Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
For the quarterly period ended March 31, 2010
   
OR
     
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-9035

POPE RESOURCES, A DELAWARE
LIMITED PARTNERSHIP
(Exact name of registrant as specified in its charter)
 
Delaware
 
91-1313292
(State or other jurisdiction of
 
(IRS Employer
incorporation or organization)
 
Identification Number)

19245 10th Avenue NE, Poulsbo, WA 98370
Telephone: (360) 697-6626
(Address of principal executive offices including zip code)
(Registrant's telephone number including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes ¨ No¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer” “accelerated filer” and “smaller reporting company” in rule 12b-2 of the Exchange Act. (check one)
Large Accelerated Filer¨
 
Accelerated Filer x
Non-accelerated Filer¨
 
Smaller Reporting Company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-2 of the Exchange Act)Yes ¨Nox

Partnership units outstanding at May 3, 2010: 4,598,248


 
Pope Resources
Index to Form 10-Q Filing
For the Quarter Ended March 31, 2010

Description
 
Page Number
Part I. Financial Information
   
     
Item 1 Financial Statements (unaudited)
   
Condensed Consolidated Balance Sheets
 
4
Condensed Consolidated Statements of Operations
 
5
Condensed Consolidated Statements of Cash Flows
 
6
Notes to Condensed Consolidated Financial Statements
 
7
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
13
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk
 
28
     
Item 4. Controls and Procedures
 
29
     
Part II. Other Information
   
     
Item 1. Legal Proceedings
 
29
     
Item 1A. Risk Factors
 
29
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
31
     
Item 3. Defaults Upon Senior Securities
 
31
     
Item 4. Submission of Matters to a Vote of Security Holders
 
31
     
Item 5. Other Information
 
31
     
Item 6. Exhibits
 
32
     
Signatures
 
33
 
 
 

 

PART I – FINANCIAL INFORMATION

ITEM 1
 
FINANCIAL STATEMENTS
 
 
3

 

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
Pope Resources, a Delaware Limited Partnership
March 31, 2010 and December 31, 2009
(Thousands)

   
2010
   
2009
 
ASSETS
           
Current assets:
           
Pope cash and cash equivalents
  $ 6,917     $ 6,035  
ORM Timber Funds cash and cash equivalents
    1,317       1,145  
Cash and cash equivalents
    8,234       7,180  
Student loan auction rate securities, current
    -       690  
Accounts receivable, net
    647       261  
Land held for sale
    367       367  
Current portion of contracts receivable
    316       320  
Prepaid expenses and other
    291       444  
Total current assets
    9,855       9,262  
Properties and equipment, at cost:
               
Land held for development
    26,183       25,872  
Land
    25,068       25,072  
Roads and timber, net of accumulated depletion
               
of $55,500, and $54,743
    119,778       120,457  
Buildings and equipment, net of accumulated
               
depreciation of $7,408, and $7,321
    3,995       3,967  
Total properties and equipment, at cost
    175,024       175,368  
Other assets:
               
Contracts receivable, net of current portion
    1,131       1,140  
Student loan auction rate securities, non-current
    -       796  
Other
    474       490  
Total other assets
    1,605       2,426  
Total assets
  $ 186,484     $ 187,056  
LIABILITIES AND PARTNERS' CAPITAL
               
Current liabilities:
               
Accounts payable
  $ 545     $ 586  
Accrued liabilities
    730       784  
Current portion of environmental remediation
    116       200  
Current portion of long-term debt
    18,636       831  
Deferred revenue
    637       469  
Other current liabilities
    214       196  
Total current liabilities
    20,878       3,066  
Long-term liabilities:
               
Long-term debt, net of current portion
    10,098       28,659  
Environmental remediation, net of current portion
    1,069       1,069  
Other long-term liabilities
    180       205  
Partners' capital and non controlling interests:
               
Partners' capital (units outstanding: 4,539 and 4,520)
    83,350       83,126  
Noncontrolling interests
    70,909       70,931  
Total partners' capital and noncontrolling interests
    154,259       154,057  
Total liabilities, partners' capital, and noncontrolling interests
  $ 186,484     $ 187,056  
 
See accompanying notes to condensed consolidated financial statements.

4

 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
 
Pope Resources, a Delaware Limited Partnership
For the Three Months Ended March 31, 2010 and 2009
(Thousands, except per unit data)

   
2010
   
2009
 
             
Revenue
  $ 5,966     $ 4,979  
Cost of timber and land sold
    (2,606 )     (2,198 )
Operating expenses
    (1,847 )     (1,978 )
General and administrative expenses
    (941 )     (844 )
Income (loss) from operations
    572       (41 )
                 
Other income (expense):
               
Interest expense
    (541 )     (617 )
Capitalized interest
    240       305  
Interest income
    34       69  
Realized gain on student loan auction rate securities
    11       -  
Unrealized loss on student loan auction rate securities
    -       (60 )
Total other expense
    (256 )     (303 )
                 
Income (loss) before income taxes
    316       (344 )
Income tax expense
    (12 )     -  
Net income (loss)
    304       (344 )
                 
Net loss attributable to noncontrolling interests:
               
ORM Timber Funds
    147       221  
Net income (loss) attributable to unitholders
  $ 451     $ (123 )
                 
Allocable to general partners
  $ 6     $ (2 )
Allocable to limited partners
    445       (121 )
    $ 451     $ (123 )
                 
Earnings (loss) per unit attributable to unitholders:
               
Basic
  $ 0.10     $ (0.03 )
Diluted
  $ 0.10     $ (0.03 )
                 
Weighted average units outstanding:
               
Basic
    4,530       4,591  
Diluted
    4,586       4,591  
                 
Distributions per unit
  $ 0.10     $ 0.20  

See accompanying notes to condensed consolidated financial statements.

5


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
Pope Resources, a Delaware Limited Partnership
Three Months Ended March 31, 2010 and 2009
(Thousands)

   
2010
   
2009
 
Net income (loss)
  $ 304     $ (344 )
Adjustments to reconcile net income (loss) to net cash provided by operating
               
activities:
               
Depletion
    724       569  
Equity based compensation
    161       159  
Depreciation and amortization
    154       203  
Realized gain on student loan auction rate securities
    (11 )     -  
Unrealized loss on student loan auction rate securities
    -       60  
Cost of land sold
    67       -  
Capitalized development activities, net of reimbursements
    (320 )     (329 )
Increase in cash from changes in operating accounts:
               
Deferred revenue
    168       256  
Accounts receivable
    (386 )     (261 )
Contracts receivable
    13       28  
Prepaid expenses and other current assets
    153       58  
Accounts payable and accrued liabilities
    (91 )     80  
Other current liabilities
    18       44  
Environmental remediation
    (84 )     (60 )
Other long-term liabilities
    (25 )     (24 )
Other, net
    1       (4 )
Net cash provided by operating activities
    846       435  
Cash flows from investing activities:
               
Redemption of investments
    1,497       -  
Reforestation and roads
    (132 )     (133 )
Other capital expenditures
    (137 )     (318 )
Proceeds from fixed asset sale
    -       4  
Net cash provided by (used in) investing activities
    1,228       (447 )
                 
Cash flows from financing activities:
               
Repayment of long-term debt
    (757 )     (1,343 )
Unit repurchases
    -       (782 )
Proceeds from option exercises
    72       -  
Cash distributions to unitholders
    (460 )     (932 )
Capital call- ORM Timber Fund II, Inc.
    -       305  
Preferred stock issuance- ORM Timber Fund II, Inc.
    125       -  
Other
    -       (1 )
Net cash used in financing activities
    (1,020 )     (2,753 )
Net increase (decrease) in cash and cash equivalents
    1,054       (2,765 )
Cash and cash equivalents at beginning of period
    7,180       17,978  
Cash and cash equivalents at the end of the three-month period
  $ 8,234     $ 15,213  
 
See accompanying notes to condensed consolidated financial statements.
 
 
6

 

POPE RESOURCES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 2010

1.
The condensed consolidated financial statements as of March 31, 2010 and December 31, 2009 and for the three-month periods (quarters) ended March 31, 2010 and 2009 have been prepared by Pope Resources, A Delaware Limited Partnership (the “Partnership”) pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). The condensed consolidated financial statements are unaudited, but, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments and accruals) necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The financial information as of December 31, 2009, is derived from the Partnership’s audited consolidated financial statements and notes thereto for the year ended December 31, 2009, and should be read in conjunction with such financial statements. The results of operations for the interim periods are not indicative of the results of operations that may be achieved for the entire fiscal year ending December 31, 2010.
 
Certain amounts have been reclassified in the December 31, 2009 financial statements to conform to the March 31, 2010 presentation.  See note 5.
 
2.
The financial statements in the Partnership's 2009 annual report on Form 10-K include a summary of significant accounting policies of the Partnership and should be read in conjunction with this Quarterly Report on Form 10-Q.
 
3.
Basic net earnings (loss) per unit are based on the weighted average number of units outstanding during the period. Diluted net earnings per unit is calculated by dividing net income (loss) attributable to unitholders, adjusted for non-forfeitable distributions paid out to unvested restricted unitholders, by the weighted average units outstanding during the year plus additional units that would have been outstanding assuming the exercise of in-the-money unit equivalents using the treasury stock method.  Unit equivalents are excluded from the computation if their effect is anti-dilutive, as is the case when the company has a net loss for the period.  For computing the dilutive effect of unit options for the quarter ended March 31, 2010, 55,807 unit equivalents outstanding were included in the calculation of fully diluted units outstanding, and the remainder was excluded as anti-dilutive.  For the quarter ended March 31, 2009, all unit equivalents outstanding were excluded from the calculation of fully diluted units outstanding due to the net loss for the quarter which made these options anti-dilutive.
 
For the quarter ended March 31, 2010, options to purchase 2,096 units at prices ranging from $25.50 to $37.73 were not included in the calculation as they were anti-dilutive. For the same period in 2009, options to purchase 47,369 units at prices ranging from $18.99 to $37.73 were not included in the calculation as they were anti-dilutive.
 
 
7

 
 
(Thousands)
 
Quarter Ended
March 31,
 
   
2010
   
2009
 
Net income (loss) attributable to Pope Resources’ unitholders
  $ 451     $ (123 )
Nonforfeitable distributions paid to unvested restricted unitholders
    (6 )     (12 )
Cumulative preferred dividends payable to Fund II preferred shareholders
    (4 )     -  
Net income (loss) to unitholders
  $ 441     $ (135 )
Weighted average units outstanding (in thousands):
               
Basic
    4,530       4,591  
Dilutive effect of unit equivalents
    56       -  
Diluted
    4,586       4,591  
                 
Earnings (loss) per unit: Basic
  $ 0.10     $ (0.03 )
                 
Earnings (loss) per unit: Diluted
  $ 0.10     $ (0.03 )
 
Options to purchase 152,553 and 163,053 units at prices ranging from $9.30 to $37.73 per unit were outstanding as of March 31, 2010 and 2009, respectively.
 
4.
In 2005, we adopted the 2005 Unit Incentive Plan. Following adoption of this plan the Human Resources Committee of the Board of Directors began issuing restricted units instead of unit options as its primary method of granting equity based compensation. However, the plan also does permit the issuance of unit options, unit appreciation rights and other equity compensation at the discretion of the Human Resources Committee.

Restricted Units
As of March 31, 2010, total compensation expense not yet recognized related to non-vested restricted unit awards was $908,000 with a weighted average 18 months remaining to vest.

Restricted units
 
March 31, 2010
 
Number outstanding
    59,395  
Aggregate intrinsic value
  $ 1,539,000  
 
Unit Options
Unit options have not been granted since December 2005. Units options granted prior to January 1, 2006 were non-qualified options granted at an exercise price not less than 100% of the fair value on the grant date. Unit options granted to employees vested over four or five years. Board members had the option of receiving their annual retainer in the form of unit options and those options vested immediately as they were granted monthly for services rendered during the month. Options granted have a life of ten years.
 
8

 
Options Outstanding and Exercisable
 
March 31, 2010
 
Number outstanding
    152,553  
Weighted average exercise price
  $ 15.38  
Aggregate intrinsic value
  $ 1,620,000  
Weighted average remaining contractual term (yrs)
    2.17  
 
5.
Supplemental disclosure of cash flow information: interest paid, net of amounts capitalized, totaled $299,000 and $309,000 for the three months ended March 31, 2010 and 2009, respectively.   Income taxes paid in the first quarter of 2010 was $5,000 compared to an income tax refund received of $1,000 in the first quarter of 2009.

During the quarter ended September 30, 2009, the Partnership changed its classification of cash flows to include real estate development capital expenditures within cash flows from operating activities.  Prior to the quarter ended September 30, 2009, these expenditures were reported within investing activities within the Partnership’s statement of cash flows.  Certain accounts in the prior year statement of cash flows have been revised for comparative purposes to conform to the presentation in the current year financial statements.  The table below details the changes made to the statement of cash flows for the three-month period ended March 31, 2009.

   
As Originally
             
(Thousands)
 
Reported
   
Adjustments
   
As Revised
 
Cash flows from operating activities:
                 
Capitalized development activities
    -       (329 )     (329 )
Net cash provided by operating activities
    764       (329 )     435  
                         
Cash flows from investing activities:
                       
Capitalized development activities
    (329 )     329       -  
Net cash used in investing activities
    (776 )     329       (447 )
 
6.  
The fair values of cash and cash equivalents and investments held at March 31, 2010 and December 31, 2009 were as follows (in thousands):

   
March 31, 2010
 
         
Gross
       
   
Amortized
   
Unrealized
   
Estimated
 
   
Cost
   
Loss
   
Fair Value
 
Cash and cash equivalents
  $ 8,234     $ -     $ 8,234  
       
   
December 31, 2009
 
           
Gross
         
   
Amortized
   
Unrealized
   
Estimated
 
   
Cost
   
Loss
   
Fair Value
 
Cash and cash equivalents
  $ 7,180     $ -     $ 7,180  
Securities maturing after ten years:
                       
Auction rate securities, current
    925       (235 )     690  
Auction rate securities, non-current
    1,000       (204 )     796  

9

 
During the three-month period ended March 31, 2010, we liquidated the remaining $1.5 million of auction rate securities held as of December 31, 2009 resulting in a realized gain of $11,000 compared with no realized gain or loss for the comparable period in 2009.  The realized gain for the first quarter of 2010 resulted from the following three transactions:

Date
 
Description
 
Proceeds
   
Basis
   
Gain/(Loss)
 
Jan 21st
 
Pennsylvania Higher Education
  $ 25,000     $ 18,653     $ 6,347  
Jan 28th
 
Pennsylvania Higher Education
    702,000       671,490       30,510  
Mar 5th
 
Brazos
    770,000       796,100       (26,100 )
   
Total
  $ 1,497,000     $ 1,486,243     $ 10,757  
 
7.
ASC 820 Fair Value Measurements and Disclosures (FASB Statement No. 157 Fair Value Measurement (SFAS No. 157)) was followed to determine the fair value of the Partnership’s investments. ASC 820 (SFAS No. 157) defines a hierarchy of three levels of evidence used to determine fair value:
 
 
·
Level 1 - quoted prices for identical assets/liabilities in active markets
 
·
Level 2 - quoted prices in a less active market, quoted prices for similar but not identical assets/liabilities, inputs other than quoted prices
 
·
Level 3 - significant unobservable inputs including the Partnership’s own assumptions in determining the fair value of investments

The following table provides the fair value measurements of applicable Partnership financial assets according to the levels defined in ASC 820 as of March 31, 2010 and December 31, 2009:

   
March 31, 2010
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Cash and cash equivalents
  $ 8,234     $ -     $ -     $ 8,234  
                                 
   
December 31, 2009
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Cash and cash equivalents
  $ 7,180     $ -     $ -     $ 7,180  
Auction rate securities, current
    -       690       -       690  
Auction rate securities, non-current
    -       796       -       796  
Total financial assets at fair value
  $ 7,180     $ 1,486     $ -     $ 8,666  
 
8.
Total comprehensive income for the three-month period ended March 31, 2010 is $304,000 which is solely net income for the quarter compared to total comprehensive loss of $325,000 for the comparable period in 2009 which includes unrealized gain of $19,000 on auction rate securities.
 
9.
The Partnership has two general partners: Pope MGP, Inc. and Pope EGP, Inc. In total, these two entities own 60,000 partnership units. The allocation of distributions and income (loss) between the general and limited partners is pro rata among all units outstanding.
 
10.
In the presentation of the Partnership’s revenue and operating income by segment all intersegment revenue and expense is eliminated to determine externally reported operating income by business segment.  The table that follows reconciles internally reported income (loss) from operations to externally reported income (loss) from operations by business segment, for the quarters ended March 31, 2010 and 2009:
 
10

 
   
Fee
                         
   
Timber
   
Timberland
                   
   
Pope
               
Management
                   
Three Months Ended
 
Resources
   
Timber
   
Total
   
&
   
Real
             
March 31, (Thousands)
 
Timber
   
Funds
   
Fee Timber
   
Consulting
   
Estate
   
Other
   
Consolidated
 
2010
                                         
Revenue internal
  $ 5,503     $ 278     $ 5,781     $ 253     $ 216     $ -     $ 6,250  
Eliminations
    (19 )     -       (19 )     (253 )     (12 )     -       (284 )
Revenue external
    5,484       278       5,762       -       204       -       5,966  
                                                         
Cost of timber and land sold
    (2,529 )     (76 )     (2,605 )     -       (1 )     -       (2,606 )
                                                         
Operating, general and
                                                       
administrative expenses internal
    (761 )     (384 )     (1,145 )     (257 )     (729 )     (941 )     (3,072 )
Eliminations
    15       253       268       16       -       -       284  
Operating, general and
                                                       
administrative expenses external
    (746 )     (131 )     (877 )     (241 )     (729 )     (941 )     (2,788 )
                                                         
Income (loss) from operations
                                                       
internal
    2,213       (182 )     2,031       (4 )     (514 )     (941 )     572  
Eliminations
    (4 )     253       249       (237 )     (12 )     -       -  
Income (loss) from operations
                                                       
external
  $ 2,209     $ 71     $ 2,280     $ (241 )   $ (526 )   $ (941 )   $ 572  
                                                         
2009
                                                       
Revenue internal
  $ 4,565     $ 1     $ 4,566     $ 412     $ 262     $ -     $ 5,240  
Eliminations
    (45 )     -       (45 )     (204 )     (12 )     -       (261 )
Revenue external
    4,520       1       4,521       208       250       -       4,979  
                                                         
Cost of timber and land sold external
    (2,197 )     -       (2,197 )     -       (1 )     -       (2,198 )
                                                         
Operating, general and
                                                       
administrative expenses internal
    (898 )     (276 )     (1,174 )     (357 )     (708 )     (844 )     (3,083 )
Eliminations
    12       204       216       45       -       -       261  
Operating, general and
                                                       
administrative expenses external
    (886 )     (72 )     (958 )     (312 )     (708 )     (844 )     (2,822 )
                                                         
Income (loss) from operations
                                                       
internal
    1,470       (275 )     1,195       55       (447 )     (844 )     (41 )
Eliminations
    (33 )     204       171       (159 )     (12 )     -       -  
Income (loss) from operations
                                                       
external
  $ 1,437     $ (71 )   $ 1,366     $ (104 )   $ (459 )   $ (844 )   $ (41 )

11

 
11.
As of March 31, 2010 and December 31, 2009, the Partnership had the following long-term debt outstanding:
 
(Amounts in thousands:)
 
Mar-10
   
Dec-09
 
Mortgage payable to Northwest Farm Credit Services (NWFCS),
           
interest at 6.4%, collateralized by timberlands with monthly interest-
           
only payments. Matures in September 2019.
  $ 9,800     $ 9,800  
                 
Mortgage payable to John Hancock Life Insurance Company
               
(JHLIC), interest at 7.63%, collateralized by timberlands with
               
monthly interest payments and annual principal payments. Matures
               
in April 2011.
    18,554       19,303  
                 
Local improvement district assessments, with interest ranging from
               
5.03% to 6.5%, due through 2013.
    260       260  
                 
Fund I note payable to the City of Tacoma, with interest at 4.5%,
               
with monthly principal and interest payments maturing January
               
2014.
    120       127  
    $ 28,734     $ 29,490  
 
The Company's long-term debt is not actively traded and, as such, fair values were estimated using discounted cash flow analyses, based on the Company's current estimated incremental borrowing rates for similar types of borrowing arrangements.  As of March 31, 2010 and December 31, 2009, the Partnership’s fixed-rate debt outstanding had a fair value of approximately $29.7 million and $30.5 million, respectively.

On April 16, 2010, we used existing cash balances of $6.2 along with proceeds of $13.7 million from our operating line of credit to retire the $18.6 million timberland mortgage held by JHLIC, an amount that is included in current liabilities as of March 31, 2010.  The early retirement of this mortgage triggered $1.3 million of debt extinguishment costs which will be recorded in the second quarter of 2010 in addition to approximately $25,000 of unamortized loan fees relating to the extinguished debt.  We are currently in the process of negotiating a new long-term mortgage.
 
 
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ITEM 2

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report contains a number of projections and statements about our expected financial condition, operating results, and business plans and objectives. These statements reflect our management's estimates and present intentions based on our current goals, in light of currently known circumstances and management's expectations about future developments. Statements about expectations, plans and future performance are “forward looking statements” within the meaning of applicable securities laws. Because these statements describe our goals, objectives and anticipated performance, they are inherently uncertain, and some or all of these statements may not come to pass. Accordingly, you should not interpret these statements as promises that we will perform at a given level or that we will take any or all of the actions we currently expect to take. Our future actions, as well as our actual performance, will vary from our current expectations, and under various circumstances these variations may be material and adverse. Some of the factors that may cause our actual operating results and financial condition to fall short of our expectations are set forth in the part of this report entitled “Item 1A: Risk Factors” below and other factors discussed elsewhere in this report or in our annual report on Form 10-K for the fiscal year ended December 31, 2009. Some of the issues that may have an adverse and material impact on our business, operating results and financial condition include economic conditions that affect consumer demand for our products and the prices we receive for them; the effect of financial market conditions on our investment portfolio and related liquidity; environmental and land use regulations that limit our ability to harvest timber and develop property; access to debt financing by our customers as well as ourselves; risks associated with our credit refinancing plans and objectives and the attendant potential for impacts on our liquidity; and other risks and uncertainties which are discussed in our other filings with the Securities and Exchange Commission. The forward-looking statements in this report reflect our estimates as of the date of the report, and we cannot undertake to update these statements as our business operations and environment change.

This discussion should be read in conjunction with the condensed consolidated financial statements and related notes included with this report.
 
EXECUTIVE OVERVIEW

Pope Resources, A Delaware Limited Partnership (“we” or the "Partnership"), was organized in late 1985 as a result of a spin-off by Pope & Talbot, Inc. (“P&T”). We are engaged in three primary businesses. The first, and by far most significant segment in terms of owned assets, revenues, income and operations, is the Fee Timber segment. This segment includes timberlands owned directly by the Partnership and operations of both ORM Timber Fund I, LP (“Fund I”) and ORM Timber Fund II, Inc. (“Fund II” and collectively the “Funds”). Operations in this segment consist of growing timber to be harvested as logs for sale to domestic manufacturers and to a lesser extent export brokers. The second most significant business in terms of total assets owned is the development and sale of real estate. Real Estate activities primarily take the form of securing permits, entitlements, and, in some cases, installing infrastructure for raw land development and then realizing that land’s value through the sale of larger parcels to buyers who will take the land further up the value chain, either to home buyers or to operators and lessors of commercial property. Since these land projects span multiple years, the Real Estate segment may incur losses for multiple years while a project is developed until that project is sold resulting in operating income. Our third business segment, Timberland Management & Consulting, consists of raising investment capital from third parties for investment in timberland through private equity timber funds like the Funds and providing timberland management and related services for a fee to the Funds, as well as for other third party owners of timberland.

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Our current strategy for adding timberland acreage is centered on our private equity timber fund business model. For example, in March 2009 we completed the final close for Fund II with $84 million of committed capital including Pope Resources’ 20% co-investment. In October 2009, Fund II closed on its first two timberland acquisitions representing 41% of its committed capital.  Our 20% co-investment in the Funds affords us a share of the Funds’ operating cash flows while allowing us to earn annual asset management and timberland management fees as well as incentive fees based upon the overall success of each fund. Management also believes that this strategy allows us to maintain more sophisticated expertise in timberland acquisition, valuation, and management than could be cost-effectively maintained for the Partnership’s timberlands alone. Our Real Estate challenges center around how and when to “harvest” a parcel of land and capture the optimum value increment by selling the property, balancing the long-term risks of carrying and developing a property against the potential for income and positive cash flows upon sale.

During periods in which the U.S. and, to a much lesser extent, Asian residential real estate markets perform poorly, we tend to experience diminishing financial performance in both our Fee Timber and Real Estate segments. In Fee Timber, declines in building construction affect log prices and volumes directly.  As discussed below in greater detail, we often further reduce our harvest during these periods so as to avoid liquidating our timber assets at low prices, an opportunity afforded to us by our relatively low leverage and our relatively low-cost operating model. Land held for sale in western Washington by our Real Estate segment is suitable primarily for residential and commercial building sites and the market for this product has recently suffered along with regional and national markets, producing a decline in our sales.

We have a board approved unit repurchase program which permits repurchases through December 2010.  As of March 31, 2010, we have repurchased 111,295 units with a weighted average unit purchase price of $19.18 and we have an unutilized authorization for unit repurchases of $2.9 million.

RESULTS OF OPERATIONS

The following table reconciles and compares key revenue and cost elements that impacted our net income for the quarter ended March 31, 2010 versus the first and fourth quarters of 2009. In addition to the table’s detailed numerical analysis, the explanatory text that follows the table describes many of these changes by business segment.
 
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Q1 2010 vs. Q1 2009
   
Q1 2010 vs. Q4 2009
 
   
Total
   
Total
 
             
Net income (loss) attributable to unitholders:
           
1st Quarter 2010
  $ 451     $ 451  
4th Quarter 2009
            (376 )
1st Quarter 2009
    (123 )        
Variance
  $ 574     $ 827  
                 
Detail of earnings variance:
               
Fee Timber
               
Log price realizations (A)
  $ (417 )   $ 301  
Log volumes (B)
    1,358       578  
Depletion
    (155 )     (172 )
Production costs
    (254 )     (126 )
Other Fee Timber
    382       5  
Timberland Management & Consulting
               
Management fee changes
    (208 )     -  
Other Timberland Mgmnt & Consulting
    71       (69 )
Real Estate
               
Environmental remediation liability
    -       30  
Land and conservation easement sales
    (1 )     (214 )
Timber depletion on HBU sale
    -       6  
Other Real Estate
    (66 )     50  
General & administrative costs
    (97 )     257  
Net interest expense
    (24 )     (5 )
Other (taxes, noncontrolling int., unrealized loss)
    (15 )     186  
Total variance
  $ 574     $ 827  

(A)  
Price variance calculated by extending the change in average realized price by current period volume.
(B)  
Volume variance calculated by extending change in sales volume by the average log sales price for the comparison period.
 
Fee Timber
 
Fee Timber results include operations from 114,000 acres of fee timber owned by the Partnership and 36,000 acres of fee timber owned by the Funds.  Fee Timber revenue is earned primarily from the harvest and sale of logs from these timberlands which are located in western Washington and northwestern Oregon and, to a lesser extent, from leasing cellular communication towers and selling gravel and other resources from our timberlands. Revenue from the sale of timberland tracts will also appear in results for this segment on the relatively infrequent occasions when those transactions occur. Our Fee Timber revenue is driven primarily by the volume of timber harvested which is generally expressed in thousand board feet (MBF) or million board feet (MMBF). Fee Timber expenses, which consist predominantly of depletion, harvest and transportation costs, vary directly and roughly proportionately with harvest volume and the resulting revenues.  Revenue and costs related to harvest activities on timberland owned by the Funds are consolidated into this discussion of operations.
 
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Planned Harvest for 2010.  We began 2010 with a plan to harvest 32 MMBF representing a 47% harvest volume deferral from the estimate of our long-term sustainable harvest of 60 MMBF, which includes 16 MMBF of harvest from properties of the Funds. As first quarter progressed, we responded to improved domestic and export market conditions by moving more of our planned harvest volume into the first quarter.  Given the improvement in log markets, we intend to continue harvesting more than planned, as we did in the first quarter to take advantage of higher prices, and will do so the rest of the year if market conditions stay constant or improve.
 
When discussing our Fee Timber operations, we compare current results to both the previous quarter and the corresponding quarter of the prior year. These comparisons offer an understanding of trends in market price and patterns of harvest volumes that affect Fee Timber operating results. Revenue and operating income for the Fee Timber segment for the quarters ended March 31, 2010, December 31, 2009 and March 31, 2009 were as follows:
 
         
Mineral, Cell
                   
         
Tower &
   
Total Fee
         
Harvest
 
($ Million)
 
Log Sale
   
Other
   
Timber
   
Operating
   
Volume
 
Quarter Ended
 
Revenue
   
Revenue
   
Revenue
   
Income/(loss)
   
(MBF)
 
Pope Resources Timber
  $ 5.1     $ 0.4     $ 5.5     $ 2.2       11,592  
Timber Funds
    -       0.3       0.3       0.1       -  
Total Fee Timber March 31, 2010
  $ 5.1     $ 0.7     $ 5.8     $ 2.3       11,592  
                                         
Pope Resources Timber
  $ 4.2     $ 0.4     $ 4.6     $ 1.7       10,200  
Timber Funds
    -       -       -       -       -  
Total Fee Timber December 31, 2009
  $ 4.2     $ 0.4     $ 4.6     $ 1.7       10,200  
                                         
Pope Resources Timber
  $ 4.2     $ 0.3     $ 4.5     $ 1.4       8,745  
Timber Funds
    -       -       -       (0.1 )     -  
Total Fee Timber March 31, 2009
  $ 4.2     $ 0.3     $ 4.5     $ 1.3       8,745  
 
Comparing Q1 2010 to Q4 2009. Fee Timber revenue and operating income for the first quarter 2010 were $1.2 million and $586,000 higher, respectively, than the fourth quarter of 2009.  This is a result of a $26/MBF, or 6%, increase in average log price realized combined with a 1.4 MMBF, or 14%, increase in harvest volume, and to a lesser extent, $275,000 of revenue from the sale of 60 acres from Fund I.
 
Comparing Q1 2010 to Q1 2009. Fee Timber revenue and operating income for the first quarter of 2010 are $1.3 million and $1.1 million higher, respectively, than the comparable period in the prior year.  The increase in revenue and operating income is due to a 2.8 MMBF, or 33%, increase in harvest volume offset in part by a $36/MBF, or 8%, decrease in average log price realized. This log price decline reflects a shift in the mix of our export log volume away from the higher valued Japanese market to the lower valued Chinese market and, to a lesser extent, a shift in the mix of logs harvested from Douglas-fir to whitewood.   Douglas-fir generally produces a more valuable sawlog with the highest quality sawlogs often sold to log brokers exporting to Japan.  The market for log exports has shifted for the time being from Japan to China and Korea where the preferred log is of lower quality, and thus lower value, than Japan.  As a result of more mild winter weather on our Columbia tree farm, which contains a higher proportion of whitewood volume, we were able to commence logging on this tree farm earlier than anticipated.  This resulted in a higher mix of whitewood in 2010 compared to 2009.  As a result of these mix changes, our average log price realized has declined to $441 per MBF from $477 per MBF.
 
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ORM Timber Funds.  The Funds are consolidated into our financial statements. The 80% of these Funds owned by third parties is reflected in our Statement of Operations under the caption “Net loss attributable to noncontrolling interest-ORM Timber Funds.” We deferred harvesting from each of the Funds’ tree farms in anticipation of weak log markets in 2010.  However, given improvements in domestic and export log markets in the first quarter, we intend to begin harvesting from the Funds’ tree farms to take advantage of higher prices, and will continue to do so the rest of the year if market conditions stay constant or improve.  The Funds generated $278,000 of revenue in the first quarter of 2010, primarily from a small Fund I land sale, compared with $27,000 generated in the fourth quarter of 2009 and $1,000 first quarter of 2009. On the strength of the Fund I land sale, the Funds generated operating income of $71,000 for the quarter ended March 31, 2010, compared to incurring operating losses of $33,000, and $71,000 in the quarters ended December 31, 2009 and March 31, 2009, respectively.
 
Log Volume
 
The Partnership harvested the following log volumes by species from its timberlands for the quarters ended March 31, 2010, December 31, 2009 and March 31, 2009:
 
Log sale volumes (MBF):
 
Quarter Ended
 
                                     
 
 
Mar-10
   
% Total
   
Dec-09
   
% Total
   
Mar-09
   
% Total
 
Sawlogs
                                               
Douglas-fir
    9,023       78 %     7,373       72 %     7,530       86 %
Whitewood
    487       4 %     526       5 %     65       1 %
Cedar
    146       1 %     149       2 %     64       1 %
Hardwood
    89       1 %     135       1 %     119       1 %
Pulp
                                               
All Species
    1,847       16 %     2,017       20 %     967       11 %
Total
    11,592       100 %     10,200       100 %     8,745       100 %
 
Comparing Q1 2010 to Q4 2009. For the quarter ended March 31, 2010, we harvested 36% of our planned annual harvest plan for 2010 of 32 MMBF as compared to 32% of actual annual harvest volume of 32 MMBF for the quarter ended December 31, 2009.  Strengthening log markets and mild winter weather on our Columbia tree farm led to the decision to accelerate harvest and capture log prices available in the first quarter of 2010.
 
Comparing Q1 2010 to Q1 2009. In comparing the first quarter 2010 harvest volumes against the same period in 2009, we harvested 36% of our planned harvest compared to 27% of our actual annual harvest volume for 2009.  This was due to our decision to accelerate harvest in 2010 while log prices were strengthening.
 
Log Prices
 
While harvest volume is largely within management’s control, one additional factor that impacts Fee Timber income is the price we realize upon selling our logs. Logs from the Partnership’s tree farms serve a number of different domestic and export markets, with domestic mills representing the largest market segment. We have experienced general strengthening of log prices in the first quarter of 2010 due to two factors: first, mill inventories of logs had been drawn down such that even a modest increase in demand produced a meaningful pricing improvement.  Second, the re-emergent Chinese and Korean log export markets put additional pressure on sawlog supplies that was not forecasted.  Notably absent as a factor contributing to this demand dynamic is a significant increase in housing starts. It is this absence that gives us pause as to the sustainability of this nascent log price recovery.
 
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We realized the following log prices from our fee timberlands for the quarters ended March 31, 2010, December 31, 2009 and March 31, 2009:
 
   
Quarter Ended
 
   
Mar-10
   
Dec-09
   
Mar-09
 
Average price realizations
                 
(per MBF):
                 
Sawlogs
                 
Douglas-fir
  $ 467     $ 438     $ 508  
Whitewood
    371       332       306  
Cedar
    794       718       798  
Hardwood
    499       466       475  
Pulp
                       
All Species
    300       329       227  
Overall
    441       415       477  

Douglas-fir: Douglas-fir is noted for its structural characteristics that make it generally preferable to other softwoods and hardwoods for the production of construction grade lumber and plywood. Demand and price for Douglas-fir sawlogs is very dependent upon the level of new home construction. Single-family home starts leveled off and have remained below 550,000 units throughout the first quarter of 2010.  The absence of home construction was made up for at least in part by a burgeoning export market to China and Korea which created competition for Douglas-fir sawlogs with prices driven up $29/MBF, or 7%, from the fourth quarter of 2009.

Whitewood: “Whitewood” is a term used to describe several softwood species, but for us primarily refers to western hemlock. Though generally considered to be of a lower quality than Douglas-fir, these logs are also used for manufacturing construction grade lumber and plywood. The increased competition in the first quarter of 2010 for Douglas-fir put pressure on the whitewood markets.  In the first quarter of 2010, 86% of the whitewood we sold was harvested from our Columbia tree farm compared to the Hood Canal tree farm sourcing 100% of the first quarter 2009 whitewood harvest.  Whitewood harvested from the Columbia tree farm is generally of higher quality than that grown on the Hood Canal tree farm and, in the face of increased demand from export markets, this high quality whitewood yielded a weighted average price $65/MBF more than the volumes harvested from the Hood Canal tree farm for the comparable period in the prior year.  When comparing first quarter 2010 to fourth quarter 2009, we experienced a price lift of $39/MBF, or 12%, as a result of increased competition from the export market for logs that would otherwise be sold to domestic mills.

Cedar: Cedar is a minor component in most upland timber stands and is generally used for outdoor applications such as fencing, siding and decking. Although there is a link between demand for these products and housing starts, this link is not as strong as with most other softwood species. Cedar prices were flat in the first quarter of 2010 compared to the same period in 2009.  However, cedar prices increased by $76/MBF, or 11%, in the three-month period ended March 31, 2010 versus the fourth quarter of 2009.

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Hardwood: “Hardwood” can refer to many different species, but on our tree farms primarily consists of red alder. The local mills that process red alder sawlogs are using the resource to manufacture lumber for use in furniture and cabinet construction. In the first quarter of 2010 hardwood sawlog prices increased $24/MBF, or 5%, versus the comparable quarter in 2009 and increased $33/MBF, or 7%, versus the fourth quarter of 2009. We believe this increase resulted primarily from a small increase in demand for lumber, which came at a time when some mills had relatively low inventories.

Pulp: Pulp is a lower quality log of any species that is manufactured into wood chips. These chips are used primarily to make a full range of pulp and paper products from unbleached linerboard used in paper bags and cardboard boxes to fine paper and specialty products. The pulpwood market has enjoyed relative strength over the last couple of years as a direct result of sawmills taking significant downtime in response to the slowdown in housing starts.  Sawmills typically provide the bulk of the chips used by pulp manufacturers, so curtailed sawmill production helped to push up the price of pulp logs sold directly to pulp mills. For the quarter ended March 31, 2010, pulp prices were up $73/MBF, or 32% over the same period in 2009.  When compared to the fourth quarter of 2009, pulp prices were off $29/MBF, or 9%, for the period ended March 31, 2010.  This price decline from the fourth quarter of 2009 resulted primarily from an increase in production at lumber mills during the first quarter, which we believe was attributable to strengthening lumber prices.  The increase in sawmill operating rates has in-turn generated an increase in wood chips as a byproduct of lumber manufacturing.

Customers
The table below categorizes timber sold by customer type for the quarters ended March 31, 2010, December 31, 2009 and March 31, 2009 (volumes in MBF):
 
   
Q1 2010
   
Q4 2009
   
Q1 2009
 
Destination
 
Volume
   
Price
   
Volume
   
Price
   
Volume
   
Price
 
Domestic mills
    6,176     $ 459       5,738     $ 403       5,779     $ 446  
Export brokers
    3,569       481       2,443       515       1,999       688  
Pulp
    1,847       300       2,019       329       967       227  
Total
    11,592     $ 441       10,200     $ 415       8,745     $ 477  
 
Comparing Q1 2010 to Q4 2009. We experienced increased export market demand in the first quarter of 2010 resulting in an increase in volume sold to the export market representing 31% of the first quarter 2010 sales volume compared to 24% in the fourth quarter of 2009.  Most of this export log volume increase was destined for the Chinese and Korean markets, which explains the $34/MBF decline in the price of logs destined for export markets when compared to the fourth quarter of 2009.  The increased competition from export markets impacted domestic mills where volume sold in the first quarter of 2010 declined to 53% of the production volume in the first quarter of 2010 versus 56% in the fourth quarter of 2009.  The pulp market received 16% of our production volume in the first quarter of 2010 versus 20% in the fourth quarter of 2009.

Comparing Q1 2010 to Q1 2009. The robust export market in the first quarter of 2010 also explains notable shifts in sales volumes, primarily between export brokers and domestic mills, when comparing the first quarter of 2010 to the same period in 2009.  Volumes sold to export brokers increased to 31% of total sales volume in the first quarter of 2010, up from 23% in the comparable period in 2009. Similar to the comparison noted for the fourth quarter of 2009, the higher mix of export log volume flowing to the Chinese and Korean markets resulted in a $207/MBF decline in the price of logs destined for export markets when compared to the first quarter of 2009.  As mentioned above, volume sold to domestic lumber mills represented 53% of the production volume in the first quarter of 2010 versus 66% in the comparable quarter of 2009.  Pulp volumes were 16% in the first quarter of 2010 compared with 11% in the first quarter of 2009.

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Cost of Sales
 
Cost of sales for the Fee Timber segment consists of harvest and haul costs and depletion expense. Harvest and haul costs represent the direct cost incurred to convert trees into logs and deliver those logs to their point of sale. Depletion expense represents the cost of acquiring or growing the harvested timber. The applicable depletion rate is derived by dividing the aggregate cost of timber and capitalized road expenditures by the estimated volume of merchantable timber available for harvest at the beginning of that year. The depletion rate is then applied to the volume harvested in a given period to calculate depletion expense for that period.
 
Fee Timber cost of sales for the quarters ended March 31, 2010, December 31, 2009 and March 31, 2009,  respectively, are as follows, with the first table expressing these costs in total dollars and the second table expressing the costs on a per unit of production basis:
 
 
    ($ Million)
Quarter Ended:
 
Harvest,
Haul and
Other
   
Depletion
   
Total Cost 
of Sales
 
March 31, 2010
  $ 1.9     $ 0.7     $ 2.6  
December 31, 2009
    1.8       0.5       2.3  
March 31, 2009
    1.6       0.6       2.2  

Quarter Ended:
 
Harvest, Haul
and Other per
MBF
   
Depletion per
MBF
   
Total Cost of
Sales per MBF
 
March 31, 2010
  $ 163     $ 62     $ 225  
December 31, 2009
    172       54       226  
March 31, 2009
    186       65       251  
 
Comparing Q1 2010 to Q4 2009. Cost of sales increased to $2.6 million, or 13%, in the first quarter of 2010 relative to the fourth quarter of 2009 as a result of a 14% harvest volume increase from 10.2 MMBF in the fourth quarter of 2009 to 11.6 MMBF in the first quarter of 2010.  Harvest and haul costs per MBF decreased $9/MBF in the first quarter of 2010 relative to the fourth quarter of 2009.  This was primarily due to reductions in harvest costs. Harvest costs vary based upon the physical site characteristics of the specific acres harvested during the period. For example, difficult-to-access sites or those located on steep hillsides are more expensive to harvest. Furthermore, haul costs vary based upon the distance between the harvest area and the mill customer’s location.  The fourth quarter 2009 harvest included low-quality stands which were depleted at a rate that was lower than the rate used for the balance of our tree farms.  First quarter 2010 harvests did not include any of these low-quality stands. As a result, depletion was $8/MBF higher in the first quarter of 2010 compared to the fourth quarter of 2009.
 
Comparing Q1 2010 to Q1 2009. Cost of sales increased $409,000 in the first quarter of 2010 from the comparable period in 2009 as a result of a 33% increase in harvest from 8.7 MMBF in the first quarter of 2009.  Average harvest and haul costs declined $23/MBF in the current quarter when compared to the same period in 2009.
 
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Operating Expenses
 
Fee Timber operating expenses for the quarter ended March 31, 2010 were $877,000 compared to $708,000 and $958,000 for the quarters ended December 31, 2009 and March 31, 2009, respectively.  Operating expenses include management, silviculture and the cost of both maintaining existing roads and building temporary roads required for harvest activities. The increase in operating expense in the first quarter of 2010 over the fourth quarter of 2009 is due primarily to the timing of operating activities on the tree farms which tend to be more active during the first quarter of the year.  The decline in operating expenses from the same period in 2009 reflects management’s cost reduction efforts implemented at the end of the first quarter of 2009 in response to weak log markets.
 
Timberland Management & Consulting
 
The Timberland Management & Consulting segment develops timberland property investment portfolios on behalf of the Funds. In addition, we provide our timberland management services to third-party owners of timberland.  As of March 31, 2010, the Timberland Management & Consulting segment managed approximately 36,000 acres on behalf of the Funds.
 
The revenue earned from managing the Funds is eliminated as a result of consolidating the Funds into the Partnership’s financial statements.  For the quarter ended March 31, 2009, we managed approximately 267,000 of timberland for Cascade Timberlands LLC (Cascade) and 24,000 acres for Fund I.  Revenue and operating income for the Timberland Management & Consulting segment for the quarters ended March 31, 2010 and 2009 were as follows:

($ Thousand)
           
Quarter Ended
 
Revenue
   
Operating loss
 
March 31, 2010
  $ -     $ 241  
March 31, 2009
    208       104  

Comparing Q1 2010 to Q1 2009. Revenue in first quarter of 2010 declined $208,000 versus the comparable period in 2009 as result of the termination of the Cascade Timberlands management contract in mid-2009.  Operating loss increased in the first quarter when compared to the first quarter of 2009 due in large part to the loss of revenue associated with termination of the Cascade contract.
 
Revenue and expense incurred through the management of the Funds is accounted for within this segment but eliminated as a result of the consolidation of the Funds in our financial statements.  We generated $253,000 and $204,000 of revenue in the quarters ended March 31, 2010 and 2009, respectively, from the management of the Funds that was eliminated with a corresponding decrease in operating expenses of the Fee Timber segment.
 
Fund II closed with $84.4 million of committed capital which includes our co-investment of $16.9 million in March 2009.  During the fourth quarter of 2009, $34.4 million, or 41% of Fund II’s capital, was invested in two acquisitions totaling 12,000 acres.  Fund II’s two-year drawdown period ends in March 2011, but can be extended an additional year by a vote of the investors in Fund II.  We continue to evaluate and pursue suitable timberland for acquisition with the remaining $49.5 million of committed capital.
 
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Operating Expenses
 
Timberland Management & Consulting operating expenses for the quarters ended March 31, 2010, and March 31, 2009 were $241,000, and $312,000, respectively. The decrease in operating expense results from a reduction of expenses following the termination of the Cascade contract.
 
Real Estate
 
The Partnership’s Real Estate segment consists primarily of revenue from the sale of land and sales of conservation easements (“CE”) from the Partnership’s tree farms together with residential and commercial property rents.  The Partnership’s real estate holdings are located primarily in Pierce, Kitsap, and Jefferson Counties in Washington State.  Revenue in the Real Estate segment is generated through the sale of land, the rental of homes and commercial properties at the Port Gamble townsite, and the sale of land development rights.  Land sales include the sale of unimproved land which generally consists of larger acreage sales rather than single lot sales and are normally completed with very little capital investment prior to sale.  Rural Lifestyles lot sales generally require some capital improvements such as zoning, road building, or utility access improvements prior to completing the sale.  Commercial and residential plat land sales represent land sold after development rights have been obtained and are generally sold with certain infrastructure improvements.  Sales of development rights can take different forms, including but not limited to the preclusion of future real estate development.
 
Revenue and operating loss for the Real Estate segment for the quarters ended March 31, 2010 and 2009 were as follows:
 
($ Thousand)
           
Quarter Ended
 
Revenue
   
Operating loss
 
March 31, 2010
  $ 204     $ 526  
March 31, 2009
    250       459  
 
Comparing Q1 2010 to Q1 2009. In the absence of land sales, revenue for the Real Estate segment consisted primarily of residential and commercial property rents in the first quarter of both 2010 and 2009. Revenue was lower in the first quarter of 2010 versus the comparable period in 2009 as a result of a reduction in commercial rental revenue.  The millsite at the townsite of Port Gamble had been leased to the Washington State Department of Transportation in support of a long-term project to replace a portion of the Hood Canal Bridge.  This lease ended late in 2009 resulting in a decline in commercial lease revenue.
 
Operating Expenses
 
Real Estate operating expenses for the quarter ended March 31, 2010 totaled $729,000, a 3% increase over this segment’s operating expenses for the first quarter of 2009. The primary factor in this modest increase to operating expense is a decline in property taxes capitalized to long-term projects.  These projects have been deferred in response to weak markets for developed land and as a result the property taxes incurred on these projects are now being expensed.
 
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Basis in Real Estate Projects
 
Land Held for Development” on our Condensed Consolidated Balance Sheet represents the Partnership’s cost basis in land that has been identified as having greater value as development property rather than as timberland.  Our Real Estate segment personnel work with local officials to establish entitlements for further development of these parcels.  Costs clearly associated with development or the construction of fully entitled projects are generally capitalized, whereas costs associated with projects that are in the entitlement phase are generally expensed.  Those properties that are either for sale, under contract or the Partnership has an expectation they will sell within the next 12 months, are classified as a current asset under Land Held for Sale.

When facts and circumstances indicate that the carrying value of properties may be impaired, an evaluation of recoverability is performed by comparing the carrying value to the projected future undiscounted cash flows.  If the carrying value of such assets may not be fully recoverable, we would recognize an impairment loss, adjusting for changes in estimated fair market value, and would charge this amount against current operations. We have continuously owned most of our land for decades.  As a result, the land basis associated with most of our development properties is well below even the weakened current market values prevalent today. As such, we do not anticipate an asset impairment charge on our development projects.

Environmental Remediation
 
The environmental remediation liability represents estimated payments to be made to monitor (and remedy if necessary) certain areas in and around the townsite and millsite of Port Gamble, Washington. Port Gamble was designated a “Rural Historic Town” under Washington State’s Growth Management Act in 1999.  This designation allows for substantial new commercial, industrial, and residential development using historic land use patterns and densities while maintaining the town’s unique architectural character.  Operations at Port Gamble include commercial and residential lease activities and the wedding and events business.

P&T operated a sawmill at Port Gamble, from 1853 to 1995 and since 2000 management has worked both directly and indirectly through P&T to remedy environmental contamination at the townsite and millsite and to monitor results of the cleanup efforts.  After contamination was discovered at the townsite, millsite, and in the adjacent bay, the Partnership entered into a settlement and remediation agreement with P&T pursuant to which both parties allocated responsibility for cleanup costs.  Under Washington State law, both Pope Resources and P&T were potentially liable persons based on historic ownership and/or operation of the site.  These laws provide for joint and several liability among parties owning or operating property on which contamination occurs, meaning that cleanup costs can be assessed against any or all such parties.  Following a series of actions under the U.S. Bankruptcy Code that began in 2007, P&T has been liquidated, leaving the Partnership as one of few potentially liable persons.

The environmental liability at March 31, 2010 includes $116,000 that the Partnership expects to expend in the next 12 months and $1.1 million thereafter. Activities at the site during the first three months of 2010 included the submittal of an internal draft of the millsite feasibility study report to Washington State’s Department of Ecology, meeting with stakeholder groups, and identification of revisions to millsite and baywide feasibility study reports as well as issues requiring additional review and resolution by a technical work group. Upon approval of the feasibility study and subsequent clean-up action plan, we will have a clearer sense of how and when the environmental remediation will be resolved.

In 2001, the Partnership sold a resort community and its water and sewer utilities in the community of Port Ludlow.  The buyer of the project believes some remediation is required for contamination discovered on the site, and we have agreed to participate in an investigation in 2010 regarding any liability the Partnership may have or may be alleged to have.  While we have not concluded that we have an obligation to remediate, our March 31, 2010 environmental remediation accrual contains $30,000 which represents the maximum portion of the agreed-upon investigative costs to be paid by the Partnership.

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Activity in the environmental remediation liability is detailed as follows:

   
Balances at
   
Additions
   
Expenditures
       
   
the Beginning
   
to
   
for
   
Balance at
 
($ Thousands)
 
of the Year
   
Accrual
   
Remediation
   
Year-end
 
Year ended December 31, 2009
  $ 1,554     $ 30     $ 315     $ 1,269  
Quarter ended March 31, 2010
    1,269       -       84       1,185  
 
General and Administrative (G&A)
 
G&A expenses for the quarters ended March 31, 2010 and 2009 were $941,000 and $844,000, respectively.  This increase in G&A expense in 2010 is due to professional fees incurred in 2010 in excess of prior year amounts.