10-K 6 t_k107.txt ANNUAL REPORT, 4-30-2001 TREESOURCE INDUSTRIES, INC. 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 Commission file number April 30, 2001 0-16158 TREESOURCE INDUSTRIES, INC., formerly WTD Industries, Inc. (Exact name of registrant as specified in its charter) Oregon 93-0832150 (State of Incorporation) (I.R.S. Employer Identification No.) 529 S.E. Grand Ave, Suite 300 Registrant's telephone number, Portland, Oregon 97214 including area code: (503) 246-3440 (Address of principal executive offices) Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value (Title of Class) 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 (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 twelve 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 ----- ----- State the aggregate market value of the Common Stock held by non-affiliates of the registrant, as of July 12, 2001: $111,629. Indicate the number of shares outstanding of each of the registrant's classes of Common Stock, as of July 12, 2001: Common Stock, no par value: 11,162,874. -1- FORM 10-K TABLE OF CONTENTS Item No. Page No. -------------------------------------------------------------------------------- PART I 3 Item 1. BUSINESS 3 Item 2. PROPERTIES 8 Item 3. LEGAL PROCEEDINGS 9 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 9 PART II 10 Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 10 Item 6. SELECTED FINANCIAL DATA 11 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 12 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 20 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 20 PART III 21 Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 21 Item 11. EXECUTIVE COMPENSATION 23 Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 31 Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 32 PART IV 33 Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K 33 (a) (1) Financial Statements 33 (a) (2) Financial Statement Schedules 33 (a) (3) Exhibit Index 33 (b) Reports on Form 8-K 39 -2- PART I Item 1. BUSINESS The Company ----------- TreeSource Industries, Inc. is a corporation organized in Oregon in 1983, which, through its subsidiaries, manufactures softwood and hardwood lumber and by-products. TreeSource Industries, Inc. and its subsidiaries are hereinafter referred to as "TreeSource" or the "Company." The Company changed its name effective October 27, 1998 from WTD Industries, Inc. to TreeSource Industries, Inc. The Company markets its products primarily in the United States and Canada. Reorganization of the Company ----------------------------- During the third quarter of fiscal 1998, demand by Asia for wood products declined dramatically causing lumber prices in North America to decline. Lumber markets remained weak through the third quarter of fiscal 1999. The Company incurred significant losses as a result of this protracted period of weak lumber markets combined with the Company's high level of debt and substantial preferred stock dividend obligations, and failed to generate sufficient cash from operations to enable the Company to pay its commitments and continue operating. In response to this situation, on September 27, 1999 the Company filed for voluntary reorganization under Chapter 11 of the U.S. Bankruptcy Code (the "Code"). The Company continues to operate its business as a debtor-in-possession. As a debtor-in-possession under the Code, the Company is authorized to operate its business subject to the terms of a cash collateral order, but may not engage in transactions outside of the ordinary course of business without Court approval. In April 2000 the Company filed a plan of reorganization with the U.S. Bankruptcy Court (the "Court"). Due to the downturn in the lumber market, the Company successfully petitioned the Court to delay consideration of and then to withdraw the plan of reorganization. On March 31, 2001 the period of exclusivity (the time in which the Company has the sole right to present a plan of reorganization) expired, which will allow other interested parties an opportunity to submit a plan of reorganization. No alternative plan of reorganization has been proposed. In July 2001, the Company's pre-petition senior secured debt securities were purchased by an investment group. This sale, in itself, may not affect the status of the Company's bankruptcy proceedings. In an effort to maximize value for all parties, the Company is evaluating its strategic alternatives, which include a sale of the Company's operations. The Company's senior secured lenders have a security interest in substantially all the assets of the Company. Regardless of which alternative the Company ultimately pursues it is unlikely that the Company's current classes of common and preferred stock will have any value upon conclusion of the bankruptcy proceedings. During fiscal 2001 the Company sold at auction the machinery and equipment at its facilities in Burke, Vermont, Central Point, Oregon, Midway, Oregon, and curtailed -3- production indefinitely at its mills in Morton, Washington, South Bend, Washington, and North Powder, Oregon. All of the mill assets, except for the assets of the Glide, Spanaway, Trask, and Tumwater mills, are classified as "Assets held for sale" and are carried at management's estimate of their net realizable value, including any estimated remediation costs that have not been separately classified as environmental liabilities. Products and Markets -------------------- Softwood Lumber --------------- The Company manufactures a variety of softwood lumber products, predominantly from Douglas fir, hemlock, and white fir. The Company produces softwood studs in several species, generally as 2x4 or 2x6 lumber in lengths of 8 to 10 feet. The Company also makes dimension softwood lumber in a wide range of widths and thicknesses in lengths from 6 to 26 feet. Softwood lumber accounted for 86% of net sales in fiscal 2001, 89% of net sales in fiscal 2000, and 87% of net sales in fiscal 1999. The Company sells softwood lumber to a large number of customers, but the majority of sales are made to distribution centers and wholesalers and directly to large retailers. Softwood lumber is used in a variety of applications, including residential and commercial construction, packaging, and industrial uses. Other Products -------------- The Company produces a small quantity of hardwood lumber in sizes targeted principally for the furniture and cabinet industries. Wood chips, a by-product of the manufacturing process, are sold principally to pulp and paper manufacturers. Wood chips and other by-products accounted for 8% of net sales in fiscal 2001, 7% of net sales in fiscal 2000, and 8% of net sales in fiscal 1999. Distribution and Marketing -------------------------- The Company markets, distributes, and arranges transportation for its lumber products through TreeSource Industries, Inc. Through its centralized sales function, the Company coordinates the production capabilities of individual mills to meet a broad range of customer needs. TreeSource sells primarily through telephone contacts from its office in Portland, Oregon. Shipments of wood products are generally made by rail or truck directly from the mill. Exports do not represent a material portion of the Company's net sales. The Company does not attempt to accumulate a large backlog of orders. TreeSource's general practice is to maintain an order file ranging from about one to four weeks' production. The filling of orders for certain items, however, may require a substantially longer period of time. The dollar value of the Company's backlog of orders at April 30, 2001 and 2000 was $4 million and $8 million, respectively. Backlog on any particular date may not be indicative of the Company's average backlog, net sales, or the backlog for any succeeding period. -4- No single customer accounted for as much as 10% of the Company's net sales during fiscal 2001. The loss of any one customer would not, in management's opinion, have a material adverse impact on the Company and its subsidiaries taken as a whole. Timber Supply ------------- The Company has historically purchased timber and logs in sufficient quantities to match only the current operating requirements of its mills. During the past year the Company generally increased the quantity of logs held in inventory pursuant to its revised procurement strategy to allow it to maintain timber and log supplies to assure reasonably uninterrupted mill production during periods of inclement weather and changes in local log market conditions. The goal of the strategy is to allow mills to increase their hours of operation, more effectively manage both the price and quality of log purchases during periods of tight supply, and maintain more stable operating costs. Timber and logs comprise the majority of the cost of products sold by the Company. The Company relies mainly on open market log purchases to supply its raw material needs. It also purchases timber-cutting contracts ("timber contracts") and has historically obtained logs to a minor extent from its own fee timberlands. At April 30, 2001, the Company owned a small amount of fee timberlands in the vicinity of various mills. The following table shows the percentages of logs supplied by open market purchases, public timber contracts and fee timberlands, and total log footage required: Year Ended Open Timber Fee Log April 30, Market Contracts Timber Requirements ---------- ------ --------- ------ ------------ 1996 94% 5% 1% 228,162 MBF 1997 94% 5% 1% 320,507 MBF 1998 94% 6% -- 284,300 MBF 1999 94% 5% 1% 233,501 MBF 2000 96% 4% -- 279,670 MBF 2001 89% 11% -- 163,001 MBF MBF - Thousand Board Feet During fiscal years 1996 through 1999, the Company operated most of its mills on a one-shift basis, typically using logs purchased on the open market from industrial and non-industrial private land owners. In the latter half of fiscal 1999 and the first quarter of fiscal 2000, three mills were moved to a two-shift operating basis, increasing their annual log consumption. During the last quarter of fiscal 2000 and continuing through fiscal 2001, however, the production at five of the Company's nine operating mills was curtailed due to the relatively low lumber market prices, which dramatically reduced the Company's annual log requirements. The ability to maintain the present level of operations at the Company's mills depends on a continuing supply of logs from these private sources. The availability and cost of timber and logs have been, and should continue to be, influenced by a variety of factors, including demand by domestic and export competitors, the environmental and harvest policies of federal and state agencies, and in the long term, the acreage of commercial timberland. For further discussion of current industry -5- conditions relating to timber supply, see the section titled "Factors Affecting Forward-Looking Statements--Availability of Logs." Employees --------- The Company and its subsidiaries had approximately 500 employees at July 12, 2001. The Company uses bonus programs to motivate its employees. See Note 10 to Consolidated Financial Statements. Environmental Regulation ------------------------ The Company is subject to federal, state, and local pollution control regulations, including those regulating air, water, and noise pollution, that have required, and are expected to continue to require, operating and capital expenditures. During fiscal 2001, the Company incurred expenditures of approximately $134,000 for environmental protection measures. Expenditures are projected to be approximately $1,130,000 for fiscal 2002.

1. These facilities are classified as "Assets Held for Sale" and, because they were determined to be impaired, are carried at estimated fair values. The fair values were based upon appraisal values and include estimated remediation costs to prepare the site for sale if such costs are not separately classified as an environmental liability. 2. Environmental remediation is anticipated to be required and the cost for the known issues have been estimated and accrued. The Company recognizes and accrues for environmental remediation costs when they are probable and the costs can be estimated. Generally, environmental remediation costs may be higher than budgeted if sawmill operations at a site cease, the equipment is -6- auctioned, and the land is placed for sale. Since all of the assets of the Company are for sale and the outcome of such a sale is uncertain, the extent, if any, of any additional required environmental remediation at many of the Company's mill sites is unknown. Additional expenditures may be necessary to remediate the sites in preparation for sale. Such amounts cannot be estimated at this time and may be material. Changes in various regulations regarding air and water emissions and disposal or landfill of log yard debris may require material expenditures in the future. See "Factors Affecting Forward-Looking Statements--Federal and State Regulations." Industry Conditions ------------------- The United States lumber industry is highly sensitive to the condition of the nation's economy and tends to experience poor financial results during general economic downturns. Although sales traditionally increase in the spring and summer months and decline during the fall and winter months in response to seasonal building construction cycles, such seasonal patterns are sometimes absent. The lumber market experienced difficult conditions throughout fiscal 2001 due to an over supply of lumber. North American housing starts and lumber production reached their highest levels for the decade in calendar 1999: 1.77 million housing starts and 65.6 billion board feet of production respectively. As interest rates increased in calendar 2000, housing starts declined 4% to 1.70 million. This decline in demand relative to the lumber industry's production capacity caused lumber prices for many products to fall to their lowest levels since 1992. This over-capacity situation persisted throughout fiscal 2001 causing mills to either curtail production or close permanently. Wood chip demand and prices are determined by conditions in the global pulp and paper industry and generally are not affected by seasonal business cycles. During the first three quarters of fiscal 2001, demand for pulp and paper products improved as compared to fiscal 2000. However, starting in December 2000 and continuing throughout the last quarter of fiscal 2001, demand fell off sharply due to the overall slowdown in the U.S. economy. By April 2001, this drop in the quantity demanded triggered a decline in unit prices of several key paper grades by more than 10% as compared to the previous year. Decreased paper prices forced many producers to begin curtailing production, which ultimately put substantial downward pressure on wood chip prices as the quantity of chips available exceeded the quantity needed by the paper industry. See "Factors Affecting Forward-Looking Statements." Competition ----------- The wood products industry is highly competitive and includes a large number of companies manufacturing relatively standardized products. The principal means of competition in the lumber industry are log costs, fiber recovery, unit production costs, pricing, product quality, and the ability to satisfy customer needs promptly. The Company believes it can compete effectively based on the foregoing factors. Some of TreeSource's competitors are large, integrated companies that have significantly greater financial, production and marketing resources than the Company. Some of these competitors have a significant base of low-cost fee timberlands and timber contracts, which protects them from fluctuations in log prices and gives them an advantage over the -7- Company, which relies on the open log market to supply the bulk of its raw materials requirements. The Company's competition also includes lumber manufacturers located in Canada that benefit from advantageous exchange rates and, in some areas, low-cost government owned timber when exporting lumber to the United States. Due to the recent expiration of the North American Softwood Lumber Agreement between the U.S. and Canada, the industry could be negatively impacted if substantial amounts of Canadian lumber flow into U.S. markets. A countervailing duty suit, filed by the Coalition for Fair Lumber Imports on April 2, 2001, initiated a review of the issue by both the U.S. Department of Commerce and the U.S. International Trade Commission. However, because of the number of complex legal and economic questions remaining to be answered, the ultimate resolution of this issue is uncertain. See the sections titled, "Timber Supply," "Management's Discussion and Analysis of Financial Condition and Results of Operations," and "Factors Affecting Forward-Looking Statements." Item 2. PROPERTIES

(1) The machinery and equipment of all facilities are subject to the security interests of certain lenders. (2) Capacity is generally computed using a two-shift-per-day, five-day-per-week operating schedule. (3) The equipment at these facilities has been auctioned and the land is being prepared for sale. (4) Facility operated during fiscal 2001 and has subsequently ceased operating and is for sale. (5) This facility is currently operating as a custom drying operation and is for sale. (6) These subsidiaries lease the real property on which the mill is located pursuant to ground leases. During fiscal 2001 the equipment at the Burke and Central Point facilities was auctioned and the land is currently being prepared for sale. In addition, production at the Morton, North Powder, and South Bend facilities was curtailed indefinitely and these facilities are being held for sale. The Company continues to hold for sale the remaining assets of Burke Lumber Co., Midway Engineered Wood Products, Inc., Morton Forest Products Co., North Powder Lumber Co., Pacific Hardwoods-South Bend Co., Pacific -8- Softwoods Co., and Sedro-Woolley Lumber Co. These assets are classified as "Assets Held for Sale" and are carried at management's estimate of their net realizable value. Corporate Headquarters ---------------------- The Company relocated its corporate headquarters on April 2, 2001 upon expiration of the lease for its former location and to reduce expenses. The Company's new corporate headquarters are located in an industrial area at 529 SE Grand Avenue in Portland, Oregon. Item 3. LEGAL PROCEEDINGS On September 27, 1999, TreeSource Industries, Inc. and a majority of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the Federal Bankruptcy Code. The proceeding was filed in the U.S. Bankruptcy Court for the Western District of Washington in Seattle (the "Bankruptcy Court"). The jointly administered proceeding is titled: "TreeSource Industries, Inc., et al.," Case Numbers 99-10932, 99-10937 through 99-10961. The Company and its Trask River Lumber subsidiary were named defendants in a claim for wages and penalties filed in U.S. District Court for the District of Oregon on February 17, 1999 (Allen, Blount, et al., vs. WTD Industries, Inc., Trask River Lumber and Bruce L. Engel). Although the case was stayed by the Company's Chapter 11 filing, the plaintiffs filed a class Proof of Claim. The U.S. District Court certified a class and the parties have agreed to a settlement of the class members' wage claims. The Court has allowed claims for penalties and attorney fees. Allowed claims will be treated in accordance with the terms of the Company's Chapter 11 plan of reorganization. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. -9- PART II Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Principal Market ---------------- Effective January 7, 1999, the Company's Common Stock is quoted on the OTC Bulletin Board, under the symbol TRES.OB. Before that date, the Company's stock was quoted on the Nasdaq National Market System under the same symbol (before October 27, 1998, under the symbol WTDI). The number of holders of record of TreeSource Industries, Inc. Common Stock at June 8, 2001 was 572. The Company estimates that the total number of its direct and beneficial shareholders is approximately 2,050. Stock Price and Dividend Information ------------------------------------ The following tables show the range of reported high and low bid quotations for the two years ended April 30, 2001: Fiscal Year Ended April 30, 2001 Low High --------------------- ------- ------- First Quarter $0.0156 $0.0625 Second Quarter $0.0156 $0.0625 Third Quarter $0.0050 $0.0420 Fourth Quarter $0.0100 $0.0300 Fiscal Year Ended April 30, 2000 Low High --------------------- ------- ------- First Quarter $0.3125 $0.4375 Second Quarter $0.0250 $0.3438 Third Quarter $0.0156 $0.0781 Fourth Quarter $0.0625 $0.0781 The high and low bid quotations shown are those quoted on the OTC Bulletin Board. They reflect inter-dealer prices, do not include retail markups, markdowns, or commissions, and may not necessarily represent actual transactions. Prior to the Company's October 1986 public stock offering, there was no public trading market for its Common Stock. It is likely that any value remaining in the Company's equity securities will be eliminated as a result of the Company's Chapter 11 proceedings. TreeSource does not pay any cash dividends on its Common Stock. The Company's various debt instruments restrict the payment of dividends. See Notes 1 and 9 to Consolidated Financial Statements. -10- Item 6. SELECTED FINANCIAL DATA

-11- Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Overview -------- On a quarter-to-quarter basis, the Company's financial results have and will vary widely, due to seasonal fluctuations and market factors affecting the demand for logs, lumber, and other wood products. Therefore, past results for any given year or quarter are not necessarily indicative of future results. Lumber market conditions for fiscal 2001 remained generally weak due to the oversupply of lumber in the North American market. The average unit price for the benchmark Douglas fir 2x4 standard and better decreased from $385 per unit for fiscal 2000 to an average of $294 per unit for fiscal 2001, a 24% reduction. During the same period, the unit cost of the #2 Douglas fir sawlog, a benchmark for the Company's raw materials costs, also decreased from an average of $634 to $566 per unit, an 11% reduction. Because lumber prices decreased more than log costs, industry margins and the Company's profits were reduced. In response to the deterioration of the market, the Company has sold at auction the assets at its facilities in Burke, Vermont and Central Point, Oregon, and has curtailed production indefinitely at its mills in Morton, Washington, South Bend, Washington, and North Powder, Oregon. These idle mills are currently held for sale along with the assets of Burke Lumber Co., Midway Engineered Wood Products, Inc., Pacific Softwoods Co., Philomath Forest Products Co. and Sedro-Woolley Lumber Co. Reorganization of the Company ----------------------------- During the third quarter of fiscal 1998, demand by Asia for wood products declined dramatically causing lumber prices in North America to decline. Lumber markets remained weak through the third quarter of fiscal 1999. The Company incurred significant losses as a result of this protracted period of weak lumber markets combined with the Company's high level of debt and substantial preferred stock dividend obligations, and failed to generate sufficient cash from operations to enable the Company to pay its commitments and continue operating. In response to this situation, on September 27, 1999 the Company filed for voluntary reorganization under Chapter 11 of the U.S. Bankruptcy Code (the "Code"). The Company continues to operate its business as a debtor-in-possession. As a debtor-in-possession under the Code, the Company is authorized to operate its business subject to the terms of a cash collateral order, but may not engage in transactions outside of the ordinary course of business without Court approval. In April 2000 the Company filed a plan of reorganization with the U.S. Bankruptcy Court (the "Court"). Due to the downturn in the lumber market, the Company successfully petitioned the Court to delay consideration of and then to withdraw the plan of reorganization. On March 31, 2001 the period of exclusivity (the time in which the Company has the sole right to present a plan of reorganization) expired, which will allow -12- other interested parties an opportunity to submit a plan of reorganization. In July 2001, the Company's pre-petition senior secured debt securities were purchased by an investment group. This sale, in itself, may not affect the status of the Company's bankruptcy proceedings. In an effort to maximize value for all parties, the Company is evaluating its strategic alternatives, which include a sale of the Company's operations. The Company's senior secured lenders have a security interest in substantially all the assets of the Company. Regardless of which alternative the Company ultimately pursues it is unlikely that the Company's current classes of common and preferred stock will have any value upon conclusion of the bankruptcy proceedings. The costs associated with the reorganization totaled $1,287,000 for fiscal 2001. Interest expense for the year was approximately $4,300,000 lower than it otherwise would have been due to the filing for reorganization. During the reorganization period, the Company is allowed relief from payment of interest charges on pre-petition debt, but is required to accrue interest expense on claims that are, in the opinion of management, fully secured. No interest expense has been recorded since September 27, 1999 on the Company's senior secured debt or unsecured senior subordinated notes because management believes these claims are under-secured. See Note 6 to Consolidated Financial Statements. In July 2001, all of the Company's outstanding pre-petition senior secured debt securities were purchased by an investment group. This sale may not affect the Company's bankruptcy proceedings. Yearly Comparisons ------------------ The following table compares certain income and expense items as a percentage of net sales, and the period-to-period percentage change for each item:

-13- Comparison of 2001 to 2000 -------------------------- Net sales for the year ended April 30, 2001 decreased $101.4 million (40.1%) from the year ended April 30, 2000. This decrease was principally caused by a 34% decrease in lumber sales volume and a 10% decrease in the net sales average. The decrease in lumber shipments in fiscal 2001 as compared to fiscal 2000 reflects the Company's curtailment of operations at its facilities in Burke, Vermont, Central Point, Oregon, Morton, Washington, North Powder, Oregon, and South Bend Washington. In addition the Company took downtime at the remaining mills when market conditions did not justify continuing operations. Gross profit for the year ended April 30, 2001 was 0.8% of net sales, compared to 6.6% of net sales for the year ended April 30, 2000. Lumber sales average and volume decreased by 19% and 26%, respectively, from the year ended April 30, 2000, while the Company's average log costs decreased by only 6%. Unit manufacturing costs in fiscal 2001 decreased by 2% from costs in fiscal 2000, primarily due to a curtailment of operations at relatively higher cost production facilities. Selling, general and administrative expenses in the year ended April 30, 2001, excluding reorganization and impairment charges, decreased by $0.8 million (6.9%) as compared to the year ended April 30, 2000. Impairment charges for the year ended April 30, 2001 were $4.9 million as compared to $0.2 million for fiscal 2000. The increase in impairment charges was primarily a result of curtailing operations and placing for sale Morton Forest Products Co., North Powder Lumber Co., and Pacific Hardwoods-South Bend Co. Reorganization charges related to the Company's Chapter 11 filing were $1.3 million in fiscal 2001 and $2.8 million in fiscal 2000. The decrease in reorganization charges reflects the Company's efforts to reduce bankruptcy related activities and costs. During fiscal 2001 the equipment at the Burke, Central Point, and Midway facilities was sold at auction. Based on the proceeds of these sales, the impairment reserve was adjusted to reflect the Company's revised estimate of the net realizable value of the remaining assets held for sale. Four facilities are currently being held for sale: Morton Forest Products Co., North Powder Lumber Co., Pacific Hardwoods-South Bend Co. and Pacific Softwoods Co., along with the parcels of land associated with Burke Lumber Co., Central Point Lumber Co., Midway Engineered Wood Products, Inc., Philomath Forest Products Co., and Sedro-Woolley Lumber Co. See Note 3 to Consolidated Financial Statements. As of April 30, 2001, the Company had available approximately $48 million and $36 million, respectively, in net operating losses ("NOLs") for federal and state income tax purposes. Due to the bankruptcy, substantial doubt exists regarding the Company's ability to utilize these NOLs. As a result, the Company fully reserved for the NOLs generated during the twelve months ended April 30 for 2000 and 2001. The Company periodically reviews the above factors and may change the amount of valuation allowance as facts and circumstances dictate. Comparison of 2000 to 1999 -------------------------- Net sales for the year ended April 30, 2000 increased $57.2 million (29%) from the year ended April 30, 1999. This increase was principally caused by a 15% increase in -14- lumber sales volume and an 11% increase in the net sales average. The increase in lumber shipments in fiscal 2000 as compared to fiscal 1999 reflects the Company's strategy to increase asset utilization by increasing the number of shifts operated at three facilities. Gross profit for the year ended April 30, 2000 was 6.6% of net sales, compared to 5.8% of net sales for the year ended April 30, 1999. Lumber sales average and volume increased by 11% and 15%, respectively, from the year ended April 30, 1999, while the Company's average log costs increased by 10%. Unit manufacturing costs in fiscal 2000 decreased by 3% from costs in fiscal 1999, primarily due to an increase in the number of shifts operated at select facilities and an increase in productivity at most facilities. Selling, general and administrative expenses in the year ended April 30, 2000, excluding reorganization and impairment charges, increased by $0.2 million (1.4%) as compared to the year ended April 30, 1999. Impairment charges for the year ended April 30, 2000 were $0.2 million as compared to $6.3 million for fiscal 1999. Reorganization charges related to the Company's Chapter 11 filing were $2.8 million in fiscal 2000 and $0 in fiscal 1999. During fiscal 2000 the equipment at the Philomath and Sedro-Woolley facilities was auctioned. Due to the results of the auction, the impairment reserve was adjusted to reflect the Company's estimate of the net realizable value of the remaining assets held for sale. Three facilities are currently being held for sale: Burke Lumber Co., Midway Engineered Wood Products, Inc., Pacific Softwoods Co., along with the parcels of land associated with Philomath Forest Products Co., and Sedro-Woolley Lumber Co. See Note 3 to Consolidated Financial Statements. As of April 30, 2000, the Company had available approximately $40 million and $28 million, respectively, in net operating losses ("NOLs") for federal and state income tax purposes. Due to the bankruptcy, substantial doubt exists regarding the Company's ability to fully utilize these NOLs. As a result, the Company fully reserved for the NOLs generated during the twelve months ended April 30 for both 1999 and 2000. As of April 30, 2000 the Company has a deferred tax asset of $0.8 million. The Company periodically reviews the above factors and may change the amount of valuation allowance as facts and circumstances dictate. LIQUIDITY AND CAPITAL RESOURCES At April 30, 2001, the Company had net working capital of $17 million as compared to a net working capital of $28 million at April 30, 2000. This decrease of $11 million primarily resulted from reductions in accounts receivable, inventories, accounts payable and accrued expenses due to the curtailment of operations at the Central Point, Morton, North Powder, and Pacific Hardwoods facilities. See Notes 1 and 6 to Consolidated Financial Statements. The Company currently holds in an escrow account $1.8 million in cash, from the sale of the equipment at Burke, Philomath and Sedro-Woolley. Cash and cash equivalents decreased by approximately $0.7 million during the year ended April 30, 2001, to $1.2 million, excluding $1.8 million in restricted cash generated from the sale of certain assets. Although the Company's operating losses -15- exceeded $18 million, approximately $0.8 million of cash was generated from operations due to the curtailment of operations at several facilities which resulted in a $5.2 million reduction in receivables, a $8.3 million decrease in inventories, a $1.1 million reduction in prepaid assets and a $3.2 million decrease in accounts payable and accrued expenses. In addition, the Company generated $0.9 million through the sale at auction of some of the equipment at certain non-operating mills. The Company historically has not had a line of credit or working capital financing available to it, and, therefore, had relied on cash provided by its operations to fund its working capital needs. In early October 1999, in connection with the Company's Chapter 11 filing the Company obtained a $16 million debtor-in-possession revolving working line of credit to provide for day-to-day liquidity and seasonal log inventory increases. The Company is currently operating as a debtor-in-possession under a cash collateral order approved by the Court, pursuant to a number of conditions. The cash collateral order allows the Company to use funds from operations and the revolving line of credit for normal operating purposes. The cash collateral order also grants a security interest in substantially all the assets of the Company to the pre-petition senior secured lenders and post-petition secured debtor-in-possession lenders. The current cash collateral order expires August 5, 2001. If the Company is unable to either confirm a plan of reorganization or obtain a new cash collateral order by August 6, 2001, the Company may not be able to meet its short-term liquidity needs. The Company's pre-petition senior secured creditors have already agreed to one such new cash collateral order during these bankruptcy proceedings. As of April 30, 2001 there was a $0.4 million loan balance on the Company's line of credit and $1.35 million in letters of credit outstanding. For the year ending April 30, 2001, the Company also spent $1 million for capital improvements to its facilities. The Company had no material commitments for capital spending at April 30, 2001. After receiving approval from the Court, the Company paid $0.7 million out of restricted cash to the pre-petition secured lenders in July 2000 for the reduction of pre-petition long-term debt. The Company does not invest in market risk sensitive instruments. FACTORS AFFECTING FORWARD-LOOKING STATEMENTS The statements contained in this report that are not statements of historical fact and may include forward-looking statements (as defined in Section 27A of the Securities Act of 1933, as amended) that involve a number of risks and uncertainties. Moreover, from time to time the Company may issue other forward-looking statements. The following factors are among the elements that could cause actual results to differ materially from the forward-looking statements and should be considered in evaluating any forward-looking statements. -16- Uncertain Outcome of Company's Chapter 11 Filing ------------------------------------------------ On September 27, 1999, the Company filed for voluntary reorganization under Chapter 11 of the Code. The Company's continued existence will depend on the outcome of the Company's Chapter 11 filing. The Company is pursuing strategic alternatives that include the sale of its operations. The outcome of such a sale is uncertain. To be successful any plan of reorganization must sufficiently restructure the Company's pre-petition debt to reduce debt servicing costs and allow the Company to restore its liquidity and meet its future cash requirements. If the Company is unable to confirm a plan of reorganization the Company may be unable to continue operating. Confirmation of any plan depends on the support of the Company's creditors and the Court. If the Company is unable to demonstrate that it is viable as a going concern, confirmation of a plan of reorganization is unlikely. To demonstrate its viability, the Company must show that it is worth more as an operating entity than liquidated. The Company's worth is based on a number of factors including: past financial performance, the value of its assets, projected future market conditions and operating configuration, and projected capital expenditures, among other items. The Company and its creditors may have differing opinions regarding the Company's worth that could result in the opposition and possible rejection of any plan of reorganization proposed by the Company. Liquidity and Capital Resources ------------------------------- On October 5, 1999 the Company obtained a $16 million debtor-in-possession revolving line of credit ("Revolver"). The Revolver is secured by accounts receivable and inventory. The Revolver was consented to by the pre-petition senior secured lenders to whom substantially all of the Company's assets were pledged. Through the cash collateral order issued by the Bankruptcy Court, the pre-petition senior secured lenders agreed to the Company's request for a revolving line of credit to fund seasonal inventory and general corporate needs. From time to time the cash collateral order expires. If the Company fails to negotiate a new cash collateral order, there can be no assurance that cash provided by operations will be sufficient to fund the Company's future operating and capital needs. See Note 7 to Consolidated Financial Statements. Adverse Operating Conditions; Fluctuations in Quarterly Results --------------------------------------------------------------- Modest decreases in the unusually robust domestic demand for lumber in an environment of slowing economic growth has, and may again cause adverse operating conditions if domestic demand cools. A decline in lumber demand to the levels experienced over the past five years may cause an oversupply of lumber and corresponding weakness in lumber prices. Such adverse operating conditions have and may again cause the Company to take such actions as curtailing operations at some or all facilities. On a quarter-to-quarter basis, the Company's financial results have varied widely and will continue to vary due to seasonal fluctuations and market factors affecting both the availability of, and the demand for, logs and the demand for lumber and other wood -17- products. The industry is subject to fluctuations in sales and earnings due to such factors as industry production in relation to product demand and variations in interest rates and housing starts. The demand for lumber and wood products is primarily affected by the level of new residential construction activity, which is subject to fluctuations due to changes in economic conditions, real estate prices, interest rates, credit availability, property taxes, energy costs, population growth, weather conditions and general economic conditions, all of which are beyond the control of the Company. Demand for the Company's products is generally lower in the fall and winter quarters when activity in the construction, industrial, and repair and remodeling markets is slower; demand is generally higher in the spring and summer quarters, when these markets are more active. Fire danger and excessively dry or wet conditions temporarily reduce logging activity and may increase open-market log prices. The industry is also affected by timber management policies, which change from time to time and may cause actual or feared shortages in some areas. These policies change because of environmental concerns, public agency budget issues, and a variety of other reasons. Currency fluctuations affect the industry when exchange rates spur log exports and drive up domestic log prices, and when a relatively strong U.S. dollar encourages lumber exports from competing countries, such as Canada, or discourages exports to other countries, such as Japan. Therefore, past results for any given year or quarter are not necessarily indicative of future results. The Company believes that period-to-period comparisons of its financial results may not be meaningful and should not be relied upon as indications of future performance. Availability of Logs -------------------- Raw materials comprise the majority of the cost of products sold by the Company. The Company depends primarily on open-market log purchases for its raw material needs. In the past the Company generally purchased logs in sufficient quantities to match the current operating requirements for its mills. Although in October 1999 the Company revised its log procurement strategy to generally increase the quantity of logs held in inventory to reduce the risk of interrupting mill production during periods of inclement weather and changes in local log market conditions. The historically weak lumber market during fiscal 2001 caused management to modify that strategy and adopted a breakeven approach for log procurement at most facilities. To enable the Company to operate its facilities on a consistent basis, log inventory levels need to be sufficient to reduce the risk of temporary closures and reduce or avoid high-cost spot log purchases during periods of adverse weather. The availability and cost of logs are influenced by a variety of factors, including demand by competitors and exporters, the environmental and harvest policies of federal and state agencies, the annual harvest levels of commercial timberland owners, and, in the long term, the quantity of commercial timberland. Various factors, including environmental and endangered species concerns, particularly regulations relating to the northern spotted owl, the marbled murrelet, and various species of fish have limited, and are likely to continue to limit, the amount of timber offered for sale by certain government agencies, which historically have been major suppliers of timber to the western forest products industry. -18- State and private timber supplies may be inadequate to fill the shortfall. Although the Company does not rely significantly on purchases of federal timber, uncertainty associated with timber supply issues combined with continued lack of significant public timber sales activity may contribute to log supply and price volatility. The availability of logs may also be affected by other factors, which include damage by fire, insect infestation, disease, prolonged drought, and other natural disasters. Log and lumber markets may continue to experience rapid changes in values because of actual and perceived market conditions that may sometimes result in inconsistent relationships between log and lumber prices. These changes could result in large swings in the gross margin realized by the Company on lumber produced. Such swings in gross margin may be increased by generally higher log inventories maintained by the Company during the winter period pursuant to the Company's revised log procurement and inventory strategy. There can be no assurance that sales of logs from the Company's current sources may not be reduced or that the Company will be able to procure sufficient logs at favorable prices in order to continue operation of its manufacturing facilities in the future. The inability of the Company to obtain logs in sufficient quantities could have a material adverse impact on the Company's business, financial condition and results of operations. Technological Change -------------------- Technology and innovation continually impact the lumber manufacturing process. Changes are continually being adopted by the industry in general that cause mills to invest in new capital equipment to remain competitive. Depreciation has exceeded capital spending at the Company's core facilities. The technology employed at the mills generally lags that of the Company's major competitors, heightening the risk of becoming non-competitive. The Company believes that the technological advances made over the past five years and their adoption by the Company's competitors will make TreeSource's mills economically obsolete if capital spending is not increased. If the Company is not able to increase capital spending to keep pace with the technological advances adopted by the Company's competitors, such inability could have a material adverse impact on the Company's business, financial condition and results of operations. Manufacturing Risks ------------------- The Company manufactures softwood and hardwood lumber and by-products. As a manufacturer, the Company continually faces risks regarding the availability and cost of raw materials and labor, the potential need for additional capital equipment, increases in maintenance costs, plant and equipment obsolescence, quality control, and excess capacity. See section titled, "Industry Conditions." The Company curtails production at facilities from time to time because of conditions that temporarily impair log flow or when imbalances between log costs and product prices cause the cost of operation to exceed the cost of shutdown. See section titled, "Employees." The Company may permanently close facilities that are determined to lack future potential for profit under expected operating conditions. A disruption in the Company's production or distribution could have a material adverse impact on the Company's business, financial condition and results of operations. -19- Federal and State Regulations ----------------------------- Laws and regulations dealing with the Company's operations are subject to change and new laws and regulations are frequently introduced concerning the timber industry. From time to time, bills are introduced in the state legislatures and the U.S. Congress that relate to the business of the Company, including the protection and acquisition of old-growth and other timberlands, endangered species, environmental protection, and the restriction, regulation, and administration of timber-harvesting practices. The forest products industry remains subject to potential state or local ballot initiatives and evolving federal and state case law that could affect timber-harvesting practices. It is impossible to assess the effect of such matters on the future operating results or financial position of the Company. The Company is also subject to various federal, state, and local regulations regarding waste disposal and pollution control, including air, water, and noise pollution. The cost of remediation at the Company's sites at Philomath, Oregon, and Sedro-Woolley, Washington, may be more expensive than anticipated and may require the approval of certain regulators. See section titled, "Environmental Regulation." Various governmental agencies have enacted or are considering regulations regarding log yard management and disposal of log yard waste that may require material expenditures in the future. Such regulations could have a material adverse impact on the Company. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data required by this item are listed in Item 14 of Part IV of this report, which begins at page 33. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. -20- PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The directors and executive officers of the Company as of July 12, 2001, are: Name Age Position ---- --- -------- Scott Christie.............. 52 Director Richard W. Detweiler........ 59 Director Jess R. Drake............... 60 Director, President, and Chief Executive Officer Robert W. Lockwood.......... 40 Vice President-Finance, Chief Financial Officer, Treasurer, and Secretary Kevin Murray ............... 43 Vice President-Sales and Marketing William H. Wright........... 64 Director The Company currently has seven seats on its Board of Directors, with three positions vacant because of the resignation in February 1999 of K. Stanley Martin, a former Class 3 director and the Company's Vice President-Finance, the resignation in June 1999 of Robert J. Riecke, also a former Class 3 director and the Company's General Counsel, Secretary, and Vice President-Administration, and the resignation of Larry G. Black, a Class 2 director, in July 2000. The Company intends to leave these seats vacant for now, but may elect to fill them in the future. Pursuant to the Company's Articles of Incorporation and Bylaws, the Board is divided into three classes of directors, with each class serving a term of three years or until such time as a valid successor is appointed. As a result of the Company's Chapter 11 filing on September 27, 1999, the Company did not hold an Annual Meeting of Shareholders in fiscal 2000. Directors whose terms on the Board of Directors would have expired will continue to serve until a valid successor is appointed. Mr. Christie's term would have expired at the 1999 annual meeting of shareholders. Mr. Drake, a Class 3 director, was elected by the Board in November of 1998 to fill a vacancy created by the retirement of the Company's former president. Mr. Drake's term would also have expired at the 1999 annual meeting of shareholders. The terms of Class 1 Directors, Messrs. Wright and Detweiler, will expire at the 2001 Annual Meeting of Shareholders. Subject to certain conditions, in the event the Company misses three consecutive quarterly dividend payments, four quarterly dividend payments within twenty-four months or a total of eight quarterly dividend payments, the holders of the Series A Preferred Stock have the right to obtain voting control of the Company's Board of Directors by electing a majority of the Board of Directors, either through replacement of incumbent directors, or by increasing the size of the Board. As of April 30, 2001 the Company was in arrears on nine consecutive quarterly dividend payments totaling approximately $5,587,000. In addition, the Company did not pay a tenth consecutive quarterly dividend payment due May 31, 2001. Scott Christie has been a director of the Company since March 1988. Mr. Christie is currently general partner of Christie Capital Management. Since 1987, Mr. Christie has -21- been engaged as an investment advisor for his own account and the account of other individuals. From 1983 until 1987, Mr. Christie was senior vice president of Kidder, Peabody & Co. Incorporated, an investment banking firm. Mr. Christie headed Kidder, Peabody's underwriting team for the Company's initial public offering and 1987 debenture offering. Richard W. Detweiler has been a director of the Company since December 1995. Mr. Detweiler is currently a partner of Carlisle Enterprises, an investment partnership. From 1990 to 1996, Mr. Detweiler was chief executive officer of Precision Aerotech, a diversified manufacturing company. Mr. Detweiler has 33 years of manufacturing management experience, including 16 years in general management. Jess R. Drake has been the Company's president and a director since November 1998. From 1987 to 1998, Mr. Drake was vice president and general manager of the Northwest Operations of Simpson Timber Company. Mr. Drake has experience in manufacturing, timberlands, domestic and international sales, finance, and strategic planning in both the United States and Canada and has held general management roles for 20 of his more than 30 years in the forest products industry. Robert W. Lockwood is chief financial officer, treasurer and vice president-finance of the Company, positions he has held since April 1999, and secretary since July 1999. Mr. Lockwood is responsible for all financial affairs of the Company. From 1985 to 1999, Mr. Lockwood was employed by Simpson Investment Company, where he held financial and strategic planning roles in the timber, wood products, and pulp and paper industry sectors and most recently was the controller of Simpson's Northwest region wood products businesses. Kevin P. Murray is vice president-sales and marketing of the Company, a position he has held since April 2000. Mr. Murray has primary responsibility for managing all aspects of the Company's lumber sales and transportation. Prior to joining the Company, Mr. Murray was with Western International Forest Products for nineteen years, where he managed various lumber sales divisions. William H. Wright has been a director of the Company since April 1992. Mr. Wright has held a variety of management positions in the forest products industry since 1957. He is currently president of Heartwood Consulting Service, which advises forest products clients. From 1989 until 1994, he was president and chief executive officer of Dee Forest Products Inc., a manufacturer of hardboard and related products. From 1984 to 1989, Mr. Wright was general manager of Stevenson Co-Ply Inc., a manufacturer of veneer and plywood. Section 16(a) Beneficial Ownership Reporting Compliance ------------------------------------------------------- Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), requires that the Company's officers, directors and persons who own more than 10% of the Company's Common Stock file with the Securities and Exchange Commission ("SEC") initial reports of beneficial ownership on Form 3 and reports of changes in beneficial ownership of Common Stock and other equity securities of the Company on Form 4. Officers, directors, and greater than 10% shareholders of the Company are required by SEC regulations to furnish to the Company copies of all Section 16(a) reports -22- that they file. To the Company's knowledge, based solely on reviews of such reports furnished to the Company and written representations that no other reports are required, all Section 16(a) filing requirements applicable to its officers, directors, and greater than 10% beneficial owners were complied with during the fiscal year ended April 30, 2001. Item 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table shows the annual and other compensation paid by the Company to its chief executive officer and the four other most highly compensated executive officers who received in excess of $100,000 (the "Named Executive Officers") for each of the last three fiscal years.

(1) Personal benefits for each executive officer named in the table did not exceed $50,000 or 10% of such executive officer's total annual salary and bonus for the fiscal years ended April 30, 2000 and 1999, respectively. (2) Mr. Drake took office on November 4, 1998; All Other Compensation for fiscal 1999 includes a $100,000 signing bonus and $32,300 for consulting services provided prior to November 4, 1998. (3) In addition to his base salary, Mr. Drake received $53,918 as a local housing expense reimbursement during the fiscal year ended April 30, 2001. This amount is included in All Other Compensation. (4) Mr. Drake's bonus for fiscal 2000 was $630,000 plus $51,884 in interest. This amount was approved by the Company's Board of Directors on July 11, 2000, but remained unpaid until June 29, 2001. The bonus for fiscal year 2001 has not been calculated or approved by the Board; however, management specifically accrued a liability of $210,000 during the year in anticipation of Mr. Drake's fiscal 2001 bonus compensation. (5) The Company also paid additional disability insurance, separate from the Company's regular benefit plan, on behalf of Mr. Drake in the amounts of $7,088, $8,339, and $8,339 during the fiscal years ended April 30, 2001, 2000, and 1999, respectively. These amounts are included in the All Other Compensation category by year. (6) In addition to the base salary, Mr. Lockwood received $41,793 as a local housing expense reimbursement during the fiscal year ended April 30, 2001. This amount is included in All Other Compensation. (7) Mr. Lockwood's bonus for fiscal 2000 was $120,000 plus $9,883 in interest. The bonus amount was approved by the Company's Board of Directors on July 11, 2000, but remained unpaid until June 29, 2001. The bonus for fiscal 2001 has not been calculated or approved by the Board; however, management specifically accrued a liability of $60,000 in anticipation of Mr. Lockwood's fiscal 2001 bonus compensation. (8) The Company also paid additional disability insurance, separate from the Company's regular benefit plan, on behalf of Mr. Lockwood in the amount of $780 during the fiscal 2001. This amount is included in All Other Compensation. (9) Mr. Murray took office on April 17, 2000. -23- OPTION GRANTS IN LAST FISCAL YEAR The following table provides information on option grants for the last fiscal year to the Named Executive Officers:

(1) These assumed appreciation rates are not derived from the historical or projected prices of the Company's Common Stock or results of operations or financial condition, and they should not be viewed as a prediction of possible prices or value for the Company's Common Stock in the future. These assumed rates of 5% and 10% would result in the Company's Common Stock price increasing from $0.05 per share to approximately $0.0814 per share and $0.1297 per share, respectively. (2) Vesting Schedule: 5/1/00 - 33%; 5/1/01 - 67%; 5/1/02 - 100%. Market value of the Company's Common Stock on the date of grant was $0.05. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES The following table provides information on option exercises for the last fiscal year by the Named Executive Officers and the value of their unexercised options as of April 30, 2001:

(1) Based on the fair market value of the Common Stock at April 30, 2001 of $.01 per share as reported on the OTC Bulletin Board for that date. -24- EMPLOYMENT AGREEMENTS Effective November 4, 1998 the Company entered into a three-year Employment Contract with Jess R. Drake. The Employment Contract provides for an initial annual base salary of $350,000, with annual increases if provided to other executive officers, or as deemed appropriate by the Board of Directors. Additionally, a signing bonus of $100,000 was paid upon execution of the Employment Contract. The Employment Contract provides for an annual bonus of up to 180% of the current annual salary if certain financial and non-financial goals are met or exceeded. The Employment Contract also required the grant of stock options according to a formula, which resulted in 543,295 options being awarded to Mr. Drake, with 25% vesting upon grant and 25% vesting annually until fully vested. These stock options were issued outside the Company's 1996 Option Plan. Vesting of the options is accelerated in certain events including a change of control, as defined, termination of employment for other than cause, as defined, or upon acceleration of the Company's senior secured debt. Additionally, if the Company terminates Mr. Drake's employment without certain identifiable causes before the end of the Employment Contract's term, the Company is obligated to pay an amount equal to two times Mr. Drake's last base annual salary and a pro rata share of that year's bonus. The Company's senior secured lenders have agreed to subordinate their claims to amounts due Mr. Drake under his Employment Contract, up to a maximum of $1.1 million. See Exhibits 10.11 and 10.12. Effective April 20, 1999 the Company entered into a three-year Employment Contract with Robert W. Lockwood. The provisions are identical to the terms of the Employment Contract with Mr. Drake, except that the starting annual salary for Mr. Lockwood is $150,000, there is no signing bonus, the bonus criteria are different, and the annual bonus may be up to 80% of Mr. Lockwood's current annual salary. Mr. Lockwood's Employment Contract also provides for the award of stock options for 200,000 shares, 100,000 of which were issued on April 20, 1999, options for the purchase of an additional 50,000 shares were granted on April 20, 2000, and the remaining 50,000 were granted on May 1, 2000. These stock options were issued outside the Company's 1996 Option Plan. The Company's senior secured lenders have agreed to subordinate their claims to amounts due Mr. Lockwood under his Employment Contract, up to a maximum of $500,000. See Exhibits 10.13 and 10.14. On September 8, 1999 the Company entered into one year employment agreements with eleven corporate and mill managers. The terms of these contracts varied as to the base salaries, but all include a provision for payment upon termination of twelve months of severance pay plus the previous year's bonus. These contracts were renewed on substantially the same terms on October 27, 2000. The estimated cumulative total potential cost to the Company under the severance provision is $813,000. Effective June 20, 2001 the Company entered into new employment agreements with ten of the original eleven corporate and mill managers as well as with seven additional employees. The terms of the employment agreements vary as to the base salaries and duration of severance pay, but all include a provision for payment upon termination of severance pay plus an amount equivalent to the previous year's -25- bonus. These employment agreements expire April 30, 2002. The estimated cumulative total potential cost to the Company under the severance provisions is $1,224,000. Benefits -------- The Company maintains an Internal Revenue Code ("IRC") Section 401(k) Retirement Savings Plan under which employees, including executive officers, are permitted to make salary deferral contributions. All participants including executive officers are entitled to employer matching contributions pursuant to this plan. Compensation of Directors ------------------------- Each of the Company's outside directors is paid an annual retainer of $15,000 for attending up to six Board meetings, plus $750 for each additional Board meeting or committee meeting attended, and $225 for each telephone conference meeting attended or written consent executed. Directors who are also employees of the Company do not receive additional compensation for their services as directors. In fiscal 2001, no outside directors received option grants. Executive Bonuses ----------------- During fiscal 2001 no bonus payments were made to either employees or executive officers under the "key employee" bonus program based on fiscal year net profit after tax. The president and vice president-finance of the Company may each receive an annual bonus, if certain financial and non-financial goals are met, up to a maximum of 180% of current annual salary for the president, and up to 80% of current annual salary for the vice president-finance. Although the Company has accrued $1,020,000 in bonus expense related to their employment contracts, no bonus amount was paid to either Mr. Drake, president, or Mr. Lockwood, vice president-finance during fiscal 2001. On June 29, 2001 both Mr. Drake and Mr. Lockwood were paid their fiscal 2000 bonuses plus interest that was otherwise due on July 30, 2000. Mr. Drake and Mr. Lockwood received bonus plus interest of $681,884 and $129,883 respectively for fiscal 2000. Stock Option Plan ----------------- In October 1996 the Company implemented a Stock Option Plan ("1996 Option Plan") to supersede the 1986 Option Plan, which terminated in July 1996. In October 1998, the Company's shareholders approved an amendment to the 1996 Option Plan pursuant to which the number of shares of Common Stock available for issuance under the 1996 Option Plan was increased to 1,425,000 shares, subject to adjustment from time to time as provided in the 1996 Option Plan. The purpose of the 1996 Option Plan is to enhance the long-term value of the Company by offering opportunities to those employees, directors, officers, consultants, agents, advisors and independent contractors of the Company and its subsidiaries who are key to the Company's growth and success, and to encourage them to remain in the service of the Company and its subsidiaries and to acquire and maintain stock ownership in the Company. -26- Not more than 50,000 shares of Common Stock, in the aggregate, may be granted under the 1996 Option Plan to any participant during any fiscal year, except that one-time grants of options for up to 100,000 shares may be made to newly hired participants. Any shares of Common Stock that cease to be subject to an option (other than by reason of exercise), including, without limitation, in connection with the cancellation of an award, will be available for issuance in connection with future grants of awards under the 1996 Option Plan. Options granted under the 1996 Option Plan will be "nonqualified stock options" (that is, options that are not designed to qualify as "incentive stock options," as defined in IRC Section 422). The option price for each option granted under the 1996 Option Plan will be determined by the plan administrator, but will be not less than 85% of the Common Stock's fair market value on the date of grant. The option term will be fixed by the plan administrator, but if not so specified will be ten years. Each option will be exercisable pursuant to a vesting schedule determined by the plan administrator. If not so established, the option will vest over four years from the date of grant, with 20% of the shares of underlying Common Stock vesting on the six-month anniversary of the grant date and an additional 20% of the shares vesting on the one-year anniversary of the option's grant date, and after every successive year of the optionee's continuous employment or relationship with the Company. The plan administrator will also determine the circumstances under which an option will be exercisable in the event the optionee ceases to provide services to the Company or one of its subsidiaries. If not so established, options generally will be exercisable for one year after termination of services as a result of disability or death and for one month after all other terminations. An option will not be exercisable following an optionee's termination if the optionee's services are terminated for cause, as defined in the 1996 Option Plan. The 1996 Option Plan is administered by the Company's Compensation Committee with respect to option grants to employees. Option grants to others are administered by the Board of Directors. Compensation Committee Interlocks --------------------------------- The Compensation Committee is composed of two independent non-employee directors, Mr. Christie and Mr. Wright. The Compensation Committee is responsible for recommending to the full Board of Directors, for its approval, the base compensation for all executive officers. Executive officers who serve on the Company's Board of Directors do not participate in any deliberations or decisions regarding their own compensation. The Compensation Committee receives recommendations from the chief executive officer regarding appropriate levels of base compensation for the other executive officers, including executive officers who are directors. -27- Board Compensation Committee Report on Executive Compensation ------------------------------------------------------------- The Company's executive officer compensation policies are designed to attract, motivate and retain senior management by providing an opportunity for overall competitive compensation based on an adequate base compensation amount and participation in an annual bonus system. In August 1998, the Company changed all salaried bonus programs to incorporate longer-term measurement and pay-out periods. At the mill level, salaried employees, excluding certain clerical staff, are eligible for a bonus, to be computed and paid quarterly, based in part on the achievement of certain manufacturing goals, such as the recovery level of lumber derived from raw material, and based in part on the mills exceeding quarterly profit targets. Salaried employees at the corporate level, other than executive officers, may receive a quarterly bonus based on Company-wide quarterly net profits after tax. Executive officers participate in a "key employee" bonus program based on the Company's fiscal year net profit after tax, with the amount paid into the bonus pool determined by a preset schedule. See Exhibit 10.4. The president and vice president-finance may each receive an annual bonus, if certain financial and non-financial goals are met, of up to a maximum of 180% of current annual salary for the president and 80% of current annual salary for the vice president-finance. The Company also uses long-term stock-based incentive opportunities in the form of options to purchase the Company's Common Stock. Executive officers who serve on the Company's Board of Directors do not participate in any deliberations or decisions regarding option awards to them. The Committee believes that stock-based performance compensation arrangements are beneficial in aligning management's and shareholders' interests in the advancement of shareholder value. During fiscal 2001, Robert W. Lockwood, the Company's chief financial officer, treasurer, and secretary, was awarded options to purchase 50,000 shares of the Company's common stock pursuant to the terms of his employment agreement. No option grants were made to other executive officers during fiscal 2001. TreeSource provides the same group life and health insurance coverage to executive officers as other employees and requires all employees, including executive officers, to pay approximately 25% of health insurance premiums by payroll deduction. The president is not currently enrolled in the insurance plan but the Company does provide to the president a special disability policy to reflect his higher level of annual compensation. The Company allows its executive officers and all other employees to contribute a percentage of their compensation to the Company-sponsored 401(k) Retirement Savings Plan. In November of 2000 the Company amended its 401(k) Retirement Savings Plan allowing all hourly and salaried employees, including executive officers, to receive matching contributions. Neither the executive officers nor other employees are covered by any other Company-sponsored retirement plans. -28- It is the Company's practice to participate in and use, as a basis for comparison, an analysis of executive compensation in the Northwest prepared by the compensation consulting group of Milliman & Robertson, Inc. This analysis is useful in establishing base salary levels and monitoring overall compensation levels as compared to other publicly-traded companies of similar size. Mr. Drake's employment with the Company commenced November 4, 1998. Mr. Drake's cash compensation for fiscal 2001 was $403,922 and excludes any earned bonus. Payment of Mr. Drake's fiscal 2000 bonus, which normally would have been paid in fiscal 2001, was delayed until June 2001. Mr. Drake's bonus for fiscal 2001 has yet to be determined. Mr. Drake's annual base salary is $350,000. The median annual base salary and bonus for chief executive officers of comparably sized public companies, as published by the Milliman & Robertson compensation survey for 1999/2000, are $280,000 and $289,325, respectively. Compensation Committee Members Scott Christie William H. Wright -29- Stock Performance Graph The following line graph sets forth the cumulative total shareholder return on the Company's Common Stock and the cumulative total return of the companies listed on the Standard and Poor's 500 Stock Index and the Standard and Poor's Paper & Forest Products Index, assuming reinvestment of dividends. The comparisons are not intended to forecast or be indicative of possible future performance of the Company's Common Stock. [GRAPH OMITTED] Apr96 Apr97 Apr98 Apr99 Apr00 Apr01 S&P 500 Index 100 125.13 176.52 215.04 236.82 206.10 TreeSource Industries Inc. 100 263.64 227.27 63.64 6.55 0.00 S&P Paper & Forest Products Index 100 99.70 126.81 141.41 116.18 126.22 -30- Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table shows the beneficial ownership as of July 12, 2000 of the Company's Common Stock by (i) each director, (ii) each beneficial owner of more than 5% of the Common Stock, (iii) the Named Executive Officers, and (iv) all directors and officers as a group. Except as otherwise specifically noted, each person noted below has sole investment and voting power with respect to shares indicated. Amount and Nature of Name and Address of Beneficial Owner Beneficial Ownership % ------------------------------------------- ------------------------ ------ Phillip K. Stegemoeller(1) 1,000,000 9.0% 110 West 6th Street Aberdeen, WA 98520 Quinault Corporation P.O. Box C 1,921,300 17.2% Aberdeen, WA 98570 Amount and Nature of Name of Directors and Executive Officers Beneficial Ownership (2) % ------------------------------------------- ------------------------ ------ Scott Christie 90,000 * Richard W. Detweiler 60,000 * Jess R. Drake 407,471 3.5% Robert W. Lockwood 125,000 1.1% William H. Wright 90,000 * All directors and executive officers as a group (6 persons) 772,471 6.5% =============================================================================== * Less than 1% (1) As determined by reference to the beneficial owner's most recent Form 4 filing dated December 27, 1999. (2) Includes shares reserved for issuance under options exercisable within 60 days of July 12, 2001 as follows: Mr. Christie 90,000; Mr. Detweiler 60,000; Mr. Drake 407,471; Mr. Lockwood 125,000; and Mr. Wright 90,000. -31- Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS During fiscal 2001, four of the Company's subsidiaries purchased logs worth approximately $2.5 million from Quinault Logging Company. During fiscal 2000 five of the Company's subsidiaries purchased logs worth approximately $8.1 million from Quinault Logging Company. Mr. Larry G. Black, director of the Company from October 1997 until his resignation on July 11, 2000, is chief executive officer of Quinault Logging Company and is president and sole director of Quinault Corporation, beneficial owner of approximately 17.2% of the Company's Common Stock. -32- PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K Page ---- (a) (1) Financial Statements The following consolidated financial statements of the Registrant and its subsidiaries are contained in this report: Report of Independent Certified Public Accountants 41 Consolidated Statements of Operations for the Years Ended April 30, 2001, 2000 and 1999 42 Consolidated Balance Sheets at April 30, 2001 and 2000 43 Consolidated Statements of Cash Flows for the Years Ended April 30, 2001, 2000 and 1999 45 Consolidated Statement of Changes in Stockholders' Equity for the Years Ended April 30, 2001, 2000 and 1999 46 Notes to Consolidated Financial Statements 47 (a) (2) Financial Statement Schedules The schedules called for under Regulation S-X are not submitted because they are not applicable, are not required, or because the required information is not material or is included in the financial statements or notes thereto. Page ---- (a) (3) Exhibit Index 2.1 Final form of Registrant's Second Amended Joint Plan of Reorganization dated October 5, 1992, filed with the United States Bankruptcy Court for the Western District of Washington. (1) 3.1 Fourth Restated Articles of Incorporation of the Registrant adopted November 27, 1992, as amended on October 26, 1998. (21) 3.2 Second Restated Bylaws of the Registrant effective November 27, 1992. (8) -33- Page ---- 4.1 Debtor-in-Possession Credit Agreement dated as of October 5, 1999 between Registrant and General Electric Capital Corporation. (25) 4.2 Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle-First National Bank, and Bank of America Oregon. (2) 4.2.1 Amendment dated as of October 18, 1994 to Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle-First National Bank, and Bank of America Oregon. (9) 4.2.2 Amendment dated as of January 27, 1995 to Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle-First National Bank, and Bank of America Oregon. (11) 4.2.3 Amendment dated as of May 1, 1995 to Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle-First National Bank, and Bank of America Oregon. (11) 4.2.4 Amendment dated as of January 1, 1996 to Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle-First National Bank, and Bank of America Oregon. (12) 4.2.5 Amendment dated as of May 1, 1996 to Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle-First National Bank, and Bank of America Oregon. (13) -34- Page ---- 4.2.6 Amendment dated as of December 17, 1996 to Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle-First National Bank, and Bank of America Oregon. (14) 4.2.7 Amendment dated as of October 1, 1997 to Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle-First National Bank, and Bank of America Oregon. (17) 4.2.8 Amendment dated as of January 1, 1998 to Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle-First National Bank, and Bank of America Oregon. (18) 4.2.9 Amendment dated as of April 1, 1998 to Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle-First National Bank, and Bank of America Oregon. (22) 4.3 Indenture dated as of November 30, 1992, between Registrant and State Street Bank and Trust Company, as Trustee, with respect to 8% Senior Subordinated Notes due 2005. (3) 10.1 Amended and Restated 1986 Stock Option Plan dated December 30, 1992.* (4) 10.1.2 Form of Stock Option Agreement for directors of Registrant.* (8) 10.1.3 Form of Stock Option Agreement for executive officers of the Registrant.* (8) 10.1.4 1996 Stock Option Plan dated October 21, 1996.* (16) 10.1.5 Form of Stock Option Agreement for directors and officers of the Registrant.* (19) 10.1.6 Amendment dated August 7, 1998 to 1996 Stock Option Plan.* (24) -35- Page ---- 10.3 Form of Indemnification Agreement for directors, officers and certain employees effective January 30, 1991.* (8) 10.4 Description of Key Employee Profit-Sharing Bonus Plan.* (24) 10.61 WTD Industries, Inc. Retirement Savings Plan and Trust dated as of May 1, 1989.* (6) 10.62 Amendment No. 1 to WTD Industries, Inc. Retirement Savings Plan and Trust Effective May 1, 1989.* (7) 10.63 Amendment No. 2 to WTD Industries, Inc. Retirement Savings Plan and Trust adopted May 30, 1991.* (7) 10.64 Amendment No. 3 to WTD Industries, Inc. Retirement Savings Plan and Trust adopted June 26, 1992.* (7) 10.65 Amendment No. 4 to WTD Industries, Inc. Retirement Savings Plan and Trust adopted April 30, 1993.* (8) 10.66 Amendment No. 5 to WTD Industries, Inc. Retirement Savings Plan and Trust adopted December 28, 1994.* (10) 10.67 Amendment No. 6 to WTD Industries, Inc. Retirement Savings Plan and Trust adopted June 10, 1997.* (19) 10.68 Amendment No. 7 to WTD Industries, Inc. Retirement Savings Plan and Trust adopted May 18, 1999.* (24) 10.8 Amended and Restated Rights Agreement dated as of March 4, 1998, between the Registrant and ChaseMellon Shareholder Services, as Rights Agent. (20) 10.9 Employment Agreement dated May 27, 1998 between Robert J. Riecke and Registrant.* ** (22) 10.10 Settlement Agreement dated May 15, 1998 between Bruce L. Engel and Registrant.* (23) 10.11 Employment Contract dated October 31, 1998, between Jess R. Drake and Registrant.* (21) 10.12 Stock Option Letter Agreement dated November 3, 1998 between Jess R. Drake and Registrant.* (21) 10.13 Employment Contract dated April 6, 1999, between Robert W. Lockwood and Registrant.* (24) -36- Page ---- 10.14 Non-Qualified Stock Option Agreement dated April 20, 1999 between Robert W. Lockwood and Registrant.* (24) 12.2 Computation of Registrant's Net Income (Loss) to Average Total Assets. 68 12.3 Computation of Registrant's Net Income (Loss) to Average Stockholders' Equity. 69 12.4 Computation of Registrant's Average Stockholders' Equity to Average Total Assets. 70 21.1 Subsidiaries of the Registrant (list updated as of July 12, 1999). 71 23.1 Consent of Independent Certified Public Accountants. 72 (1) Incorporated by reference to the exhibit of like number to the Registrant's report on Form 8-K dated November 23, 1992. (2) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended October 31, 1992, previously filed with the Commission. (3) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended January 31, 1993, previously filed with the Commission. (4) Incorporated by reference to Exhibit 6.0 to the Registrant's Registration Statement on Form S-8 (No. 33-62714) filed with the Commission on May 14, 1993. (5) Incorporated by reference to the exhibit of like number to the Registrant's Registration Statement on Form S-1 (No. 33-7389) filed with the Commission on July 21, 1986, as amended by Amendment Nos. 1 through 3 thereto filed with the Commission on September 3, 1986, October 14, 1986 and October 24, 1986, respectively. (6) Incorporated by reference to the exhibit of like number to the Registrant's annual report on Form 10-K for the year ended April 30, 1989, previously filed with the Commission. (7) Incorporated by reference to the exhibit of like number to the Registrant's annual report on Form 10-K for the year ended April 30, 1992, previously filed with the Commission. -37- (8) Incorporated by reference to the exhibit of like number to the Registrant's annual report on Form 10-K for the year ended April 30, 1993, previously filed with the Commission. (9) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended October 31, 1994, previously filed with the Commission. (10) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended January 31, 1995, previously filed with the Commission. (11) Incorporated by reference to the exhibit of like number to the Registrant's annual report on Form 10-K for the year ended April 30, 1995, previously filed with the Commission. (12) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended January 31, 1996, previously filed with the Commission. (13) Incorporated by reference to the exhibit of like number to the Registrant's annual report on Form 10-K for the year ended April 30, 1996, previously filed with the Commission. (14) Incorporated by reference to Exhibit 4.2.4 to the Registrant's quarterly report on Form 10-Q for the quarter ended January 31, 1997, previously filed with the Commission. (15) Incorporated by reference to the exhibit of like number to the Registrant's report on Form 8-K filed with the Commission on June 12, 1997. (16) Incorporated by reference to Exhibit 99.1 to the Registrant's Registration Statement on Form S-8 (No. 333-15461) filed with the Commission on November 4, 1996. (17) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended October 31, 1997, previously filed with the Commission. (18) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended January 31, 1998, previously filed with the Commission. (19) Incorporated by reference to the exhibit of like number to the Registrant's annual report on Form 10-K for the year ended April 30, 1997, previously filed with the Commission. (20) Incorporated by reference to Exhibit 2.1 to the Registrant's report on Form 8-A filed with the Commission on March 20, 1998. -38- (21) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended October 31, 1998, previously filed with the Commission. (22) Incorporated by reference to the exhibit of like number to the Registrant's annual report on Form 10-K for the year ended April 30, 1998, previously filed with the Commission. (23) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended July 31, 1998, previously filed with the Commission. (24) Incorporated by reference to the exhibit of like number to the Registrant's annual report on Form 10-K for the year ended April 30, 1999, previously filed with the Commission. (25) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended October 31, 1999, previously filed with the Commission. * Management contract or compensatory plan or arrangement. ** A schedule attached to this exhibit identifies all other documents not required to be filed as exhibits because such exhibits are substantially identical to this exhibit. Except for instruments already filed as exhibits to this Form 10-K, the Registrant agrees to furnish the Commission upon request a copy of each instrument with respect to long-term debt of the Registrant and its consolidated subsidiaries, the amount of which does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. (b) Reports on Form 8-K None. -39- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TreeSource Industries, Inc. (Registrant) By: /s/ Jess R. Drake ------------------------------------ Jess R. Drake President and Chief Executive Officer July 24, 2001 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated as of July 24, 2001. /s/ Jess R. Drake /s/ Robert W. Lockwood ----------------------------------- --------------------------------------- Jess R. Drake Robert W. Lockwood President, Chief Executive Officer Vice President-Finance, Secretary, and Director Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer) /s/ Scott Christie ----------------------------------- Scott Christie, Director /s/ Richard W. Detweiler ----------------------------------- Richard W. Detweiler, Director /s/ William H. Wright ----------------------------------- William H. Wright, Director -40- REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Stockholders TreeSource Industries, Inc. We have audited the accompanying consolidated balance sheets of TreeSource Industries, Inc. and subsidiaries (the "Company") as of April 30, 2001 and 2000, and the related consolidated statement of operations, stockholders' equity and cash flows for each of the years in the three-year period ended April 30, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of TreeSource Industries, Inc. and subsidiaries as of April 30, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended April 30, 2001, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, on September 27, 1999, the Company filed a petition for relief under Chapter 11 of the U.S. Bankruptcy Code and has since operated as a debtor-in-possession. There can be no assurance that sufficient cash will be generated by operations and that the Company will be able to gain acceptance from its creditors and shareholders of a reorganization plan. The matters referred to in the preceding paragraph raise substantial doubt as to the Company's ability to continue as a going concern. The accompanying financial statements do not include all adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that may be necessary should the Company be unable to continue in existence. /s/ Moss Adams LLP ------------------------------ MOSS ADAMS LLP Beaverton, Oregon June 15, 2001 -41-

The accompanying notes are an integral part of these consolidated financial statements. -42-

The accompanying notes are an integral part of these consolidated financial statements. -43-

The accompanying notes are an integral part of these consolidated financial statements. -44-

The accompanying notes are an integral part of these consolidated financial statements. -45-

The accompanying notes are an integral part of these consolidated financial statements. -46- TREESOURCE INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - CHAPTER 11 PROCEEDINGS During the third quarter of fiscal 1998, demand by Asia for wood products declined dramatically causing lumber prices in North America to decline. Lumber markets remained weak through the third quarter of fiscal 1999. The Company incurred significant losses as a result of this protracted period of weak lumber markets combined with the Company's high level of debt and substantial preferred stock dividend obligations, and failed to generate sufficient cash from operations to enable the Company to pay its commitments and continue operating. In response to this situation, on September 27, 1999 the Company filed for voluntary reorganization under Chapter 11 of the U.S. Bankruptcy Code (the "Code"). The Company continues to operate its business as a debtor-in-possession. As a debtor-in-possession under the Code, the Company is authorized to operate its business subject to the terms of a cash collateral order, but may not engage in transactions outside of the ordinary course of business without Court approval. In April 2000 the Company filed a plan of reorganization with the U.S. Bankruptcy Court (the "Court"). Due to the downturn in the lumber market, the Company successfully petitioned the Court to delay consideration of and then to withdraw the plan of reorganization. On March 31, 2001 the period of exclusivity (the time in which the Company has the sole right to present a plan of reorganization) expired, which will allow other interested parties an opportunity to submit a plan of reorganization. In July 2001, the Company's outstanding pre-petition senior secured debt securities were purchased by an investment group. This sale, in itself, may not affect the status of the Company's bankruptcy proceedings. In an effort to maximize value for all parties, the Company is evaluating its strategic alternatives, which include a sale of the Company's operations. The Company's senior secured lenders have a security interest in substantially all the assets of the Company. Regardless of which alternative the Company ultimately pursues, it is unlikely that the Company's current classes of common and preferred stock will have any value upon conclusion of the bankruptcy proceedings. The Company is currently operating as a debtor-in-possession under a cash collateral order approved by the Court, pursuant to a number of conditions. The cash collateral order allows the Company to use funds from operations and the revolving line of credit for normal operating purposes. The cash collateral order also grants a security interest in substantially all the assets of the Company to the pre-petition senior secured lenders and post-petition secured debtor-in-possession lenders. The current cash collateral order expires August 5, 2001. If the Company is unable to either confirm a plan of reorganization or obtain a new cash collateral order by August 6, 2001, the Company may not be able to meet its short term liquidity needs. -47- NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of consolidation and operations - The consolidated financial statements include the accounts of TreeSource Industries, Inc. (formerly WTD Industries, Inc.) and its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated. The Company operates in one industry segment, the manufacture and sale of softwood and hardwood lumber products, wood chips and other by-products. Most lumber products are sold to distributors and wholesalers or directly to large retailers. The Company's products are used in many applications, including residential and commercial construction, packaging, and industrial uses. The Company's sales are predominantly in the United States; export sales are not material. During the year ended April 30, 2001, the Company had no customers that accounted for 10% or more of net sales. Temporary cash investments and trade receivables potentially subject the Company to concentrations of credit risk. The Company places its temporary cash investments with high credit-quality financial institutions, and by policy limits the amount of credit exposure to any one institution. The Company reviews a customer's credit history before extending credit and continually evaluates its accounts receivable. Concentrations of credit risk on trade receivables are limited due to the Company's large number of customers and their widely varying locations. Generally, the Company does not require collateral or other security to support its trade receivables. Cash and cash equivalents - Cash and cash equivalents consist of cash on hand, deposits in banks and financial instruments with a maturity of three months or less. Restricted cash - Restricted cash consists of the net auction proceeds from the sale of certain impaired assets during fiscal 2001. These funds are being held in a non-interest bearing account for payment, subject to court approval, of certain secured claims. Accounts receivable - Trade accounts receivable are shown net of allowances for doubtful accounts and discounts of $175,000 and $160,000 at April 30, 2001 and 2000, respectively. Inventories - Inventories are valued at the lower of cost or market. Cost is determined using the average cost and first-in, first-out (FIFO) methods. A summary of inventory by principal product classification follows (in thousands): -48- APRIL 30, ----------------------------------------- 2001 2000 ---------------- ---------------- Logs $ 2,510 $ 6,571 Lumber 3,888 8,109 Supplies and Other 442 1,120 ---------------- ---------------- $ 6,840 $ 15,800 ================ ================ At April 30, 2001 and 2000, $338,000 and $555,000, respectively, of log inventory was valued at market, which represented a $3,000 reduction from cost. At April 30, 2001, $3,526,000 of lumber inventory was valued at market, which represented a $228,000 reduction from cost. At April 30, 2000, $7,532,000 of lumber inventory was valued at market, which represented a $1,111,000 reduction from cost. Property, plant and equipment - Property, plant and equipment of the Company's facilities are stated at cost. For financial reporting purposes, the Company uses the units-of-production method for computing depreciation over the estimated useful lives of assets, ranging from ten to thirty years for buildings and improvements, and three to ten years for machinery and equipment. When assets are retired or disposed of, cost and accumulated depreciation are reversed from the related accounts and any gain or loss is included in the consolidated statement of operations. Timber and timberlands - Timber and timberlands are stated at the lower of aggregate cost or estimated disposal value, less the amortized cost of timber harvested. The portion of the cost attributable to standing timber is charged against income as timber is cut at rates based on the relationship between unamortized timber value and the estimated volume of recoverable timber. The costs of roads and land improvements are capitalized and amortized over their economic lives. The carrying costs of timber, timberlands and timber-related assets are expensed as incurred. The Company classifies timber and timber-related assets as current or long-term based upon expected harvest and disposal plans. Timber-cutting contracts - The Company purchases timber under various types of contracts. Certain contracts, for which the total purchase price is fixed, are recorded as assets along with the related liability at the date acquired. The remaining contracts, for which the total purchase price depends on the volume of timber removed, are considered to be commitments and are not recorded until the timber is removed. See Note 12 to Consolidated Financial Statements. Income taxes - Income taxes are provided for transactions in the year in which they are reflected in earnings, even though they may be reported for tax purposes in a different year. The resulting difference between taxes charged to operations and taxes paid is reported as deferred income taxes. Tax credits are recognized in the year utilized, using the flow-through method. See Note 8 to Consolidated Financial Statements. -49- Accrued expenses - The following is a summary of the components of accrued expenses (in thousands): APRIL 30, -------------------------------- 2001 2000 -------------- ------------ Payroll and related items $ 4,077 $ 3,100 Freight payable 607 1,018 Accrued Chapter 11 professional fees 186 877 Environmental liabilities 747 -- Other 530 2,907 -------------- ------------ $ 6,147 $ 7,902 ============== ============ Since the Court reviews and approves the Chapter 11 professional fees prior to payment, the related accrued amount is management's estimate of professional services performed but not billed through April 30, 2001. Because the Court has the ability to adjust these fees, the actual amounts owed may differ from management's estimates. Reserves for self-insurance - workers' compensation - Under its self-insurance plan, the Company accrues the estimated cost of workers' compensation claims based on prior years' open claims. An accrual of $1.5 million and $1.6 million is included in the accompanying fiscal 2001 and 2000 financial statements, respectively. Payments based on actual fiscal 2000 claims ultimately filed could differ from these statements. Shipping costs - The Company classifies shipping and handling expenses as part of cost of goods sold. Use of estimates - The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ materially from those estimates. NOTE 3 - IMPAIRMENT CHARGES The Company classified certain property, plant and equipment related to four facilities as Assets Held for Sale during fiscal 2001. A total of seven facilities and land parcels related to two former facilities are currently so classified. In accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," the Company recorded an impairment loss associated with two facilities in fiscal 1998, three facilities in fiscal 1999 and four facilities in fiscal 2001. The resulting adjustments of approximately $4.4 million in fiscal 2001, $6.1 million in fiscal 1999 and $4.2 million in fiscal 1998 were recorded to reduce the book value of these assets to their estimated fair value. The Company considers continued operating losses and significant and long-term changes in industry conditions to be its primary indicators of potential impairment. An impairment is recognized if the future undiscounted cash flows of each facility is estimated to be insufficient to recover its related carrying value. As such, the carrying values of these -50- assets were written down to the Company's estimates of fair value. Fair value is based on appraisal values and may consider remediation costs if they are not, in management's opinion, probable and estimable and as such separately classified as environmental liabilities. Environmental remediation costs are recognized and classified as accrued expense when they are probable and estimable. During fiscal 2001, machinery and equipment at three of these locations were sold at auction. The proceeds from the sales at two of the locations are held by the Company as restricted cash. The proceeds from the sale at the third location were used for general corporate purposes. See Note 2 to Consolidated Financial Statements. At April 30, 2001, the impaired assets have a remaining carrying amount of $6.0 million. Together, these nine facilities recorded net sales of $23.6 million, $85.1 million, and $75.8 million, and contributed net operating losses of $6.3 million, $2.9 million, and $8.9 million for the years ended April 30, 2001, 2000, and 1999, respectively, excluding the impairment charges recognized in fiscal 1999 and 2001. The Company continually considers market conditions and changes occurring in the forest products industry to evaluate the status of its individual mill facilities, and management believes that all necessary impairment adjustments have been made at April 30, 2001. -51- NOTE 4 - NET INCOME (LOSS) PER SHARE This computation is based on net income (loss) less preferred dividends paid during the period, divided by the weighted average number of shares of Common Stock and equivalents assumed to be outstanding during the period. Anti-dilutive Common Stock equivalents consisting of certain employee stock options and certain convertible Preferred Stock, are excluded from the calculation. The calculations of net income (loss) per share for the years ended April 30, 2001, 2000 and 1999 are summarized below (in thousands, except per-share data):

NOTE 5 - TIMBER, TIMBERLANDS AND TIMBER-RELATED ASSETS The following summarizes the components of timber, timberlands and timber-related assets (in thousands): APRIL 30, ----------------------- 2001 2000 -------- -------- Timber held under contract $ 1,376 $ 984 Timber, timberlands, and timber deposits 1,376 1,049 Logging roads (at amortized cost) 335 163 -------- -------- $ 3,087 $ 2,196 ======== ======== -52- Timber held under contract is composed of various public and private timber contracts representing approximately 4.2 million board feet (MMBF) at April 30, 2001 and 2.7 MMBF at April 30, 2000. Outstanding obligations relating to these contracts at April 30, 2001 and 2000 were $447,878 and $147,000, respectively. NOTE 6 - LIABILITIES SUBJECT TO COMPROMISE Under the Code, a claim is treated as secured only to the extent of such creditor's collateral, and the balance of the claim is treated as unsecured. Generally, unsecured and under-secured debt does not accrue interest after the filing, while a fully secured claim continues to accrue interest. Accordingly, interest expense totaling approximately $4.3 million was not accrued during the year ended April 30, 2001 as management believes these debts are under-secured. Amounts included under the caption "Current borrowings" at April 30, 2001 represent draws on a line of credit that was established to provide additional liquidity during the reorganization process. See Note 7 to the Consolidated Financial Statements. These amounts are not subject to compromise. Amounts included under the caption "Liabilities Subject to Compromise" represent claims that are unsecured or where, in the opinion of management, the value of the corresponding collateral is estimated to be less than the amount of the debt. Included under this caption at April 30, 2001 are the following (in thousands): April 30, 2001 ----------- Trade, interest and other miscellaneous claims to unsecured creditors $ 6,133 Secured notes 261 Unsecured notes 1,007 Senior secured debt 41,711 ----------- $ 49,112 =========== Unsecured and under-secured claims may be liquidated and discharged at less than their face value. It is impossible at this time to predict the actual amount of recovery that each creditor may realize, since the valuation of the Company's assets and its claims may be subject to adjustment as part of the bankruptcy proceedings. As a result of the Chapter 11 proceedings, TreeSource Industries, Inc. and its subsidiaries are in default on substantially all of their pre-petition debt agreements. Acceleration of this debt is stayed subject to the Chapter 11 proceedings. Such debt cannot be paid or restructured until the conclusion of the proceedings, unless ordered by the Court. During fiscal 2001, pursuant to a Court order, the Company paid $738,000 in principal on its pre-petition secured debt due to the sale of assets of Sedro-Woolley Lumber Co. -53- NOTE 7 - BORROWINGS

As discussed in Note 6, the Company is in default on substantially all of its pre-petition debt agreements as a result of the Company's Chapter 11 filing. Acceleration of these debts is stayed subject to the Chapter 11 proceedings. Such debt cannot be paid or restructured until the conclusion of the Chapter 11 proceedings, unless ordered by the Court. All of the Company's borrowings, with the exception of any borrowings against the debtor-in-possession, have been reclassified to "Liabilities Subject to Compromise." The Company obtained a $16 million Line of Credit in October 1999 that matures upon the earliest of August 5, 2001 or the effective date of a final order of reorganization. Borrowings under the Line of Credit fluctuate daily based on cash needs and are subject to customary covenants and collateral reserves. The weighted average rate of interest on outstanding short term borrowings on the Line of Credit is 9.0%. The Line of Credit allows the Company to borrow from time to time up to $14 million (the remaining $2 million must remain in reserve pursuant to the terms of the Line of Credit), including up to $5 million of letters of credit. As of April 30, 2001 there were $418,000 in borrowings on the Line of Credit and $1,350,000 in letters of credit outstanding. -54- NOTE 8 - PROVISION FOR INCOME TAXES The federal and state income tax provision consists of the following (in thousands): Year Ended April 30, -------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Income (loss) before income taxes $ (17,398) $ 1,012 $ (10,342) =========== =========== =========== Provision for income taxes (benefit): Federal $ 669 $ 100 $ (96) State 0 0 0 ----------- ----------- ----------- $ 669 $ 100 $ (96) =========== =========== =========== Current $ (81) $ 100 $ (96) Deferred 750 0 0 ----------- ----------- ----------- $ 669 $ 100 $ (96) =========== =========== =========== The difference between the actual income tax provision (benefit) and the tax provision (benefit) computed by applying the statutory federal tax rate to income (loss) before taxes is attributable to the following (in thousands):

-55- At April 30, 2001 and 2000, deferred tax assets and liabilities were composed of the following (in thousands): Year Ended April 30, -------------------------- 2001 2000 ----------- ----------- Deferred tax assets: Vacation accruals $ 180 $ 241 Insurance accruals 538 672 Professional fee amortization and accruals 587 575 Depreciation and capitalization differences between financial and tax accounting 515 64 Tax benefit of NOL carryforward and tax credits carryforward 20,038 16,602 Bad debts, discounts and other 939 255 ----------- ----------- Net deferred tax assets 22,797 18,409 Valuation allowance (22,797) (17,659) ----------- ----------- Net deferred tax asset reported $ 0 $ 750 =========== =========== Because of the difficult operating environment and the likely delayed or decreased use of the Company's deferred tax assets to offset future income, management has elected to record no income tax expense during the current year related to the income generated, but instead adjusted the reserve on the deferred tax assets. This, coupled with an adjustment to the usable net operating loss, resulted in an increase to the valuation reserve of approximately $5.1 million for the year ended April 30, 2001. The current year income tax expense of $669,000 is attributable to the Company's decision to fully reserve for any deferred tax assets and the refund of income taxes paid in the prior year. Management periodically reviews the above factors and may change the amount of valuation allowance as facts and circumstances change. As of April 30, 2001, the Company has approximately $48 million of federal NOL and approximately $36 million of state NOL available to offset future taxable income. These carryforwards begin to expire in 2007 and 2012. NOTE 9 - STOCKHOLDERS' EQUITY Stockholders' equity at April 30, 2001 consists of the following: Series A Preferred Stock, $100 per share liquidation preference; 500,000 shares authorized; 270,079 shares issued and outstanding, limited voting rights; cumulative dividends payable quarterly in advance at the prime rate, with a minimum rate of 6% and a maximum rate of 9%; convertible into Common Stock at $7.50 per share after April 30, 1999; redeemable at original issue price plus any accrued dividends at the option of the -56- Board of Directors, in the form of cash or in exchange for senior unsecured debt with 12% coupon. The holders of the Series A Preferred Stock have the right to obtain voting control of the Company's Board of Directors in the event the Company misses three consecutive quarterly dividend payments, four quarterly dividend payments within twenty-four months or a total of eight quarterly dividend payments. The Company is currently in arrears on ten consecutive quarterly dividend payments as of May 31, 2001 totaling $5,587,000. Series B Preferred Stock, $100 per share liquidation preference; 500,000 shares authorized; 6,111 shares issued and outstanding; limited voting rights; convertible into 212,693 shares of Common Stock; dividends payable only if paid on the Company's Common Stock; redeemable at original issue price plus accrued dividends at the option of the Board of Directors after all Series A Preferred Stock has been redeemed. Series C Junior Participating Preferred Stock, $100 per share liquidation preference; 400,000 shares authorized; no shares issued or outstanding; each share has 100 votes, voting together with Common Stock; dividends payable only if paid on the Company's Common Stock at 100 times the Common Stock dividend rate. This class of Preferred Stock was authorized in connection with the Shareholder Rights Plan adopted by the Company on March 4, 1998. Common Stock, no par value; 40,000,000 shares authorized; 11,162,874 shares issued and outstanding for both years ended April 30, 2001 and April 30, 2000. Before giving effect to any shares that might be issued pursuant to the management incentive Stock Option Plan or conversion of any Series A Preferred Stock, the total number of common shares would increase to 11,375,567 shares if the shares of Series B Preferred Stock remaining outstanding at May 31, 2001 were converted to Common Stock. It is unlikely, in any event, that the Company's current classes of common and preferred stock will have any value upon conclusion of the bankruptcy proceedings. On March 4, 1998, the Board of Directors adopted a Shareholder Rights Plan ("Plan"). Under the Plan, the Board declared a distribution of one Preferred Share Purchase Right ("Right") for each outstanding share of the Company's Common Stock. The distribution was payable on March 4, 1998 to the shareholders of record on that day. The Rights are attached to, and automatically trade with, the outstanding shares of the Company's Common Stock. The Rights will become exercisable in the event that any person or group of affiliated persons becomes a holder of 15% or more of the Company's outstanding shares of Common Stock or any person or group of affiliated persons who at the date of the Rights Agreement, beneficially owned 15% or more of the then-outstanding shares of Common Stock, has acquired beneficial ownership of 31% or more of the outstanding shares of Common Stock. In addition, the Rights will become exercisable in the event of the commencement of a tender or exchange offer that, if consummated, would result in that person or group of affiliated persons meeting the above-listed requirements as to -57- ownership of the Company's outstanding shares of Common Stock. Once the Rights become exercisable, each Right entitles its holder to purchase, by payment of a $7.50 exercise price, one one-hundredth of a share of Series C Junior Participating Preferred Stock, subject to adjustment. In addition, at any time after the above mentioned criteria have been met and prior to the acquisition of a 50% position, the Board of Directors may require each outstanding Right to be exchanged for one share of Common Stock. In general, none of the benefits of the Rights will be available to a holder of the Common Stock who meets the above-mentioned criteria. The Rights may be redeemed by the Company at a price of $0.01 per Right at any time prior to the above-mentioned criteria being met and to the expiration date of such Rights on March 4, 2008. NOTE 10 - STOCK OPTIONS AND EMPLOYEE BENEFIT PLANS The Company has in effect a Stock Option Plan ("Option Plan"). Non-qualified stock options may be granted to directors, independent contractors, consultants and employees to acquire up to 1,425,000 shares of Common Stock. Options may be granted for a term not to exceed 10 years and are not transferable other than by will or the laws of descent and distribution. The Option Plan provides for incremental vesting based upon the optionee's period of service with the Company, and is administered by the Board of Directors. Stock options outstanding at April 30, 2001, 2000 and 1999 related only to employees and directors. Stock Options ---------------------------- Weighted Average Number of Exercise Shares Price ------------ ------------ Shares under option at April 30, 1999 1,514,320 $ 1.34 Options granted 60,000 0.09 Options exercised 0 0.00 Options canceled (131,000) 1.61 ------------ Shares under option at April 30, 2000 1,443,320 $ 1.26 Options granted 50,000 0.04 Options exercised 0 0.00 Options canceled (391,625) 1.82 ------------ Shares under option at April 30, 2001 1,101,695 $ 1.01 ============ Options exercisable at April 30, 2001 888,371 $ 1.12 ============ -58- Exercise prices for options outstanding as of April 30, 2001 ranged from $0.03825 to $3.00. The weighted average remaining contractual life of those options is 6.6 years and the weighted average exercise price is $1.01.

Options for 1,060,000 shares remain available for grant under the 1996 Stock Option Plan. These options will have an exercise price of an amount per share determined by the Company's Board of Directors, but not less than 85% of the fair market value of the Company's Common Stock on the date of grant. During fiscal 2001 the Company granted stock options for the purchase of 50,000 shares of the Company's Common Stock to Robert W. Lockwood pursuant to the terms of his employment contract. The term of these options is ten years from the date of grant and they are not transferable other than by will or the laws of descent and distribution. The options will vest over a three-year period. The Company maintains a weekly discretionary bonus program for its mill employees based on the performance of each production shift at individual mills. The bonus program for mill employees is designed to reward safety, productivity, and regular attendance. This bonus program is open-ended but designed to attract employees with a competitive compensation package when average bonuses are added to base wages. It is also designed so that manufacturing labor costs, per unit of lumber produced, go down as the average bonus level goes up. The Company also has two additional bonus programs. The first covers most salaried employees except for senior management, and is a quarterly bonus program based on pre-tax profits. The second is an annual bonus program covering senior executives and is also based on pre-tax profits. These programs, which automatically move the Company's total general and administrative expense up or down in cyclical earnings periods, are vital to the Company's ability to attract desirable salaried employees at lower than industry average compensation and benefits and to retain such employees through cyclical down-turn in earnings. -59- The following summarizes the amounts paid pursuant to the Company's bonus programs (in thousands) during the fiscal years ended: Year Ended April 30, ----------------------------- 2001 2000 1999 ------- ------- ------- Hourly employee bonus $ 3,500 $ 5,300 $ 4,100 Salaried employee bonus 150 600 900 ------- ------- ------- $ 3,650 $ 5,900 $ 5,000 ======= ======= ======= The Company maintains a 401(k) Retirement Savings Plan. Under the plan, eligible participants may contribute a maximum of 20% of their compensation. The Company matches 50% of the first 5% contributed by the employee. During the years ended April 30, 2001, 2000 and 1999, the Company incurred expenses for matching contributions and plan administration of $299,000; $291,000; and $261,000 respectively. Company contributions to this plan are funded on a current basis. NOTE 11 - RELATED PARTY TRANSACTIONS During fiscal 2001, four of the Company's subsidiaries purchased logs worth approximately $2.5 million from Quinault Logging Company. During fiscal 2000 five of the Company's subsidiaries purchased logs worth approximately $8.1 million from Quinault Logging Company. Mr. Larry G. Black, who was a director of the Company from October 1997 until his resignation effective July 7, 2000, is chief executive officer of Quinault Logging Company and is president and sole director of Quinault Corporation, and the beneficial owner of approximately 17.2% of the Company's Common Stock. NOTE 12 - COMMITMENTS AND CONTINGENCIES (a) Timber commitments - At April 30, 2001, the Company had contracts to purchase approximately 11.7 MMBF of timber from the Oregon State Department of Forestry and others for an estimated stumpage cost of $3,703,000. Deposits were made on these contracts and additional payments are required as timber is removed. The expiration dates of the contracts are as follows: Year Ending Stumpage April 30, MMBF Cost ----------- -------- ------------ 2002 2.2 $ 582,000 2003 0.0 0 2004 9.2 2,982,000 2005 0.0 0 2006 0.3 139,000 -------- ------------ 11.7 $ 3,703,000 ======== ============ -60- (b)Leases - At April 30, 2001, the Company had future minimum rental commitments for operating leases as follows: 2001 - $939,000; 2002 - $306,000; 2003 - $197,000; 2004 - $172,000; 2005 - $169,000; thereafter - $332,000. In bankruptcy, the Company may elect to reject certain leases causing a reduction in the future minimum rental commitments for operating leases. Total rental expense for all leases was $1,204,000, $1,447,000 and $1,613,000 for the years ended April 30, 2001, 2000 and 1999, respectively. Actual rental expense includes short-term rentals and leases shorter than one year, which are not included in the commitments. (c) Litigation - On September 27, 1999, the Company filed for voluntary reorganization under Chapter 11 of the Code. Due to the Company's Chapter 11 filing, all action against the Company is stayed. The Company is involved in certain litigation primarily arising in the normal course of its business. In the opinion of management, the Company's liability, if any, under such pending litigation, excluding the Company's Chapter 11 filing, will not have a material impact upon the Company's consolidated financial condition or results of operations. (d) Environmental compliance - The Company is subject to various federal, state and local regulations regarding waste disposal and pollution control. Various governmental agencies have enacted, or are considering, regulations regarding a number of environmental issues that may require material expenditures in the future. These include regulations regarding log yard management, disposal of log yard waste, kiln process waste water, and air emissions from hog fuel fired boilers. The potential expenditures required for the Company to comply with any such regulations could have a material adverse impact on its consolidated financial condition and/or results of operations. However, management believes that the Company will be able to comply with existing regulations without a material impact on its consolidated financial condition or results of operations. The following table summarizes not only the amount of environmental expenses that are accrued at April 30, 2001, but also, the amount the Company estimates will be paid out during fiscal 2002. -61-

NOTE 14 - VALUATION AND QUALIFYING RESERVES The following table summarizes the activity associated with the Company's allowance for doubtful accounts and allowance for discounts for the years ended April 30, 2001, 2000 and 1999 (in thousands): Allowance for doubtful accounts - deducted from accounts receivable in the balance sheet Year Ended April 30, ----------------------------------------- 2001 2000 1999 --------- --------- --------- Balance at beginning of year $ 60 $ 55 $ 39 Charged to costs and expenses 76 82 35 Deductions (1) (21) (77) (19) -------- -------- -------- Balance at end of year $ 115 $ 60 $ 55 ========= ========= ========= Allowance for discounts - deducted from accounts receivable in the balance sheet Year Ended April 30, ----------------------------------------- 2001 2000 1999 --------- --------- --------- Balance at beginning of year $ 100 $ 87 $ 89 Charged to costs and expenses 1,356 2,344 1,814 Deductions(2) (1,396) (2,331) (1,816) --------- --------- -------- Balance at end of year $ 60 $ 100 $ 87 ========= ========= ========= (1) Uncollected receivables written off, net of recoveries. (2) Discounts taken by customers. -63- NOTE 15 - REORGANIZATION CHARGES As a result of the Chapter 11 proceedings, the Company has incurred legal accounting and other professional fees. The following table summarizes the amounts charged to income through April 30, 2001 (in thousands). April 30, 2001 ------------ Legal $ 653 Consulting 256 Accounting 23 Other 355 ------------ $ 1,287 ============ -64- CORPORATE INFORMATION --------------------- Annual Meeting Transfer Agent for Series A Preferred To be announced Stock and Series B Preferred Stock TreeSource Industries, Inc. 529 SE Grand Avenue, Suite 300 Stock Transfer Department Portland, Oregon 97214-2232 P.O. Box 5805 Phone: (503) 246-3440 Portland, Oregon 97228-5805 Fax: (503) 205-7605 529 SE Grand Avenue, Suite 300 Web: http://www.treesource.com Portland, Oregon 97214-2232 Phone: (503) 246-3440 Common Stock Fax: (503) 205-7605 TreeSource Industries, Inc. Common stock is traded on the Bulletin Change of address information and Board (Symbol TRES) questions regarding transfers and conversions should be directed to the Transfer Agent for Common Stock transfer agent. ChaseMellon Shareholder Services, L.L.C. Overpeck Centre Trustee for 8% Senior Subordinated 85 Challenger Road Notes due 2005 Ridgefield Park, New Jersey 07660 State Street Bank & Trust Company Phone: (800) 522-6645 Corporate Trust Department Fax: (206) 292-3196 P.O. Box 778 Web: http://www.chasemellon.com Boston, Massachusetts 02110 Two International Place Boston, Massachusetts 02110 Phone: (617) 662-1753 Fax: (617) 662-1456 Counsel Perkins Coie Portland, Oregon Auditors Moss Adams LLP Beaverton, Oregon -65- BOARD OF DIRECTORS, HEADQUARTERS, AND MILL LOCATIONS Board of Directors Headquarters Scott Christie (2) TreeSource Industries, Inc. General Partner P.O. Box 5805 Christie Capital Management Portland, Oregon 97228-5805 Novato, California 529 SE Grand Avenue, Suite 300 Elected 1988 Portland, Oregon 97214-2232 Phone: (503) 246-3440 Richard W. Detweiler (1) Fax: (503) 205-7605 Principal Web: http://www.treesource.com Carlisle Enterprises LaJolla, California Elected 1995 Sales and Marketing William H. Wright (1)(2) TreeSource, Inc. President P.O. Box 5805 Heartwood Consulting Service Portland, Oregon 97228-5805 Gresham, Oregon 529 SE Grand Avenue, Suite 300 Elected 1992 Portland, Oregon 97214-2232 Phone: (503) 246-8600 Jess R. Drake (3) Toll free outside Oregon: 1-800-843-5254 President Fax: (503) 245-1483 TreeSource Industries, Inc. Web: http://www.treesource.com Portland, Oregon Elected 1998 Timber Western Timber Co. P.O. Box 5805 Portland, Oregon 97228-5805 529 SE Grand Avenue, Suite 300 Portland, Oregon 97214-2232 Phone: (503) 246-3440 Fax: (503) 205-7605 Web: http://www.treesource.com (1) Audit Committee (2) Compensation Committee (3) Executive Committee -66- Operating Locations Glide Lumber Products Co. Pacific Softwoods Co. P.O. Box 370 P.O. Box 370 Glide, Oregon 97443-0370 Philomath, Oregon 97370-0370 1577 Glide Loop Road 950 Clemens Mill Road Glide, Oregon 97443-9711 Philomath, Oregon 97370 Phone: (541) 496-3571 Phone: (541) 929-2902 Fax: (541) 496-0373 Fax: (541) 929-2916 Morton Forest Products Co. Spanaway Lumber Co. P.O. Box I 19111 38th Avenue East Morton, Washington 98356-0049 Tacoma, Washington 98446-1189 247 Priest Road Phone: (253) 847-1935 Morton, Washington 98356-9404 Fax: (253) 847-2023 Phone: (360) 496-6666 Fax: (360) 496-6667 North Powder Lumber Co. Trask River Lumber Co. P.O. Box 169 5900 Moffett Road North Powder, Oregon 97867-0169 Tillamook, Oregon 97141-9621 105 Second Street Phone: (503) 842-4007 North Powder, Oregon 97867 Fax: (503) 842-3178 Phone: (541) 898-2149 Fax: (541) 898-2817 Pacific Hardwoods-South Bend Co. Tumwater Lumber Co. P.O. Box 185 P.O. Box 4158 South Bend, Washington 98586-0185 Tumwater, Washington 98501-0158 819 Ocean Street 8277 Center Street, S.W. Raymond, Washington 98577-2905 Tumwater, Washington 98501-7227 Phone: (360) 942-5525 Phone: (360) 352-1548 Fax: (360) 942-5529 Fax: (360) 943-4091 -67-

TREESOURCE INDUSTRIES INC 10-K