MAXXAM INC - 10-K Annual Report

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

FORM 10-K

---------------------------

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

For the fiscal year ended December 31, 2002 Commission File Number 1-3924

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

Delaware 95-2078752
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
5847 San Felipe, Suite 2600

Houston, Texas 77057
(Address of Principal Executive Offices) (Zip Code)

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

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

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

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

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

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

Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes |_| No |X|

The aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was last sold, as of the last business day of the registrant's most recently
completed second fiscal quarter: $40.3 million.

Number of shares of common stock outstanding at March 21, 2003: 6,527,671

DOCUMENTS INCORPORATED BY REFERENCE:

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

Part I

List of Defined Terms
Item 1. Business
General
Forest Products Operations
Real Estate Operations
Racing Operations
Kaiser Aluminum

Item 2. Properties

Item 3. Legal Proceedings

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

Part II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

Item 6. Selected Financial Data

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

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Item 8. Financial Statements and Supplementary Data
Independent Auditors' Report
Report of Independent Public Accountants
Consolidated Balance Sheet
Consolidated Statement of Operations
Consolidated Statement of Cash Flows
Consolidated Statement of Stockholders' Equity (Deficit)
Notes to Consolidated Financial Statements

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

Part III

Items 10-13. To be filed with the Registrant's definitive proxy statement

Item 14. Controls and Procedures

Item 15. To be filed with the Registrant's definitive proxy statement..............................

Part IV

Item 16. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

Signatures

Certifications

Index of Exhibits

List of Defined Terms

Set forth below is a list of all terms used and defined in this Report and
the Consolidated Financial Statements and the pages on which they first appear.

1994 Director Plan
1994 Omnibus Plan
2002 Omnibus Plan
Acquiring Person
Additional Debtors
APB Opinion 30
Bankruptcy Court
Bear Creek lawsuit
Beltway Assets
Beltway Notes
BOF
Britt
Cases
CDF
CEQA
CESA
Class A Preferred Stock
Code
Common Stock
Company
Custodial Trust Agreement
CWA
Debtors
Elk River Order
Environmental Plans
EPA
EPIC-SYP/Permits lawsuit
ERF lawsuit
ESA
FASB
FDIC
FDIC action
FDIC counterclaim
Federated
Filing Date
FIN 45
FIN 46
FireRock, LLC
Forest Practice Act
Giddeon Holdings
GIS
GPS
Harvest Value Schedule
HCP
Headwaters Agreement
Headwaters Timberlands
Humboldt DA action
HWC lawsuit
Junior Preferred Stock
KACC
Kahn lawsuit
Kaiser
Kaiser Financial Statements
Kaiser Shares
Lakepointe Assets
Lakepointe Notes
LIFO
LTSY
Master Purchase Agreement
MAXXAM
MAXXAM Parent
MGHI
MGHI Notes
MGI
Motel Assets
Motel Notes
MPC
North Coast Water Board
Old growth
Original Debtors
OTS
OTS action
Pacific Lumber
Pacific Lumber Credit Agreement
Palco Companies
Palmas
Palmas Country Club Notes
PDMPI
Permits
PSLRA
QAL
Racing Act
Racing Commission
Required Liquidity Amount
Respondents
Rights
Salmon Creek
SAR Account
SBE Price
Scheduled Amortization
Scotia LLC
Scotia LLC Line of Credit
Scotia LLC Timber
Scotia LLC Timber Rights
Scotia LLC Timberlands
Series A Right
Series B Right
SFAS
SFAS No. 115
SFAS No. 123
SFAS No. 143
SFAS No. 144
SFAS No. 145
SFAS No. 146
SFAS No. 148
SFAS No. 66
SHRP, Ltd.
SOP 90-7
State Water Board
SunRidge Canyon LLC
SYP
take
THP No. 520 lawsuit
THPs
Timber Notes
Timber Notes Indenture
TMDLs
USAT
USWA
USWA lawsuit
Wrigley lawsuit
young growth

PART I

ITEM 1. BUSINESS

GENERAL

MAXXAM Inc. and its subsidiaries are collectively referred to herein as
the "COMPANY" or "MAXXAM" unless otherwise indicated or the context indicates
otherwise. The Company is a holding company and, as such, conducts substantially
all of its operations through its subsidiaries. The Company operates in three
principal industries:

o Forest products, through MAXXAM Group Inc. ("MGI") and MGI's wholly owned
subsidiaries, The Pacific Lumber Company ("PACIFIC LUMBER"), Scotia
Pacific Company LLC ("SCOTIA LLC"), and Britt Lumber Co., Inc. ("BRITT").
MGI operates in several principal aspects of the lumber industry -- the
growing and harvesting of redwood and Douglas-fir timber, the milling of
logs into lumber and the manufacture of lumber into a variety of finished
products. Housing, construction and remodeling are the principal markets
for the Company's lumber products. Subsidiaries of MGI also own several
commercial real estate properties (which operations are reflected under
the sections dealing with the real estate segment).

o Real estate investment and development, managed through its wholly owned
subsidiary, MAXXAM Property Company ("MPC"). The Company, principally
through its wholly owned subsidiaries, is engaged in the business of
residential and commercial real estate investment and development,
primarily in Puerto Rico, Arizona, California and Texas, including
associated golf course or resort operations in certain locations.

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

In addition to the above, the Company owns approximately 62% of Kaiser
Aluminum Corporation ("KAISER"), an integrated aluminum producer. Kaiser and a
number of its subsidiaries have filed for reorganization under Chapter 11 of the
United States Bankruptcy Code. See "--Aluminum Operations --Reorganization
Proceedings" and Notes 1 and 4 to the Consolidated Financial Statements
contained herein. Except as otherwise indicated, all references herein to
"Notes" represent the Notes to the Consolidated Financial Statements contained
herein.

This Annual Report on Form 10-K contains statements which
constitute"forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995 ("PSLRA"). These statements appear in a
number of places (see Item 1."Business--Forest Products Operations--Timber and
Timberlands" and "--Regulatory and Environmental Factors;" most sections under
Item 3. "Legal Proceedings;" and several sections under Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations"). Such
statements can be identified by the use of forward-looking terminology such as
"believes," "expects," "may," "estimates," "will," "should," "plans" or
"anticipates" or the negative thereof or other variations thereon or comparable
terminology, or by discussions of strategy. Readers are cautioned that any such
forward-looking statements are not guarantees of future performance and involve
significant risks and uncertainties, and that actual results may vary materially
from the forward-looking statements as a result of various factors. These
factors include the effectiveness of management's strategies and decisions,
general economic and business conditions, developments in technology, new or
modified statutory or regulatory requirements and changing prices and market
conditions. This Report identifies other factors which could cause differences
between such forward-looking statements and actual results. No assurance can be
given that these are all of the factors that could cause actual results to vary
materially from the forward-looking statements.

FOREST PRODUCTS OPERATIONS

GENERAL

The Company engages in forest products operations through MGI and its
wholly owned subsidiaries, Pacific Lumber, Britt, and Scotia LLC, which is a
wholly owned subsidiary of Pacific Lumber. Pacific Lumber, which has been in
continuous operation for over 130 years, engages in several principal aspects of
the lumber industry--the growing and harvesting of redwood and Douglas-fir
timber, the milling of logs into lumber products and the manufacturing of lumber
into a variety of value-added finished products. Britt manufactures redwood
fencing and decking products from small diameter logs, a substantial portion of
which Britt acquires from Pacific Lumber.

During 2001, comprehensive external and internal reviews were conducted by
Pacific Lumber with respect to its business operations. These reviews were an
effort to identify ways in which Pacific Lumber could operate on a more
efficient and cost effective basis. Based upon the results of these reviews,
Pacific Lumber, among other things, closed two of its sawmills, eliminated
certain of its operations, including its soil amendment and concrete block
activities, has begun utilizing more efficient harvesting methods, and adopted
certain other cost saving measures. Most of these changes were implemented by
Pacific Lumber in the last quarter of 2001, or the first quarter of 2002. As of
March 31, 2002, Pacific Lumber also ended its company-staffed logging operations
(which historically performed approximately half of its logging), and now relies
exclusively on contract loggers. See "--Production Facilities" and "--Regulatory
and Environmental Factors - Timber Operations."

TIMBER AND TIMBERLANDS

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

Pacific Lumber owns and manages, directly or through subsidiaries,
approximately 218,000 acres of virtually contiguous commercial timberlands
located in Humboldt County along the northern California coast, an area which
has very favorable soil and climate conditions for growing timber. These
timberlands contain approximately 66% redwood, 30% Douglas-fir and 4% other
timber (by volume), are located in close proximity to Pacific Lumber's and
Britt's sawmills, and contain an extensive network of roads. Approximately
205,000 acres of Pacific Lumber's timberlands are owned by Scotia LLC (the
"SCOTIA LLC TIMBERLANDS"), and Scotia LLC has the exclusive right to harvest
(the "SCOTIA LLC TIMBER RIGHTS") approximately 12,200 acres of Pacific Lumber's
timberlands. The timber in respect of the Scotia LLC Timberlands and the Scotia
LLC Timber Rights is collectively referred to as the "SCOTIA LLC TIMBER."
Substantially all of Scotia LLC's assets are pledged as security for Scotia
LLC's 6.55% Series B Class A-1 Timber Collateralized Notes, 7.11% Series B Class
A-2 Timber Collateralized Notes and 7.71% Series B Class A-3 Timber
Collateralized Notes (collectively, the "TIMBER NOTES"). The Indenture governing
the Timber Notes is referred to herein as the "TIMBER NOTES INDENTURE." Pacific
Lumber harvests and purchases from Scotia LLC virtually all of the logs
harvested from the Scotia LLC Timber. See "--Relationship with Scotia LLC" below
for a description of this and other relationships between Pacific Lumber and
Scotia LLC.

In March 1999, Pacific Lumber and its wholly owned subsidiaries, Scotia
LLC and Salmon Creek LLC ("SALMON CREEK") (collectively, the "PALCO COMPANIES")
consummated the Headwaters Agreement (the "HEADWATERS AGREEMENT") with the
United States and California. Pursuant to the agreement, approximately 5,600
acres of timberlands owned by the Palco Companies (the "HEADWATERS TIMBERLANDS")
were transferred to the United States in exchange for (a) an aggregate of $300.0
million, (b) approximately 7,700 acres of timberlands, and (c) approval by the
federal and state governments of habitat conservation and sustained yield plans
(the "ENVIRONMENTAL PLANS") in respect of the Scotia LLC Timberlands. California
also agreed to offer to purchase a portion of Pacific Lumber's Grizzly Creek
grove and to purchase Scotia LLC's Owl Creek grove (which purchases were
subsequently consummated; see Note 5).

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

Pacific Lumber engages in extensive efforts to supplement the natural
regeneration of timber and increase the amount of timber on its timberlands.
Pacific Lumber is required to comply with California forestry regulations
regarding reforestation, which generally require that an area be reforested to
specified standards within an established period of time. Pursuant to the
services agreement described below (see "--Relationship with Scotia LLC"),
Pacific Lumber conducts regeneration activities on the Scotia LLC Timberlands
for Scotia LLC. Reforestation of redwood timber generally is accomplished
through redwood sprouts from harvested trees and the planting of redwood
seedlings at levels designed to optimize growth. Douglas-fir timber is
regenerated almost entirely by planting seedlings. During 2002, Pacific Lumber
planted an estimated 1,100,000 redwood and Douglas-fir seedlings.

California law requires large timberland owners, including Pacific Lumber,
to demonstrate that their operations will not decrease the sustainable
productivity of their timberlands. A timber company may comply with this
requirement by submitting a sustained yield plan to the California Department of
Forestry and Fire Protection ("CDF") for review and approval. A sustained yield
plan contains a timber growth and yield assessment, which evaluates and
calculates the amount of timber and long-term production outlook for a company's
timberlands, a fish and wildlife assessment, which addresses the condition and
management of fisheries and wildlife in the area, and a watershed assessment,
which addresses the protection of aquatic resources. The relevant regulations
require determination of a long-term sustained yield ("LTSY"), which is the
average annual growth sustainable by the timber inventory at the end of a
100-year planning period. The LTSY is determined based upon timber inventory,
projected growth and harvesting methodologies, as well as soil, water, air,
wildlife and other relevant considerations. A sustained yield plan must
demonstrate that the average annual harvest over any rolling ten-year period
within the planning horizon does not exceed the LTSY.

Pacific Lumber is also subject to federal and state laws providing for the
protection and conservation of wildlife species which have been designated as
endangered or threatened, certain of which are found on Pacific Lumber's
timberlands. These laws generally prohibit certain adverse impacts on such
species (referred to as a "TAKE"), except for incidental takes which do not
jeopardize the continued existence of the affected species and which are made in
accordance with an approved habitat conservation plan and related incidental
take permit. A habitat conservation plan analyzes the impact of the incidental
take and specifies measures to monitor, minimize and mitigate such impact. As
part of the Headwaters Agreement, the federal and state governments approved the
Environmental Plans, consisting of a sustained yield plan (the "SYP") and a
multi-species habitat conservation plan (the "HCP") in respect of the Scotia LLC
Timberlands. See "--Regulatory and Environmental Factors" and Note 16.

In May 2002, Pacific Lumber completed its first timber cruise since 1986.
The results of the timber cruise provided Pacific Lumber with an estimate of the
volume of merchantable timber on Pacific Lumber's timberlands. The new cruise
data reflected a 0.1 million MBF decrease in estimated overall timber volume as
compared to the estimated volumes reported as of December 31, 2001 using the
1986 cruise data (adjusted for harvest and estimated growth). The new cruise
data indicates that there is significantly less old growth timber than estimated
as of December 31, 2001, using the 1986 cruise data. There was also an estimated
increase in young growth timber volume almost equal to the estimated decrease in
old growth timber volume. This change in mix could adversely affect the
Company's revenues. However, because there are many variables that affect
revenues and profitability, the Company cannot quantify the effect of the
revised estimate on current and future cash flows. The new timber volumes are
now being utilized in various aspects of Pacific Lumber's operations, including
estimating volumes on timber harvesting plans ("THPs") and determining depletion
expense.

HARVESTING PRACTICES

The ability of Pacific Lumber to harvest timber depends in large part upon
its ability to obtain regulatory approval of THPs. Prior to harvesting timber in
California, companies are required to obtain the CDF's approval of a detailed
THP for the area to be harvested. A THP must be submitted by a registered
professional forester and must include information regarding the method of
proposed timber operations for a specified area, whether the operations will
have any adverse impact on the environment and, if so, the mitigation measures
to be used to reduce any such impact. The CDF's evaluation of THPs incorporates
review and analysis of such THPs by several California and federal agencies and
public comments received with respect to such THPs. The number of Pacific
Lumber's approved THPs and the amount of timber covered by such THPs varies
significantly from time to time, depending upon the timing of agency review and
other factors. Timber covered by an approved THP is typically harvested within a
one year period from the date that harvesting first begins. The Timber Notes
Indenture requires Scotia LLC to use its best efforts (consistent with prudent
business practices) to maintain a number of pending THPs which, together with
THPs previously approved, would cover rights to harvest a quantity of Scotia LLC
Timber adequate to pay interest and principal amortization based on the Minimum
Principal Amortization schedule for the Timber Notes for the next succeeding
twelve month period. See Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Forest Products
Operation--Industry Overview and Selected Operational Data" for information
regarding developments in the rate of THP approvals. See also "--Regulatory and
Environmental Factors," Item. 3 "Legal Proceedings," and Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations" for
various legal, regulatory, environmental and other challenges being faced by
Pacific Lumber in connection with timber harvesting and other operations on its
timberlands.

Pacific Lumber maintains a detailed geographical information system
covering its timberlands (the "GIS"). The GIS covers numerous aspects of Pacific
Lumber's timber properties, including timber type, tree class, wildlife and
botanical data, geological information, roads, rivers and streams. Pursuant to
the services agreement (described below), Pacific Lumber, to the extent
necessary, provides Scotia LLC with personnel and technical assistance in
updating, upgrading and improving the GIS and the other computer systems owned
by Scotia LLC. By carefully monitoring and updating this data base and
conducting field studies, Scotia LLC's foresters are better able to develop
detailed THPs addressing the various regulatory requirements. Pacific Lumber
also utilizes a Global Positioning System ("GPS") which can provide precise
location of geographic features through satellite positioning. Use of the GPS
greatly enhances the quality and efficiency of the GIS data.

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

PRODUCTION FACILITIES

Pacific Lumber operates two highly mechanized sawmills and related
facilities located in Fortuna and Carlotta, California. Pacific Lumber's
sawmills historically have been supplied almost entirely from timber harvested
from Pacific Lumber's timberlands, but are supplemented from time to time by
logs purchased from third parties. Pacific Lumber has over the years implemented
numerous technological advances that have increased the operating efficiency of
its production facilities and the recovery of finished products from its timber.
Pacific Lumber produced approximately 194, 160 and 205 million board feet of
lumber in 2002, 2001and 2000, respectively. The Fortuna sawmill produces
primarily common grade lumber. The Carlotta sawmill produces both common and
upper grade redwood lumber. As part of Pacific Lumber's strategic review of its
operations, Sawmills "A" and "B" in Scotia, California, were closed in 2001.
See "--General."

Britt owns a 46,000 square foot mill in Arcata, California. Britt's
primary business is the processing of small diameter redwood logs into fencing
products for sale to retail and wholesale customers. Britt purchases, primarily
from Pacific Lumber but also from other timberland owners, small diameter (6 to
15 inch) redwood logs of varying lengths. Britt processes these logs at its mill
into a variety of fencing products, including "dog-eared" 1" by 6" fence stock
in six foot lengths, 4" by 4" fence posts in 6 through 12 foot lengths, and
other lumber products in 6 through 12 foot lengths. Britt's purchases of logs
from third parties are generally consummated pursuant to short-term contracts of
12 months or less. Britt's manufacturing operations are conducted on 12 acres of
land, ten acres of which are leased on a long-term fixed price basis from an
unrelated third party. An 18 acre log sorting and storage yard is located
one-quarter of a mile away. Britt's (single shift) mill capacity, assuming 40
production hours per week, is estimated at 37.4 million board feet of fencing
products per year. Britt completed a 25,000 square foot remanufacturing facility
for fencing products in 2001.

Pacific Lumber operates a finishing and remanufacturing plant in Scotia
which processes rough lumber into a variety of finished products such as trim,
fascia, siding and paneling. Remanufacturing enhances the value of some grades
of lumber by assembling knot-free pieces of narrower and shorter lumber into
wider or longer pieces in Pacific Lumber's state-of-the-art end and edge glue
plant. The result is a standard sized upper grade product which can be sold at a
significant premium over common grade products. Pacific Lumber has approved a
project to consolidate its planing operations into a single location at Scotia,
resulting in a more efficient operation with significantly lower unit costs. The
projected cost is $4.5 million and the project is expected to be completed in
the fourth quarter of 2003. Pacific Lumber has also installed a lumber
remanufacturing facility at its mill in Fortuna which processes low grade
redwood common lumber into value-added, higher grade redwood fence and related
products.

Pacific Lumber dries the majority of its upper grade lumber before it is
sold. Upper grades of redwood lumber are generally air-dried for three to twelve
months and then kiln-dried to produce a dimensionally stable and higher quality
product which generally commands higher prices than "green" lumber (which is
lumber sold before it has been dried). Upper grade Douglas-fir lumber is
generally kiln-dried immediately after it is cut. Pacific Lumber owns and can
operate up to 35 kilns having an annual capacity of approximately 95 million
board feet, and which produce higher quality upper and common grades of lumber,
a substantial portion of which consists of redwood commons for siding and
decking. Pacific Lumber also maintains several large enclosed storage sheds
which can hold approximately 27 million board feet of dry lumber.

Pacific Lumber owns and operates a cogeneration power plant which is
fueled by the wood residue from logging and lumber production operations. The
operations of Pacific Lumber and Britt supplied 63% of the fuel in 2002. The
power plant is capable of producing up to 30 megawatts per hour and generates
substantially all of the energy requirements of Scotia, California, the town
adjacent to Pacific Lumber's timberlands where several of its facilities are
located and where a number of its employees live. Pacific Lumber sells surplus
power to Pacific Gas and Electric Company. In 2002, the sale of surplus power
accounted for approximately 5% of Pacific Lumber's total revenues.

PRODUCTS

The following table sets forth the distribution of MGI's lumber production
(on a net board foot basis) and revenues by product line:

YEAR ENDED DECEMBER 31, 2002 YEAR ENDED DECEMBER 31, 2001
--------------------------------------------- ------------------------------------------
% OF TOTAL % OF TOTAL
LUMBER % OF TOTAL LUMBER % OF TOTAL
PRODUCTION LUMBER % OF TOTAL PRODUCTION LUMBER % OF TOTAL
PRODUCT VOLUME REVENUES REVENUES VOLUME REVENUES REVENUES
- ----------------------------------- ------------- ------------ ------------ ----------- ----------- -----------

Upper grade redwood lumber......... 8% 21% 18% 7% 19% 15%
Common grade redwood lumber........ 81% 71% 60% 68% 62% 51%
------------- ------------ ------------ ----------- ----------- -----------
Total redwood lumber............ 89% 92% 78% 75% 81% 66%
------------- ------------ ------------ ----------- ----------- -----------
Upper grade Douglas-fir lumber..... 2% 4% 3% 4% 7% 6%
Common grade Douglas-fir lumber.... 9% 4% 4% 20% 11% 9%
------------- ------------ ------------ ----------- ----------- -----------
Total Douglas-fir lumber........ 11% 8% 7% 24% 18% 15%
------------- ------------ ------------ ----------- ----------- -----------
Other grades of lumber............. 0% 0% 0% 1% 1% 1%
------------- ------------ ------------ ----------- ----------- -----------
Total lumber................. 100% 100% 85% 100% 100% 82%
============= ============ ============ =========== =========== ===========

Logs............................... 7% 6%
============ ===========

Hardwood chips..................... 0% 2%
Softwood chips..................... 1% 2%
------------ -----------
Total wood chips................ 1% 4%
============ ===========

In 2002, MGI sold 278.5 million board feet of lumber. See "Management's
Discussion and Analyses of Financial Condition and Results of
Operations--Results of Operations--Forest Products Operations--Industry
Overview" for additional information. Lumber products vary greatly by the
species and quality of the timber from which they are produced. Lumber is sold
not only by grade (such as "upper" grade versus "common" grade), but also by
board size and the drying process associated with the lumber.

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

Upper grade redwood lumber, which is derived primarily from large diameter
logs and is characterized by an absence of knots and other defects, is used
primarily in distinctive interior and exterior applications. The overall supply
of upper grade lumber has been diminishing due to increasing environmental and
regulatory restrictions and other factors. See Item 7. "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Results of
Operations--Forest Products Operations--Industry Overview." Common grade redwood
lumber, historically MGI's largest volume product, has many of the same
aesthetic and structural qualities of redwood uppers, but has some knots,
sapwood and a coarser grain. Such lumber is commonly used for construction
purposes, including outdoor structures such as decks, hot tubs and fencing.

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

MGI does not have any significant contractual relationships with third
parties relating to the purchase of logs. During 2002, MGI purchased
approximately 2.2 million board feet of logs from third parties. Pacific Lumber
uses a whole-log chipper to produce wood chips from hardwood trees which would
otherwise be left as waste (subject to availability of raw material). These
chips are sold to third parties primarily for the production of facsimile and
other specialty papers. Pacific Lumber also produces softwood chips from the
wood residue from its milling operations. These chips are sold to third parties
for the production of wood pulp and paper products.

BACKLOG AND SEASONALITY

MGI's backlog of sales orders at December 31, 2002 was approximately $42.7
million, of which it is estimated that $13.6 million will be shipped in the
first quarter of 2003. For 2001, sales orders were made on a short-term basis.
Accordingly, the backlog of sales orders at December 31, 2001, was $15.7
million, the substantial portion of which was delivered in the first quarter of
2002. See Item 7. "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Results of Operations--Forest Products
Operations--Net Sales." MGI has historically experienced lower first quarter
sales due largely to the general decline in construction-related activity during
the winter months. As a consequence, MGI's results in any one quarter are not
necessarily indicative of results to be expected for the full year. See
"--Regulatory and Environmental Factors" below and Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations--Forest Products Operations--Industry
Overview."

MARKETING

The housing, construction and remodeling markets are the primary markets
for MGI's lumber products. MGI's policy is to maintain a wide distribution of
its products both geographically and in terms of the number of customers. MGI
sells its lumber products throughout the country to a variety of accounts, the
large majority of which are wholesale distributors, followed by industrial
users, manufacturers and exporters. Upper grades of redwood and Douglas-fir
lumber are sold throughout the entire United States, as well as to export
markets. Common grades of redwood lumber are sold principally west of the
Mississippi River, with California accounting for approximately 67% of these
sales in 2002. Common grades of Douglas-fir lumber are sold primarily in
California. In 2002, Pacific Lumber had three customers which accounted for
approximately 9%, 8% and 6%, respectively, of MGI's total net lumber sales.
Exports of lumber accounted for approximately 4% of MGI's total revenues in
2002. MGI markets its products through its own sales staff which focuses
primarily on domestic sales.

MGI actively follows trends in the housing, construction and remodeling
markets in order to maintain an appropriate level of inventory and assortment of
products. Due to its high quality products, competitive prices and long history,
MGI believes it has a strong degree of customer loyalty.

COMPETITION

MGI's lumber is sold in highly competitive markets. Competition is
generally based upon a combination of price, service, product availability and
product quality. MGI's products compete not only with other wood products but
with metals, masonry, plastic and other construction materials made from
non-renewable resources. The level of demand for MGI's products is dependent on
such broad factors as overall economic conditions, interest rates and
demographic trends. In addition, competitive considerations, such as total
industry production and competitors' pricing, as well as the price of other
construction products, affect the sales prices for MGI's lumber products.
Competition in the common grade redwood and Douglas-fir lumber market is
intense, with MGI competing with numerous large and small lumber producers. MGI
primarily competes with the northern California mills of Simpson, Redwood Empire
and Mendocino Redwood. In August of 2002, Georgia Pacific, previously a large
producer of redwood products and a competitor has closed its sawmill in northern
California.

EMPLOYEES

As of March 1, 2003, MGI had approximately 915 employees, none of whom are
covered by a collective bargaining agreement.

RELATIONSHIP WITH SCOTIA LLC

Scotia LLC's foresters, wildlife and fisheries biologists, geologists,
botanists and other personnel are responsible for providing a number of forest
stewardship techniques, including protecting the timber located on the Scotia
LLC Timberlands from forest fires, erosion, insects and other damage, overseeing
reforestation activities and monitoring environmental and regulatory compliance.
Scotia LLC's personnel are also responsible for preparing THPs and updating the
information contained in the GIS. See "--Harvesting Practices" above for a
description of the GIS updating process and the THP preparation process.

Scotia LLC and Pacific Lumber are parties to several agreements between
themselves, including a master purchase agreement (the "MASTER PURCHASE
AGREEMENT") and a services agreement, relating to the conduct of their forest
products' operations. The Master Purchase Agreement governs the sale to Pacific
Lumber by Scotia LLC of logs harvested from the Scotia LLC Timberlands. Under
the services agreement, Pacific Lumber provides operational, management and
related services to Scotia LLC with respect to the Scotia LLC Timberlands.
Scotia LLC and Pacific Lumber are also parties to agreements providing for
reciprocal rights of ingress and egress through their respective properties, the
indemnification of Scotia LLC by Pacific Lumber for environmental liabilities
incurred in connection with the Scotia LLC Timberlands, and certain services
provided by Scotia LLC to Pacific Lumber.

REGULATORY AND ENVIRONMENTAL FACTORS

General
Pacific Lumber's business is subject to the Environmental Plans and a
variety of California and federal laws and regulations dealing with timber
harvesting, threatened and endangered species and habitat for such species, and
air and water quality. Compliance with such laws and regulations also plays a
significant role in Pacific Lumber's business. The California Forest Practice
Act (the "FOREST PRACTICE ACT") and related regulations adopted by the
California Board of Forestry and Fire Protection (the "BOF") set forth detailed
requirements for the conduct of timber harvesting operations in California.
These requirements include the obligation of timber companies to obtain
regulatory approval of detailed THPs containing information with respect to
areas proposed to be harvested. See "--Harvesting Practices" above. California
law also requires large timberland owners, including Pacific Lumber, to
demonstrate that their proposed timber operations will not decrease the
sustainable productivity of their timberlands. See "--Timber and Timberlands"
above. The federal Endangered Species Act (the "ESA") and California Endangered
Species Act (the "CESA") provide in general for the protection and conservation
of specifically listed wildlife and plants. These laws generally prohibit the
take of certain species, except for incidental takes pursuant to otherwise
lawful activities which do not jeopardize the continued existence of the
affected species and which are made in accordance with an approved habitat
conservation plan and related incidental take permits. A habitat conservation
plan, among other things, specifies measures to minimize and mitigate the
potential impact of the incidental take of species and to monitor the effects of
the activities covered by the plan. The operations of Pacific Lumber are also
subject to the California Environmental Quality Act (the "CEQA"), which provides
for protection of the state's air and water quality and wildlife, and the
California Water Quality Act and federal Clean Water Act (the "CWA"), which
require that Pacific Lumber conduct its operations so as to reasonably protect
the water quality of nearby rivers and streams. Compliance with such laws,
regulations and judicial and administrative interpretations, together with other
regulatory and environmental matters, have resulted in restrictions on the scope
and timing of Pacific Lumber's timber operations (such as recent actions of the
regional water board and its staff--see "--Water Quality" below), increased
operational costs and engendered litigation and other challenges to its
operations.

The Environmental Plans
The Environmental Plans, consisting of the HCP and the SYP, were approved
by the federal and state governments upon the consummation of the Headwaters
Agreement. In connection with approval of the Environmental Plans, incidental
take permits (the "PERMITS") were issued with respect to certain threatened,
endangered and other species found on the Scotia LLC Timberlands. The Permits
cover the 50-year term of the HCP and allow incidental takes of 17 different
species covered by the HCP, including four species which are found on the Scotia
LLC Timberlands that had previously been listed under the ESA and/or the CESA by
the applicable governmental entities. The agreements which implement the
Environmental Plans also provide for various remedies (including the issuance of
written stop orders and liquidated damages) in the event of a breach by Scotia
LLC of these agreements or the Environmental Plans.

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

The first analysis by the Palco Companies of a watershed, Freshwater, was
released in June 2001. This analysis was used by the Palco Companies and the
government agencies to develop proposed harvesting prescriptions. The Freshwater
prescriptions resulted in a reduction in the size of the streamside buffers set
forth in the Environmental Plans and also provide for geologic reviews in order
to conduct any harvesting activities on potential landslide-prone areas.
Watershed analysis based prescriptions are currently being developed for other
portions of the Scotia LLC Timberlands. At least one additional watershed
analysis study is expected to be completed in 2003. The HCP required the Palco
Companies, together with the government agencies, to establish a watershed
analysis schedule resulting in completion of the initial watershed analysis
process for all covered lands within five years. However, due largely to the
number of agencies involved and the depth and complexity of the analysis, the
process has thus far proven to require more time than originally anticipated.
Accordingly, the Palco Companies will be working with the government agencies to
establish an appropriate timeline for implementation of watershed analysis on
the remaining portions of Scotia LLC Timberlands to ensure that such studies are
time and cost efficient, and that such studies continue to provide scientific
results necessary to evaluate potential changes to the harvesting restrictions
on those lands.

The HCP imposes certain restrictions on the use of roads on the
timberlands covered by the HCP during several months of the year and during
periods of wet weather. However, Pacific Lumber has conducted, and expects to be
able to continue to conduct, some harvesting during these periods. A pending
adaptive management change to the road restrictions of the Environmental Plans
would help ensure that road restrictions are consistent with the operational
needs of the Palco Companies. The HCP also requires that 75 miles of roads be
stormproofed on an annual basis and that certain other roads must be built or
repaired. The nature of this work requires that it be performed in the dry
periods of the year. To date, over 360 miles of roads have been stormproofed.

The HCP contains an adaptive management provision, which various
regulatory agencies have clarified will be implemented on a timely and efficient
basis, and in a manner which will be both biologically and economically sound.
This provision allows the Palco Companies to propose changes to many of the HCP
prescriptions based on, among other things, economic considerations. The
regulatory agencies have also clarified that in applying this adaptive
management provision, to the extent the changes proposed do not result in the
jeopardy of a particular species, the regulatory agencies will consider the
practicality of the suggested changes, including the cost and economic
feasibility and viability. The Palco Companies and the agencies have implemented
various adaptive management changes related to wildlife and rare plants, and
other changes relating to roads and streamside buffers are under consideration
by the government agencies. These adaptive management changes have increased the
ability to conduct harvesting operations and/or reduce operating costs while
still meeting the obligations of the Environmental Plans.

Water Quality
Under the Federal Clean Water Act, the Environmental Protection Agency
(the "EPA") is required to establish total maximum daily load limits ("TMDLs")
in water courses that have been declared to be "water quality impaired." The EPA
and the North Coast Regional Water Quality Control Board ("NORTH COAST WATER
BOARD") are in the process of establishing TMDLs for many northern California
rivers and certain of their tributaries, including nine water courses that flow
within the Scotia LLC Timberlands. The Company expects this process to continue
into 2010. In December 1999, the EPA issued a report dealing with TMDLs on two
of the nine water courses. The agency indicated that the requirements under the
HCP would significantly address the sediment issues that resulted in TMDL
requirements for these water courses. The North Coast Water Board has begun the
process of establishing the TMDL requirements applicable to two other water
courses on the Company's timberlands, with a targeted completion of spring 2004
for these two water courses. The final TMDL requirements applicable to the
Company's timberlands may require aquatic protection measures that are different
from or in addition to those in the HCP or that result from the prescriptions to
be developed pursuant to the watershed analysis process provided for in the HCP.

Effective January 1, 2003, a California statute eliminates a waiver
previously granted to, among others, timber companies. This waiver had been in
effect for a number of years and waived the requirement under California water
quality regulations for timber companies to follow certain waste discharge
requirements in connection with their timber harvesting and related operations.
The new statute provides, however, that regional water boards such as the North
Coast Water Board are authorized to renew the waiver. The North Coast Water
Board has renewed the waiver for timber companies through December 31, 2003.
Should the North Coast Water Board decide not to extend this or another waiver
beyond December 31, 2003, it may thereafter notify a company that the Board will
require such company to follow certain waste discharge requirements in order to
conduct harvesting operations on a THP. The waste discharge requirements may
include aquatic protection measures that are different from or in addition to
those provided for in the THP approved by the CDF. Accordingly, harvesting
activities could be delayed and/or adversely affected as these waste discharge
requirements are developed and implemented.

Beginning with the 2002-2003 winter operating period, the Palco Companies
have been required to submit "Reports of Waste Discharge" to the North Coast
Water Board in order to conduct winter harvesting activities in the Freshwater
Creek and Elk River watersheds. After consideration of these reports, the North
Coast Water Board imposed requirements on the Palco Companies to implement
additional mitigation and erosion control practices in these watersheds. These
additional requirements will somewhat increase operating costs. The North Coast
Water Board also issued a clean up and abatement order (the "ELK RIVER ORDER")
for the Elk River watershed and is contemplating similar actions for the
Freshwater, Bear, Jordan and Stitz Creeks watersheds. The Elk River Order is
aimed at addressing existing sediment production sites through clean up actions.
The order, as well as additional orders in the other watersheds (should they be
issued), could result in significant costs to Pacific Lumber beginning in 2003
and extending over a number of years. The Palco Companies have appealed the Elk
River Order to the State Water Resources Control Board (the "STATE WATER
BOARD"), but are holding the appeal in abeyance while they discuss this matter
with the North Coast Water Board and its staff.

Impact of Future Legislation
Laws, regulations and related judicial decisions and administrative
interpretations dealing with Pacific Lumber's business are subject to change and
new laws and regulations are frequently introduced concerning the California
timber industry. From time to time, bills are introduced in the California
legislature and the U.S. Congress which relate to the business of Pacific
Lumber, including the protection and acquisition of old growth and other
timberlands, threatened and endangered species, environmental protection, air
and water quality and the restriction, regulation and administration of timber
harvesting practices.

For instance, in January 2003, the Natural Resources Committee of the
California Senate issued a report that recommended consideration of legislation
on a number of issues that would affect Pacific Lumber, including collection of
fees for THPs, providing a stronger role for regional water boards in the THP
process, limiting the use of clearcutting, and regulating the rate of harvest in
individual watersheds. On February 7, 2003, Senate Bill 217 was introduced
addressing a number of these issues and others. If this legislation is passed as
written, it will have a significant adverse impact on Pacific Lumber. It is
likely that other legislation addressing these issues will be introduced as
well.

In addition to existing and possible new or modified statutory enactments,
regulatory requirements and administrative and legal actions, the California
timber industry remains subject to potential California or local ballot
initiatives and evolving federal and California case law which could affect
timber harvesting practices. It is not possible to assess the effect of such
future legislative, judicial and administrative events on Pacific Lumber or its
business.

Treesitters on Timberlands
Pacific Lumber has over the past several months had a number of persons
trespass on its timberlands for the purpose of "treesitting" (i.e. occupying
trees for varying periods of time). To date, these activities have not had a
material impact on Pacific Lumber; however, there can be no assurance that this
will continue to be the case.

Timber Operators License

In order to conduct logging operations, road building, stormproofing and
certain other activities, a company must obtain from the CDF a Timber Operator's
License. In December 2001, Pacific Lumber was granted a Timber Operator's
License for 2002 and 2003. At the end of the first quarter of 2002, Pacific
Lumber ended its company-staffed logging operations and now relies exclusively
on contract loggers.

REAL ESTATE OPERATIONS

GENERAL

The Company, principally through its wholly owned subsidiaries, invests in
and develops residential and commercial real estate primarily in Arizona, Puerto
Rico, California and Texas. Real estate properties and receivables as of
December 31, 2002 are as follows:

BOOK VALUE AS
OF DECEMBER 31,
2002
---------------
(IN MILLIONS)

Palmas del Mar (Puerto Rico):
Developed lots.................................................................. 1 lot $ 0.1
Undeveloped land and parcels held for sale...................................... 1,218 acres 31.3
Property, plant and equipment, receivables and other, net....................... 12.1
---------------
Total........................................................................ 43.5
---------------
Resort operations (owned facilities)(1):
Palmas Country Club(2)....................................................... 26.6
Casino....................................................................... 1.3
---------------
Total................................................................... 27.9
---------------
Fountain Hills (Arizona):
Residential, commercial and industrial developed lots........................... 73 lots 6.4
Undeveloped residential land.................................................... 1,000 acres 10.8
Property, plant, equipment and receivables, net................................. 3.8
---------------
Total........................................................................ 21.0
---------------
Rancho Mirage (California):
Residential developed lots and lots under development........................... 68 lots 23.3
Undeveloped land................................................................ 57 acres 10.3
Property, plant, and equipment, net............................................. 0.5
---------------
Total........................................................................ 34.1
---------------

Other properties................................................................... 0.9
---------------
Commercial rental properties:
Property, plant and equipment, net:
Lake Pointe Plaza (Texas).................................................... 123.4
Cooper Cameron building (Texas).............................................. 32.6
Motel 6 facilities (various)................................................. 52.6
CVS Pharmacy building (Texas)................................................ 3.4
---------------
Total real estate properties and receivables............................... $ 339.4
===============
- ---------------

(1) At Palmas del Mar, third parties own other resort facilities, including a
hotel, marina and restaurants.
(2) Palmas Country Club operations include two 18-hole golf courses, a 20
court tennis facility, a member clubhouse, and a beach club. Amounts shown
are net of accumulated depreciation.

BOOK VALUE AS
OF DECEMBER 31,
2002
--------------
(IN MILLIONS)
Joint Ventures:
FireRock, LLC(1):
Residential developed lots and lots under development........................ 118 lots $ 8.0
Undeveloped land............................................................. 40 acres 0.1
Golf course, clubhouse and other club facilities............................. 20.2
Other property, plant and equipment, net..................................... 0.9
--------------
Total...................................................................... $ 29.2
==============
Investment in FireRock, LLC.................................................. $ 7.1
==============

SunRidge Canyon L.L.C.(1):
Golf course.................................................................. $ 8.6
==============
Investment in SunRidge Canyon L.L.C.......................................... $ 0.5
==============
- ------------------

(1) 50% owned.

Revenues from real estate operations were as follows:

YEARS ENDED
DECEMBER 31,
-----------------------
2002 2001
---------- -----------

Palmas del Mar:
Real estate sales...................................................................... $ 14.2 $ 11.7
Commercial, resort operations and other................................................ 11.1 12.6
---------- -----------
Total............................................................................... 25.3 24.3
---------- -----------
Fountain Hills:
Real estate sales...................................................................... 8.7 33.6
Commercial operations and other........................................................ 3.7 3.5
---------- -----------
Total............................................................................... 12.4 37.1
---------- -----------
Rancho Mirage:
Real estate sales...................................................................... 0.2 -
Commercial operations and other........................................................ - 0.2
---------- -----------
Total............................................................................... 0.2 0.2
---------- -----------
Other:
Real estate sales...................................................................... 1.5 2.9
Commercial operations and other........................................................ 0.2 0.2
---------- -----------
Total............................................................................... 1.7 3.1
---------- -----------
Commercial rental properties:
Lake Pointe Plaza...................................................................... 8.6 4.4
Cooper Cameron building................................................................ 0.3 -
Motel 6 facilities..................................................................... 0.4 -
CVS Pharmacy building.................................................................. - -
---------- -----------
Total............................................................................... $ 48.9 $ 69.1
========== ===========

FireRock, LLC(1):
Real estate sales...................................................................... $ 16.4 $ 24.9
Golf course operations ................................................................ 2.5 3.2
---------- -----------
Total............................................................................... $ 18.9 $ 28.1
========== ===========
SunRidge Canyon L.L.C.(1):
Real estate sales...................................................................... $ 0.3 $ 0.8
Golf course operations................................................................. 3.5 4.2
---------- -----------
Total............................................................................... $ 3.8 $ 5.0
========== ===========
- -----------------

(1) 50% owned.

PALMAS DEL MAR

Palmas del Mar, a master-planned residential community and resort located
on the southeastern coast of Puerto Rico near Humacao ("PALMAS"), was acquired
by a subsidiary of the Company in 1984. Originally over 2,700 acres, Palmas now
has approximately 1,200 acres of undeveloped land remaining. The Company is
planning the development and sale of certain of the remaining acreage through
Palmas del Mar Properties, Inc. ("PDMPI"), the subsidiary through which the
Company primarily conducts operations at Palmas. Future sales are expected to
consist of undeveloped acreage, semi-developed parcels and fully-developed lots.
Resort operations include two golf courses, tennis, beach club and casino
facilities, and a timeshare operation owned by subsidiaries of the Company.
Certain other amenities, including a hotel, marina, equestrian center and
various restaurants, are owned and operated by third parties.

FOUNTAIN HILLS

In 1968, a subsidiary of the Company purchased and began developing
approximately 12,100 acres of real property at Fountain Hills, Arizona, which is
located near Phoenix and adjacent to Scottsdale, Arizona. The year-round
population of Fountain Hills is over 21,000. Development of Fountain Hills is
substantially complete and the Company is planning the sale or development of
the remaining acreage at Fountain Hills. Future sales are expected to consist
mainly of undeveloped acreage, semi-developed parcels and fully-developed lots.
The principal undeveloped acreage is comprised of Eagle's Nest, a 487-acre
custom lot development planned to include 244 lots, and Adero Canyon, a 431-
acre custom lot development planned to include 171 lots. The Company is in the
process of formulating its development plans with respect to these projects.
Financing for the developments will be accomplished either through new or
existing credit facilities or joint venture arrangements.

In 1994, a subsidiary of the Company entered into and holds a 50% interest
in a joint venture to develop a 950 acre area in Fountain Hills known as
SunRidge Canyon. The development is a residential, golf-oriented, upscale
master-planned community. Sales of the individual lots began in November 1995
and concluded in 2002. The only remaining asset is a championship level, 18-hole
daily fee golf course.

In 1998, a subsidiary of the Company entered into and holds a 50% interest
in a joint venture to develop an 808 acre area in Fountain Hills known as
FireRock Country Club. The development is a residential, golf-oriented, upscale
master-planned community consisting of three phases of custom lots, three
multifamily parcels and a private country club. A championship level private
18-hole golf course opened in 2000. The first and second phases of the custom
lots portion of the project (298 lots) have been developed, and construction of
the third phase (81 lots) is currently underway. The three multifamily parcels
were sold in 2001 and 2002.

RANCHO MIRAGE

In 1991, a subsidiary of the Company acquired Mirada, a 220-acre luxury
resort-residential project located in Rancho Mirage, California. Mirada is a
master planned community built into the Santa Rosa Mountains, 650 feet above the
Coachella Valley floor. Three of the six parcels within the project have been
developed, one of which is the first phase of a custom lot subdivision of 46
estate lots. The Lodge at Ranch Mirage, formerly the Ritz-Carlton Rancho Mirage
Hotel, which is owned and operated by a third party, was developed on the second
parcel. The third parcel is a recently completed custom lot subdivision
comprised of 63 estate lots. The three remaining parcels encompass approximately
57 acres. Under a development agreement with the City of Rancho Mirage which
extends until 2011, this acreage may be developed with a variety of residential
and commercial uses. The Company is currently planning to develop and/or market
the remaining parcels. The Company has obtained final regulatory and
environmental approvals for development of all three of its remaining parcels
within Mirada.

COMMERCIAL RENTAL PROPERTIES

In June 2001, subsidiaries of the Company acquired Lake Pointe Plaza, an
office complex located in Sugar Land, Texas, for a purchase price of $131.3
million. The transaction was financed by the subsidiaries through the issuance
of $117.3 million of non-recourse notes and the balance from a cash payment of
$14.0 million. The property was acquired subject to two leases to existing
tenants. All of the remaining space, representing a majority of the premises,
was simultaneously leased to an affiliate of the seller. The office complex is
fully leased for a period of 20 years under these three leases. See Note 5 for
further information.

In November 2002, a subsidiary of the Company acquired the Cooper Cameron
building, an office building located in Houston, Texas, for a purchase price of
$32.7 million. The transaction was financed by the subsidiary through a cash
payment of $3.0 million and the issuance of $29.7 million in non-recourse notes.
At the time of the acquisition, the subsidiary simultaneously leased the
property back to the seller for a period of 22 years. See Note 5 for further
information.

In December 2002, a subsidiary of the Company, acquired two business
trusts which own a portfolio of sixteen motel properties located in ten
different states. The purchase price consisted of a cash payment of $3.5
million. The properties secure certain non-recourse notes with an outstanding
principal balance of $49.4 million. The properties were acquired subject to an
existing lease agreement under which the properties are fully leased through
April 2019, and under which all obligations are guaranteed by the parent company
of the current tenant. See Note 5 for further information.

OTHER PROPERTIES

The Company, through its subsidiaries, owns certain other real estate
properties. Efforts are underway to sell most of these properties.

MARKETING

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

COMPETITION AND REGULATION AND OTHER INDUSTRY FACTORS

There is intense competition among companies in the real estate investment
and development business. Sales and payments on real estate sales obligations
depend, in part, on available financing and/or disposable income and, therefore,
are affected by changes in general economic conditions and other factors. The
real estate development business and commercial real estate business are subject
to other risks such as shifts in population, fluctuations in the real estate
market, and unpredictable changes in the desirability of residential, commercial
and industrial areas. The resort and time-share business of Palmas competes with
similar businesses in the Caribbean, Florida and other locations. The golfing
operations in connection with the SunRidge Canyon and FireRock developments
compete with similar businesses in the areas in and surrounding Phoenix,
Arizona.

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

EMPLOYEES

As of March 1, 2003, the Company's real estate operations had
approximately 125 employees.

RACING OPERATIONS

GENERAL

SHRP, Ltd. owns and operates Sam Houston Race Park, a Texas Class 1 horse
racing facility located within the greater Houston metropolitan area and Valley
Race Park, a greyhound racing facility located in Harlingen, Texas.

RACING OPERATIONS AND FACILITIES

Sam Houston Race Park and Valley Race Park offer pari-mutuel wagering on
live thoroughbred, quarter horse and greyhound racing during meets approved by
the Texas Racing Commission (the "RACING COMMISSION") on a yearly basis and on
simulcast horse and greyhound racing throughout the year. Under the Texas Racing
Act and related regulations (collectively, the "RACING ACT"), commission
revenues for both facilities are a designated portion of the pari-mutuel handle.
Revenues are also earned on live and simulcast racing as both a guest and host
track (i.e. both facilities receive broadcasts of live racing conducted from
other racetracks under various guest simulcast agreements and broadcast live
racing conducted at Sam Houston Race Park and Valley Race Park to other race
tracks and off track wagering sites under various host simulcast agreements).
Sam Houston Race Park and Valley Race Park also derive revenues from food and
beverages sales, admission and parking fees, group sales, and advertising sales.

REGULATION OF RACING OPERATIONS

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

MARKETING AND COMPETITION

SHRP, Ltd.'s management believes that the majority of Sam Houston Race
Park's patrons reside within a 25-mile radius, which includes most of the
greater Houston metropolitan area, and that a secondary market of occasional
patrons exists outside the 25-mile radius but within a 50-mile radius of the
facility. Sam Houston Race Park uses a number of marketing strategies in an
attempt to reach these people and make them more frequent visitors to Sam
Houston Race Park. These strategies include newspaper, television, radio and
direct mail advertising to develop awareness, and conducting promotions such as
giveaways and contests to increase customer traffic. Valley Race Park employs
similar strategies to attract patrons. Both race parks also rent out facilities
and grounds for group events, which are often unrelated to racing but which
increase revenues and expose the facility to potential customers. Sam Houston
Race Park had 126 days of live racing during 2002, and currently has 126 days of
live racing scheduled for 2003. Valley Race Park had 127 live racing
performances (over 110 days) during 2002, and currently has 129 live racing
performances (over 109 days) scheduled for 2003.

Sam Houston Race Park competes with other forms of entertainment,
including casinos located approximately 125 to 150 miles from Houston, a
greyhound racetrack located 55 miles away, a wide range of sporting events and
other entertainment activities in the Houston area, and certain other forms of
wagering, including the Texas State Lottery, charitable bingo and internet based
gaming. Sam Houston Race Park could in the future also compete with other forms
of gambling in Texas, including casino gambling on Indian reservations or
otherwise. While Sam Houston Race Park believes that the location of Sam Houston
Race Park is a competitive advantage over the other more distant gaming ventures
mentioned above, the most significant challenge for Sam Houston Race Park is to
develop and educate new racing fans in a market where pari-mutuel wagering had
been absent from the 1930's to 1994. Other competitive factors faced by Sam
Houston Race Park include the allocation of sufficient live race days by the
Racing Commission and attraction of a sufficient number and quality of race
horses to run at Sam Houston Race Park. Competitive factors faced by Valley Race
Park include the Texas State Lottery, charitable bingo and internet based
gaming, as well as the attraction of sufficient greyhounds to run live racing,
along with the ability of Valley Race Park to market its simulcast signal due to
its brief live racing season.

EMPLOYEES

As of March 1, 2003, the Company's racing operations had approximately 280
year-round employees and an additional approximately 400 who only work during
live racing.

KAISER ALUMINUM

GENERAL

Kaiser operates in several principal aspects of the aluminum industry--the
mining of bauxite, the refining of bauxite into alumina, the production of
primary aluminum from alumina, and the manufacture of fabricated (including
semi- fabricated) aluminum products.

REORGANIZATION PROCEEDINGS

Kaiser, its principal operating subsidiary, Kaiser Aluminum & Chemical
Corporation ("KACC"), and a number of KACC's subsidiaries (collectively, the
"DEBTORS") have filed for reorganization under Chapter 11 of the U.S. Bankruptcy
Code (the "CASES"). The Cases are being jointly administered, with the Debtors
managing their businesses in the ordinary course as debtors-in-possession
subject to the control and supervision of the Bankruptcy Court (the "BANKRUPTCY
COURT"). The Cases were filed as a result of liquidity and cash flow problems of
Kaiser arising in late 2001 and early 2002. Kaiser's objective in the Cases is
to achieve the highest possible recoveries for all creditors and stockholders,
consistent with the Debtors' abilities to pay and the continuation of their
businesses. However, there can be no assurance that the Debtors will be able to
attain these objectives or achieve a successful reorganization. Further, there
can be no assurance that the liabilities of the Debtors will not be found in the
Cases to exceed the fair value of their assets. This could result in claims
being paid at less than 100% of their face value and the equity of Kaiser's
stockholders being diluted or cancelled.

The Company and its subsidiary, MAXXAM Group Holdings Inc. ("MGHI"),
collectively own 50,000,000 shares of the common stock of Kaiser (the "KAISER
SHARES"). In April 2002, Kaiser filed with the Bankruptcy Court a motion seeking
an order prohibiting the Company (or MGHI), without first seeking Bankruptcy
Court relief, from making any disposition of the Kaiser Shares, including any
sale, transfer, or exchange of such stock, or treating any Kaiser Shares as
worthless for federal income tax purposes. Kaiser indicated in its Bankruptcy
Court filing that it was concerned that such a transaction could have the effect
of depriving Kaiser of the ability to utilize the full value of its net
operating losses, foreign tax credits and minimum tax credits. On July 22, 2002,
the Company and MGHI agreed with Kaiser that they would not dispose of any of
the Kaiser Shares prior to a hearing on the merits of Kaiser's motion. The
parties also agreed that the Company (or MGHI) may upon 10 days written notice
to Kaiser (a) request the Bankruptcy Court to hear the matter at a special
hearing or (b) have the matter heard at one of Kaiser's scheduled monthly
bankruptcy hearings.

Kaiser's common stock is publicly traded on the OTC Bulletin Board under
the trading symbol "KLUCQ." As of March 21, 2003, the market value for the
Kaiser Shares was $2.5 million (based on the price per share quoted at the close
of business on such date). There can be no assurance that such value would be
realized should the Company dispose of its investment in the Kaiser Shares.

SUMMARY OF BUSINESS OPERATIONS

Kaiser conducts its operations through its five main business
units--bauxite and alumina, primary aluminum, commodities marketing, flat-rolled
products and engineered products.

Facilities
As of December 31, 2002, Kaiser owned or had interests in (a) two bauxite
mining facilities in Jamaica (Kaiser Jamaica Bauxite Company and Alumina
Partners of Jamaica); (b) three alumina refining facilities in Louisiana
(Gramercy), Jamaica (Alumina Partners of Jamaica), and Australia (Queensland
Alumina Limited; "QAL"); (c) four primary aluminum smelters in Washington (Mead and
Tacoma), Ghana (Volta Aluminium Company), and Wales (Anglesey Aluminium); (d) a
rolling mill in Trentwood, Washington; and (e) and ten engineered products
facilities located in Arizona, California, Ohio, Oklahoma, South Carolina,
Tennessee, Texas, Virginia, Washington and Canada. A substantial portion of
Kaiser's primary aluminum capacity has been idle for varying periods of time.
See Notes 3,5,6 and 15 to Kaiser's Consolidated Financial Statements which are
attached as Exhibit 99.1 hereto (the "KAISER FINANCIAL STATEMENTS") for further
information.

Commodities Marketing Business Unit
Kaiser's operating results are sensitive to changes in the prices of
alumina, primary aluminum, and fabricated aluminum products. Prices for alumina,
primary aluminum and fabricated aluminum products are subject to significant
fluctuation. From time to time in the ordinary course of business, Kaiser's
commodities marketing business unit enters into hedging transactions to provide
risk management in respect of its net exposure of earnings and cash flow related
to primary aluminum price changes. See Note 13 to the Kaiser Financial
Statements for further information.

COMPETITION

Kaiser competes globally with producers of bauxite, alumina, primary
aluminum, and fabricated aluminum products. Primary aluminum and, to some
degree, alumina are commodities with generally standard qualities, and
competition in the sale of these commodities is based primarily upon price,
quality and availability. Kaiser competes with numerous domestic and
international fabricators in the sale of fabricated aluminum products.
Competition in the sale of fabricated products is based upon quality,
availability, price and service, including delivery performance.

MISCELLANEOUS

For further information concerning the business and financial condition of
Kaiser, see Item 3. "Legal Proceedings--Kaiser Litigation" and the Kaiser
Financial Statements, as well as Kaiser's Annual Report on Form 10-K for the
fiscal year ended December 31, 2002.

EMPLOYEES

At March 1, 2003, MAXXAM and its subsidiaries had approximately 1,760
year-round and seasonal employees, excluding those employed by Kaiser.

ITEM 2. PROPERTIES

For information concerning the principal properties of the Company, see
Item 1. "Business."

ITEM 3. LEGAL PROCEEDINGS

GENERAL

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

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

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

MAXXAM INC. LITIGATION

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

USAT MATTERS

On December 26, 1995, the United States Department of Treasury's Office of
Thrift Supervision ("OTS") initiated a formal administrative proceeding (the
"OTS ACTION") against the Company and others alleging, among other things,
misconduct by the Company and certain of its affiliated persons (collectively,
the "RESPONDENTS") and others with respect to the failure of United Savings
Association of Texas ("USAT"). At the time of receivership in 1988, the Company
owned approximately 13% of USAT's parent company. The OTS sought damages ranging
from $326.6 million to $821.3 million under various theories, civil money
penalties and a removal from, and prohibition against the Company and the other
remaining Respondents engaging in, the banking industry.

The Respondents claimed that none of them had any liability in this
matter. Following 110 days of proceedings before an administrative law judge
during 1997-1999, the hearing on the merits of the case concluded on March 1,
1999. Following post-trial briefing, on September 12, 2001, the administrative
law judge issued a recommended decision in favor of the Respondents on each
claim made by the OTS. On October 17, 2002, the OTS action was settled for $0.2
million and with no admission of wrongdoing on the part of the Respondents. The
OTS agreed to drop its administrative action and not pursue any further legal
action against the Respondents with regard to the OTS action. The Company agreed
that it would not pursue legal action against the OTS or its employees as part
of the FDIC counterclaim (see below). The Respondents also agreed to accept for
three years certain restrictions with respect to insured financial institutions
(including not becoming a controlling shareholder or otherwise serving as an
institution-affiliated party). The Company does not believe that these
restrictions are significant as it has no present or contemplated intention to
engage in any of these activities.

On August 2, 1995, the Federal Deposit Insurance Corporation ("FDIC")
filed a civil action entitled Federal Deposit Insurance Corporation, as manager
of the FSLIC Resolution Fund v. Charles E. Hurwitz (the "FDIC ACTION") in the
U.S. District Court for the Southern District of Texas (No. H-95-3956). The
original complaint was against Mr. Hurwitz and alleged damages in excess of
$250.0 million based on the allegation that Mr. Hurwitz was a controlling
shareholder, de facto senior officer and director of USAT, and was involved in
certain decisions which contributed to the insolvency of USAT. As a result of
the settlement of the OTS action, the FDIC and Mr. Hurwitz have stipulated to a
dismissal of the FDIC action. This stipulation does not affect the FDIC
counterclaim or motion for sanctions described in the following paragraph.

On May 31, 2000, the Respondents filed a counterclaim to the FDIC action
(the "FDIC COUNTERCLAIM") in U.S. District Court in Houston, Texas (No.
H95-3956). The FDIC counterclaim states that the FDIC illegally paid the OTS to
bring claims against the Respondents. The plaintiffs are seeking reimbursement
of attorneys' fees and damages from the FDIC. As of December 31, 2002, such fees
were in excess of $38 million. On November 8, 2002, the Respondents filed an
amended counterclaim and an amended motion for sanctions. The Respondents are
pursuing this claim vigorously.

In September 1997, the Company filed suit against a group of its insurers
after unsuccessful negotiations with certain of the insurers regarding coverage,
under the terms of certain directors and officers liability policies, of
expenses incurred in connection with the OTS and FDIC actions. The insurers
requested arbitration and as a result the lawsuit was dismissed in April 1998.
Binding arbitration with the primary carrier was held in October 2002. On
February 20, 2003, the arbitration panel determined that the insurer should pay
the Company approximately $6.5 million (plus interest). As the limits of the
primary policy were not reached by the arbitration panel's award, the Company
does not expect to be able to recover any amounts from the other insurers.

On January 16, 2001, an action was filed against the Company, Federated
Development Company (the predecessor of a principal shareholder of the Company;
"FEDERATED") and certain of the Company's directors in the Court of Delaware
Chancery Court entitled Alan Russell Kahn v. Federated Development Co., MAXXAM
Inc., et. al., Civil Action 18623NC (the "KAHN LAWSUIT"). The plaintiff purports
to bring this action as a stockholder of the Company derivatively on behalf of
the Company. The lawsuit concerns the FDIC and OTS actions, and the Company's
advancement of fees and expenses on behalf of Federated and certain of the
Company's directors in connection with these actions. It alleges that the
defendants have breached their fiduciary duties to the Company, and have wasted
corporate assets, by allowing the Company to bear all of the costs and expenses
of Federated and certain of the Company's directors related to the FDIC and OTS
actions. The plaintiff seeks to require Federated and certain of the Company's
directors to reimburse the Company for all costs and expenses incurred by the
Company in connection with the FDIC and OTS actions, and to enjoin the Company
from advancing to Federated or certain of the Company's directors any further
funds for costs or expenses associated with these actions. The parties have
agreed to an indefinite extension of the defendants' obligations to respond to
the plaintiffs' claims. Although it is impossible to assess the ultimate outcome
of the Kahn lawsuit, the Company believes that the resolution of this matter
should not result in a material adverse effect on its consolidated financial
position, results of operations or liquidity.

FOREST PRODUCTS LITIGATION

Pending lawsuits could affect Pacific Lumber's ability to implement the
HCP and/or the SYP, implement certain of Pacific Lumber's approved THPs, or
carry out certain other operations, as discussed below. Two such lawsuits were
resolved during 2002. See Note 16. Certain of the remaining pending cases are
described below.

In March 1999, an action entitled Environmental Protection Information
Association, Sierra Club v. California Department of Forestry and Fire
Protection, California Department of Fish and Game, The Pacific Lumber Company,
Scotia Pacific Company LLC, Salmon Creek Corporation, et al. (the
"EPIC-SYP/PERMITS LAWSUIT") was filed and is now pending in Superior Court in
Humboldt County, California (No. CV-990445). This action alleges, among other
things, various violations of the CESA and the CEQA, and challenges, among other
things, the validity and legality of the SYP and the Permits issued by
California. The plaintiffs seek, among other things, injunctive relief to set
aside California's approval of the SYP and the Permits issued by California. In
March 1999, a similar action entitled United Steelworkers of America, AFL-CIO,
CLC, and Donald Kegley v. California Department of Forestry and Fire Protection,
The Pacific Lumber Company, Scotia Pacific Company LLC and Salmon Creek
Corporation (the "USWA LAWSUIT") was filed in Superior Court in Humboldt County,
California (No. CV-990452) challenging the validity and legality of the SYP. In
connection with the EPIC-SYP/Permits lawsuit, the trial judge has issued a stay
of the effectiveness of the Permits for approval of new THPs, but released from
the stay, and refused to enjoin, operations under THPs that were previously
approved consistent with the Permits. In addition, on November 26, 2002, the
Court exempted from the stay all in- process THPs submitted through mid-October.
Although the stay prevents the CDF from approving new THPs that rely upon the
Permits, Pacific Lumber is obtaining review and approval of new THPs under a
procedure provided for in the forest practice rules that does not depend upon
the Permits. Because certain THPs will not qualify for this procedure, there
could be a reduction in 2003 harvest levels which could have an adverse impact
on Pacific Lumber. These two cases have been consolidated for trial, which began
on March 24, 2003. The judge has indicated that he expects to rule on this
matter no earlier than July 2003. The Company believes that appropriate
procedures were followed throughout the public review and approval process
concerning the Environmental Plans, and Pacific Lumber is working with the
relevant government agencies to defend these challenges. The Company does not
believe the resolution of these matters should result in a material adverse
effect on its financial condition, results of operations or the ability to
harvest timber. However, in addition to the potential short-term adverse impacts
described above, these matters could have a long-term negative impact if they
are decided adversely to the Company.

In July 2001, an action entitled Environmental Protection Information
Center v. The Pacific Lumber Company, Scotia Pacific Company LLC (No. CD1-2821)
was filed in the U.S. District Court for the Northern District of California
(the "BEAR CREEK LAWSUIT"). The lawsuit alleges that Pacific Lumber's harvesting
and other activities under certain of its approved and proposed THPs will result
in discharges of pollutants in violation of the CWA. The plaintiff asserts that
the CWA requires the defendants to obtain a permit from the North Coast Water
Board before beginning timber harvesting and road construction activities and is
seeking to enjoin these activities until such permit has been obtained. The
plaintiff also seeks civil penalties of up to $27,500 per day for the
defendant's alleged continued violation of the CWA. The Company believes that
the requirements under the HCP are adequate to ensure that sediment and
pollutants from its harvesting activities will not reach levels harmful to the
environment. Furthermore, EPA regulations specifically provide that such
activities are not subject to CWA permitting requirements. The Company believes
that Pacific Lumber has strong legal defenses in this matter; however, there can
be no assurance that this lawsuit will not have a material adverse impact on the
Company's consolidated financial condition, results of operations or liquidity.

On November 20, 2002, an action entitled Humboldt Watershed Council, et al
v. North Coast Regional Water Quality Control Board, et al. (No. CPF02-502062)
(the "HWC LAWSUIT"), naming Pacific Lumber as real party in interest, was filed
in the Superior Court for the County of San Francisco. The suit seeks to enjoin
Pacific Lumber's timber operations in the Elk and Freshwater watersheds until
and unless the regional and state water boards impose on those operations waste
discharge requirements that meet standards demanded by the plaintiff. On
February 24, 2003, the Court granted Pacific Lumber's motion to change venue to
Humboldt County and deferred consideration of plaintiff's motion for a temporary
restraining order. The Company believes that Pacific Lumber and the regional and
state boards have valid defenses to this action. However, an adverse ruling
could result in a delay of timber operations that could have a material adverse
impact on the Company's consolidated financial position, results of operations
or liquidity.

On February 25, 2003, the recently elected District Attorney of Humboldt
County filed a civil suit entitled The People of the State of California v.
Pacific Lumber, Scotia Pacific Holding Company and Salmon Creek Corporation in
the Superior Court of Humboldt County (No. DR030070) (the "HUMBOLDT DA ACTION").
The suit was filed under California's unfair competition law and alleges that
the Palco Companies used certain unfair business practices in connection with
completion of the Headwaters Agreement, and that this resulted in the Palco
Companies being able to harvest significantly more trees under the Environmental
Plans than would have otherwise been the case. The suit seeks a variety of
remedies including a civil penalty of $2,500 for each additional tree that has
been or will be harvested due to this alleged increase in harvest, as well as
restitution and an injunction in respect of the additional timber harvesting
allegedly being conducted. The Company believes that this suit is without merit;
however, there can be no assurance that the Palco Companies will prevail or that
an adverse outcome would not be material to the Company's consolidated financial
position, results of operations or liquidity.

On November 16, 2001, Pacific Lumber filed a case entitled The Pacific
Lumber Company, et al. v. California State Water Resources Control Board (No.
DR010860) in the Humboldt County Superior Court ("THP NO. 520 LAWSUIT") alleging
that the State Water Board had no legal authority to impose mitigation measures
that were requested by the staff of the North Coast Water Board during the THP
review process and rejected by the CDF. When the staff of the North Coast Water
Board attempted to impose these mitigation measures in spite of the CDF's
decision, Pacific Lumber appealed to the State Water Board, which imposed
certain of the requested mitigation measures and rejected others. Pacific Lumber
filed the THP No. 520 lawsuit challenging the State Water Board's decision, and
on January 24, 2003, the Court granted Pacific Lumber's request for an order
invalidating the imposition of these additional measures. Other claims included
in this action have been dismissed by Pacific Lumber without prejudice to its
future rights. On March 25, 2003, the State Water Board appealed this decision.
While the Company believes the Court's decision will be sustained, a reversal
could result in increased demands by the regional and state water boards and
their staffs to impose controls and limitations upon Pacific Lumber's timber
harvesting beyond those provided for by the Environmental Plans.

KAISER LITIGATION

BANKRUPTCY PROCEEDINGS

See Notes 1 and 4 for a discussion of Kaiser's reorganization proceedings.

ASBESTOS-RELATED LITIGATION

Kaiser is a defendant in a number of lawsuits, some of which involve
claims of multiple persons, in which the plaintiffs allege that certain of their
injuries were caused by, among other things, exposure to asbestos during, and as
a result of, their employment or association with Kaiser or exposure to products
containing asbestos produced or sold by Kaiser. For additional information, see
Note 12 to the Kaiser Financial Statements. As of December 31, 2002, Kaiser had
established an accrual of $126.1 million for asbestos-related costs (net of
estimated insurance recoveries of $484.0 million).

OTHER KAISER LITIGATION

Kaiser is involved in a number of other litigation matters, including
lawsuits related to a 1999 explosion at KACC's Gramercy, Louisiana, alumina
refinery and allegations of unfair labor practices in connection with a two-year
strike by the United Steelworkers of America ("USWA"). See Note 12 to the Kaiser
Financial Statements for information regarding various other lawsuits and claims
which are pending against Kaiser. Generally, claims arising from actions or
omissions prior to the Filing Date will be settled in connection with Kaiser's
plan of reorganization.

OTHER MATTERS

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

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

Not applicable.

PART II

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

The Company's common stock, $.50 par value ("COMMON STOCK"), is traded on
the American Stock Exchange. The stock symbol is MXM. The following table sets
forth, for the calendar periods indicated, the high and low sales prices per
share of the Company's Common Stock as reported on the American Stock Exchange
Consolidated Composite Tape.

2002 2001
-----------------------------------------------
HIGH LOW HIGH LOW
---------- ----------- ---------- ----------

First quarter.............................................. $ 17.80 $ 9.40 $ 16.25 $ 13.00
Second quarter............................................. 13.35 10.50 27.48 11.60
Third quarter.............................................. 11.05 7.00 24.80 18.53
Fourth quarter............................................. 10.90 6.04 20.25 17.02

The following table sets forth the number of record holders of each class
of publicly owned securities of the Company at March 3, 2003:

NUMBER OF
RECORD
TITLE OF CLASS HOLDERS
- ------------------------------------------------------------------------------------------------ -----------

Common Stock.................................................................................... 2,975
Class A $.05 Non-cumulative Participating Convertible Preferred Stock........................... 24

The Company has not declared any cash dividends on its capital stock and
has no present intention to do so.

ITEM 6. SELECTED FINANCIAL DATA

The following summary of consolidated financial information for each of
the five years ended December 31, 2002 is not reported upon herein by
independent public accountants and should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto which are contained in
Item 8 herein.

YEARS ENDED DECEMBER 31,
------------------------------------------------------------
2002 (1) 2001 2000 1999 1998
---------- ----------- ----------- ---------- -----------
(IN MILLIONS OF DOLLARS, EXCEPT SHARE AMOUNTS)
----------- ----------- ---------- -----------
CONSOLIDATED STATEMENT OF OPERATIONS:
Net sales......................................... $ 446.6 $ 2,018.2 $ 2,448.0 $ 2,350.7 $ 2,618.7
Operating income (loss)........................... (16.0) 45.4 130.6 (51.5) 125.6
Income (loss) before extraordinary items(2)....... (86.4) (459.6) 30.0 73.6 (14.7)
Extraordinary items, net (3)...................... 2.4 3.6 3.9 - (42.5)
Net income (loss)................................. (84.0) (456.0) 33.9 73.6 (57.2)

CONSOLIDATED BALANCE SHEET AT END OF PERIOD:
Total assets...................................... 1,107.3 3,935.3 4,504.0 4,393.1 4,075.2
Long-term debt, less current maturities........... 982.3 1,706.8 1,882.8 1,956.8 1,971.7
Stockholders' equity (deficit) (4)................ (582.5) (475.6) 49.1 27.8 (56.8)

PER SHARE INFORMATION:
Basic:
Income (loss) before extraordinary items....... $ (13.23) $ (69.83) $ 3.95 $ 9.58 $ (2.10)
Extraordinary items, net....................... 0.36 0.55 0.52 - (6.07)
---------- ----------- ----------- ---------- -----------
Net income (loss).............................. $ (12.87) $ (69.28) $ 4.47 $ 9.58 $ (8.17)
========== =========== =========== ========== ===========
Diluted:
Income (loss) before extraordinary items....... $ (13.23) $ (69.83) $ 3.95 $ 9.49 $ (2.10)
Extraordinary items, net....................... 0.36 0.55 0.52 - (6.07)
---------- ----------- ----------- ---------- -----------
Net income (loss).............................. $ (12.87) $ (69.28) $ 4.47 $ 9.49 $ (8.17)
========== =========== =========== ========== ===========

- ------------------------------------

(1) Results for the Company's aluminum operations have been included for the
period from January 1, 2002, through February 11, 2002. See Note 1 for a
discussion of the Chapter 11 filing by the Debtors.
(2) Income (loss) before extraordinary items for 2002 includes other items of
$0.5 million attributable to Kaiser for the period from January 1, 2002,
through February 11, 2002 (see Note 3). 2001 results include the following
related to Kaiser: additional valuation allowances related to Kaiser's
deferred tax assets of $505.4 million (see Note 12), business interruption
insurance recoveries of $36.6 million (see Note 3), a pre-tax gain of
$163.6 million on the sale of an approximate 8.3% interest in QAL (see Note
5), a pre-tax charge of $57.2 million for asbestos-related claims, and net
gains on power sales and several other non- recurring items totaling $163.6
million (see Note 3). 2001 results include the following related to forest
products: a pre-tax gain of $16.7 million on the sale of the Grizzly Creek
grove (see Note 5). 2000 results include the following related to Kaiser:
estimated business interruption insurance recoveries of $110.0 million and
several other non-recurring items totaling $48.9 million (see Note 3). 2000
results include the following related to forest products: a pre-tax gain on
the sale of the Owl Creek grove of $60.0 million. 1999 results include the
following related to Kaiser: a pre-tax gain on the involuntary conversion
at the Gramercy facility of $85.0 million, a pre-tax charge of $53.2
million for asbestos-related claims and a pre-tax gain of $50.5 million on
the sale of AKW L.P. 1999 results include the following related to forest
products: a pre-tax gain of $239.8 million on the sale of the Headwaters
Timberlands.
(3) The extraordinary gains for 2002 and 2001 relate to repurchases of the 12%
Senior Secured Notes of MGHI (the "MGHI NOTES"). The extraordinary gain for
2000 relates to the repurchase of Timber Notes. The extraordinary loss for
1998 relates to refinancing of forest products long-term debt.
(4) MAXXAM Inc. has not declared or paid any cash dividends during the five
year period ended December 31, 2002.

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

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

RESULTS OF OPERATIONS

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

The Company operates in three industries: forest products, through MGI and
its wholly owned subsidiaries, principally Pacific Lumber, Scotia LLC and Britt;
real estate investment and development, managed through MPC; and racing
operations through SHRP, Ltd. MGHI owns 100% of MGI and is a wholly owned
subsidiary of the Company. In addition, the Company owns 62% of Kaiser, an
integrated aluminum producer. All references to the "Company," "Kaiser," "MGHI,"
"MGI," "Pacific Lumber," "MPC" and "SHRP, Ltd." refer to the respective
companies and their subsidiaries, unless otherwise indicated or the context
indicates otherwise.

DECONSOLIDATION OF KAISER

Under generally accepted accounting principles, consolidation is generally
required for investments of more than 50% of the outstanding voting stock of an
investee, except when control is not held by the majority owner. Under these
rules, legal reorganization or bankruptcy represent conditions which can
preclude consolidation in instances where control rests with the Bankruptcy
Court, rather than the majority owner. As a result of Kaiser's filing for
bankruptcy (as discussed in Note 1), Kaiser's financial results were
deconsolidated beginning February 12, 2002, and the Company began reporting its
investment in Kaiser using the cost method, under which the investment is
reflected as a single amount on the Company's balance sheet of $(516.2) million,
and the recording of earnings or losses from Kaiser was discontinued after
February 11, 2002. Since Kaiser's results are no longer consolidated and the
Company believes that it is not probable that it will be obligated to fund
losses related to its investment in Kaiser, any adjustments reflected in
Kaiser's financial statements subsequent to February 12, 2002 (relating to the
recoverability and classification of recorded asset amounts and classification
of liabilities or the effects on existing stockholders' deficit as well as
adjustments made to Kaiser's financial information for loss contingencies and
other matters), are not expected to affect the Company's financial results.

The following condensed pro forma financial data reflects the results of
operations of the Company, excluding Kaiser, for the periods presented (in
millions, except share data).

YEAR ENDED DECEMBER 31,
--------------------------------------
2002 2001 2000
----------- ----------- ------------

Net sales.................................................................. $ 279.1 $ 285.5 $ 278.2
Costs and expenses......................................................... (271.5) (311.0) (292.8)
----------- ----------- ------------
Operating income (loss).................................................... 7.6 (25.5) (14.6)
Other income (expenses), net............................................... 17.9 50.5 127.0
Interest expense........................................................... (80.2) (81.7) (83.4)
----------- ----------- ------------
Income (loss) before income taxes and minority interests................... (54.7) (56.7) 29.0
Income tax benefit (provision)............................................. 16.5 18.7 (15.5)
Minority interests......................................................... 0.3 - -
----------- ----------- ------------
Income (loss) before extraordinary items................................... (37.9) (38.0) 13.5
Extraordinary items........................................................ 2.4 3.6 3.9
----------- ----------- ------------
Net income (loss).......................................................... $ (35.5) $ (34.4) $ 17.4
=========== =========== ============

Net income (loss) per share:
Basic................................................................... $ (5.45) $ (5.22) $ 2.30
Diluted................................................................. (5.45) (5.22) 2.29

See Note 4 for further discussion of Kaiser's reorganization proceedings
and other information regarding the Company's investment in Kaiser. See also the
Kaiser Financial Statements attached hereto as Exhibit 99.1.

FOREST PRODUCTS OPERATIONS

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

The Company's forest products operations are conducted by MGI, through
Pacific Lumber, Scotia LLC and Britt. The segment's business is somewhat
seasonal, and its net sales have been historically higher in the months of April
through November than in the months of December through March. Management
expects that MGI's revenues and cash flows will continue to be somewhat
seasonal. Accordingly, MGI's results for any one quarter are not necessarily
indicative of results to be expected for the full year.

Regulatory and environmental matters play a significant role in the
Company's forest products operations. See Item 1. "Business - Forest Products
Operations - Regulatory and Environmental Matters" and Note 16 for a discussion
of these matters. Regulatory compliance and related litigation have caused
delays in obtaining approvals of THPs and delays in harvesting on THPs once they
are approved. This has resulted in a decline in harvest, an increase in the cost
of logging operations, and lower net sales, as well as increased costs related
to timber harvest litigation.

Since the consummation of the Headwaters Agreement in March 1999, there
has been a significant amount of work required in connection with the
implementation of the Environmental Plans, and this work is expected to continue
for several more years. In 1999 and 2000, this caused delays in obtaining
approvals of THPs. The rate of approvals of THPs during 2001 improved over that
for the prior year, and further improvements were experienced in 2002. As
discussed in Note 16, other factors may adversely impact the Company's ability
to meet its harvesting goals. The North Coast Water Board is requiring the
Company to apply certain waste discharge requirements to approved THPs covering
winter harvesting operations in the Freshwater and Elk River watersheds, and the
North Coast Water Board could require the Company to follow waste discharge
requirements before harvesting operations are conducted on THPs in other
watersheds. This requirement could cause delays in harvesting. A stay issued in
connection with the EPIC-SYP/Permits lawsuit requires the Company to follow an
alternative THP approval process for THPs submitted to the CDF after
mid-October, resulting in delays in obtaining approvals of THPs.

Furthermore, there can be no assurance that certain other pending legal,
regulatory and environmental matters or future governmental regulations,
legislation or judicial or administrative decisions, adverse weather conditions,
or low lumber or log prices, will not have a material adverse effect on the
Company's financial position, results of operations or liquidity. See Item 1.
"Business--Forest Products Operations--Regulatory and Environmental Factors,"
Item 3. "Legal Proceedings" and Note 16 for further information regarding
regulatory and legal proceedings affecting the Company's operations.

During 2001, comprehensive external and internal reviews were conducted of
Pacific Lumber's business operations. These reviews were conducted in an effort
to identify ways in which Pacific Lumber could operate on a more efficient and
cost effective basis. Based upon the results of these reviews, Pacific Lumber,
among other things, closed two of its four sawmills, eliminated certain of its
operations, including its soil amendment and concrete block activities, began
utilizing more efficient harvesting methods and adopted certain other cost
saving measures. Most of these changes were implemented by Pacific Lumber in the
last quarter of 2001, or the first quarter of 2002. Pacific Lumber also ended
its internal logging operations (which historically performed approximately half
of its logging) as of March 31, 2002, and now relies exclusively on contract
loggers. In connection with the changes described above, Pacific Lumber recorded
charges to earnings of $2.2 million for impaired assets, $2.6 million for
restructuring initiatives, and $3.4 million for environmental remediation costs
during 2001 (see Note 3). Further actions may be taken during the next year as a
result of Pacific Lumber's continuing evaluation process, and additional
writedowns of certain assets may be required.

In May 2002, the Company completed the first timber cruise on its
timberlands since 1986. The results of the timber cruise provided the Company
with an estimate of the volume of merchantable timber on the Company's
timberlands. The new cruise data reflected a 0.1 million MBF decrease in
estimated overall timber volume as compared to the estimated volumes reported as
of December 31, 2001, using the 1986 cruise data (adjusted for harvest and
estimated growth). The new cruise data indicates that there is significantly
less old growth timber than estimated as of December 31, 2001, using the 1986
cruise data. There was also an estimated increase in young growth timber volume
almost equal to the estimated decrease in old growth timber volume. This change
in mix could adversely affect the Company's revenues. However, because there are
many variables that affect revenues and profitability, the Company cannot
quantify the effect of the revised estimate on current and future cash flows.
The new timber volumes are now being utilized in various aspects of the
Company's operations, including estimating volumes on THPs and determining
depletion expense.

The following table presents selected operational and financial
information for the years ended December 31, 2002, 2001 and 2000 for the
Company's forest products operations.

YEARS ENDED DECEMBER 31,
------------------------------
2002 2001 2000
--------- --------- ---------
(IN MILLIONS OF DOLLARS,
EXCEPT SHIPMENTS AND PRICES)
--------- ---------
Shipments:
Lumber: (1)
Redwood upper grades......................................................... 27.0 16.2 15.8
Redwood common grades........................................................ 224.3 165.0 143.8
Douglas-fir upper grades..................................................... 4.7 8.8 11.5
Douglas-fir common grades.................................................... 22.4 50.5 76.1
Other........................................................................ 0.1 3.9 5.9
--------- --------- ---------
Total lumber.................................................................... 278.5 244.4 253.1
========= ========= =========
Wood chips (2).................................................................. 68.8 104.9 169.5
========= ========= =========
Average sales price:
Lumber: (3)
Redwood upper grades...............