cash and cash equivalents available in 1999 compared to 1998.
Other Income (Expense), net. Other income, net, was $1.1 million for 1999 compared to other expense, net, of $0.3 million for 1998, representing an increase to income of $1.4 million. The increase is primarily attributable to a mark-to-market gain on an interest rate collar of approximately $1.0 million during 1999. In addition, revenues from land use management operations such as grazing permits increased in 1999.
Cash Flow From Operations. During 1999, cash flow from operations increased $7.0 million or 37.8% primarily as a result of increased gross margins and a reduction of selling, general and administrative expenses, offset partially by decreased proceeds from timber and property sales, increase in balance of notes receivable and a decrease in accrued liabilities.
Liquidity and Capital Resources
The Company's primary sources of liquidity have been cash provided by operating activities as well as debt and equity financings. As of December 31, 2000 the Company had a cash balance of $3.2 million and had $2.0 million of working capital.
Operating Activities. Cash flows provided by operating activities in 2000 were $28.9 million, compared to cash flows provided by operating activities of $25.5 million in 1999. The $3.4 million increase in cash flows provided by operating activities was primarily attributable to a $10.4 million decrease in net income which was more than offset by the addback of non-cash operating items and the changes in assets and liabilities.
Investing Activities. Cash flows used in investing activities were $2.3 million in 2000, as compared to cash flows used in investing activities of $1.3 million during 1999. The increase is primarily attributable to a purchase of cutting rights in June 2000 for approximately $1.3 million, partially offset by the Company's $0.3 million investment in affiliate in 1999.
Financing Activities. Cash flows used in financing activities were $26.2 million in 1999 and 2000. During 1999 and 2000, the Company paid $26.2 million in distributions to its members.
Notes
On November 14, 1997, the Company issued $225.0 million aggregate principal amount of Notes (the "Notes") representing unsecured general obligations of the Company which bear interest at 9 5/8% per annum, payable semiannually in arrears on May 15 and November 15. The Notes mature on November 15, 2007 unless previously redeemed. The Notes will not require any mandatory redemption or sinking fund payments prior to maturity and are redeemable at the option of the Company in whole or in part, on or after November 15, 2002 at predetermined redemption prices plus accrued interest to the redemption date. Upon the occurrence of certain events constituting a "change of control" (as defined in the Indenture), the Company must offer to purchase the Notes, at a purchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest to the date of purchase. There can be no assurance that the Company will have access to sufficient funds to repurchase the Notes in the event of a change in control.
The indenture governing the Notes (the "Indenture") contains various affirmative and restrictive covenants applicable to the Company and its subsidiaries, including limitations on the ability of the Company and its subsidiaries to, among other things, (i) incur additional indebtedness (other than certain permitted indebtedness) unless the Company's Consolidated Fixed Charge Coverage Ratio (as defined in the Indenture) is greater than 2.25 to 1.00, and (ii) make distributions to the Master Partnership, make investments (other than permitted investments) in any person, create liens, engage in transactions with affiliates, suffer to exist any restrictions on the ability of a subsidiary to make distributions or repay indebtedness to the Master Partnership, engage in sale and leaseback transactions, enter into a merger, consolidation or sale of all or substantially all of its assets, sell assets or harvest timber in excess of certain limitations or engage in a different line of business. Under the Indenture, the Company will be permitted to make cash distributions to the Master Partnership so long as no default or event of default exists or would exist upon making such distribution (a) if the Company's Consolidated Fixed Charge Coverage Ratio (as defined in the Indenture) is greater than 1.75 to 1.00, in an amount, in any quarter, equal to Available Cash (as defined in the Indenture) for the immediately preceding fiscal quarter or (b) if the Company's Consolidated Fixed Charge Coverage Ratio is equal to or less than 1.75 to 1.00, in an aggregate amount not to exceed (i) $7.5 million less the aggregate of all restricted payments made under this clause (b)(i) during the immediately preceding 16 fiscal quarters (or shorter period, if applicable, beginning on the issue date of the Notes), plus (ii) the net proceeds of certain capital contributions (including the sale of Units) received by the Master Partnership. The Company was in compliance with these covenants at December 31, 2000 and 1999.
Affiliate Credit Facility
During the second quarter of 2000, the Company renewed its existing credit agreement with an affiliate of the Manager ("Affiliate Credit Facility"). The Affiliate Credit Facility allows the Company to borrow up to $12.0 million under certain terms and covenants. The covenants include restrictions on the Company's ability to make cash distributions, incur certain additional indebtedness or incur certain liens. In addition, the Company is required to maintain certain financial ratios. The Affiliate Credit Facility will expire on June 30, 2001. At that time, amounts borrowed will be due and payable. As of December 31, 2000 there were no outstanding borrowings under the Affiliate Credit Facility. The Company's intent is to replace the Affiliate Credit Facility with a bank facility during 2001. The Company also has the ability to generate cash flow through the acceleration of planned log and timber deed sales. In addition, the Company's intent is to use new funds raised through investment and commercial banks for acquisitions, if any, although there can be no assurance that such financing will be available on terms acceptable to the Company.
Under the Affiliate Credit Facility, so long as no Event of Default (as defined in the Affiliate Credit Facility) exists or would result, the Company will be permitted to make quarterly cash distributions to the Master Partnership in an amount not to exceed Available Cash (as defined in the Affiliate Credit Facility) in the preceding quarterly period.
Capital Expenditures/Cash Distributions
Capital expenditures in 2000 totaled $2.3 million. The Company purchased timber cutting rights for approximately 4.2 MMBF of timber for $1.3 million. The remaining $1.0 million in capital expenditures incurred were mainly in the nature of land management/silvicultural costs, miscellaneous equipment and computer hardware. Capital expenditures were financed through cash flow generated by operations. As the Company does not currently own and does not plan to own manufacturing facilities, and all logging is subcontracted to third parties, it is anticipated that capital expenditures in the future will not be significant and will consist mainly of land management/silvicultural expenditures. It is currently anticipated that the Company will not maintain significant log inventories, although small log inventories may be maintained for a short period of time, or incur material capital expenditures for machinery and equipment. The Company anticipates that capital expenditures will be approximately $1.5 million in 2001. Capital expenditures will consist primarily of capitalized silvicultural costs and miscellaneous equipment purchases.
Cash required to meet the Company's debt service and the Master Partnership's quarterly cash distributions will be significant. To meet its working capital requirements, the Company has been selling logs and making timber sales at a rate in excess of the Manager's estimate of the current annual board footage growth on the Company's timberlands. The debt service and quarterly cash distributions have been funded from operations and borrowings. Given projected volumes for sales of logs and timber, estimated current board footage growth on the timberlands and the harvest restrictions in the Notes, unless prices improve, costs are reduced, new markets are developed or the Company makes accretive acquisitions, the Company's ability in the future to make distributions at current levels will be adversely affected. The Company continues to evaluate means to improve cash flows, including the factors mentioned above. There can be no assurance that prices will improve or that the Company will be able to take any of these actions and it is unlikely prices will improve or any of these actions will take effect within a short-term horizon.
Effects of Inflation
Prices for the Company's stumpage and logs may be subject to sharp cyclical fluctuations due to market or other economic conditions, including the level of construction activity but generally do not directly follow inflationary trends. Costs of forest operations and general and administrative expenses generally reflect inflationary trends.
Recent Developments
In November 2000, the Company announced that an independent committee of the board of directors had been formed to evaluate management proposals to take the Master Partnership private. The independent committee has retained separate legal counsel and intends to retain financial advisors to assist in this process. To date, a proposal from management has not been received.
New Accounting Standard - SFAS No. 133
In June of 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities", which as amended, is required to be adopted for fiscal quarters of fiscal years beginning after June 15, 2000. SFAS 133 requires the Company to recognize all derivatives in the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If the derivative is a hedge, depending upon the nature of the hedge, changes in fair value of the derivative will either be offset against the changes in fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The Company had no outstanding derivative positions at December 31, 2000, and therefore believes that adoption of SFAS 133 will not significantly affect its financial statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 8.
Item 8. Financial Statements
The information required hereunder is included in this report as set forth in the "Index to Financial Statements" on Page.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The Manager manages and operates the activities of the Company. As is commonly the case with publicly traded limited partnerships, the Company does not directly employ any of the persons responsible for managing or operating the Company.
In January 1999, the Manager appointed William A. Wyman and Alan B. Abramson, two members of the Manager's Board of Directors who are neither officers, employees or security holders of the Manager nor directors, officers, or employees of any affiliate of the Manager, to serve on the Manager's Conflicts Committee. The Conflicts Committee has the authority to review specific matters as to which the Board of Directors believes there may be a conflict of interest in order to determine if the resolution of such conflict proposed by the Manager is fair and reasonable to the Company. Any matters approved by the Conflicts Committee will be conclusively deemed to be fair and reasonable to the Company, approved by all partners of the Company and not a breach by the Manager or its Board of Directors of any duties they may owe the Company or the Unitholders. The Board of Directors also has an audit committee (the "Audit Committee") composed of the two independent directors as well as George R. Hornig, which reviews the external financial reporting of the Company, recommends engagement of the Company's independent public accountants and reviews the Company's procedures for internal auditing and the adequacy of the Company's internal accounting controls. The Board of Directors also has a compensation committee (the "Compensation Committee"), consisting of five directors, including the two independent directors, which determines the compensation of the officers of the Manager and administers its employee benefit plans. In addition, the Board of Directors has a Long-Term Incentive Plan Committee (the "LTIP Committee"), which consists of four directors, including the two independent directors, which acts with respect to the Company's Long-Term Incentive Plan.
Directors, Executive Officers and Key Employees of the Manager
The following table sets forth certain information with respect to the members of the Board of Directors of the Manager, its executive officers and certain key employees. Executive officers and directors are elected for one-year terms.
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(1) Member of the Executive (Chairman), Nominating (Chairman), Finance and Compensation Committees.
(2) Member of the Compensation and LTIP Committees.
(3) Member of the Executive, Audit, Finance (Chairman) and Compensation Committees.
(4) Member of the Audit (Chairman), Conflicts (Chairman), Compensation and LTIP Committees.
(5) Member of the Audit, Conflicts, Compensation (Chairman) and LTIP Committees.
(6) Member of the Nominating, Finance and LTIP (Chairman) Committees.
John M. Rudey serves as Chairman, Chief Executive Officer, President and as a Director of the Manager. Since 1992, Mr. Rudey has served as Chief Executive Officer of Garrin Properties Holdings, Inc., a private investment company that manages and advises investment portfolios principally concentrated in the timber and forest products industries and in real estate.
Aubrey L. Cole serves as a Director of the Manager. Since 1989 Mr. Cole has been a consultant for Aubrey Cole Associates, a sole proprietorship which provides management consulting services and makes investments. From 1986 to 1989, Mr. Cole was the Vice Chairman of the Board and Director of Champion International Corporation (a publicly traded forest products company) and from 1983 to 1993, Mr. Cole was the Chairman of Champion Realty Corporation (a land sales subsidiary of Champion International). Mr. Cole is a Director of Deotexas Inc. (a development stage company).
George R. Hornig serves as a Director of the Manager. Since 1999, Mr. Hornig has been Managing Director of Credit Suisse First Boston's Private Equity Division. From 1993 to 1999, Mr. Hornig was an Executive Vice President of Deutsche Bank Americas Holdings, Inc. (the United States arm of Deutsche Bank, a German banking concern) and affiliated predecessor entities. From 1991 to 1993, Mr. Hornig was the President and Chief Operating Officer of Dubin & Swieca Holdings, Inc., an investment management business. From 1988 to 1991, Mr. Hornig was a co-founder, Managing Director and Chief Operating Officer of Wasserstein Perella & Co., Inc. (a mergers and acquisitions investment bank). From 1983 to 1988, Mr. Hornig was an investment banker in the Mergers and Acquisitions Group of The First Boston Corporation. Prior to 1983, Mr. Hornig was an attorney with Skadden, Arps, Slate, Meagher & Flom. Mr. Hornig is also a director of Unity Mutual Life Insurance Company and Forrester Research, Inc.
William A. Wyman serves as a Director of the Manager, having been elected to the Board in January, 1999. Mr. Wyman is a former President of the Management Consulting Group of Booz, Allen & Hamilton. Mr. Wyman joined Booz Allen in 1965, where, until 1984 when he retired, he counseled a variety of service, natural resources and manufacturing companies on projects concerning strategic profit improvement and management organization. Mr. Wyman has served as a director of Donaldson, Lufkin & Jenrette, SS&C Technologies, Prime Response, Predictive Systems, Internosis, and Pega Systems.
Alan B. Abramson serves as a Director of the Manager, having been elected to the Board in January, 1999. Mr. Abramson is the President of Abramson Brothers Incorporated, a real-estate management and investment firm, where he has been employed since 1972. He serves as a Director of Datascope, Inc., a medical technology company.
Robert F. Wright serves as a Director of the Manager. Since 1988, Mr. Wright has served as President and Chief Executive Officer of Robert F. Wright Associates, Inc., a firm making strategic investments and providing business consulting services. Previously, Mr. Wright spent 40 years, 28 years as a partner, at Arthur Andersen & Co. Mr. Wright is a director of the following companies: Hanover Direct Inc. (a catalog marketer), Reliance Standard Life Insurance Co. and affiliates (life insurance companies), The Navigators Group Inc. (a property insurance company), Deotexas Inc. (a development stage company), Universal American Financial Corp. (an insurance company), Quadlogic Controls Corp. (a meter manufacturer) and G.V.A. Williams Real Estate Co., Inc. (a real estate company).
Thomas C. Ludlow became Vice President and Chief Financial Officer of the Manager in July 2000. From 1998 to 2000, Mr. Ludlow was Chief Financial Officer of Forest Systems, LLC, a Boston based timber investment management company. From 1995 to 1998, Mr. Ludlow was Director and head of North American Forest Products for Deutsche Morgan Grenfell, an international investment bank. Prior to 1995, Mr. Ludlow worked with various financial institutions. Mr. Ludlow holds an HBA in Business from the University of Western Ontario and an MBA from the Anderson School at the University of California, Los Angeles.
Martin Lugus serves as Vice President - Timberland Operations of the Manager, responsible for all land management and operations on fee lands. Mr. Lugus was employed by Weyerhaeuser for 28 years, during which time he served as Forestry Manager from 1981 to 1991 and Timberlands Manager from 1991 to 1996 and then for the Manager in his current role.
Toby A. Luther serves as the Corporate Controller - Western Operations of the Manager, responsible for all accounting functions. Prior to joining the Manager in 1999, Mr. Luther was an accountant with PricewaterhouseCoopers.
Key Employees
Walter L. Barnes serves as Assistant Vice President - Harvesting of the Manager, responsible for all solid wood logging and fiber operations. From 1993-1996, prior to joining the Manager, Mr. Barnes acted as the Operations Harvest Manager for Weyerhaeuser. Mr. Barnes was employed by Weyerhaeuser for 28 years and has extensive experience managing different harvesting systems on both the East and West sides of the Cascade Range.
Robert A. Broadhead serves as Assistant Vice President - Marketing of the Manager since 1996, responsible for all log and stumpage sales transactions. Prior to joining the Manager in 1996, Mr. Broadhead was employed by Weyerhaeuser for 20 years and gained additional experience in investing and planning while serving as Planning Manager from 1981 to 1994.
Jay Jeffrey Vermilya serves as Assistant Vice President - Planning of the Manager, responsible for all harvest planning as well as operating and developing the inventory and GIS systems. From 1979 to 1987 Mr. Vermilya worked for Crown Zellerbach Corp. and them from 1987 to 1994 as Chief Forester for the Cambell Group. Mr. Vermilya then went to work for Weyerhaeuser as district forester and then for the Manager in 1996 in the same role until 2000, when he assumed his current responsibilities.
Christopher J. Sokol serves as Assistant Vice President - Forestry of the Manager, responsible for forestry operations, environmental relationships, harvest prescriptions and nursery/orchard operations. Prior to joining the Manager in 1996, Mr. Sokol was employed by Weyerhaeuser for 22 years and gained additional experience in forest regeneration and timber sales while serving as District Forester from 1982 to 1991 and as Forestry Manager thereafter.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Manager's officers and directors, and persons who own more than 10% of a registered class of equity securities of the Master Partnership, to file reports of ownership and changes in ownership with the Securities and Exchange Commission and the Nasdaq National Market. Officers, directors and greater than ten percent securityholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.
Based on its review of the copies of such forms received by it, or written representations regarding ownership of the Master Partnership's securities, the Company believes that during the fiscal year 2000, all filings required were properly made.
Item 11.
Item 11. Executive Compensation
The Master Partnership and the Manager were formed in June 1997. Under the terms of the Operating Company Agreement, the Company is required to reimburse the Manager for expenses relating to the operation of the Company, including salaries and bonuses of employees employed on behalf of the Company, as well as the costs of providing benefits to such persons under employee benefit plans and for the costs of health and life insurance.
The following table sets forth annual salary, bonus and all other compensation awards and payouts earned by the Manager's Chief Executive Officer and the four most highly compensated executive officers who earned in excess of $100,000 (the "Named Executive Officers") for services rendered during the fiscal year ended December 31, 2000:
SUMMARY COMPENSATION TABLE --------------------------
Long-Term Incentive Plan
The Manager has adopted the U.S. Timberlands Company, LP Amended and Restated 1997 Long-Term Incentive Plan (the "Long-Term Incentive Plan") for key employees and directors of the Manager and its affiliates. The summary of the Long-Term Incentive Plan contained herein does not purport to be complete and is qualified in its entirety by reference to the Long-Term Incentive Plan, which is filed as an exhibit to the Company's Form S-1 Registration Statement. The Long-Term Incentive Plan consists of two components, a unit option plan (the "Unit Option Plan") and a restricted unit plan (the "Restricted Unit Plan"). The Long-Term Incentive Plan currently permits the grant of Unit Options and Restricted Units covering an aggregate of 857,748 Common Units.
Unit Option Plan. The Unit Option Plan currently permits the grant of options ("Unit Options") covering 857,748 Common Units. Unit Options granted during the Subordination Period will become exercisable automatically upon, and in the same proportions as, the conversion of the Subordinated Units to Common Units. If a grantee's employment is terminated by reason of his death, disability or retirement, the grantee's Unit Options will become immediately exercisable. In addition, a grantee's Unit Options will become immediately exercisable in the event of a "change of control" of the Company (as defined in the Long-Term Incentive Plan).
Upon exercise of a Unit Option, the Manager will acquire Common Units in the open market at a price equal to the then-prevailing price on the principal national securities exchange upon which the Common Units are then traded, or directly from the Company or any other person, or use Common Units already owned by the Manager, or any combination of the foregoing. The Manager will be entitled to reimbursement by the Company for the difference between the cost incurred by the Manager in acquiring such Common Units and the proceeds received by the Manager from an optionee at the time of exercise. Thus, the cost of the Unit Options will be borne by the Company. If the Master Partnership issues new Common Units upon exercise of the Unit Options, the total number of Units outstanding will increase and the Manager will remit the proceeds received from the optionee to the Company.
The Unit Option Plan has been designed to furnish additional compensation to key executives and key directors and to increase their proprietary interest in the future performance of the Company measured in terms of growth in the market value of Common Units.
The following table sets forth certain information with respect to option grants to the named executive officers during fiscal 2000:
OPTION/SAR GRANTS IN LAST FISCAL YEAR
(1) The Unit Options become exercisable automatically upon, and in the same proportion as, the conversion of the Subordinated Units to Common Units, which date shall be no earlier than the date of record for the distribution for the quarter ended December 31, 2000.
(2) A ten-year period (the maximum length of the Unit Option term) was used for compounding purposes in the above calculations.
The following table sets forth certain information with respect to the aggregate number and value of options at the fiscal year-end 2000:
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR ENDED OPTION/SAR VALUES -----------------------------------
(1) At the close of trading on December 31, 2000, the market value of the Common Units was $6.69 per common unit. Since the Unit Options, once exercisable, would be exercisable at a range of $9.813 to $14.750 per unit, the in-the-money computation is inapplicable.
(2) In August of 2000 Mr. Byrne resigned as the CFO of U.S. Timberlands.
Restricted Unit Plan. A Restricted Unit is a "phantom" unit that entitles the grantee to receive a Common Unit upon the vesting of the phantom unit. No grants have been made under the Restricted Unit Plan. The LTIP Committee may, in the future, determine to make grants under such plan to key employees and directors containing such terms as the Committee shall determine. Restricted Units granted during the Subordination Period will vest automatically upon, and in the same proportions as, the conversion of the Subordinated Units to Common Units. Common Units to be delivered upon the "vesting" of rights may be Common Units acquired by the Manager in the open market, Common Units already owned by the Manager, Common Units acquired by the Manager directly from the Company or any other person, or any combination of the foregoing. The Manager will be entitled to reimbursement by the Company for the cost incurred in acquiring such Common Units. If the Master Partnership issues new Common Units, the total number of Units outstanding will increase and the Company will receive no remuneration.
The issuance of the Common Units pursuant to the Restricted Unit Plan is intended to serve as a means of incentive compensation for performance and not primarily as an opportunity to participate in the equity appreciation in respect of the Common Units. Therefore, no consideration will be payable by the plan participants upon vesting and issuance of the Common Units.
The Manager's Board of Directors in its discretion may terminate the Long-Term Incentive Plan at any time with respect to any Common Units or Unit Options for which a grant has not theretofore been made. The Manager's Board of Directors will also have the right to alter or amend the Long-Term Incentive Plan or any part thereof from time to time; provided, however, that no change in any outstanding grant may be made that would impair the rights of the participant without the consent of such participant.
Compensation of Directors
Compensation for Directors of the Manager covers services rendered for both the Company and the Master Partnership. No additional remuneration will be paid to employees who also serve as directors. Each independent director receives $50,000 annually, for which they each agree to participate in four regular meetings of the Board of Directors and four Audit/Conflicts Committee meetings. Each other non-employee director receives $50,000 annually (to be paid in cash or Subordinated Units, as determined by each director), for which they each agree to participate in four regular meetings of the Board of Directors. Each non-employee director will receive $1,250 for each additional meeting in which he participates. In addition, each non-employee director will be reimbursed for his out-of-pocket expenses in connection with attending meetings of the Board of Directors or committees thereof. Each director will be fully indemnified by the Company for his actions associated with being a director to the extent permitted under Delaware law.
The Manager has entered into consulting agreements with each of Aubrey Cole Associates (a consulting firm affiliated with Mr. Cole), Robert F. Wright Associates, Inc. (a consulting firm affiliated with Mr. Wright) and Mr. Hornig pursuant to which each such person or firm provides consulting services to the Manager. Each such agreement provides for an annual retainer of $25,000, plus $150 per hour (with a maximum per diem of $1,200) for services rendered at the request of the Manager. In addition, the Manager entered into a consulting agreement with Mr. Wyman that provides for an annual retainer of $50,000 for services rendered at the request of the Manager. Each consulting agreement will be reviewed annually by a majority of the directors who do not have consulting agreements.
The Company paid approximately $129,000, $117,000 and $144,000 to the Directors of the Manager for consulting services during 2000, 1999 and 1998, respectively.
Employment Agreements
The Manager has entered into an employment agreement with Mr. Rudey (the "Executive"). The agreement has a term expiring on December 31, 2002, and includes confidentiality and non-compete provisions.
The agreement provides for an annual base salary of $450,000, subject to such increases as the Board of Directors of the General Partner may authorize from time to time. Effective January 1, 2001, the Board of Directors authorized an increase to $463,500. In addition, the Executive is eligible to receive an annual cash bonus to be determined by the Compensation Committee not to exceed 100% of his base salary. The Executive will be entitled to participate in such other benefit plans and programs as the Manager may provide for its employees in general.
The agreement provides that in the event the Executive's employment is terminated without "Cause" (as defined in the Employment Agreements) or if the Executive terminates his employment for "Good Reason" (as defined below), such individual will be entitled to receive a severance payment in an amount equal to his base salary for the remainder of the employment term under the Employment Agreement or 12 months, whichever is less, plus a prorated bonus for the year of such termination calculated based on the bonus being equal to 100% of base salary. In the event of termination due to death or disability, the Executive will be entitled to accrued salary and benefits up to the date of the termination. In the event the individual's employment is terminated for "Cause," he will receive accrued salary and benefits up to the date of termination.
Good Reason is defined in the agreement generally as: (i) failure of the Manager's members to elect or re-elect the Executive to the Board of Directors, (ii) failure of the Manager to vest in the Executive the position, duties and responsibilities contemplated by his Employment Agreement, (iii) failure of the Manager to pay any portion of the Executive's compensation, (iv) any material breach by the Manager of any material provision of the Employment Agreement and (v) a material reduction in the individual's duties, responsibilities or status upon a "change of control" as defined in the Employment Agreement. "Cause" is defined generally as: (i) any felony conviction, (ii) any material breach by the Executive of a material written agreement between the Executive and the Company, (iii) any breach caused by the Executive of the Partnership Agreement, (iv) any willful misconduct by the Executive materially injurious to the Company, (v) any willful failure by the Executive to comply with any material policies, procedures or directives of the Board of Directors of the Manager or (vi) any fraud, misappropriation of funds, embezzlement or other similar acts of misconduct with respect to the Company.
Committee Interlocks and Insider Participation in Compensation Decisions
The Compensation Committee of the Manager is composed of Messrs. Rudey, Abramson, Wyman, Hornig and Cole. Mr. Rudey also serves as Chairman of the Manager.
The duties of the Compensation Committee are to (i) determine the annual salary, bonus and benefits, direct and indirect, of all executive officers, (ii) review and recommend to the full Board any and all matters related to benefit plans covering the foregoing officers and any other employees and (iii) serve as the Long-Term Incentive Plan Committee for the Company's Long-Term Incentive Plan.
When setting executive officer compensation levels, the Compensation Committee considers a variety of quantitative and qualitative criteria tied to the strategic goals of the Company, such as maintaining the Minimum Quarterly Distribution, an executive's acceptance of additional responsibility and acquisition activity. The above factors were applied by the Compensation Committee in determining the salary and bonus amounts for all executives, including the CEO.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
None.
Item 13.
Item 13. Certain Relationships and Related Transactions
The Company is managed by the Manager pursuant to the Operating Company Agreement. Under the Operating Company Agreement the Manager is entitled to reimbursement of certain costs of managing the Company. These costs included compensation and benefits payable to officers and employees of the Manager, payroll taxes, general and administrative expenses and legal and professional fees.
Consulting Agreements
The Manager has entered into consulting agreements with each of Aubrey Cole Associates (a consulting firm affiliated with Mr. Cole), Robert F. Wright Associates, Inc. (a consulting firm affiliated with Mr. Wright) and Mr. Hornig pursuant to which each such person or firm provides consulting services to the Manager. Each such agreement provides for an annual retainer of $25,000, plus $150 per hour (with a maximum per diem of $1,200) for services rendered at the request of the Manager. Each consulting agreement will be reviewed annually by a majority of the directors who do not have consulting agreements. In addition, the Manager entered into a consulting agreement with Mr. Wyman that provides for an annual retainer of $50,000 for services rendered at the request of the Manager. See also Compensation of Directors included in Item 11.
Related Party Transactions
Glenn A. Zane, a principal of Mason, Bruce & Girard, served as the Acting Senior Vice President and Acting Director of Operations for the Company during 1999. In January 2000, Mr. Zane resigned as the Acting Senior Vice President and Acting Director of Operations for the Company. The Company has continued to utilize Mr. Zane and Mason, Bruce & Girard for consulting services. The Company paid approximately $821,000 and $925,000 to Mason, Bruce and Girard during 2000 and 1999, respectively. Such payments were for consulting services and include Mr. Zane's compensation as Acting Senior Vice President and Acting Director of Operations during 1999.
Investment in Affiliate
In October 1999, the Company made an investment in U.S. Timberlands Yakima, LLC (USTY), an unconsolidated affiliate. USTY, a then newly formed entity organized to acquire timber properties located in Central Washington and Central Oregon, is engaged in the growing of trees and sale of logs and standing timber to third party wood processors. The Master Partnership contributed to USTY $294,000 of cash for 49% of USTY's common interests (the "Common LLC Interests"). The remaining Common LLC Interests were acquired for $306,000 in cash by U.S. Timberlands Holding Group, LLC, a Delaware limited liability company in which John Rudey and George Hornig, respectively, the Chairman of the Board and a director of the Company's Manager, hold a controlling interest. The Company also acquired all of the senior preferred interests in USTY (the "Senior or Preferred LLC Interests") for its contribution to USTY of timberlands consisting primarily of non-income producing, pre-merchantable pine plantations having an agreed upon value of $22.0 million. The Company recorded its investment in the Senior LLC interest at its $18.9 million cost basis for the contributed timberlands. Terms of the Preferred LLC Interests include a cumulative annual guaranteed return of 5% of the $22.0 million agreed upon value of the contributed timberlands. The Preferred LLC Interests are redeemable at the Company's option on December 31, 2004 or at USTY's option at any time prior thereto, for a redemption price equal to the agreed upon value of the Preferred LLC Interests plus any portion of the guaranteed return not received by the Company prior to the redemption date. Generally, USTY's net income or losses are allocated to the Common LLC Interests. However, net losses exceeding the account balances of the Common LLC Interests are allocated to the Preferred LLC Interest. The Company accounts for the Preferred LLC Interest at cost, reduced by losses, if any, in excess of the Common LLC Interests. The Master Partnership accounts for its Common LLC Interest by the equity method. The Manager of the Company provides management services to USTY for a fee equal to 2% of USTY's earnings before interest, taxes, depreciation and amortization. The Company granted U.S. Timberlands Holdings Group, LLC an irrevocable proxy to vote its Common and Preferred Interests. During 1999, concurrently with and in order to facilitate USTY's acquisition of the Washington timberlands referred to above, an entity controlled by John M. Rudey agreed to acquire in the future a portion of the property and any related liabilities that the Company and USTY were unwilling to acquire, the sale of which was a condition of the seller to the USTY acquisition. Such entity was paid $2.7 million by the seller for its agreement to acquire such property and any related liabilities. The Manager's Conflicts Committee reviewed and approved the structure of the Company's investment in the affiliate.
Repurchase of Certain Member Interests; Severance Payments
On January 5, 1998, the Manager made certain changes in senior management. In connection therewith, Edward J. Kobacker, the former Executive Vice President and Chief Operating Officer and a former Director of the Manager, became entitled to receive approximately $700,000 in severance payments pursuant to his employment agreement. In addition, pursuant to the terms of the Manager's operating agreement, the member interests of each of Mr. Stephens, Mr. Kobacker and John H. Beuter, a former Director of the Manager, were subject to repurchase at an aggregate price of $385,000 payable in three annual installments commencing February 1, 1998. The Company has reimbursed the Manager for such repurchase payments.
During January 1999, the Company paid $260,000, $175,000 and $145,000 to Messrs. Symington, Michie and McDowell, respectively, as severance under their employment agreements with the Company. In July 1999, under the terms of a settlement the Company reached with Messrs. Symington, Michie, and McDowell, the Company committed to pay an additional sum of $675,000 to Messrs. Symington, Michie, and McDowell.
Affiliate Credit Facility
See the description of the Affiliate Credit Facility included in the Liquidity and Capital Resources section of Item 7.
PART IV
Item 14.
Item 14. Exhibits, Financial Statements, and Reports on Form 8-K
(a)(1) and (2) Financial Statements
See "Index to Financial Statements" set forth on page.
(a)(3) Exhibits
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended December 31, 2000.
* Incorporated by reference to the same numbered Exhibit to the Registrant's Registration Statement on Form S-1 filed November 13, 1997. + Incorporated by reference to the same numbered Exhibit to the Registrant's Current Report on Form 8-K filed January 15, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 16th day of April 2001. U.S. TIMBERLANDS KLAMATH FALLS, LLC By: U.S. Timberlands Services Company, LLC Its Manager
By: /s/ John M. Rudey -------------------------------------------------- John M. Rudey, Chairman, Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.
EXHIBIT INDEX
23.1 Consent of Richard A. Eisner & Company, LLP dated April 13, 2001.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Members of U.S. Timberlands Klamath Falls, LLC
We have audited the accompanying consolidated balance sheets of U.S. Timberlands Klamath Falls, LLC and subsidiary as of December 31, 2000 and 1999, and the related consolidated statements of operations, changes in members' equity and cash flows for each of the years in the three-year period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements enumerated above present fairly, in all material respects, the financial position of U.S. Timberlands Klamath Falls, LLC and subsidiary as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with generally accepted accounting principles.
Richard A. Eisner & Company, LLP
New York, New York January 24, 2001, except as to Note 15, as to which the date is February 26, 2001
U.S. TIMBERLANDS KLAMATH FALLS, LLC AND SUBSIDIARY
Consolidated Balance Sheets (in thousands)
See notes to consolidated financial statements.
U.S. TIMBERLANDS KLAMATH FALLS, LLC AND SUBSIDIARY
Consolidated Statements of Operations (in thousands)
See notes to consolidated financial statements.
U.S. TIMBERLANDS KLAMATH FALLS, LLC AND SUBSIDIARY
Consolidated Statements of Changes in Members' Equity (in thousands)
Managing Nonmanaging Member's Member's Total Interest Interest Members' Equity
Balance, January 1, 1998 $ 1,471 $ 145,646 $ 147,117 Distributions to members (227) (22,476) (22,703) Net loss (64) (6,319) (6,383) ---------- ------------- ------------
Balance, December 31, 1998 1,180 116,851 118,031 Distributions to members (263) (25,981) (26,244) Net income 67 6,584 6,651 ---------- ------------- ------------
Balance, December 31, 1999 984 97,454 98,438 Distributions to members (262) (25,981) (26,243) Net loss (39) (3,894) (3,933) ---------- ------------- ------------
Balance, December 31, 2000 $ 683 $ 67,579 $ 68,262 ========== ============= ============
See notes to consolidated financial statements.
U.S. TIMBERLANDS KLAMATH FALLS, LLC AND SUBSIDIARY
See notes to consolidated financial statements.
U.S. TIMBERLANDS KLAMATH FALLS, LLC AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2000 and 1999 (dollar amounts in thousands)
1. Business and Significant Accounting Policies:
Business The accompanying consolidated financial statements include the accounts of U.S. Timberlands Klamath Falls, LLC ("USTK"), a Delaware limited liability company, and its wholly owned subsidiary, U.S. Timberlands Finance Corp. ("Finance Corp."), collectively referred to hereafter as the Company. Finance Corp. serves as the co-obligor for USTK's notes (defined below). It has nominal assets and does not conduct operations. All intercompany transactions have been eliminated in consolidation. An investment in affiliate is carried at cost, plus accrued dividends to the extent earned, reduced by losses, if any, in excess of the common members' interest in the investee (See Notes 3 and 9).
U.S. Timberlands Company, LP (the "MLP") owns a 99% nonmanaging member interest in USTK. The MLP was formed on June 27, 1997 to acquire and own substantially all of the equity interests in USTK and through USTK to acquire and own the business and assets of U.S. Timberlands Management Company, LLC, formerly known as U.S. Timberlands Services Company, LLC. U.S. Timberlands Services Company, LLC (the "Manager") manages the business of the Company and owns a 1% managing member interest in USTK.
The primary activity of the Company is the growing of trees and the sale of logs and standing timber to third party wood processors. The Company's timber is located in Oregon, east of the Cascade Range. Logs harvested from the timberlands are sold to unaffiliated domestic conversion facilities. These logs are processed for sale as lumber, plywood and other wood products, primarily for use in new residential home construction, home remodeling and repair and general industrial applications.
Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition Revenue on delivered log sales are recognized upon delivery to the customer. Revenue on timber deeds and timber and property sales are generally recognized upon closing. Revenue from timber sold under stumpage contracts (i.e., the customer arranges to harvest and deliver the logs) is recognized when the timber is harvested. Deferred revenue as of December 31, 2000 represents a customer deposit for a timber deed sale that was closed in January 2001. At December 31, 1999 deferred revenue represents cash received in advance of logs harvested under stumpage contracts.
Concentration of Credit Risk Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade accounts and notes receivable. The majority of the Company's trade accounts and notes receivable are derived from sales to third party wood processors. The Company's four largest customers accounted for approximately 22%, 14%, 11%, and 10% of the Company's aggregate net revenues from log, stumpage, and timber deed sales for the year ended December 31, 2000. In 1999, these customers represented approximately 17%, 15%, 18%, and 14%, respectively, of aggregate net revenues from log, stumpage and deed sales. In 1998, these four customers accounted for approximately 27%, 18%, 19%, and 10% of aggregate net revenues from log, stumpage and deed sales. No other single customer accounted for more than 10% of aggregate net revenues from log, stumpage, and timber deed sales in those years. Credit risk on trade receivables is mitigated by control procedures to monitor the credit worthiness of customers. The Company mitigates credit risk related to notes receivable by obtaining asset lien rights or performing credit worthiness procedures or both. The Company's four largest customers accounted for 27% of the Company's accounts receivable at December 31, 2000 and none of the Company's accounts receivable at December 31, 1999. The Company periodically reviews its allowance for doubtful accounts and reserves an estimated amount for such accounts. As of December 31, 2000 and 1999 the Company had an allowance for doubtful accounts of $550 and $200, respectively.
1. Business and Significant Accounting Policies (Continued):
Cash and Cash Equivalents Cash and cash equivalents consist of highly liquid investments with maturities at date of purchase of 90 days or less.
Timber and Timberlands Timber and timberlands is comprised of timber, timberlands, logging roads, and seed stock and nursery stock.
Timber, timberlands and roads Timber, timberlands and roads are stated at cost less depletion and amortization for timber previously harvested. The cost of the timber harvested (including logging roads) is determined based on the volume of timber harvested in relation to the amount of estimated net merchantable volume, utilizing a single composite pool. The Company estimates its timber inventory using statistical information and data obtained from physical measurements, site maps, photo-types and other information gathering techniques. These estimates are updated annually and may result in adjustments of timber volumes and depletion rates, which are recognized prospectively. Changes in these estimates have no effect on the Company's cash flow.
Seed orchard and nursery stock The Company operates and maintains a seed orchard and nursery. Costs incurred by the orchard and nursery to produce seed and seedlings utilized in the reforestation of the Company's timberlands are capitalized to seed orchard and nursery stock in the accompanying balance sheets. A certain amount of seed and seedling stock is sold to unaffiliated customers and is reflected as a component of by-products and other revenues in the accompanying statements of operations.
Property, Plant and Equipment Property, plant and equipment, including significant improvements thereto, are stated at cost less accumulated depreciation and amortization. Cost includes expenditures for major improvements and replacements. Maintenance and repairs are charged to expense as incurred. When assets are sold, retired or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in income.
The cost of property, plant and equipment is depreciated using the straight-line method over the estimated useful lives of the related assets. Buildings and improvements are generally depreciated over 40 years and equipment is depreciated over 3 to 5 years. Leasehold improvements are amortized under the straight-line method based on the shorter of the lease periods or the estimated useful lives of the improvements.
Deferred Financing Fees Deferred financing fees consist of fees incurred in connection with obtaining the related debt financing. The Company amortizes deferred financing fees over the terms of the related debt. The Company presents deferred financing fees net of accumulated amortization. The accumulated amortization of deferred financing fees as of December 31, 2000 and 1999 was $2,102 and $1,427, respectively.
Income Taxes USTK is a limited liability company. Accordingly, USTK is not liable for federal or state income taxes since USTK's income or loss is reported on the separate tax returns of the individual members. Accordingly, no provision for current or deferred income taxes has been reflected in the accompanying financial statements.
1. Business and Significant Accounting Policies (Continued): Unit-Based Compensation Plans The Company accounts for its granting of unit options to employees and directors of the MLP's Manager under the MLP's unit-based compensation plans under the provisions of the Accounting Principles Board's Opinion No. 25, "Accounting for Stock Issued to Employees". The Company has adopted the disclosure only provisions of the Financial Accounting Standards Board Statement No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation" (See Note 10).
New Accounting Standard In June of 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities", which as amended, is required to be adopted for fiscal quarters of fiscal years beginning after June 15, 2000. SFAS 133 requires the Company to recognize all derivatives in the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If the derivative is a hedge, depending upon the nature of the hedge, changes in fair value of the derivative will either be offset against the changes in fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The Company had no outstanding derivative positions at December 31, 2000, and therefore believes that the adoption of SFAS 133 will not significantly affect its financial statements.
Reclassifications Certain amounts in prior years have been reclassified for comparability purposes and have no impact on net income or members' equity.
2. Timber and Timberlands: Timber and Timberlands consisted of the following at December 31:
2000 1999 ----------- ------------
Timber and logging roads $ 317,651 $ 317,856 Timberlands 39,111 39,338 Seed orchard and nursery stock 1,364 1,277 ----------- ------------
358,126 358,471 Less accumulated depletion and road amortization 93,017 64,643 ----------- ------------
$ 265,109 $ 293,828 =========== ============
3. Investment in Affiliate: Following is summarized financial information for U.S. Timberlands Yakima, LLC, the MLP's equity basis affiliate (See Note 9), as of and for the years ended December 31:
6. Short-Term Debt: In 2000, the Company extended a credit facility with an affiliate of the Manager (the "Affiliate Credit Facility"), which allows the Company to borrow up to $12.0 million. The Company's obligations under the Affiliate Credit Facility represent unsecured general obligations. Borrowings under the Affiliate Credit Facility bear interest at the prime lending rate as published in the Wall Street Journal plus applicable margin (1.25% at December 31, 2000), which is based on the Company's leverage ratio. The prime lending rate was 9.50% at December 31, 2000. The Affiliate Credit Facility expires on June 30, 2001 and all amounts borrowed thereunder shall then be due and payable. There were no outstanding borrowings under the Affiliate Credit Facility at December 31, 2000 and 1999. Peak borrowings were $6,000 and $3,000 under the Affiliate Credit Facility during 2000 and 1999, respectively. A commitment fee of 0.5% is payable quarterly on the unused available portion of the Affiliate Credit Facility. Total interest and fees paid to the affiliate were $130 and $58 in 2000 and $25 and $29 in 1999, respectively.
The Affiliate Credit Facility contains certain restrictive covenants, including limits on the ability of the Company to make cash distributions, incur certain additional indebtedness or incur certain liens. The Affiliate Credit Facility also contains financial ratio covenants as to EBITDDA (earnings before interest, taxes, depreciation, depletion, and amortization), interest coverage ratio, and leverage ratio. The Company was in compliance with these covenants at December 31, 2000.
7. Long-Term Debt:
Senior Notes The $225,000 of Notes, which were issued in 1997, were issued jointly and severally by the Company and its wholly owned subsidiary, Finance Corp. (collectively the "Issuers"). The Issuers serve as co-obligors of the Notes. The Notes represent unsecured general obligations of the Company and bear interest at 9-5/8% payable semiannually in arrears on May 15 and November 15, and mature on November 15, 2007 unless previously redeemed. The Notes are redeemable at the option of the Issuers in whole or in part, on or after November 15, 2002 at predetermined redemption prices plus accrued interest to the redemption date.
The Notes contain certain restrictive covenants, including limiting the ability of the Company and its subsidiary to make cash distributions, incur additional indebtedness, sell assets or harvest timber in excess of certain limitations.
8. Members' Equity: Allocation of Income (Loss) As provided in the Company's Operating Agreement, income and losses are allocated 99% to the MLP and 1% to the Manager.
Cash Distributions The MLP is required to make quarterly cash distributions from Available Cash, as defined in the MLP's Partnership Agreement. The Company distributes cash to the MLP to the extent necessary for the MLP to meet its required quarterly cash distributions, in accordance with USTK's Operating Agreement. Generally, cash distributions are paid in order of preferences: first the minimum quarterly distribution of $0.50 per unit (the "MQD") to the MLP's Common Unitholders and the Manager, and second, to the extent cash remains available, to Subordinated Unitholders.
The MLP Agreement sets forth certain cash distribution target rates for the Company to meet in order for the Manager's share of Available Cash to increase (such increases referred to as "Incentive Distributions"). To the extent that the quarterly distributions exceed $.550 per Common and Subordinated Unit, the Manager receives 15% of the excess Available Cash rather than the base amount of 2%. To the extent that the quarterly distributions exceed $.633 per Common and Subordinated Unit, the Manager receives 25% of the excess Available Cash and to the extent that the quarterly distributions exceed $.822 per Common and Subordinated Unit, the Manager receives 50% of the excess Available Cash. Since the quarterly distributions did not exceed the minimum quarterly distributions for 2000, 1999 or 1998, the Manager did not receive any such Incentive Distributions for those years.
9. Certain Relationships and Related Party Transactions: Manager The Manager has the ability to control management of the Company and the MLP and has all voting rights of the Company and the MLP except for certain matters set forth in USTK's Operating Agreement and in the MLP's Partnership Agreement, as amended. The ownership of Subordinated and Common Units by certain affiliates of the Manager effectively gives the Manager the ability to prevent its removal.
The Manager does not receive any management fee or other compensation in connection with its management of the Company. The Manager and its affiliates perform services for the Company and are reimbursed for all expenses incurred on behalf of the Company, including the costs of employee, officer and director compensation properly allocable to the Company, and all other expenses necessary or appropriate to the conduct of the business of, and allocable to, the Company. USTK's Operating Agreement provides that the Manager will determine the expenses that are allocable to the Company in any reasonable manner determined by the Manager in its sole discretion. Related noninterest bearing receivables and payables between the Manager and the Company are settled in the ordinary course of business. As of December 31, 2000 and 1999, the Company had a payable to the Manager of $955 and $840, respectively. During 2000, 1999, and 1998 expenses allocated to and reimbursed by the Company totaled $7,717, $8,347, and $9,058, respectively.
9. Certain Relationships and Related Party Transactions (Continued): Certain conflicts of interest could arise as a result of the relationships described above. The Board of Directors and management of the Manager have a duty to manage the Company and the MLP in the best interests of the Unitholders and, consequently, must exercise good faith and integrity in handling the assets and affairs of the Company.
Consulting Agreements As of December 31, 2000, the Manager has consulting agreements with affiliates of certain Directors of the Manager, pursuant to which each such person or firm has provided and/or will provide consulting services to the Manager. The agreements provide for an annual retainer of $25 to $50, plus an hourly rate for services rendered at the request of the Manager. Payments by the Manager related to consulting agreements in 2000, 1999, and 1998 amounted to $129, $117, and $144, respectively.
Investment in Affiliate In October 1999, the Company made an investment in U.S. Timberlands Yakima, LLC (USTY), an unconsolidated affiliate. USTY, a then newly formed entity organized to acquire timber properties located in Central Washington and Central Oregon, is engaged in the growing of trees and sale of logs and standing timber to third party wood processors. The MLP contributed to USTY $294 of cash for 49% of USTY's common interests (the "Common LLC Interests"). The remaining Common LLC Interests were acquired for $306 in cash by U.S. Timberlands Holding Group, LLC, a Delaware limited liability company in which John Rudey and George Hornig, respectively, the Chairman of the Board and a director of the Company's Manager, hold a controlling interest. The Company also acquired all of the senior preferred interests in USTY (the "Senior or Preferred LLC Interests") for its contribution to USTY of timberlands consisting primarily of non-income producing, pre-merchantable pine plantations having an agreed upon value of $22,000. The Company recorded its investment in the Senior LLC interest at its $18,850 cost basis for the contributed timberlands. Terms of the Preferred LLC Interests include a cumulative annual guaranteed return of 5% of the $22,000 agreed upon value of the contributed timberlands. The Preferred LLC Interests are redeemable at the Company's option on December 31, 2004 or at USTY's option at any time prior thereto, for a redemption price equal to the agreed upon value of the Preferred LLC Interests plus any portion of the guaranteed return not received by the Company prior to the redemption date. Generally, USTY's net income or losses are allocated to the Common LLC Interests. However, net losses exceeding the account balances of the Common LLC Interests are allocated to the Preferred LLC Interest. The Company accounts for the Preferred LLC Interest at cost plus accrued dividends to the extent earned, reduced by losses, if any, in excess of the Common LLC Interests. The MLP accounts for its Common LLC Interest by the equity method.
The Manager of the Company provides management services to USTY for a fee equal to 2% of USTY's earnings before interest, taxes, depreciation and amortization. The MLP and Company granted U.S. Timberlands Holding Group, LLC an irrevocable proxy to vote their respective Common and Preferred Interests. During 1999, concurrently with and in order to facilitate USTY's acquisition of the Washington timberlands referred to above, an entity controlled by John M. Rudey agreed to acquire in the future a portion of the property and any related liabilities that the Company and USTY were unwilling to acquire, the sale of which was a condition of the seller to the USTY acquisition. Such entity was paid $2,700 by the seller for its agreement to acquire such property and any related liabilities. The Manager's Conflicts Committee reviewed and approved the structure of the Company's investment in the affiliate.
In June 2000, the Company purchased timber cutting rights for approximately 4.2 million board feet from USTY for $1.3 million. These timber cutting rights expire in June 2003. In December 2000, the Company sold approximately 8,000 acres of timberland located in Central Oregon to USTY for $2,900.
9. Certain Relationships and Related Party Transactions (Continued): Payments to Affiliate See Note 6 regarding interest and commitment fees paid to an affiliate of the Manager under the Affiliate Credit Facility.
Severance and Settlement Selling, general and administrative expenses in 1999 included $675 related to settlement with former employees of the Company. In 1998, selling, general and administrative expenses included approximately $1,280 in severance to former employees. In addition, pursuant to the terms of the Manager's operating agreement, the member interests of three former employees were subject to repurchase at an aggregate price of $385 payable in three annual installments commencing February 1, 1998. The aggregate repurchase of the member interests was included in selling, general and administrative expenses in 1998 and the Company has reimbursed the Manager for such repurchase payments.
Other Related Party Transactions During 1999, Glenn A. Zane served as Acting Senior Vice President and Acting Director of Operations for the Company. The Company paid approximately $821 and $925 during 2000 and 1999, respectively, to Mason, Bruce & Girard, of which Mr. Zane is a partner. Such payments were for consulting services and include Mr. Zane's compensation.
10. Management Incentive Plans: Unit Option Plans The MLP maintains a Unit Option Plan which provides for the granting of unit options ("Unit Options") to employees and directors of the Manager who perform services for the Company.
The Plan permits the grant of Unit Options covering 857,749 of the MLP's Common Units. Unit Options granted under the MLP's Unit Option Plan are determined by the Long-Term Incentive Plan Committee of the MLP's Board of Directors (the "LTIP Committee") and are granted at fair market value at the date of the grant. During 1997, in connection with the reorganization of the Company and concurrent with the initial offering of public units by the MLP, 604,153 Unit Options were granted to key employees and directors of the MLP's General Partner. An additional 90,622 Unit Options were granted to key employees and directors on December 12, 1997, in connection with the closing of the sale of 1,118,803 Common Units pursuant to the exercise by the underwriters of their overallotment option. In 1998, 100,000 Unit Options were granted to directors and 240,170 options were granted to employees, and in 1999, 200,000 Unit Options were granted to directors and 142,620 options were granted to employees. In 2000, 54,000 Unit Options were granted to employees. The Unit Options granted expire ten years from the date of grant and become exercisable automatically upon and in the same proportion as the conversion of MLP's Subordinated Units to Common Units. Provided that the minimum quarterly distribution (as that term is defined in the MLP Agreement) has been paid to Common and Subordinated Unitholders for three consecutive four-quarter periods, 25% of the Subordinated Units will convert to Common Units as early as 2001, 25% as early as 2002 and the remaining 50% may convert to Common Units as early as 2003. Once the performance criteria are achieved, the Company will record compensation expense for the difference between the exercise price and fair value of the Common Units, with a corresponding increase to members' equity. Although the performance criteria were met for the years ended December 31, 2000, 1999 and 1998, no compensation expense was recorded during such years, as the market price of the units was less than the exercise price during such years.
10. Management Incentive Plans (Continued): Activity with respect to the MLP's unit option plan follows:
(a) Options were originally granted with exercise prices ranging from $21.00 to $21.44 per unit. During December 1998, the exercise price was reduced to $14.75 per unit by the Board of Directors.
As of December 31, 2000 exercise prices for options outstanding were between $5.84 and $14.75 with a weighted average exercise price of $13.75 per unit. The weighted average remaining contractual life of the options was 8 years. There were no unit options exercisable at December 31, 2000, 1999 or 1998.
10. Management Incentive Plans (Continued): The Company has computed, for pro forma disclosure purposes as required by SFAS 123, the value of the Unit Options granted by the MLP under the Unit Option Plan. These computations were made using the Black-Scholes option-pricing model, as prescribed by SFAS 123, with the following weighted average assumptions for 2000, 1999 and 1998:
The weighted-average fair value of unit options was $3.61, $2.87 and $2.02 for options granted in 2000, 1999 and 1998, respectively.
If the Company had adopted the expensing provisions of SFAS 123, the impact on 2000, 1999 and 1998's net income (loss) would have been as follows:
For purposes of the pro forma disclosures, the estimated fair value of the unit options is amortized to expense over their estimated exercise period, which corresponds to the assumed subordinated units conversion period.
Restricted Unit Plan: During 1997, the MLP authorized the establishment of a restricted unit plan (the "Restricted Unit Plan"), which allows it to grant units (the "Restricted Units") to employees at the discretion of the LTIP Committee. No consideration will be payable by the plan participants upon vesting and issuance of the Restricted Units. Restricted Units granted during the subordination period would vest automatically upon and in the same proportion as the conversion of Subordinated Units to Common Units. Restricted Units granted subsequent to the subordination period are the equivalent of Common Units. No Restricted Units have been granted as of December 31, 2000.
Income Interests of the Manager In connection with the Common Units offering and the related formation of the MLP's General Partner, the Manager issued income interests to certain officers and directors of the General Partner at no cost. Such income interests participate pro rata in cash distributions from USTK and the MLP. Under certain circumstances, the MLP's General Partner is required to repurchase the income interests from officers and directors upon termination of their employment at fair market value as determined by independent appraisal (see Note 9, severance and settlement).
11. Fair Value of Financial Instruments: A summary of the fair value of the Company's significant financial instruments and the methods and significant assumptions used to estimate those values is as follows:
(a) Short-term financial instruments - The fair value of short-term financial instruments, including cash and cash equivalents, trade and other receivables, notes receivable, trade accounts payable and certain accrued liabilities, approximates their carrying amounts in the financial statements due to the short maturities of such items.
(b) Long-term debt - The estimated fair value of the Company's long-term debt was approximately $180,000 and $207,000 at December 31, 2000 and 1999, respectively, based on published market quotations.
(c) Interest rate collar agreement - The Company entered into interest rate collar agreements to manage interest rate risk. Contemplated variable rate borrowings did not occur, and accordingly, these agreements are marked to market. The fair value of these agreements is the estimated amount that the Company would receive or pay upon termination of the agreements at the balance sheet date or other specific point in time. The Company terminated the interest rate collar agreements effective in October 1999. Income or losses on these agreements is reflected in other income (expense) in the accompanying statements of operations in the amount $991 in 1999 and ($361) in 1998.
12. Quarterly Results (Unaudited):
(a) The quarter ended December 31, 2000 includes revenues of $2,773 and related costs of $2,641 from a property sale.
13. 401(K) Defined Contribution Plan: The Company sponsors a 401(k) defined contribution plan which covers substantially all full-time employees. Company contributions to the plan totaled $30 in 2000, $34 in 1999 and $26 in 1998.
14. Commitments and Contingencies: Log Supply Agreement On August 30, 1996, the Company entered into a wood supply agreement with Collins Products, LLC to supply a volume of approximately 34 million board feet of merchantable timber annually to Collins at market prices. The term of the agreement is ten years and is renewable for two additional terms of five years, each at the option of Collins.
Litigation In November 2000, six purported class action lawsuits were filed against the Manager and the Board of Directors of the Manager (the "Board") alleging breach of fiduciary duty and self-dealing by the Manager and the Board in connection with an announcement on November 2, 2000 that a group led by senior management has begun the process to explore taking the MLP private (the "Going-Private Transaction").
All six lawsuits were filed in the Court of Chancery of the State of Delaware for the County of New Castle. Each lawsuit was filed by a unitholder of the MLP, on behalf of all other unitholders of the MLP who are similarly situated, and seeks to have the class certified and the unitholder bringing the lawsuit named as representative of the class. In addition, the lawsuits seek to enjoin the Going-Private Transaction, to rescind the Going-Private Transaction if it is consummated, and to recover damages and attorneys' fees. In addition to naming the Manager and the Board as defendants, all six lawsuits name the MLP as a defendant.
In the opinion of management, after consultation with outside counsel, the pending lawsuits are not expected to have a material adverse effect on the Company's financial position or results of operations.
15. Subsequent Event: Distribution In January 2001, the Board of Directors of the Manager authorized the Company to make a distribution applicable to the fourth quarter 2000. The total distribution in the amount of $6,561 (including $131 to the Manager) was paid on February 14, 2001 to Unitholders of record as of February 2, 2001.
Preferred Investment On February 26, 2001, the Company contributed cutting rights on approximately 31,000 acres of timberland located in Central Oregon to its affiliate, USTY. The cutting rights have an agreed upon value of $12.0 million and were added to the Company's Preferred Interest in USTY. Terms of the additional senior preferred interest include a cumulative annual guaranteed return of 5% of the $12.0 million agreed upon value. The additional senior preferred interest is redeemable at the Company's option on December 31, 2004 or at USTY's option any time prior thereto for a redemption price equal to the agreed upon value of the Preferred Interest, either in cash or by returning the contributed timberlands, plus any portion of the guaranteed return not yet paid by USTY prior to the redemption date. The Company recorded its additional preferred interest at its basis for the timber of approximately $10.9 million.