POPE RESOURCES
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 June 30, 2006

OR

 
o
 
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
(State or other jurisdiction of incorporation or organization)
 91-1313292
(IRS Employer 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.     Yes x    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in rule 12b-2 of the Securities and Exchange Act of 1934).
Large Accelerated Filer o    Accelerated Filer x     None Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-2 of the Exchange Act     Yes o    No x
 
Partnership units outstanding at August 1, 2006: 4,682,121


Pope Resources
Index to Form 10-Q Filing
For the Quarter Ended June 30, 2006

Description
Page Number
Part I. Financial Information
 
Item 1 Financial Statements (unaudited)
 
Condensed Consolidated Balance Sheets
4
Condensed Consolidated Statements of Earnings
5
Condensed Consolidated Statements of Cash Flows
6
Notes to Condensed Consolidated Financial Statements
7-13
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
14-34
   
Item 3. Quantitative and Qualitative Disclosures about Risk
34
   
Item 4. Controls and Procedures
34
   
Part II. Other Information
 
Item 1. Legal Proceedings
35
Item 1A. Risk Factors
35
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
36
Item 3. Defaults Upon Senior Securities
36
Item 4. Submission of Matters to a Vote of Security Holders
36
Item 5. Other Information
37
Item 6. Exhibits
37
   
Signatures
38



P A R T I - FINANCIAL INFORMATION

ITEM 1


FINANCIAL STATEMENTS
 
3

 
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
         
           
Pope Resources
         
June 30, 2006 and December 31, 2005
         
           
(Thousands)
         
   
2006
 
2005
 
           
Assets
         
Current assets:
         
Cash and cash equivalents
 
$
2,679
 
$
3,361
 
Short-term investments
   
20,000
   
15,000
 
Accounts receivable
   
3,805
   
1,049
 
Land held for sale at cost
   
2,947
   
4,371
 
Current portion of contracts receivable
   
13
   
14
 
Prepaid expenses and other
   
225
   
336
 
Total current assets
   
29,669
   
24,131
 
               
Properties and equipment at cost:
             
Land held for development
   
11,723
   
9,661
 
Land and land improvements
   
15,359
   
15,542
 
             
Roads and timber (net of accumulated depletion of $41,857 and $37,030)
    48,714     53,019  
Buildings and equipment (net of accumulated depreciation of $6,601 and $6,488)
   
3,434
   
3,340
 
     
79,230
   
81,562
 
Other assets:
             
Contracts receivable, net of current portion
   
958
   
483
 
Other
   
166
   
182
 
     
1,124
   
665
 
Total assets
 
$
110,023
 
$
106,358
 
               
Liabilities and Partners' Capital
             
Current liabilities:
             
Accounts payable
 
$
1,260
 
$
1,147
 
Accrued liabilities
   
1,400
   
3,865
 
Current portion of long-term debt
   
1,342
   
1,602
 
Deferred revenue
   
1,245
   
304
 
Environmental remediation
   
47
   
152
 
Minority interest
   
36
   
325
 
Other current liabilities
   
73
   
59
 
Total current liabilities
   
5,403
   
7,454
 
               
Long-term debt, net of current portion
   
30,919
   
32,281
 
Other long term liabilities
   
321
   
218
 
               
Partners' capital (units outstanding 4,643 and 4,646)
   
73,380
   
66,405
 
               
Total liabilities and partners' capital
 
$
110,023
 
$
106,358
 
               
See accompanying notes to condensed consolidated financial statements.
 
 
4

 
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited)
 
                   
Pope Resources
 
For the Three Months and Six Months Ended June 30, 2006 and 2005
 
                   
                   
(Thousands, except per unit data)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
   
2006
 
2005
 
2006
 
2005
 
                   
Revenues
 
$
15,610
 
$
16,131
 
$
31,693
 
$
32,787
 
Cost of sales
   
(8,414
)
 
(7,410
)
 
(14,839
)
 
(15,214
)
Operating expenses
   
(2,559
)
 
(2,671
)
 
(5,028
)
 
(5,004
)
Environmental remediation
   
-
   
(108
)
 
-
   
(108
)
General and administrative expenses
   
(902
)
 
(847
)
 
(1,906
)
 
(1,695
)
Income from operations
   
3,735
   
5,095
   
9,920
   
10,766
 
                           
Other income (expense):
                         
Interest expense
   
(469
)
 
(709
)
 
(997
)
 
(1,445
)
Interest income
   
252
   
74
   
471
   
93
 
     
(217
)
 
(635
)
 
(526
)
 
(1,352
)
                           
Income before income taxes and minority interest
   
3,518
   
4,460
   
9,394
   
9,414
 
                           
Income tax benefit (provision)
   
8
   
(263
)
 
(437
)
 
(510
)
                           
Income before minority interest
   
3,526
   
4,197
   
8,957
   
8,904
 
                           
Minority interest benefit (expense)
   
14
   
(128
)
 
(119
)
 
(229
)
                           
Net income
 
$
3,540
 
$
4,069
 
$
8,838
 
$
8,675
 
                           
                           
Allocable to general partners
 
$
46
 
$
53
 
$
116
 
$
114
 
Allocable to limited partners
   
3,494
   
4,016
   
8,722
   
8,561
 
                           
Earnings per unit:
                         
Basic
 
$
0.76
 
$
0.89
 
$
1.91
 
$
1.89
 
Diluted
 
$
0.74
 
$
0.86
 
$
1.86
 
$
1.83
 
                           
Weighted average units outstanding:
                         
Basic
   
4,641
   
4,596
   
4,638
   
4,578
 
Diluted
   
4,753
   
4,757
   
4,750
   
4,740
 
                           
See accompanying notes to condensed consolidated financial statements.

5


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
         
           
Pope Resources
         
Six Months Ended June 30, 2006 and 2005
         
           
           
(Thousands)
 
2006
 
2005
 
Cash flows provided by operating activities
         
Net income
 
$
8,838
 
$
8,675
 
Add back (deduct) non-cash charges (credits):
             
Deferred revenue
   
941
   
(685
)
Depletion
   
4,692
   
7,066
 
Equity based compensation
   
195
   
-
 
Depreciation and amortization
   
359
   
319
 
Deferred taxes
   
(19
)
 
510
 
Minority interest
   
119
   
229
 
Cost of land sold
   
2,869
   
166
 
Change in working capital accounts:
             
Accounts receivable
   
(2,756
)
 
(2,660
)
Contracts receivable
   
(474
)
 
(177
)
Other current assets
   
129
   
114
 
Accounts payable
   
113
   
(82
)
Accrued liabilities
   
(1,039
)
 
(270
)
Deposits
   
15
   
(5
)
Environmental remediation
   
(105
)
 
(362
)
Other long term liabilities
   
103
   
(25
)
Other
   
1
   
1
 
Net cash flows provided by operating activities
   
13,981
   
12,814
 
               
Cash flows from investing activities:
             
Capital expenditures
   
(5,816
)
 
(1,691
)
Purchase of short-term investments
   
(5,000
)
 
(8,007
)
               
Net cash used in investing activities
   
(10,816
)
 
(9,698
)
               
Cash flows from financing activities:
             
Option exercises
   
248
   
1,531
 
Repayment of operating line of credit
   
-
   
(758
)
Tax benefit from equity based compensation
   
34
   
-
 
Minority interest distribution
   
(167
)
 
(26
)
Repayment of long-term debt
   
(1,623
)
 
(1,667
)
Unitholder distribution
   
(2,339
)
 
(1,379
)
               
Net cash used in financing activities
   
(3,847
)
 
(2,299
)
               
Net increase (decrease) in cash and cash equivalents
   
(682
)
 
817
 
Cash and cash equivalents at beginning of year
   
3,361
   
757
 
               
Cash and cash equivalents at end of the six-month period
 
$
2,679
 
$
1,574
 
               
See accompanying notes to condensed consolidated financial statements.
 
6

POPE RESOURCES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2006

1.
The condensed consolidated financial statements as of June 30, 2006 and December 31, 2005 and for the three months (quarter) and six-month periods ended June 30, 2006 and June 30, 2005 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, 2005, is derived from the Partnership’s audited consolidated financial statements and notes thereto for the year ended December 31, 2005, and should be read in conjunction with such financial statements. The results of operations for the interim periods are not necessarily indicative of the results of operations that may be achieved for the entire fiscal year ending December 31, 2006.
 
2.
The financial statements in the Partnership's 2005 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 per unit are based on the weighted average number of units outstanding during the period. Diluted net earnings per unit are based on the weighted average number of units and dilutive unit options outstanding at the end of the period.
 
   
Quarter Ended
June 30,
 
Six Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
Weighted average units outstanding (in thousands):
                 
Basic
   
4,641
   
4,596
   
4,638
   
4,578
 
Dilutive effect of unit options
   
112
   
161
   
112
   
162
 
Diluted
   
4,753
   
4,757
   
4,750
   
4,740
 
 
Options to purchase 258,000 units at prices ranging from $9.30 to $37.73 per unit were outstanding as of June 30, 2006. For computing the dilutive effect of unit options for the quarter ended June 30, 2006, options to purchase 1,100 units at prices ranging from $33.15 to $37.73 were not included in the calculation during the three and six-month periods ended June 30, 2006.
 
Options to purchase 293,000 units at prices ranging from $9.30 to $37.73 per unit were outstanding as of June 30, 2005. For computing the dilutive effect of unit options for the quarter ended June 30, 2005, options to purchase 457 units at prices ranging from $35.00 to $37.73 were not included in the calculation because the option exercise prices were greater than the average market prices of units during the period. For the six-month period ended June 30, 2005, options to purchase 298 units at prices ranging from $36.82 to $37.73 were not included in the calculation during the three and six-month periods ended June 30, 2005.
 
7

 
4.  
Effective January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004) Share Based Payment (SFAS No. 123R) using the modified prospective approach and accordingly have not restated prior period results. SFAS 123R established the accounting for equity instruments exchanged for employee services. Under SFAS 123R, share-based compensation cost is measured at the grant date based on the calculated fair value of the award. We have also changed our accounting for equity-based compensation awarded to retirement eligible directors and employees to expense the award over the lesser of vesting period or the period between the grant date and eligibility for retirement. The impact of the adoption of SFAS 123R on our earnings was $100,000 or $.03 per diluted unit for the quarter ended June 30, 2006, and $249,000 or $.06 per diluted unit for the six months ended June 30, 2006, which includes $70,000 of expense related to the treatment of the 2006 restricted unit grant to retirement eligible employees and board members.

Prior to the adoption of SFAS No. 123R, we accounted for equity based compensation granted to employees in accordance with Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations. The following table presents the impact of our adoption of SFAS 123R on selected line items from our condensed consolidated statement of earnings for the quarter and six-month periods ended June 30, 2006 (in thousands, except per unit amounts):
 

                   
   
For the Quarter
 
For the Six Months
 
   
Ended June 30, 2006
 
Ended June 30, 2006
 
   
Following
 
If Reported
 
Following
 
If Reported
 
   
FAS 123R
 
Following APB 25
 
FAS 123R
 
Following APB 25
 
 
Condensed statement of earnings:
                 
Operating profit
 
$
3,735
 
$
3,835
 
$
9,920
 
$
10,169
 
                           
Income before income taxes
                         
and minority interest
 
$
3,518
 
$
3,618
 
$
9,394
 
$
9,643
 
                           
Net income
 
$
3,540
 
$
3,640
 
$
8,838
 
$
9,087
 
                           
Earnings per unit:
                         
Basic
 
$
0.76
 
$
0.78
 
$
1.91
 
$
1.96
 
Diluted
 
$
0.74
 
$
0.77
 
$
1.86
 
$
1.92
 

In 2005, we adopted the 2005 Unit Incentive Plan. Following adoption of this new plan the Board of Directors began issuing restricted units instead of unit options as its primary method of granting equity based compensation. Units issued as a result of option exercises and restricted unit grants are funded through the issuance of new units. As of June 30, 2006, total compensation expense related to non-vested awards not yet recognized was $914,000 with a weighted average 41 months remaining to vest.

In addition to accounting and disclosure presented in accordance with Accounting Principles Board (APB) No. 25, we also provided the disclosures required under SFAS No. 123, Accounting for Stock Based Compensation (SFAS No. 123) as amended by SFAS No. 148, Accounting for Stock Based Compensation - Transition and Disclosures. As a result, no expense was reflected in our net income for the period ended June 30, 2005 for unit options, as all options granted had an exercise price equal to the market value of the underlying units on the grant date.
 
8

 
The table below reflects our proforma net income per share for the period shown had compensation for unit options been determined based on the fair value at the grant date, consistent with the methodology prescribed under SFAS No. 123:
 

   
Quarter ended
 
Six months ended
 
   
June 30,
 
June 30,
 
(In thousands except per unit amounts)
 
2005
 
2005
 
           
Net income as reported
 
$
4,069
 
$
8,675
 
               
Compensation expense recognized
   
-
   
-
 
               
Subtract proforma compensation
             
expense under SFAS 123
   
(35
)
 
(70
)
               
Proforma net income under SFAS 123
 
$
4,034
 
$
8,605
 
               
As reported:
             
Basic
 
$
0.89
 
$
1.89
 
Diluted
 
$
0.86
 
$
1.83
 
               
Proforma net income per unit:
             
Basic
 
$
0.88
 
$
1.88
 
Diluted
 
$
0.85
 
$
1.82
 
 
The fair value of options was calculated using the Black-Scholes option-pricing model, with the following assumptions during the second quarter of 2005:

   
2005
Expected life
   
5 years
Risk free interest rate
   
4.00% - 4.49%
Dividend yield
   
1.2% - 1.6%
Volatility
   
25.0% - 27.5%
Weighted average value
 
$
8.46

 
The expected life was determined using our experience, the volatility was determined using the historical average volatility of the Partnership’s units and the risk free interest rate represents the yield on a treasury note.

9

Restricted Units: 
Pope Resources changed the primary form of equity compensation from unit options to restricted units upon adoption of the 2005 Unit Incentive Plan. The Human Resources Committee makes awards of restricted units to directors and senior managers of the Partnership and its subsidiaries. The restricted unit grants ordinarily vest over four years and are compensatory in nature. Restricted unit awards entitle the recipient to full distribution rights during the vesting period but are restricted from disposition and may be forfeited until the units vest. The fair value, as calculated using the intrinsic value method, is charged to income over the vesting period.

Restricted unit activity for the first six months of 2006 was as follows:

       
Weighted Average
 
       
Grant date
 
   
Units
 
Fair Value ($)
 
Outstanding at December 31, 2005
   
20,000
   
33.44
 
Grants
   
19,000
   
34.75
 
Forfeited
   
(1,500
)
 
33.44
 
Outstanding at March 31, 2006
   
37,500
   
34.10
 
No activity
   
-
   
-
 
Outstanding at June 30, 2006
   
37,500
   
34.10
 
 
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 had a life of 10 years.

10

Unit option activity for the first six months of 2006 was as follows:

   
Options
 
Price ($)
 
Unvested at December 31, 2005
   
77,500
   
13.02
 
Vested at December 31, 2005
   
200,500
   
16.57
 
Outstanding at December 31, 2005
   
278,000
   
15.58
 
Activity Q1 2006:
             
Forfeitures
   
(4,800
)
 
12.00
 
Exercises
   
(12,000
)
 
12.44
 
Oustanding at March 31, 2006
   
261,200
   
15.79
 
Vesting during the quarter
   
33,012
   
13.12
 
Vested at March 31, 2006
   
221,512
   
16.28
 
Unvested at March 31, 2006
   
39,688
   
13.06
 
Activity Q2 2006:
             
Exercises
   
(3,450
)
 
12.58
 
Outstanding at June 30, 2006
   
257,750
   
15.83
 
Vested at June 30, 2006
   
218,062
   
16.34
 
Unvested at June 30, 2006
   
39,688
   
13.06
 
 
The aggregate intrinsic value of all options outstanding at June 30, 2006 was $3.5 million. The aggregate intrinsic value of all exercisable options at June 30, 2006 was $3.2 million. The total intrinsic value of options exercised was $72,000 and $331,000 during the three-month and six-month periods ended June 30, 2006, respectively. The weighted average remaining contractual term for all outstanding options at June 30, 2006 was 5.3 years. The weighted average remaining contractual term for all exercisable options at June 30, 2006 was 5.5 years.

The total fair value of units vested as of June 30, 2006 was $927,000. There were 1,085,815 and 1,073,115 units available for issuance under the 2005 Unit Incentive Plan as of December 31, 2005 and June 30, 2006, respectively.

5.  
Supplemental disclosure of cash flow information: For the six months ended June 30, 2006 and 2005, interest paid net of amounts capitalized amounted to $1,221,000 and $1,444,000, respectively. Income taxes paid for the six months ended June 30, 2006 and 2005 amounted to $182,000 and $4,000.
 
6.  
Revenue, operating income, and EBITDDA which management uses as a measure of segment profit or loss for the quarters and six-month periods ended June 30, 2006 and 2005, by segment are as follows:
 
11


       
Timberland
             
Three Months Ended
 
Fee
 
Management &
 
Real
         
June 30 (Thousands)
 
Timber
 
Consulting
 
Estate
 
Other
 
Consolidated
 
2006
                     
Revenue internal
 
$
10,451
 
$
546
 
$
4,626
 
$
-
 
$
15,623
 
Eliminations
   
(2
)
 
(2
)
 
(9
)
 
-
   
(13
)
Revenue external
   
10,449
   
544
   
4,617
   
-
   
15,610
 
                                 
Cost of sales
   
(5,368
)
 
-
   
(3,046
)
       
(8,414
)
                                 
Operating expenses internal
   
(1,069
)
 
(519
)
 
(984
)
 
(902
)
 
(3,474
)
Eliminations
   
2
   
12
   
(1
)
 
-
   
13
 
Operating expenses external
   
(1,067
)
 
(507
)
 
(985
)
 
(902
)
 
(3,461
)
                                 
Income (loss) from operations internal
   
4,014
   
27
   
596
   
(902
)
 
3,735
 
Eliminations
   
-
   
10
   
(10
)
 
-
   
-
 
Income (loss) from operations external
 
$
4,014
 
$
37
 
$
586
 
$
(902
)
$
3,735
 
                                 
EBITDDA reconciliation:
                               
Minority interest
   
-
   
14
   
-
   
-
   
14
 
Depletion
   
2,119
   
-
   
-
   
-
   
2,119
 
Depreciation and amortization
   
62
   
20
   
43
   
50
   
175
 
EBITDDA
 
$
6,195
 
$
71
 
$
629
 
$
(852
)
$
6,043
 
                                 
2005
                               
Revenue internal
 
$
13,221
 
$
1,845
 
$
1,077
 
$
-
 
$
16,143
 
Eliminations
   
(1
)
 
(2
)
 
(9
)
 
-
   
(12
)
Revenue external
   
13,220
   
1,843
   
1,068
   
-
   
16,131
 
                                 
Cost of sales
   
(7,234
)
 
-
   
(176
)
 
-
   
(7,410
)
                                 
Operating expenses internal
   
(1,048
)
 
(1,043
)
 
(700
)
 
(847
)
 
(3,638
)
Eliminations
   
(8
)
 
20
   
-
   
-
   
12
 
Operating expenses external
   
(1,056
)
 
(1,023
)
 
(700
)
 
(847
)
 
(3,626
)
                                 
Income (loss) from operations internal
   
4,939
   
802
   
201
   
(847
)
 
5,095
 
Eliminations
   
(9
)
 
18
   
(9
)
 
-
   
-
 
Income (loss) from operations external
 
$
4,930
 
$
820
 
$
192
 
$
(847
)
$
5,095
 
                                 
EBITDDA reconciliation:
                               
Minority interest
   
-
   
(128
)
 
-
   
-
   
(128
)
Depletion
   
3,123
         
100
   
-
   
3,223
 
Depreciation and amortization
   
37
   
27
   
38
   
65
   
167
 
EBITDDA
 
$
8,090
 
$
719
 
$
330
 
$
(782
)
$
8,357
 
 
12

 
       
Timberland
             
Six Months Ended
 
Fee
 
Management &
 
Real
         
June 30 (Thousands)
 
Timber
 
Consulting
 
Estate
 
Other
 
Consolidated
 
2006
                     
Revenue internal
 
$
24,175
 
$
2,587
 
$
4,970
 
$
-
 
$
31,732
 
Eliminations
   
(2
)
 
(19
)
 
(18
)
 
-
   
(39
)
Revenue external
   
24,173
   
2,568
   
4,952
   
-
   
31,693
 
                                 
Cost of sales
   
(11,778
)
 
-
   
(3,061
)
 
-
   
(14,839
)
                                 
Operating expenses internal
   
(2,165
)
 
(1,257
)
 
(1,645
)
 
(1,906
)
 
(6,973
)
Eliminations
   
16
   
22
   
1
   
-
   
39
 
Operating expenses external
   
(2,149
)
 
(1,235
)
 
(1,644
)
 
(1,906
)
 
(6,934
)
                                 
Income (loss) from operations internal
   
10,232
   
1,330
   
264
   
(1,906
)
 
9,920
 
Eliminations
   
14
   
3
   
(17
)
 
-
   
-
 
Income (loss) from operations external
 
$
10,246
 
$
1,333
 
$
247
 
$
(1,906
)
$
9,920
 
                                 
EBITDDA reconciliation:
                               
Minority interest
   
-
   
(119
)
 
-
   
-
   
(119
)
Depletion
   
4,692
   
-
   
-
   
-
   
4,692
 
Depreciation and amortization
   
133
   
36
   
77
   
113
   
359
 
EBITDDA
 
$
15,071
 
$
1,250
 
$
324
 
$
(1,793
)
$
14,852
 
                                 
                                 
2005
                               
Revenue internal
 
$
26,883
 
$
3,460
 
$
2,465
 
$
-
 
$
32,808
 
Eliminations
   
-
   
(3
)
 
(18
)
 
-
   
(21
)
Revenue external
   
26,883
   
3,457
   
2,447
   
-
   
32,787
 
                                 
Cost of sales
   
(14,767
)
 
-
   
(447
)
 
-
   
(15,214
)
                                 
Operating expenses internal
   
(2,144
)
 
(1,814
)
 
(1,175
)
 
(1,695
)
 
(6,828
)
Eliminations
   
-
   
19
   
2
   
-
   
21
 
Operating expenses external
   
(2,144
)
 
(1,795
)
 
(1,173
)
 
(1,695
)
 
(6,807
)
                                 
Income (loss) from operations internal
   
9,972
   
1,646
   
843
   
(1,695
)
 
10,766
 
Eliminations
   
-
   
16
   
(16
)
 
-
   
-
 
Income (loss) from operations external
 
$
9,972
 
$
1,662
 
$
827
 
$
(1,695
)
$
10,766
 
                                 
EBITDDA reconciliation:
                               
Minority interest and investment income
   
-
   
(229
)
 
-
   
-
   
(229
)
Depletion
   
6,961
   
-
   
105
   
-
   
7,066
 
Depreciation and amortization
   
68
   
48
   
69
   
134
   
319
 
EBITDDA
 
$
17,001
 
$
1,481
 
$
1,001
 
$
(1,561
)
$
17,922
 
 
13

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 based on our current goals, in light of currently known circumstances and management's expectations about future developments. Statements about expectations and future performance are “forward looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. 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, 2005. Other issues that may have an adverse and material impact on our business, operating results and financial condition 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 financial statements and related notes included with this report.
 
EXECUTIVE OVERVIEW

Pope Resources, A Delaware Limited Partnership (“we” or the “Partnership”), was organized in October 1985 as a result of a spin-off by Pope & Talbot, Inc. (“P&T”). The Partnership is engaged in three primary businesses. The first, and by far most significant, segment in terms of owned assets and operations is the Fee Timber segment. Operations in this segment consist of growing timber to be harvested as logs for sale to export and domestic manufacturers. 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 and entitlements, and, in some cases, installing infrastructure for raw land development and then realizing that land’s value by selling parcels to buyers who may take the land further up the “value chain” ordinarily in smaller parcels either to home buyers or commercial property operators or lessors. Since these land projects span multiple years, the Real Estate segment may incur losses for multiple years until a major project is sold, which then results in operating income. Our third business is providing timberland-related services to third parties. These services may take the form of large-scale timberland management, forestry consulting, or acquisition or disposition services. We are currently managing nearly 300,000 acres of timberlands in Oregon for Cascade Timberlands LLC. Additionally, now that we have closed ORM Timber Fund I, LP, we are seeking to add to our timberland ownership, albeit indirectly, through the Partnership’s co-investment in the fund. Successful acquisitions by the fund would also result in additional management fees for the Timberland Management & Consulting segment.

Management’s major opportunity and challenge is to profitably grow our revenue base. For our Fee Timber and Timberland Management & Consulting segments, the revenue base is typically thought of in terms of acres owned or under management. Our Real Estate opportunities and challenges center on identifying properties in our portfolio of owned assets with potential development value. Once identified, we attempt to maximize that value through securing entitlements and, in some cases installing infrastructure, prior to selling the property.

14


RESULTS OF OPERATIONS

The following table reconciles and compares key revenue and cost elements that impact our net income for each of the quarter and six-month periods ended June 30, 2006 and June 30, 2005. In addition to the table’s detailed numeric analysis, the explanatory text that follows the table describes many of these changes by business segment:
 
15

 


 QUARTER AND YEAR TO DATE VARIANCE ANALYSIS
 (Amounts in $000's except per unit data)
 
   
Quarter ended
 
Six months ended
 
Net income:
 
 June 30, 2006 and 2005
 
June 30, 2006 and 2005
 
2nd Quarter 2006
 
$
3,540
 
$
8,838
 
2nd Quarter 2005
   
4,069
   
8,675
 
Variance
 
$
(529
)
$
163
 
               
Detail of earnings variance:
             
Fee Timber
             
Log price realizations (A)
 
$
433
 
$
1,050
 
Log volumes (B)
   
(3,296
)
 
(3,857
)
Depletion
   
1,005
   
2,275
 
Production costs
   
862
   
714
 
Other Fee Timber
   
80
   
91
 
Timberland Management & Consulting
         
-
 
Management fee changes
   
(673
)
 
(1,411
)
Disposition fee changes
   
-
   
1,343
 
Other Timberland Management & Consulting
   
(110
)
 
(266
)
Real Estate
         
-
 
Environmental remediation liability
   
108
   
108
 
Land sales
   
707
   
(101
)
Depletion
   
99
   
99
 
Other Real Estate
   
(520
)
 
(686
)
General & administrative costs
   
(55
)
 
(211
)
Interest expense
   
240
   
448
 
Other (taxes, minority int., interest inc.)
   
591
   
567
 
Total change in earnings
 
$
(529
)
$
163
 
 
(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 revenue is earned primarily from the harvest and sale of logs from the Partnership’s nearly 115,000 acres of fee timberland located in western Washington and, to a lesser extent, from leases of our timberland to sand and gravel pit operators and cellular communication tower purveyors. Revenue from the sales of timberland tracts will also appear periodically in results for this segment. Our Fee Timber revenue is driven primarily by the volume of timber harvested, which we ordinarily express in terms of millions of board feet, or “MMBF”, and by the average prices realized on log sales, which we express in dollars per thousand board feet, or “MBF”.
 
16

When discussing our Fee Timber operations, we compare current results to both the previous quarter and the corresponding quarter of the prior year. Both of these comparisons are made to help the reader gain an understanding of the trends in market price and harvest volumes that affect Fee Timber results of operations. Revenue and operating income for the Fee Timber segment for the quarters ended June 30, 2006, March 31, 2006 and June 30, 2005 are as follows:
 
Quarter Ended:
Log Sale
Revenue
Mineral, Cell
Tower &
Other Revenue
Total Fee
Timber
Revenue
Operating
Income
June 30, 2006
$10.0 million
$0.4 million
$10.4 million
$4.0 million
March 31, 2006
13.4 million
0.3 million
13.7 million
6.2 million
June 30, 2005
12.9 million
0.3 million
13.2 million
4.9 million

The decrease in revenue and operating income for the current quarter relative to the first quarter of 2006 is primarily attributable to a 5.4 MMBF decrease in harvest volume. Harvest volume was accelerated in the first quarter of 2006 due to strong log markets. We have a continuing practice of front-loading our planned annual harvest activities because of management’s expectation that this strategy can optimize our Fee Timber revenue by concentrating harvest volume when log supplies in our market areas are restricted. Fee Timber revenue in the current quarter is $2.8 million lower than the comparable period in 2005 due to a 5.7 MMBF decline in harvest volume partially offset by higher prices in the current period. The decline in harvest volume for the quarter is consistent with our planned reduction in our annual harvest to 57 MMBF in 2006 from 74 MMBF in 2005.
 
Revenue and operating income for the Fee Timber segment for the six-month periods ended June 30, 2006 and 2005 were as follows:
 
Quarter Ended:
Log Sale
Revenue
Mineral, Cell
Tower &
Other Revenue
Total Fee
Timber
Revenue
Operating
Income
June 30, 2006
$23.4 million
$0.8 million
$24.2 million
$10.2 million
June 30, 2005
26.2 million
0.7 million
26.9 million
10.0 million
 
In connection with a planned reduction for the year, harvest volume decreased 15% during the first six months of 2006 from the corresponding period in 2005. Harvests in 2005 included volume from two timberland acquisitions acquired in 2004 with a large component of merchantable timber that was liquidated to recoup most, if not all, of the purchase prices paid. A partial offset to this downward impact when comparing revenue between periods was an increase in average price realized from $578/MBF in 2005 to $606/MBF in 2006. Operating income increased despite this decrease in harvest volume due to a $2.3 million decrease in depletion expense. Depletion expense in 2005 was high relative to the current period because of harvest from one of our 2004 timberland acquisitions, which had a separate, higher-cost depletion pool. The proportion of volume harvested from that separate depletion pool has declined in 2006.
 
17

Log Volume
 
The Partnership harvested the following log volumes from its timberlands for the quarters ended June 30, 2006, March 31, 2006, and June 30, 2005 and the six-month periods ended June 30, 2006 and 2005:

Log volumes (MBF):
 
Quarter Ended
 
Sawlogs
 
June-06
 
% Total
 
March-06
 
% Total
 
June-05
 
% Total
 
Douglas-fir
   
11,842
   
71
%
 
16,440
   
75
%
 
12,195
   
55
%
Whitewood
   
1,149
   
7
%
 
1,997
   
9
%
 
4,113
   
18
%
Cedar
   
227
   
1
%
 
359
   
2
%
 
1,730
   
8
%
Hardwoods
   
1,144
   
7
%
 
562
   
2
%
 
1,299
   
6
%
Pulp 
                                     
All Species
   
2,288
   
14
%
 
2,675
   
12
%
 
3,026
   
13
%
Total 
   
16,650
   
100
%
 
22,033
   
100
%
 
22,363
   
100
%
 
Log volumes (MBF):
 
Six Months Ended
 
Sawlogs   
June-06
 
% Total
 
June-05
 
% Total
 
Douglas-fir
   
28,282
   
73
%
 
25,876
   
57
%
Whitewood
   
3,145
   
8
%
 
7,528
   
17
%
Cedar
   
586
   
2
%
 
3,208
   
7
%
Hardwoods
   
1,706
   
4
%
 
2,788
   
6
%
Pulp                           
All Species
   
4,964
   
13
%
 
5,963
   
13
%
 Total    
38,683
   
100
%
 
45,363
   
100
%
 
Through June 30, 2006, we have harvested 68% of our targeted 57 MMBF annual harvest for this year. Our Hood Canal tree farm is located at relatively low elevations where harvest activities can be completed year around, allowing us to take advantage of a slight premium on our log sales when other tree farms cannot be harvested due to adverse weather conditions. As we did in early 2005, we took advantage of attractive log prices in the first half of 2006, by increasing the proportion of our total annual harvest volume taken early in the year. Harvest activities in the second quarter of 2006 were moderated from the first quarter resulting in a decline in harvest volume from the first-quarter of 2006. Our harvest mix in the second and first quarters of 2006 consisted predominantly of Douglas-fir, whereas in each of 2005’s quarters we harvested more hardwoods and lower-grade softwoods. The species mix harvested in 2005 was impacted more significantly than was the case in 2006 by harvest units located on timberland acquired in 2004 which included a large component of cedar and whitewood.
 
18

Log Prices
 
While harvest volume is largely within management’s control, one additional factor that impacts our Fee Timber income is the price we realize upon selling our logs into the market. As noted above, we try to maximize Fee Timber revenue by accelerating harvest volumes during times of attractive log markets. However, log prices are a result of a broader range of economic and political factors and are largely beyond our ability to control, except at the margins. We realized the following log prices from our fee timberlands for the quarters ended June 30, 2006, March 31, 2006 and June 30, 2005 and the six-month periods ended June 30, 2006 and 2005:
 

               
   
Quarter Ended
 
   
30-Jun-06
 
31-Mar-06
 
30-Jun-05
 
Average price realizations (per MBF):
             
Sawlogs
             
Douglas-fir
 
$
665
 
$
681
 
$
644
 
Whitewood
   
452
   
439
   
487
 
Cedar
   
1,182
   
873
   
981
 
Hardwoods
   
670
   
598
   
563
 
                     
All Species
   
260
   
251
   
205
 
Pulp
                   
Overall
   
603
   
608
   
577
 
 
 
   
Six Months Ended 
 
   
30-Jun-06
 
June-05
 
Average price realizations (per MBF):
         
Sawlogs
         
Douglas-fir
 
$
675
 
$
644
 
Whitewood
   
443
   
480
 
Cedar
   
993
   
943
 
Hardwoods
   
646
   
597
 
Pulp
             
All Species
   
255
   
212
 
               
Overall
   
606
   
578
 
 
Douglas-fir: Douglas-fir represents the primary tree species growing on our timberlands and this species 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. The price realized on Douglas-fir logs decreased 2% for the current quarter versus the first quarter of 2006 and increased 3% from the comparable quarter in 2005. The modest decrease in Douglas-fir log price realized in the second quarter of 2006 compared to the first quarter of 2006 is attributed to the seasonal increase in local log supply and a softening in the lumber market which can result in downward pressure on log prices. On a year-to-date basis Douglas-fir prices have increased nearly 5%. New mill capacity has resulted in increased demand that corresponds to increased price support for delivered Douglas-fir log volume. Management expects third quarter 2006 Douglas-fir bid prices will be largely consistent with the current quarter.

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 average price realized on whitewood increased 3% for the current quarter in 2006 versus the first quarter of 2006 and decreased 7% from the comparable quarter in 2005. Harvest volume in 2005 included a large component of high quality whitewood sawlogs from the 2004 timberland acquisition which increased our average price realization in prior year. Management expects that whitewood prices for third quarter 2006 will be consistent with the current quarter.

19

Cedar: Cedar prices have increased 35% in the current quarter versus the first quarter of 2006 and 20% from the comparable quarter in prior year. Cedar prices typically weaken in the winter months as demand declines, largely because cedar lumber is used primarily as fencing material. Peak demand for this product is in the summer months, with corresponding lower demand and log prices at the beginning and end of the calendar year. On a year-to-date basis, our realized cedar price has increased 5% from the prior year. The strong price realized in both the current quarter and for the first six months of 2006 reflects a general decline in cedar volume available in the Puget Sound area. A factor contributing to this decline in supply is a reduction in cedar imported from Canada. Canada has experienced weather related declines in timber harvest during 2006 resulting in less volume available for export to the Puget Sound market. Bids received for third quarter 2006 cedar volume have strengthened slightly from second quarter price levels.

Hardwood: “Hardwood” can refer to many different species, but on our tree farms primarily represents red alder and, to a lesser extent, large leaf maple. The price realized from the sale of red alder sawlogs has increased steadily over the last couple years as new red alder mills have opened to take advantage of strong lumber pricing attributable to the growing acceptance of solid sawn red alder lumber products. These mills manufacture lumber for use in furniture construction. The 12% increase in hardwood price realized in the current quarter relative to the first quarter of 2006 and the 19% increase over the price realized in the second quarter of 2005 is due to an increase in the quality of logs sold. On a year-to-date basis, our realized price for hardwood has increased 8% in 2006 from the prior year. This increase is also due to an increase in the quality of hardwood logs sold in the current year. Bids received for third quarter 2006 hardwood volume are consistent with the current quarter.

Pulp: Pulp refers to a lower quality log of any species that is manufactured into wood chips. These chips are used to manufacture many products including bleached pulp for paper production and kraft linerboard for bag and cardboard box production. The price realized from the sale of pulp logs is primarily driven by local pulp log inventories. Pulp prices in the current quarter increased nearly 4% from the first quarter of 2006 and 27% from the comparable period in prior year. On a year-to-date basis pulp prices are up 20% over the level realized during the first six months of 2005. The increases in pulp prices result from a decline in sawmill production. Strong log prices combined with a weakening market for lumber has resulted in an increase in sawmill downtime which has in turn reduced the supply of wood chips available to the Puget Sound market. Based on bids for pulp logs to be delivered during the third quarter of 2006 management expects a continued strengthening of this market due to tight inventories of wood chips.

Customers
The table below categorizes logs sold by customer type for the quarters ended June 30, 2006, March 31, 2006 and June 30, 2005 and for the six-month periods ended June 30, 2006 and 2005:

   
Q2 2006
     
Q1 2006
     
Q2 2005
     
Destination
 
Volume*
 
Price
 
Volume*
 
Price
 
Volume*
 
Price
 
Domestic mills
   
12.7
 
$
651
   
18.8
 
$
657
   
18.9
 
$
635
 
Export brokers
   
1.7
   
706
   
0.5
   
684
   
0.5
   
601
 
Pulp
   
2.3
   
260
   
2.7
   
251
   
3.0
   
205
 
Total
   
16.7
 
$
603
   
22.0
 
$
608
   
22.4
 
$
577
 
* Volume in MMBF
                                     
 
20


   
Six Months Ended
             
   
30-Jun-06
     
30-Jun-05
     
Destination
 
Volume*
 
Price
 
Volume*
 
Price
 
Domestic mills
   
31.6
 
$
655
   
37.3
 
$
634
 
Export brokers
   
2.1
   
701
   
2.1
   
637
 
Pulp
   
5.0
   
255
   
6.0
   
212
 
Total
   
38.7
 
$
606
   
45.4
 
$
578
 
* Volume in MMBF
                         
 
Over the last several years, a strong domestic market for high-quality “peeler” logs used for producing a range of products requiring veneer components has emerged that has shifted log volume away from an already diminished export market. Volume sold to domestic lumber mills represents 76% of volume sold in the second quarter of 2006, versus 85% for both the first quarter of 2006, and the comparable period in 2005. The decrease in the proportion of log volume sold to domestic mills in the second quarter of 2006 relative to both the first quarter of 2006 and the comparable quarter in 2005 is due to some strengthening of the log export market relative to the price that domestic mills pay for the same export-quality log. The proportion of log volume sold to export brokers is more consistent when comparing year-to-date results in 2006 and 2005.

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 standing timber into logs and deliver those logs to their point of sale. Depletion expense represents the estimated cost of acquiring and 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 June 30, 2006, March 31, 2006, and June 30, 2005 and the six-month periods ended June 30, 2006 and 2005 are as follows:
 
Quarter Ended:
Harvest, Haul
and Other
Depletion
Total Cost of
Sales
June 30, 2006
$3.3 million
$2.1 million
$5.4 million
March 31, 2006
3.8 million
2.6 million
6.4 million
June 30, 2005
4.1 million
3.1 million
7.2 million

Six Months Ended:
Harvest, Haul
and Other
Depletion
Total Cost of
Sales
June 30, 2006
$7.1 million
$4.7 million
$11.8 million
June 30, 2005
7.8 million
7.0 million
14.8 million
 
21

 
 
Quarter Ended:
 
Harvest and Haul
per MBF
 
Depletion per
MBF
 
Total Cost
of Sales
June 30, 2006
$195
$127
$322
March 31, 2006
174
117
291
June 30, 2005
184
140
324
 
Six Months Ended:
 
Harvest and Haul
per MBF
 
Depletion per
MBF
 
Total Cost
of Sales
June 30, 2006
$184
$121
$305
June 30, 2005
173
153
326
 
Cost of sales has decreased in the second quarter of 2006 versus the first quarter of 2006 and the comparable period in prior year. These decreases are due in part to declines in harvest volume to 16.7 MMBF in the current quarter from 22.0 MMBF in the first quarter of 2006 and 22.4 MMBF in the second quarter of 2005, respectively. In addition to the change in harvest volume, cost of sales in the second quarter of 2005 included a higher proportionate component of volume harvested from a separate, high-rate depletion pool that also contributed to an abnormally elevated cost of sales in that prior year period. The separate depletion pool was created following a fourth quarter 2004 timberland acquisition, and applied only to timber harvested from that property based on the acquisition cost of that property and the property’s timber available for harvest. On a year-to-date basis, cost of sales has decreased $3.0 million from 2005 to 2006 with the decline also due to reductions in harvest volume and a decrease in average depletion rate discussed above. Harvest volume decreased to 38.7 MMBF from 45.4 MMBF for the first six months of 2006 and 2005, respectively. Year-to-date harvest volume from the separate depletion pool decreased to 6.2 MMBF in 2006 from 12.4 MMBF for the first six months of 2005. These two factors combined to result in a decrease in year-to-date depletion expense from $153/MBF for 2005 to $121/MBF for 2006.
 
Harvest and haul costs per MBF have increased in the second quarter of 2006 from both the first quarter of 2006 and 2005’s comparable period. 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. Harvest and haul costs increased from the first quarter of 2006 due to an increase in harvest units located on more difficult to access property relative to the first quarter of 2006. Harvest and haul costs per MBF have increased from the comparable quarter in prior year due to a combination of more difficult to access harvest units and an increase in fuel costs. On a year to date basis the per MBF cost of harvest and haul costs have increased $11/MBF due primarily to the increase in fuel costs. Fuel costs impact both the cost of hauling logs to customers and the cost of operating the equipment used to harvest and manufacture logs. We expect high fuel costs to continue to impact harvest and haul costs for the balance of the year.
 
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Depletion expense for the quarters ended June 30, 2006, March 31, 2006, and June 30, 2005 was calculated as follows:

   
Quarter ended June 30, 2006
 
   
Pooled
 
Separate
 
Combined
 
Volume harvested (MBF)
   
13,685
   
2,965
   
16,650
 
Rate/MBF
 
$
69
 
$
397
 
$
127
 
Depletion expense
 
$
942,000
 
$
1,177,000
 
$
2,119,000
 
 
   
Quarter ended March 31, 2006
 
   
Pooled
 
Separate
 
Combined
 
Volume harvested (MBF)
   
18,820
   
3,213
   
22,033
 
Rate/MBF
 
$
69
 
$
397
 
$
117
 
Depletion expense
 
$
1,299,000
 
$
1,274,000
 
$
2,573,000
 
 
   
Quarter ended June 30, 2005
 
   
Pooled
 
Separate
 
Combined
 
Volume harvested (MBF)
   
17,284
   
5,079
   
22,363
 
Rate/MBF
 
$
72
 
$
370
 
$
140
 
Depletion expense
 
$
1,246,000
 
$
1,879,000
 
$
3,125,000
 
 
   
Six Months Ended June 30, 2006
 
   
Pooled
 
Separate
 
Combined
 
Volume harvested (MBF)
   
32,505
   
6,178
   
38,683
 
Rate/MBF
 
$
69
 
$
397
 
$
121
 
Depletion expense
 
$
2,242,000
 
$
2,450,000
 
$
4,692,000
 
 
   
Six Months Ended June 30, 2005
 
   
Pooled
 
Separate
 
Combined
 
Volume harvested (MBF)
   
32,965
   
12,398
   
45,363
 
Rate/MBF
 
$
72
 
$
370
 
$
153
 
Depletion expense
 
$
2,376,000
 
$
4,586,000
 
$
6,962,000
 
 
As noted above, we created a separate depletion cost pool in the fourth quarter of 2004 for a particular timberland acquisition because of a different acquisition cost for the amount of harvestable timber. This separate depletion cost pool carries a higher depletion rate than is applicable to our combined depletion cost pool. The calculations outlined above point out the significant role that the separate depletion cost pool for timber acquired in late 2004 plays in defining the aggregate rate for each period described above. For example, as the proportionate harvest volume from the separate depletion cost pool increased in the second quarter of 2006 relative to the first quarter of 2006 the aggregate weighted average depletion rate increased to $127/MBF from $117/MBF. The depletion rate used for the separate depletion pool increased in 2006 from 2005 due to a decline in the estimated timber volume available for harvest from this particular timber tract.
 
Operating Expenses
 
Fee Timber operating expenses for each of the quarters ended June 30, 2006, March 31, 2006, and June 30, 2005 were $1.1 million. Operating expenses for both the six-month periods ended June 30, 2006 and June 30, 2005 were $2.1 million. Operating expenses include management, silviculture and the cost of both maintaining existing roads and building temporary roads required for harvest activities.
 
23

Timberland Management & Consulting
 
Revenue and operating income for the Timberland Management & Consulting segment for the quarters and six-month periods ended June 30, 2006 and 2005 were as follows:
 
     
Quarter Ended:
Revenue
Operating Income
June 30, 2006
$0.5 million
$0.0 million
June 30, 2005
1.8 million
0.8 million

     
Six Months Ended:
 
Revenue
 
Operating Income
June 30, 2006
$2.6 million
$1.3 million
June 30, 2005
3.5 million
1.7 million

Revenue and operating income for the quarter ended June 30, 2006 were $544,000 and $37,000, respectively, which represents respective $1.3 million and $783,000 declines from the comparable period in 2005. The decrease in revenue and operating income is due to a decline in acres under management for our primary timberland management client. On a year-to-date basis, revenue and operating income declined $889,000 and $329,000, respectively, between 2005 and 2006. This decline is also due to a drop in acres under management for our primary timberland management client, partially offset by a disposition fee earned in the first quarter of 2006. Revenue and operating income in 2005 were primarily generated through providing timberland management and consulting services to this same timberland management client. Operating results for all periods presented include costs related to our private equity timber fund.
 
On August 1, 2005, we announced that management had obtained capital commitments of $61.8 million, of which the Partnership has committed $12.4 million, for the launch of a private equity timber fund. Olympic Resource Management LLC is the general partner for the fund and the Partnership is a limited partner. We are actively searching for timber properties for the fund to acquire and have placed bids on a number of timber properties. Due to the strong market for timberland we have not yet successfully placed any of the committed capital from the private equity timber fund.
 
Operating Expenses
 
Timberland Management & Consulting operating expenses for the quarters ended June 30, 2006 and 2005 were $507,000 and 1.0 million, respectively. Operating expenses for the six-month periods ended June 30, 2006 and 2005 were $1.2 million and 1.8 million, respectively. The decrease in operating expenses is attributable to the reduction in acres we manage for our primary client as a result of timberland sales and a reduction in operating expenses associated with the timber fund.
 
Real Estate
 
The Partnership’s Real Estate segment consists primarily of revenue from the sale of land 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.
 
24

Revenue and operating income for the Real Estate segment for the quarters ended June 30, 2006 and 2005 were as follows:
 
     
Quarter Ended:
Revenue
Operating Income
June 30, 2006
$4.6 million
$0.6 million
June 30, 2005
1.1 million
0.2 million

     
Six Months Ended:
Revenue
Operating Income
June 30, 2006
$5.0 million
$0.2 million
June 30, 2005
2.4 million
0.8 million

Real Estate revenue is generated through the sale of land and rural residential lots, and to a lesser extent from real property rents, most of which are earned at the Port Gamble townsite. Raw land sales are generally made for something other than residential or commercial use and are normally completed with very little capital investment prior to sale. Rural residential lot sales are made to developers or individuals where the lot is expected to be used for a residential dwelling with a general requirement to undertake some capital improvements such as zoning, road building, or utility access improvements prior to completing the sale.

Real Estate revenue for the quarter and six-month periods ended June 30, 2006 and 2005 consist of the following:


For the three months ended:
                     
                       
Description
 
Revenue
 
Gross Margin
 
Acres Sold
 
Revenue/Acre
 
Gross Margin/ Acre
 
Rural Residential
 
$