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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

     WASHINGTON, D.C. 20549
_______________________________

FORM 10-Q
_______________________________

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR

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

Commission file number 0-23259

U.S. TIMBERLANDS KLAMATH FALLS, LLC

U.S. TIMBERLANDS FINANCE CORP.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: 212-755-1100
________

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          

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PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

U.S. TIMBERLANDS KLAMATH FALLS, LLC

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS)

(UNAUDITED)

See notes to the condensed consolidated financial statements

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U.S. TIMBERLANDS KLAMATH FALLS, LLC

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS)

(UNAUDITED)

See notes to the condensed consolidated financial statements

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U.S. TIMBERLANDS KLAMATH FALLS, LLC

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)

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U.S. TIMBERLANDS KLAMATH FALLS, LLC

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to the condensed consolidated financial statements

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U.S. TIMBERLANDS KLAMATH FALLS, LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except as otherwise indicated) (Unaudited)

1. Business and Basis of Presentation

Business

The accompanying consolidated financial statements include the accounts of U.S. Timberlands Klamath Falls, LLC (“USTK”), a Delaware limited liability company, and its wholly owned subsidiary, U.S. Timberlands Finance Corp. (“Finance Corp”), collectively referred to hereafter as the Company. Finance Corp. serves as the co-obligor for USTK’s 9 5/8% Senior Notes due 2007 (the “Notes”). It has nominal assets and does not conduct operations. All intercompany transactions have been eliminated in consolidation.

U.S. Timberlands Company, LP (the “MLP”) owned a 99% common membership interest in USTK. The MLP was formed in 1997 to acquire and own substantially all of the equity interests in USTK and to acquire and own the business and assets of U.S. Timberlands Management Company, LLC. U.S. Timberlands Services Company, LLC (the “Manager”) manages the business of the Company and owns a 1% common membership interest in USTK.

On October 17, 2002, the MLP announced that it had signed a definitive agreement to be acquired by an acquisition company formed by a group led by senior management (the privatization transaction). The definitive agreement contemplated a cash tender offer for 100% of the outstanding common limited partnership units not already owned by the acquiring entity or its affiliates for $3.00 per unit in cash, followed by a merger of the acquisition company with and into the MLP, pursuant to which each common limited partnership unit not already owned by the acquiring entity or its affiliates would be converted into the right to receive $3.00 per unit in cash. The tender offer commenced on November 19, 2002 and was completed on March 6, 2003. Pursuant to the tender offer, approximately 71% of the Company’s common units were tendered. The acquisition group therefore controlled approximately 87% of the outstanding common units. The remaining common units not purchased in the tender offer were acquired by the acquisition group in a merger that was completed on June 26, 2003. As a result of this privatization transaction, the 99% non-managing membership interest in the Company is owned indirectly by U.S. Timberlands Holding Group, LLC.

The primary activity of the Company is the growing of trees and the sale of logs and standing timber to third party wood processors and related party purchasers. The Company’s timber is primarily located in Oregon, east of the Cascade Range. Logs harvested from the timberlands are sold to unaffiliated domestic conversion facilities. These logs are processed for sale as lumber, plywood and other wood products, primarily for use in new residential home construction, home remodeling and repair and general industrial applications.

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Basis of Presentation

These condensed consolidated financial statements have been prepared by the Company, without audit by independent public accountants, pursuant to the rules and regulations of the United States Securities and Exchange Commission. In the opinion of management, the accompanying unaudited financial statements include all normal recurring adjustments necessary to present fairly the information required to be set forth therein. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted from these statements pursuant to such rules and regulations and, accordingly these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s 2002 Annual Report on Form 10-K. Operating results for the quarter and the six month period ended June 30, 2003 are not necessarily indicative of the results that may be expected for the full year or any other period.

There have been no significant changes in the accounting policies of the Company.

2. Timber and Timberlands

Timber and Timberlands consisted of the following:

3. Investment In Affiliate

The following is summarized financial information for U.S. Timberlands Yakima, LLC (USTY), an affiliate of the Company accounted for under the equity method:

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During the first half of 2003, the Company contributed timberlands located in Central Oregon to USTY. The contributions have an aggregate agreed upon value of $12.9 million and were added to the Company’s Preferred Interest in USTY. Terms of the additional senior preferred interest acquired are the same terms as the senior preferred interest previously issued to the Company. The Company recorded its additional preferred interests at its aggregate costs for the timberlands of approximately $11.6 million.

4. Short-Term Debt

The Company had a credit facility with an affiliate of the General Partner (the “Affiliate Credit Facility”) consisting of a revolving line of credit of up to $12.0 million. Borrowings under the Affiliate Credit Facility bore interest at the prime lending rate as published in the Wall Street Journal plus applicable margin, which was based on the Company’s leverage ratio. The Affiliate Credit Facility expired, by its terms, at the end of April 2002. The Company is seeking to replace the Affiliate Credit Facility with a working capital facility from an unaffiliated third party. However, there can be no assurance that the Company will be able to obtain a working capital credit facility in amounts sufficient to fund its working capital needs from a traditional commercial lender. While the Company continues to seek a credit facility from an unaffiliated source, affiliated lenders have made short term advances to the Company, payable on demand to the affiliates, at an annual interest rate of 10%. The affiliate has made no commitment to continue lending funds to the Company, and each request is reviewed on a case by case basis.

5. Long-Term Debt and Distributions

As of June 30, 2003, the Company was not permitted to make any distributions as it had not exceeded the requisite Consolidated Fixed Charge Coverage Ratio within the Restricted Payments provisions of the 9 5/8% Senior Notes issued by the Company.

6. Unit-based Compensation Plans

The MLP had a Unit Option Plan which permits the grant of unit options to employees and directors of the Company who perform services for the Company covering 857,749 Common Units. As permitted under SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, which was issued in December 2002 and amended SFAS No. 123, Accounting for Stock-Based Compensation, the Company has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation arrangements as defined by Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. The following table illustrates the effect on net loss if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.

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In connection with the privatization transaction described in Note 1, each outstanding unit option granted under the Unit Option Plan was converted into an option to receive, upon exercise, including payment of the exercise price, the merger consideration as defined. Because the exercise price for each option is greater than the merger consideration, the Company does not expect any options to be exercised.

7. Recent Accounting Standards

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” as an amendment to SFAS No. 123 by introducing two additional conversion methods when converting to the fair value based method from the intrinsic value method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects on reported net income (loss) of an entity’s accounting policy decisions with respect to stock-based employee compensation and amends APB Opinion No. 28 to require disclosure about those effects in interim financial information. The disclosure provisions are effective for fiscal years ending after December 15, 2002 and for interim periods beginning after December 15, 2002. The Company follows the intrinsic value method of accounting for stock-based employee

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compensation, but will continue to evaluate the benefits of a voluntary change to the fair value based method.

In January 2003, the FASB issued Interpretation No. 46 (FIN 46) "Consolidation of Variable Interest Entities" which is an interpretation of Accounting Research Bulletin No. 51 "Consolidated Financial Statements". FIN 46 requires the consolidation of entities in which an enterprise absorbs a majority of the entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Currently, entities are generally consolidated by an enterprise when it has a controlling financial interest through ownership of a majority voting interest in the entity.

The provisions of FIN 46 are required to be applied by the Company no later than July 1, 2003, and would require the Company to consolidate the financial statements of U.S. Timberlands Yakima, LLC (“USTY”) its unconsolidated affiliate which is presently being accounted for on the equity method. If the Company had consolidated USTY beginning January 1, 2003, there would have been no effect on the Company's net loss for the six months ended June 30, 2003, however revenues would have increased by $4,116, expenses would have increased by $9,104 and the $4,988 equity in net loss of affiliate would be eliminated. In addition, although there would be no change in members’ equity/(deficiency), total assets would increase by approximately $140,000, principally representing timber and timberlands, and total liabilities would increase by approximately $140,000 including $129,000 of long-term debt at June 30, 2003. Such long-term debt is collateralized by all of the USTY assets and the debt holder does not have recourse to the Company. The Company’s maximum exposure to loss as a result of its involvement with USTY is limited to its preferred ownership investment in USTY, which amounts to $45,465 at June 30, 2003.

8. Contribution to Capital of the Company

In May of 2003, U.S. Timberlands Acquisition Co., LLC reimbursed the Company for certain expenses aggregating $1,238 incurred by the Company in connection with the privatization transaction described in Note 1. These expenses consisted principally of legal expenses of the Company and the Special Committee and a fairness opinion fee to an investment banking firm retained by the Committee, which previously had been allocated to and paid by the Company. The reimbursement has been recorded as a contribution to the capital of the Company.

9. Litigation

On April 25, 2002, the Company announced that several purported class action lawsuits were filed in the Court of Chancery of the State of Delaware for the County of New Castle against the Manager and the board of directors of the General Partner alleging, among other things, breach of fiduciary duty and self-dealing by the Manager and the board in connection with the going private transaction. The lawsuits sought to enjoin the going private transaction, to rescind the going private transaction if it is consummated, and to recover damages and attorney’s fees. The lawsuits also named the Company as a defendant. On July 12, 2002, the Company was notified that all of the purported class action lawsuits were consolidated into one class action lawsuit by the Court of Chancery of the State of Delaware. On October 17, 2002, the Company announced that it had reached a tentative settlement of the purported class action lawsuits, subject to court

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approval and other customary conditions. The settlement provided, among other things, for an increase in the consideration provided in the offer to purchase the common units to $3.00 per unit. On December 12, 2002 the parties executed a Stipulation of Settlement which the Court of Chancery approved at a settlement hearing on January 30, 2003.

On June 21, 2002, the Company was notified that it was named in a lawsuit filed in State Court in Oregon as a codefendant seeking medical expenses and up to $12.0 million in damages for injuries sustained by the minor child of an employee of the Manager while riding on equipment owned by the Manager. At the time, liability insurance was in place, however, the insurance underwriter has since gone bankrupt and coverage is limited and is being administered by the Oregon Guarantee Insurance Association.

Management and its counsel are still reviewing the facts of the injury claims and it is too early to assess their effect on the Company.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

Certain information contained in this report may constitute forward-looking statements within the meaning of the federal securities laws. Although the Company believes that expectations reflected in such forward-looking statements are based upon reasonable assumptions, it can give no assurance that its expectations will be achieved. Forward-looking information is subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected. Such risks, trends and uncertainties include the highly cyclical nature of the forest products industry, general economic conditions, competition, price conditions or trends for the Company’s products, the possibility that timber supply could increase if governmental, environmental or endangered species policies change, and limitations on the Company’s ability to harvest its timber due to adverse natural conditions or increased governmental restrictions. These and other risks are described in the Company’s other reports and registration statements, which are available from the United States Securities and Exchange Commission.

In June 2003, a major customer and competitor of the Company, Crown Pacific filed for relief under Chapter 11 of the Bankruptcy Code. There was no direct financial impact to the Company. It is not known at this time how this bankruptcy will impact the forest products industry in which the Company operates, although it may lead to increased timber supply in the market.

Application of Critical Accounting Policies

The Company's condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Certain accounting policies have a significant impact on amounts reported in the financial statements. A summary of those significant accounting policies can be found in Note 1 to the Company's financial statements included in the Company's 2002 Annual Report on Form 10-K. The Company has not adopted any significant new accounting policies during the six months ended June 30, 2003.

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Among the significant judgments made by management in the preparation of the Company's financial statements are the determination of the allowance for doubtful accounts and the rates of depletion applicable to the Company's merchantable timber. These determinations are made periodically in the ordinary course of accounting.

Overview

The Company’s principal operations consist of growing and harvesting timber and selling logs, standing timber and related by-products to third party wood processors and related purchasers. These logs and byproducts are processed for sale as lumber, molding products, doors, mill work, commodity, specialty and overlaid plywood products, laminated veneer lumber, engineered wood I-beams, particleboard, hardboard, paper and other wood products. These products are used in residential, commercial and industrial construction, home remodeling and repair, general industrial applications and a variety of paper products. The results of the Company’s operations and its ability to pay distributions to its members depend upon a number of factors, many of which are beyond its control. These factors include general economic and industry conditions, domestic and export prices, supply and demand for timber logs, seasonality, government regulations affecting the manner in which timber may be harvested, and competition from other supplying regions and substitute products. The Company is currently not permitted to make any distributions to members (see Financial Condition and Liquidity).

Seasonality

The Company’s log and standing timber sales volumes are generally at their lowest levels in the first and second quarters of each year. In the first quarter, heavy snowfalls in higher elevations prevent access to many areas of the Company’s timberlands. This limited access, along with spring break-up conditions (when warming weather thaws and softens roadbeds) in March or April, restricts logging operations to lower elevations and areas with rockier soil types. As a result of these constraints, the Company’s sales volumes are typically at their lowest in the first quarter, improving in the second quarter and at their highest during the third and fourth quarters. Most customers in the region react to this seasonality by carrying sufficiently high log inventories at the end of the calendar year to carry them to the second quarter of the following year.

Current Market Conditions

Second quarter 2003 prices for finished wood products (e.g. lumber, plywood and engineered wood products) were lower than the first quarter 2003 and lower than the same period in 2002. Ponderosa Pine prices continued to lead the decline. Veneer prices were also down in the second quarter 2003.

Delivered log prices declined in White Fir and Ponderosa Pine respectively at 10% and 2% in the second quarter of 2003 compared to the comparable quarter of the prior year. Douglas Fir and Incense Cedar prices did not decline during the quarter.

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Quarter Ended June 30, 2003 Compared to Quarter Ended June 30, 2002

Revenues

Revenues for the quarter ended June 30, 2003 were $14.7 million, a decrease of $0.8 million or 5% from revenues of $15.5 million for the same period in 2002. The decrease in revenues during the second quarter of 2003 was caused by lower log sales volume and lower timber deed sales, offset in part by higher timberland sales.

Timber deed sales for the second quarter of 2003 were $1.5 million on volume of 10.9 million board feet (“MMBF”), as compared to the same period in 2002, when timber deed sales were $10.1 million on 88.5 MMBF. The average timber deed price was $136 per thousand board feet (“MBF”) during the second quarter of 2003, as compared to $114 per MBF for the same period in 2002.

Log sales for the quarter ended June 30, 2003 were $4.6 million on volume of 14.3 MMBF, as compared to the same period in 2002 when log sales were $5.0 million on 14.6 MMBF. The average sales price was $320 per MBF for the second quarter of 2003, as compared to an average of $341 per MBF for the same period in 2002. The decrease in log prices reflects a general decrease in the market.

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In addition, property sales for the second quarter were $8.3 million, as compared to $0.0 million for the same period in 2002.