a6639661.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
FORM 10-K
(Mark one)
x
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2010
or
o
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  
 
For the transition period from ________  to ________
 
Commission File No.  1-9035
 
Pope Resources, A Delaware Limited Partnership
(Exact name of registrant as specified in its charter)
 
Delaware 91-1313292
(State of Organization)    (IRS Employer I.D. No.)
 
19245 Tenth Avenue NE, Poulsbo, WA   98370
(Address of principal executive offices, Zip Code)
 
Registrant's telephone number, including area code: (360) 697-6626

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

 
Title of each class
Depositary Receipts (Units)
Name of each exchange on which registered
NASDAQ
                                                                
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. 
Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period than 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 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 
Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer o Accelerated Filer x
Non-Accelerated Filer o (Do not check if a smaller reporting company) Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Act).
Yes o No x
At June 30, 2010, the aggregate market value of the non-voting equity units of the registrant held by non-affiliates was approximately $88,128,000

The number of the registrant’s limited partnership units outstanding as of February 18, 2011 was 4,376,912.

Documents incorporated by reference:  None
 
 
 

 
 
Pope Resources, A Delaware Limited Partnership
Form 10-K
For the Fiscal Year Ended December 31, 2010
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PART I

Item 1.   BUSINESS

OVERVIEW

When we refer to “the Partnership,” “the Company,” “we,” “us,” or “our,” we mean Pope Resources, A Delaware Limited Partnership and its consolidated subsidiaries. References to notes to the financial statements refer to the Notes to the Consolidated Financial Statements of Pope Resources, A Delaware Limited Partnership included in Item 8 of this form.

The Partnership currently operates in three primary business segments: (1) Fee Timber, (2) Timberland Management & Consulting, and (3) Real Estate.  Fee Timber operations consist of growing and harvesting timber from our 175,000 acres of tree farms.  The Timberland Management & Consulting segment represents business activity conducted to obtain timberland investments on behalf of our private equity funds as well as timberland and asset management services provided to third parties.  Our Real Estate segment’s operations are focused on a portfolio of approximately 2,800 acres in the Puget Sound basin of Washington. This segment’s activities consist of efforts to enhance the value of our land by obtaining the entitlements and, in some cases, building the infrastructure necessary to enable further development.  Further segment financial information is presented in Note 12 to our consolidated financial statements included in this report.  Copies of the Partnership’s Securities Exchange Act reports and other information can also be found at www.poperesources.com.  The information contained in or connected to our web site is not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this or any other report filed with or furnished to the SEC.

DESCRIPTION OF BUSINESS SEGMENTS

Fee Timber

Operations.  Our Fee Timber segment consists of the approximately 70,000-acre Hood Canal tree farm, located in the Hood Canal area of Washington, and the 44,000-acre Columbia tree farm located in southwest Washington, along with 61,000 acres of timberlands located in western Washington and western Oregon owned by the Funds. Management views the Hood Canal and Columbia tree farms as the Partnership’s core holdings, and manages them as a single operating unit.  When we refer to these two tree farms we will describe them as the Partnership’s tree farms.  We have owned the Hood Canal tree farm, substantially as currently comprised, since our formation in 1985, and we acquired the bulk of the Columbia tree farm in 2001. We will refer to tree farms owned by the Funds as the Funds’ tree farms.  When referring to the Partnership’s and Funds’ tree farms together we will refer to them as the “Combined” tree farms.  Our Fee Timber operations consist primarily of growing, harvesting, and marketing timber to both domestic and Pacific Rim markets.  In addition, our tree farms generate other revenues from sources such as cell tower, brush, and mineral leases.  Our Fee Timber segment produced 89%, 72%, and 84% of our consolidated revenue in 2010, 2009, and 2008, respectively.

This segment also includes operations of ORM Timber Fund I, LP (Fund I) and ORM Timber Fund II, Inc. (Fund II, and collectively, the Funds), which are consolidated into our financial statements.    Fund I acquired 24,000 acres of timberland in the fourth quarter of 2006, Fund II acquired 12,000 acres of timberland in the fourth quarter of 2009, and 25,000 acres in the last half of 2010.   Our Timberland Management & Consulting segment earns management fees and incurs expenses resulting from managing property on behalf of third-party owners and investors.  Since the launch of our timberland private equity fund strategy in 2003, the activities in this segment have consisted primarily of attracting third-party investment capital for the Funds and then acquiring and managing properties on the Funds’ behalf.

Inventory.   In the discussion below, inventory and projected harvest levels for the Partnership’s Hood Canal and Columbia tree farms is presented separately from timber inventory and harvest levels for the Funds.  Timber volume is generally expressed in thousand board feet (MBF) or million board feet (MMBF).

 
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We define “merchantable timber inventory” to mean timber inventory in productive timber stands that are 35 years of age and older. As of December 31, 2010, the tree farms’ (including the Funds) total merchantable inventory volume was estimated to be 649 MMBF, which compares to estimated merchantable timber inventory volume of 497 MMBF at December 31, 2009. Merchantable inventory of the Funds as of December 31, 2010 and 2009 was 335 MMBF and 155 MMBF, respectively.

In 2010, total inventory on the Partnership’s tree farms decreased 28 MMBF as a result of the 2010 harvest of 42 MMBF partially offset by inventory growth and the shift of new age-class layers that have reached 35 years of age and, as such, are included in merchantable timber inventory.  Total inventory for the Funds increased by 180 MMBF based primarily on the addition of 25,000 acres of Fund II lands, but also from inventory growth offset by the 2010 harvest of nearly 11 MMBF from the Funds.  

The Partnership’s merchantable inventory is spread among five-year age classes as follows (volumes in MMBF):
 
     
December 31,
 
2010
2010
2010
2009
Age Class
Pulpwood
Sawtimber
Total
Total
35 to 39
13
56
69
61
40 to 44
13
67
80
99
45 to 49
5
28
33
31
50 to 54
3
10
13
12
55 to 59
2
10
12
16
60 to 64
4
35
39
47
65+
9
59
68
76
 
49
265
314
342
 
The Funds’ merchantable inventory is spread among age classes as follows (volumes in MMBF):
 
     
December 31,
 
2010
2010
2010
2009
Age Class
Pulpwood
Sawtimber
Total
Total
35 to 39
10
77
87
42
40 to 44
10
94
104
49
45 to 49
4
45
49
12
50 to 54
5
45
50
16
55 to 59
3
19
22
15
60 to 64
1
5
6
5
65+
2
15
17
16
 
35
300
335
155
 
Timber inventory volume is updated annually.  Of the timber stands older than 24 years, 10% to 20% are physically re-measured each year using a statistical sampling process called “cruising”.  Adjustments are made for depletion of areas harvested, growth (using suitable growth and yield calculations), changes in acres and associated timber volume resulting from acquisitions, dispositions, and reclassification of acres as available or unavailable for harvest.
   
The dominant timber species on the Partnership’s tree farms is 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.  In addition to Douglas-fir, other species on the Partnership’s tree farms include western hemlock, red alder, and western red cedar.  The merchantable timber inventory from the Funds consists of a heavier mix of whitewoods, including western hemlock and spruce (other conifer).  

 
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The Partnership’s total merchantable timber inventory as of December 31, 2010 is distributed among species as follows (volumes in MMBF):
 
Species
 
2010 Volume
   
Percent of total
 
Douglas-fir
    227       72 %
Western hemlock
    38       12 %
Western red cedar
    15       5 %
Other conifer
    12       4 %
Red alder
    19       6 %
Other hardwood
    3       1 %
Total
    314       100 %
 
The Funds’ total merchantable timber inventory as of December 31, 2010 is distributed among species as follows (volumes in MMBF):
 
Species
 
2010 Volume
   
Percent of total
 
Douglas-fir
    195       58 %
Western hemlock
    90       27 %
Western red cedar
    3       1 %
Other conifer
    33       10 %
Red alder
    13       4 %
Other hardwood
    1       - %
Total
    335       100 %
 
The Partnership’s tree farms as of December 31, 2010 include approximately 114,000 acres.  Of this total, approximately 95,000 acres are designated productive acres, meaning land that is capable of growing merchantable timber and where the harvesting of that timber is not constrained by physical, environmental or regulatory restrictions.  The Funds’ tree farms as of December 31, 2010 totaled 61,000 acres, of which approximately 52,000 were designated productive acres.  Readers will note in the acreage table below that 28% of the Partnership’s acreage and 25% of the Funds’ acreage is in the 25-34 year age classes, much of which will begin moving from premerchantable to merchantable timber inventory over the next five years.  As of December 31, 2010, total productive acres are spread by timber age-class as follows:

 
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Age
 
12/31/2010
         
12/31/2010
       
Class
 
Partnership Acres
   
%
 
Fund I & II Acres
   
%
Clear-cut
    1,667       2 %     233       %
0 to 4
    7,504       8 %     2,522       5 %
5 to 9
    10,358       11 %     2,843       6 %
10 to 14
    13,731       14 %     3,005       6 %
15 to 19
    4,282       4 %     4,514       9 %
20 to 24
    14,688       15 %     7,526       14 %
25 to 29
    16,775       18 %     5,513       11 %
30 to 34
    9,854       10 %     7,470       14 %
35 to 39
    4,749       5 %     6,401       12 %
40 to 44
    4,580       5 %     6,101       12 %
45 to 49
    1,594       2 %     2,368       5 %
50 to 54
    742       1 %     1,896       4 %
55 to 59
    665       1 %     736       1 %
60 to 64
    1,538       1 %     274       %
65+
    2,569       3 %     608       1 %
      95,296               52,010          
 
Timberland Acquisitions.  We made two timberland purchases in 2010 that added approximately 25,000 acres to the Fund II tree farm inventory for a total purchase price of $58.1 million.

Long-term Harvest Plan.  We generally discuss long-term harvest plans in terms of a sustainable annual harvest level that is based on the use of a non-declining even-flow (NDEF) harvest modeling constraint. When modeling future harvests, this NDEF constraint means that, absent changes to available inventory or estimated growth rates, future harvest levels will be as high as, or higher than, current levels.  While we will continue to reference estimated non-declining even flow harvest levels , we believe this concept has lost some of its relevance in our current operating environment of extremely volatile log prices combined with a large accumulation of deferred harvest volume.

In response to a dramatic downturn in log prices in 2008 we began deferring harvest volume from both the Partnership’s and Funds’ properties. During 2010, log prices were extremely volatile and are expected to remain so over the near-term while timberland owners take advantage of opportunities to harvest deferred volume into strengthening log markets. This additional “shadow” log supply, when overlaid with weak domestic log demand but strong export markets, has exacerbated the usual difficult challenge of forecasting log prices more than three months into the future. Anticipated price volatility will impact harvest volumes with the result that our log production will vary up and down from adherence to a strict NDEF target. Over time, however, we still expect our harvest activity to average something approximating an NDEF level.

Over the next three to five years, assuming a continuation in log market price recovery, we expect to meter in previously deferred harvest volumes of 27 MMBF (see table below) on top of the Partnership’s NDEF level.  Properties owned by the Funds will be treated somewhat differently inasmuch as some of these acquired tree farms contain a disproportionately large number of acres stocked with currently merchantable timber. As a result, harvest levels on these Fund properties are expected to be greater than what would be an NDEF level.

 
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(amounts in MMBF)
   
Accumulated
   
Annual NDEF
 
Volume Deferral
   
Harvest Volume
 
2008-10
Partnership Properties
43
 
27
Fund Properties*
27
 
23
Total
70
 
50
         
*
The Partnership owns 20% of the Funds.  On a look-through basis the Partnership's portion of the Funds' NDEF is 5 MMBF and its share of the Funds' accumulated deferral is also 5 MMBF.
 
Marketing and Markets.  We market timber using the manufactured log method, where we engage independent logging contractors to harvest the standing timber and manufacture it into logs that we then sell on the open market.  We retain title to the logs until delivery takes place, which normally occurs at a customer log yard.  We sell our logs both domestically and internationally through log exporting intermediaries.

The export market for logs in the Pacific Northwest has been migrating over the last couple years from a market highly focused on Japan to a market that now includes more volume to Korea and China.  Sawlogs sold to Korea and China are not of the high quality demanded by the Japanese market and, as a result, have not commanded the premium pricing generally attributed to the Japanese market. Logs flowing to markets in Korea and China have traditionally gone to domestic customers.  We expect that these new outlets for logs will help to diversify our customer mix away from domestic mills that are more heavily dependent on the U.S. housing market.  This new source of demand for domestic quality sawlogs should support increased pricing for all markets as domestic mills must now compete with this new and growing source of demand for Pacific Northwest sawlogs.  Furthermore, many of our domestic sawmill customers are shipping significant volumes of finished lumber to China, which is allowing them to compete with the export market during a time when U.S. housing starts do not independently support higher log prices.

Logs sold to Japan, Korea, and China are sold to U.S.-based brokers who in turn sell directly to offshore customers.  Over the last several years, the percentage of our annual production sold into export markets has ranged from 6% to 16%.  However, in 2010, our export mix surged to 33% with the increased demand from Korea and China.  Factors that affect the proportion of our sales to export markets include the relative strength of U.S. and foreign building markets, currency exchange rates, and ocean transportation costs.

In response to weak lumber markets over the past few years, domestic sawmills have lowered operating hours and eliminated shifts, resulting in lower capacity utilization and reduced demand for logs.  However, as housing starts have stabilized and the Chinese export lumber market has emerged as a new source of demand, domestic mills have increased operating hours and added back shifts, thus increasing capacity utilization rates and demand for logs.

Customers.   The Partnership sells its logs domestically to lumber mills and other wood fiber processors located throughout western Washington and northwest Oregon.  The Partnership’s logs are also sold to export intermediaries located at the ports of Tacoma, Olympia, Port Angeles, and Longview, Washington and Astoria, Oregon.  Whether destined for domestic or export markets, the cost of transporting logs limits the destinations to which the Partnership can profitably deliver and sell its logs.

Weyerhaeuser Company, with logs flowing to both domestic and export markets, was the largest customer for our Fee Timber segment in 2010, representing 28% of segment revenue.  The Partnership delivered logs to 43 separate customers during 2010 compared to 38 during 2009.

 
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Competition.  Most of our competitors are comparable in size or larger.  Log sellers compete on the basis of quality, pricing, and the ability to satisfy volume demands for various types and grades of logs to particular markets.  Management believes that the location, type, and grade of the Partnership’s timber will enable it to compete effectively in these markets.  However, our products are subject to increasing competition from a variety of non-wood and engineered wood products as well as competition from foreign-produced logs.

Forestry and Stewardship Practices.  The Partnerships timberland operations incorporate management activities that include reforestation, control of competing brush in young stands, thinning of the timber to achieve optimal spacing after stands are established, fertilization, and road maintenance.  During 2010, we planted 657,000 seedlings on 1,765 acres.  This compares to the years 2009 and 2008 in which the Partnership planted 815,000 and 792,000 seedlings on 1,874 and 1,821 acres, respectively.  Seedlings are generally planted from December to April depending on weather and soil conditions.  Planting will vary from year to year based upon harvest level, the timing of harvest, and seedling mortality rates on stands planted in prior years.  Management’s policy is to stay current on its reforestation program, returning all timberlands to productive status in the first planting season.

  All harvest and road construction activities are conducted under the forest practice rules and regulations of the applicable state.  These regulations are comprehensive sets of rules that require project-specific permits that govern a defined set of forest operations   For example, an application for harvest or road construction must address soil stability and potential impact to public resources.  In many cases we use scientifically based watershed analyses and we consult third-party, state-qualified, geo-technical consultants to promote safety and regulatory compliance.  In addition to new road construction, existing roads are maintained to the standards of the applicable state forest practices act in order to minimize siltation of nearby streams and avoid slope failures.

In Washington, beginning in 2000, all roads must be evaluated for hazard and scheduled for upgrading or deconstruction (abandonment), if needed, by the end of 2015.  We developed a compliance schedule for our roads in Washington and it was accepted by the state with efforts on track to complete all maintenance activities by 2015.  Oregon does not have a similar road maintenance and abandonment plan requirement at present.   

Sustainable Forestry Initiative (SFI®).  Since 2001, we have been a member of the SFI forest certification program, an independent environmental review and certification program that promotes sustainable forest management, focusing on water quality, biodiversity, wildlife habitat, and species protection.  With our voluntary entry into this certification program, we have been subject to independent audits of the required standards for the program.  Management views this certification as an important indication of our commitment to manage our lands sustainably while continually seeking ways to improve our management practices.  We believe this commitment is an important business practice that contributes positively to our reputation and to the long-term value of our assets.
 
Beginning in 2007, SFI third-party audits increased in frequency from every three years to annually.  We were re-certified in 2010, which includes both the Partnership and the Funds properties.  We believe this certification allows us to obtain the broadest market penetration for our logs while protecting the core timberland assets of the Partnership.

Fire Management.  Management has taken a number of steps to mitigate risk of loss from fire, which is nonetheless possible on any timberland property.  First, management maintains a well-developed road system that allows access and quick response to fires that may occur.  Second, management maintains a fire plan and program that provides for increased monitoring activities and requires all operators to maintain adequate fire suppression equipment during the summer fire season.  The disbursement of the major ownership blocks over a broad geographic range precludes the possibility of catastrophic loss should a major fire occur in any single area.  It is industry practice to forgo the purchase of fire insurance as it is cost prohibitive in light of the historic infrequency and relatively low risk of fire.

 
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Timberland Management & Consulting

Background.  In March 1997, our unitholders authorized management to expand our timberland business into the Investor Portfolio Management Business (IPMB).  The IPMB has two complementary business strategies: timberland investment management and timberland management.  In 1997, the Partnership formed two wholly owned subsidiaries, ORM, Inc. and Olympic Resource Management LLC (“ORMLLC”), to facilitate the IPMB activities.

ORMLLC has raised two timber funds with assets under management totaling $150 million which includes our co-investment of $28 million.  These Funds allow us greater economies of scale in the management, acquisition, and disposition of timberland than would be possible with the Partnership’s investment capital alone.  In addition, we generate asset management fees that are paid by the Funds for our management of the Funds’ portfolios.  These Funds are consolidated into our financial statements, resulting in the elimination of $1.5 million, $908,000, and $946,000 of management fee revenue in 2010, 2009, and 2008, respectively.  These fees are eliminated through a corresponding decrease in operating expenses for the Fee Timber segment.
 
Operations.  The Timberland Management & Consulting segment’s key operation has been to provide investment and timberland management services to the Funds and to other third-party timberland owners.  We anticipate growth in this segment as we continue to manage the Funds, and any future funds successfully established by the Partnership. The Timberland Management & Consulting segment represents less than 1% of consolidated revenue in 2010 and 3% of consolidated revenue for each of the years ended December 31, 2009 and 2008, after the elimination of the fees generated from asset and timberland management of the Funds.
 
Timberland Investment Management.  The goal of our timberland investment management program is to build and manage diversified timberland portfolios for third-party investors and the Partnership.  Management views this objective as a means of increasing the Partnership’s total timberland base, through our co-investment, while at the same time improving overall management economies of scale, limiting acquisition costs, and generating fee income.  We earn an asset management fee for managing this capital once timber properties are acquired.  The asset and timberland management fees generated from managing the Funds are eliminated as a result of consolidation of the Funds into the Partnership’s financial statements.  The elimination of these fees results in a decrease in the otherwise reported cost per acre of managing the Funds’ tree farms under our Fee Timber segment as well as eliminating the revenue generated from managing the Funds in the Timberland Management & Consulting segment.  An effect of these eliminations is to make the Fee Timber results look better and the Timberland Management & Consulting results look correspondingly worse.
 
Fund I closed in August 2005 and has $58 million invested in two tree farms totaling 24,000 acres.  Fund II closed in March 2009 and has $92 million invested in four tree farms for a combined total of 37,000 acres.  With $150 million of assets under management in the Funds, we are currently pursuing capital-raising and evaluating suitable timberland acquisitions for a new Fund III.
 
Timberland Management.  Our timberland management activities provide forestland management, acquisition, and disposition services to timber property owners.  These services generally take the form of a long-term contract where we provide management expertise. Specialized consulting assignments are performed on an ad-hoc basis. In July 2009, the timberland management assignment for Cascade Timberlands LLC (“Cascade”) was terminated after a four-and-a-half year tenure.  We have acted as manager on over 1.5 million acres of timberland starting in the late 1990’s through the termination of the Cascade contract, but management considers such opportunities to be sporadic and difficult to predict.

Marketing.  In addition to managing the Fund’s timberlands, we regularly pursue third-party timberland management opportunities in the western U.S. through direct marketing to timberland owners.  Marketing and business development efforts include regular contact with forest products industry representatives, non-industry owners, and others who provide key financial services to the timberland sector.  Our acquisition and disposition activities keep management informed of changes in timberland ownership that can represent opportunities for us to market our management and consulting services.

 
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Customers.  Timberland management revenue in 2010 was de minimis and in 2009 only included one client.

Competition.  We compete against both larger and comparably sized companies providing similar timberland management services.  There are approximately 22 established timberland investment management organizations competing against us in this business.  The companies in this group have access to established sources of capital and, in some cases, increased economies of scale that can put us at a disadvantage.  Our value proposition to investors is our long track record of success in the Pacific Northwest and our co-investment in each of the funds.  Regional companies that are even smaller than we are compete effectively on price for limited scope consulting and land management projects. 
 
Limitation on Expenditures.  The 1997 amendment to Pope Resources’ Limited Partnership Agreement authorizing launch of the IPMB limits our cumulative net expenditures incurred in connection with the IPMB to $5.0 million including debt guarantees.  As of December 31, 2010 cumulative expenditures incurred in pursuit of IPMB opportunities, including guarantees, were less than cumulative income generated.  Therefore, cumulative net expenditures as of December 31, 2010 against the $5.0 million limit are zero.

Real Estate

Background.  The Partnerships real estate activities are closely associated with the management of its timberlands.  Management continually evaluates timberlands in terms of the best economic use, whether this means continuing to grow and harvest timber or seeking a rezone of the property for sale or development.  After timberland has been logged, management has a choice between four primary alternatives for the underlying land: reforest and continue to use as timberland, sell as undeveloped property, improve to various levels of development for sale as improved property, or hold as property slated for later development or sale.  Generally speaking, the Real Estate segment’s activities consists of investing in and later reselling improved properties, and holding properties for later development and sale. As a result, revenue from this segment tends to fluctuate substantially, and is characterized by relatively long periods in which revenue is relatively low, while expenses incurred to increase the value of the Partnership’s development properties may be higher.  However, during periods of decreased demand, we keep soft cost and infrastructure investment to a minimum to mitigate outpacing the rate of lot or acreage absorption by the market. When improved properties are sold, income is recognized in the form of sale price net of acquisition and development costs.

Operations.   Real Estate operations include leasing residential and commercial properties in the Port Gamble townsite and work considered by management necessary to maximize the value of the Partnership’s portfolio of property that management believes has a higher-and-better-use than timberland. That portfolio currently consists of approximately 2,800 acres. In addition this segment works to negotiate conservation easements (CE) that typically encumber Fee Timber properties to preclude land from future development.  For Real Estate projects, management secures entitlements and/or infrastructure necessary to make development possible and then sells the entitled property to a party who will construct improvements.  The Real Estate segment represents 11%, 25%, and 13% of consolidated revenue in 2010, 2009, and 2008, respectively.

Development Properties

Other Land Investments.  Management recognizes the significant value represented by the Partnership’s real estate holdings and is focused on adding to that value.  The means and methods of adding value to our real estate portfolio vary considerably depending on the specific location and zoning of each parcel.  This range extends from land that has commercial activity zoning where unit values are valued on a square foot basis to large lots of recently cutover timberland where value is measured in per-acre terms.  In general, value-adding activities that allow for the highest and best use of the properties include: working with communities and elected officials to develop grass roots support for entitlement efforts, securing favorable comprehensive plan designation and zoning, acquiring easements, and obtaining preliminary plat approvals.  

 
10

 
 
Master planned communities in Gig Harbor, Kingston, and Port Gamble, Washington make up approximately 26% of the acres in our development property portfolio.  During 2010, no sales were generated from any of these projects. While many properties were being actively marketed during the past year, management elected to hold firm on its pricing rather than deeply discount offering prices in order to generate sales.  Notwithstanding market inactivity, management believes the carrying values of the development properties do not require adjustment.  Due to each property’s size, development complexity, and regulatory environment, the projects are long-term in nature and require extensive time and capital investments to maximize returns.   

Gig Harbor.   Gig Harbor, a suburb of Tacoma, Washington, is the site of a mixed-use development project that includes a 16-acre retail/commercial site, 35 acres of business park lots, and 200 acres of land with residential zoning.  In December 2008, management completed a preliminary plat submission for the 200-acre residential portion of this project that called for 558 single-family and 265 multi-family lots.  A 20-year development agreement was approved in late 2010, followed by the preliminary plat approval in early 2011.  These approvals allow for a residential development of 554 single family and 270 multi-family units.  Key provisions of the development agreement and plat approval include: (a) extending the project approval from 7 to 20 years; (b) reserving sufficient domestic water supply, sanitary sewer, and traffic trip capacity on behalf of the project’s 824 residential units; and (c) waiver of park impact fees in exchange for a 7-acre parcel of land for City park purposes.  Site-plan specific entitlement for 11.5 acres of land zoned for use as a business park was also received in 2010.  All components of this project have transportation, water and sewer capacities reserved for full build-out.  Management has been in discussions with a number of different interested parties for sale of subsets of both the single- and multi-family portions of this project.
 
Bremerton.   In 1999, the City of Bremerton approved the Partnership’s request for a planned 264-acre mixed-use development on property located within the Bremerton city limits.  In 2006, the Partnership completed the sale of the 203-acre residential component of this project.  As a condition of the sale, the Partnership constructed infrastructure in 2006 and 2007 to serve the property.  Of the remaining 61 acres, 15 acres were deeded to the Wright Creek Owners’ Association and the City of Bremerton for roads and other common area improvements leaving a 46-acre industrial park which is being developed in two phases that will result in a total of 24 lots.  Construction on the 9 lots that make up phase I was completed in 2007.  A total of one lot has been sold from Phase I.  At the completion of the sale of Phase I lots, infrastructure spending and marketing will commence for Phase II.
 
Kingston.  The Partnership prepared and submitted a formal master plan and subdivision application in 2007 for the 356-acre Kingston property named “Arborwood” that calls for the development of 663 single-family and 88 multi-family lots.  Final approval of a preliminary plat and a 15-year development agreement was completed in February 2010.  Further development will not proceed until the market demonstrates an increased appetite for residential lots.  The Partnership owns an additional 366 acres bordering this project, which has zoning for 5-acre lots.
 
Hansville.     The Partnership owns a 152-acre residential development project in Hansville called “Chatham.”  The development is the result of a plat from 1913 that originally consisted of 10-acre lots that management has reestablished into 19 distinct parcels ranging from three to 10 acres in size.  Construction was completed in late 2007 and the lots are currently being marketed for sale.
 
Port Ludlow.  Port Ludlow represents a 256-acre property located just outside the Master Planned Resort boundary of Port Ludlow, Washington.  In December 2008, a submission for plat approval was made to Jefferson County.  Preliminary Plat approval is expected in late 2011 and, if obtained, will allow for up to 54 lots ranging from 1 to 1.5 acres each, with the balance of the property designated as open space.  Development beyond the point of plat approval will not commence until demand for rural residential lots improves.

 
11

 
 
Rural Residential.  Management launched the Rural Lifestyles program to capitalize on higher-and-better-use real estate values.  These properties are typically non-contiguous smaller lots ranging in size between 5 and 40 acres with zoning ranging from one dwelling unit per 5 acres to one per 80 acres.  Development and disposition strategies vary depending on the property’s unique characteristics.  Development efforts and costs expended to ready these properties for sale include work to obtain development entitlements that will increase the property’s value as residential property as well as making improvements to existing logging roads, constructing new roads, extending dry utilities, and sometimes establishing gated entrances.  As mentioned in the Real Estate background, investments in the Rural Lifestyles program have been restricted to costs necessary to achieve entitlements, while deferring construction costs until such point in time when market conditions improve.

Consulting.  Management leveraged its knowledge in real estate by providing advice to banks and other land owners on their troubled real estate assets in 2009 and 2010.  While this consulting activity contributed only a small amount to Real Estate revenue, it was very valuable in providing knowledge of lot inventories and prices, and the health of homebuilders in the local market.

Commercial Properties

Port Gamble.  The Partnership currently owns and operates the town of Port Gamble, Washington, northwest of Kingston on the Kitsap Peninsula.  Port Gamble was designated a “Rural Historic Town” under Washington’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, as well as the wedding and events business.

The Partnership’s antecedent, Pope & Talbot, Inc. (P&T), operated a sawmill at Port Gamble from 1853 to 1995.  Starting in 2002, management 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 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.

During the fourth quarter of 2010, review continued on the draft Baywide and Millsite Remedial Investigation (RI) and Feasibility Study (FS) reports related to Port Gamble.  The reports have an estimated submission for a 30-day public comment period beginning in early March 2011.  The public comments will be part of the data that informs a cleanup action plan anticipated to be filed with a consent decree in late 2011. The development of a cleanup action plan includes formalizing cost estimates and how costs will be shared between responsible parties, which will be reflected in the Partnership’s environmental remediation accrual liability where and when appropriate.

Following a period of heavy rain in mid-December, oil from some long-buried tanks surfaced on the millsite and, as such, the environmental remediation accrual at December 31, 2010 contains costs estimated in connection with this second and separate remediation effort at Port Gamble.  We will be completing site investigations and remediating contaminated sites as necessary.
 
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Real Estate – Environmental Remediation Costs.”

Port Ludlow Resort Community. 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, we recognized an accrual as of December 31, 2010 for the Partnership’s best estimate of its potential share of any remediation costs.

 
12

 
 
Marketing.  Marketing activities in the Real Estate segment during 2010 consisted of marketing residential and commercial real estate for sale and lease.

Customers. Management typically markets its land for sale to private individuals, residential contractors, and developers of commercial property. Customers for rental space in the Port Gamble townsite consist of both residential and commercial tenants.

Competition.  Real Estate activities consist primarily of adding value to current land holdings.  Once those properties are ready for development, management will in most instances seek to market the property for sale, but in some instances may consider a strategy that would involve another developer with building expertise as a joint venture partner.

Transportation.  Land values for the Real Estate portfolio are strongly influenced by transportation options between the western side of Puget Sound where our properties are located and the Seattle-Tacoma metropolitan corridor.  Transportation options between these areas separated by bodies of water include driving on the Tacoma Narrows Bridge or taking one of several car/passenger ferries.  Ferry transportation within the market area currently utilizes vessels that carry both automobiles and passengers from each of the communities of Kingston, Bremerton, and Bainbridge Island, respectively, to and from Edmonds and Seattle.

Employees

As of December 31, 2010, the Partnership employed 42 full-time, year-round salaried employees and 3 part-time and seasonal personnel, who are distributed among the segments as follows:

Segment
 
Full-Time
   
Part-Time/
Seasonal
   
Total
 
Fee Timber
    14       -       14  
Timberland Management & Consulting
    5       -       5  
Real Estate
    13       3       16  
General & Administrative
    10       -       10  
Totals
    42       3       45  

None of our employees are subject to a collective bargaining agreement and the Partnership has no knowledge that any steps toward unionization are in progress.  Management considers the Partnership’s relations with its employees to be good.

Government Regulation

In the operation and management of its tree farms, the Partnership is subject to federal and state law.  Washington’s Forest Practices Act, in effect since 1974, is among the most rigorous in the nation.  In 2006, in concert with its Forest and Fish Law, Washington received a federal multi-species Habitat Conservation Plan (HCP) designation covering its forest regulations, meant to give timberland owners 50 years of regulatory stability.  There is an adaptive management element to the HCP, where new scientific findings may result in some new or modified regulations which could result in increased costs, additional capital expenditures, and reduced operating flexibility. 
 
In Oregon, the laws governing forest practices have the same objectives as in Washington, but lack both some of the rigor of Washington’s regulatory overlay and a counterpart to Washington’s HCP.  Whereas in Washington there is a complex application process for forest practices that may take in excess of 30 days, in Oregon the landowner notifies the state of the landowner’s operational intentions, and the regulations are enforced as part of compliance oversight of ongoing operations rather than as part of the notification phase. 
 
 
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There are potential changes to the regulatory climate that could affect forest practices in both states:
 
·  
A revised Northern Spotted Owl Recovery Plan is being worked on at the federal level that stipulates that, unlike prior versions, all forest lands should contribute to the recovery effort.  Whereas past recovery plans relied on federal and state lands for habitat set-asides, the new plan may affect or preclude operations on private land deemed to be essential habitat.  The 2010 Draft Recovery Plan is now in the peer review and public comment stage, with efforts being made to demonstrate the already large contribution being made to the recovery effort through Washington’s HCP as well as significant habitat contributions on private land in both states.
 
·  
A lawsuit in Oregon resulted in a ruling that water channeling structures such as culverts on logging roads are, in fact, point sources of pollution.  If this ruling is upheld on appeal, it could require an EPA discharge permit for each such structure, numbering millions of such permits across the nation. 
 
·  
State budget shortfalls are affecting state regulatory agencies such that the states are expected to impose new, or increase existing, fees for the conduct of forest practices.
 
Regulatory Structure.  Growing and harvesting of timber is subject to numerous laws and government policies to protect public resources such as wildlife, water quality, and other social values.  Changes in those laws and policies can significantly affect local or regional timber harvest levels and market values of timber-based raw materials.  Real estate development activities are also subject to numerous state and local regulations such as the Washington State Growth Management Act (GMA).  In addition, the Partnership is subject to federal, state, and local pollution controls (with regard to air, water and land), solid and hazardous waste management, disposal and remediation laws, and regulations in each segment and all geographic regions in which it has operations.

Growth Management.  Land holdings throughout Washington are affected by the GMA, which requires counties to submit comprehensive plans that identify the future direction of growth and stipulate where population densities are to be concentrated.  The purposes of the GMA include: (1) direction of population growth to population centers (Urban Growth Areas), (2) reduction of “suburban sprawl”, and (3) protection of historical sites.  The Partnership works with local governments within the framework of the GMA to develop its real estate holdings to their highest and best use.  Oregon also has growth management provisions in its land use laws which served as a model for Washington’s growth management provisions.   Oregon's land use laws are generally more stringent outside of urban areas, especially in commercial forest lands where residential conversions are often outright disallowed.  An exception is a coastal property owned by Fund II.  This property is unique for its Destination Resort zoning overlay which allows for comprehensive and integrated resort development.  We will be examining this opportunity over the course of the Fund II's 10-year term

Forest Management Practices.  Forest practice regulations in some U.S. states increasingly affect present or future harvest and forest management activities.  For example, in some states, these rules have one or more of the following impacts: limiting the size of clear-cut harvest units; requiring some timber to be left unharvested to protect water quality and fish and wildlife habitat; regulating construction and maintenance of forest roads; requiring reforestation following timber harvest; and providing for procedures for state agencies to review and approve proposed forest practice activities.
 
Each state in which the Partnership owns or manages timberlands has developed “best management practices” to reduce the effects of forest practices on water quality and aquatic habitats.  Additional, more stringent regulations may be adopted in order to achieve the following: enhance water quality standards under the federal Clean Water Act, protect fish and wildlife habitat, or advance other public policy objectives.
 
 
14

 
 
In the State of Washington, the Forests and Fish Law became the basis for revised Forest Practices Rules and Regulations.  The Washington Forest Protection Association produced the Forest and Fish Report through the collaborative efforts of Washington’s private landowners, federal, state and county governments, and Native American tribes.  The goals of these revised rules are to:

·  
Provide compliance with the Endangered Species Act (ESA) for aquatic and riparian dependent species on private forest lands;
·  
Restore and maintain riparian habitat on private land to support a harvestable supply of fish;
·  
Meet the requirements of the Clean Water Act for water quality on private forest lands; and
·  
Keep the timber industry economically viable in the State of Washington.

The proposed Water Quality Standards that the Washington State Department of Ecology adopted in 2003 have undergone Department of Ecology and public scrutiny.  As such, these rules should be sufficient to comply with the Anti-Degradation Implementation Plan as described in the Clean Water Act.  In June 2006, the U.S. Fish & Wildlife Service and NOAA Fisheries signed a Forest Practices Habitat Conservation Plan (HCP).  This HCP is a statewide program protecting 60,000 miles of streams on 9.3 million acres of forestland, set in motion by the Forests & Fish Law.  It ensures landowners that practicing forestry in Washington meets the requirements for aquatic species designated by the federal Endangered Species Act.

The regulatory and non-regulatory forest management programs described above have increased operating costs and resulted in changes in the value of the Partnership’s timberlands.  Management does not expect the Partnership to be disproportionately affected by these programs as compared with typical timberland owners.  Likewise, management does not expect that these programs will significantly disrupt its planned operations over large areas or for extended periods.
 
Water Quality.  The U.S. Environmental Protection Agency also promulgated regulations in 2000 requiring states to develop total maximum daily load (“TMDL”) allocations for pollutants in water bodies that have been determined to be “water quality impaired”.  The TMDL requirements set limits on pollutants that may be discharged to a body of water or set additional requirements, such as best management practices for nonpoint sources, including timberland operations, to reduce the amounts of pollutants in water quality impaired bodies of water.  These requirements have impacted tree farming principally through rules requiring tree farms to better minimize siltation caused by roads, harvest operations and other management activities from coming in contact with water quality impaired bodies of water.  TMDL targets will be established for specific water bodies in the states where the Partnership operates and these targets will be set so as to achieve water quality standards within 10 years, when practicable.  In Washington, the Road Maintenance and Abandonment Planning section of the Forest Practices Rules and Regulations has been in place since 2001, under which all sedimentation problems associated with forest roads must be mitigated by 2015.  The Partnership is on schedule to complete the necessary work to meet the 2015 deadline, which will largely address the issue of non-point pollution consisting of sedimentation originating from the Partnership’s forest operations.  It is not possible at this time to either estimate the capital expenditures that may be required for the Partnership to stay below the targets until a specific TMDL is promulgated or to determine whether these expenditures will have a material impact on the Partnership’s financial condition or results of operations.

Endangered Species and Habitats.  A number of fish and wildlife species that inhabit geographic areas near or within Partnership timberlands have been listed as threatened or endangered under the federal Endangered Species Act (ESA) or similar state laws in the United States.  Federal ESA listings include the Northern Spotted Owl, marbled murrelet, numerous salmon species, bull trout, and steelhead trout in the Pacific Northwest.  Listings of additional species or populations may result from pending or future citizen petitions or be initiated by federal or state agencies.  Federal and state requirements to protect habitat for threatened and endangered species have resulted in restrictions on timber harvest on some timberlands, including some timberlands of the Partnership.  Additional listings of fish and wildlife species as endangered, threatened, or sensitive under the ESA and similar state laws as well as regulatory actions taken by federal or state agencies to protect habitat for these species may, in the future, result in the following: an increase in operating costs; additional restrictions on timber harvests; impacts to forest management practices or real estate development activities; and potential impact on timber supply and prices.

 
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Item 1A.                RISK FACTORS

We are subject to statutory and regulatory risks that currently limit, and may increasingly limit, our ability to generate income. Our ability to grow and harvest timber can be significantly impacted by legislation, regulations or court rulings that restrict or stop forest practices. For example, events that focus media attention upon natural disasters and damage to timberlands have at various times brought increasing public attention to forestry practices.  Additional regulations, whether or not adopted in response to such events, may make it more difficult for us to harvest timber and may reduce the amount of harvestable timber on our properties. These and other restrictions on logging, planting, road building, fertilizing, managing competing vegetation, and other activities can significantly increase the cost or reduce available inventory thereby reducing income. These regulations are likely to have a similar effect on our Timberland Management & Consulting operations, particularly in the case of the Funds.  Specific examples of such regulations are cited above on page 13 in our discussion of government regulation.
 
Moreover, the value of our real estate investments, and our income from Real Estate operations, is sensitive to changes in the economic and regulatory environment, as well as various land-use regulations and development risks, including the ability to obtain the necessary permits and land entitlements that would allow us to maximize the revenue from our real estate investments. Our real estate investments are long-term in nature, which raises the risk that unforeseen changes in the economy or laws surrounding development activities may have an adverse effect on our investments. These investments often are highly illiquid and thus may not generate cash flow if and when needed to support our other operations.
 
Our business may be affected by climate change initiatives. Environmental activists, global treaty organizations, the federal government, and numerous state legislatures have intensified their scrutiny of environmentally significant industries in response to well-publicized reports of the adverse impacts of global greenhouse gas emissions, deforestation, and similar environmental impacts upon the earth's climate. A broad range of proposals have been considered by state and federal regulatory authorities, whose stated objectives would be to mitigate potential climate change by reducing or eliminating activities and business practices that are allegedly tied to global climate change. A number of these proposals remain under active consideration. These proposals include a number of restrictions and requirements which, if adopted, would adversely affect the U.S. domestic timber industry generally, and our business in particular. These include initiatives to reduce timber harvests (to promote the natural recycling of carbon dioxide into oxygen and other byproducts), which, if adopted and applied to our timberlands, would adversely impact our fee timber income; initiatives to curb heavy equipment usage, which, if adopted, would tend to increase transportation and harvest costs; substantial increases in reporting and compliance, which, if adopted, would likely increase our general and administrative expense and, potentially, our costs of sales; and a variety of other components which may reduce our revenues or increase our expenses, particularly as it relates to our Fee Timber and our Timberland Management & Consulting segments.
 
We have certain environmental remediation liabilities associated with our Port Gamble and former Port Ludlow resort properties, and those liabilities may increase.  We currently own certain real estate at Port Gamble on the Kitsap Peninsula and, up until mid-2001, owned real estate property within the resort community of Port Ludlow in Jefferson County in western Washington.  We are in active discussions with the Washington State Department of Ecology to promote protection of the environment, optimize and appropriately allocate the remaining cleanup liabilities, and maximize our control over the remediation process.
 
      Management continues to monitor the Port Gamble and Port Ludlow cleanup processes closely.  The $1.9 million remediation liability balance as of December 31, 2010 represents our best current estimate of the remaining cleanup cost and most likely outcome to various contingencies within both locations.  Where possible, the Company records to the most likely point estimate within the range and when no point estimate within the range is better than another, the Company records to the low end of the range of possible outcomes.  These liabilities are based upon a number of estimates and judgments that are subject to change as the project progresses.  Statistical models have been used to estimate the liability for the aforementioned matters and suggest a potential aggregate range of loss of $744,000 to $3.8 million.
 
 
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We benefit from certain tax treatment accorded to master limited partnerships, and if that status changes the holders of our units may realize less advantageous tax consequences.  The Partnership is a Master Limited Partnership (MLP) and is therefore not generally subject to U.S. federal income taxes.  If a change in tax law (or interpretation of current tax law) caused the Partnership to become subject to income taxes, operating results would be adversely affected.  We also have three taxable subsidiaries.  The estimation of income tax expense and preparation of income tax returns requires complex calculations and judgments.  We believe the estimates and calculations used in this process are proper and reasonable but if a federal or state taxing authority disagreed with the positions we have taken, a material change in provision for income taxes, net income, or cash flows could result.

We are sensitive to demand and price issues relating to our sales of logs in both domestic and foreign markets.  We generate Fee Timber revenue primarily by selling softwood logs to domestic mills and to third-party intermediaries who resell them to the export market.  The domestic market for logs in our operating area depends heavily on U.S. housing starts. Recent economic events have dramatically slowed U.S. housing starts, which has reduced demand for lumber.  In addition, imported lumber from Canada and increasing market acceptance of engineered wood products have acted to hold down the price of lumber. To the extent the housing crisis continues or deepens the negative impacts on our operating results could continue.  Over the past decade, we have seen log prices erode in the Japanese market as competing logs and lumber from regions outside of the United States and engineered wood products have gradually gained market acceptance.  These export markets for Pacific Northwest logs are significantly affected by fluctuations in United States, Japanese and, increasingly, Chinese and Korean economies, as well as by the foreign currency exchange rate between these Asian currencies and the U.S. dollar, as well as ocean transportation costs.
 
We and our customers are dependent upon active credit markets to fund operations.  We sell logs from our Fee Timber segment to mills and log brokers that in most circumstances rely upon an active credit market to fund their operations.  Our Real Estate sales are also often dependent upon credit markets in order to fund acquisitions. To the extent the ongoing economic crisis exacerbates existing borrowing restrictions that impact many of our customers, we expect those customers to respond by reducing their expenditures, and those reductions may have the effect of directly reducing our revenues and of indirectly reducing the demand for our products. Any such outcomes could materially and adversely impact our results of operations, cash flows, and financial condition. Laws in the state of Washington limit our ability to offer seller-financing to non-business entities without appropriate certification from the Director of Financial Institutions. We are investigating our alternatives for complying with these new rules and until such time as we are compliant with these new systems, our ability to market raw land to certain individuals will be limited.

We are controlled by our managing general partner.  As a limited partnership, substantially all of our day-to-day affairs are controlled by our managing general partner, Pope MGP, Inc.  The board of directors of Pope MGP, Inc. serves as our board of directors, and by virtue of a stockholder agreement, the shareholders of Pope MGP, Inc., Emily T. Andrews and Peter T. Pope, each have the ability to designate one of our directors and to veto the selection of each of our other directors, other than our chief executive officer, who serves as a director by virtue of his executive position.  Unitholders may remove the managing general partner only in limited circumstances, including, among other things, a vote of the holders of a two-thirds majority of the “qualified units,” which means the units that have been owned by their respective holders for at least five years prior to such vote.  By virtue of the terms of our agreement of limited partnership, as amended, or “partnership agreement”, our managing general partner directly, and Mrs. Andrews and Mr. Pope indirectly, have the ability to prevent or impede transactions that would result in a change of control of the Partnership; to prevent or, upon the approval of limited partners holding a majority of the units, to cause, the sale of the assets of the Partnership; and to cause the Partnership to take or refrain from taking certain other actions that you might otherwise perceive to be in the Partnership’s best interest.  Under our partnership agreement, we are required to pay to Pope MGP, Inc. an annual management fee of $150,000, and to reimburse Pope MGP, Inc. for certain expenses incurred in managing our business.  Reimbursements for expenses totaled $800 in 2010 and $2,000 in 2009.

 
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We may incur losses as a result of natural disasters that may occur, or that may be alleged to have occurred, on our properties.  Forests are subject to a number of natural hazards, including damage by fire, hurricanes, insects and disease, and during periods of unusually heavy rain and snowmelt, flooding and landslides may damage homes and personal property. Changes in global climate conditions may intensify these natural hazards. Severe weather conditions and other natural disasters can also reduce the productivity of timberlands and disrupt the harvesting and delivery of forest products. While damage from natural causes is typically localized and would normally affect only a small portion of our timberlands at any one time, these hazards are unpredictable and losses might not be so limited. While management believes we follow sound forest management and risk mitigation procedures, and all forest operations meet or exceed the rules and regulations governing forest practices in Washington and Oregon, we cannot be certain that we will not be the subject of claims based on allegations that we acted improperly in managing our property. These claims may take the form of individual or class action litigation, regulatory or enforcement proceedings, or both. Any such claims could result in substantial defense costs and divert management’s attention from the ongoing operation of our business, and if any such claims were successful, may result in substantial damage awards, fines or civil penalties. Consistent with the practices of other large timber companies, we do not maintain insurance against loss of standing timber on our timberlands due to natural disasters.
 
We compete with a number of larger competitors that may be better able than we to absorb the effects of price fluctuations, may be able to expend greater resources on production, may have greater access to capital, and may operate more efficiently than we can.  We compete against much larger companies in each of our business segments.  We compete with these companies for management and line personnel, as well as for purchases of relatively scarce capital assets such as land and standing timber and for sales of our products.  These larger competitors may have access to larger amounts of capital and significantly greater economies of scale, and they may be better able to absorb the risks of our line of business.  Moreover, the timber industry has experienced significant consolidation in recent years and, as that consolidation occurs, our relative market share decreases and the relative financial capacity of our competitors’ increases.  While management believes the Partnership is at a competitive advantage over some of these companies because of our lack of vertical integration into forest products manufacturing, our advantageous tax structure, and management’s attempts to diversify our asset base, we cannot assure readers that competition will not have a material and adverse effect on our results of operations or our financial condition.
 
Consolidation of sawmills in our geographic operating area may reduce competition among our customers, which could adversely affect our log prices.  In the past we have experienced, and may continue to experience, consolidation of sawmills in the Pacific Northwest.  Because a portion of our cost of sales in our Fee Timber segment, which considers the Combined tree farms, consists of transportation costs for delivery of logs to domestic sawmills, it becomes increasingly expensive to transport logs over longer distances for sales in domestic markets.  As a result, a reduction in the number of sawmills, or in the number of sawmill operators, may reduce competition for our logs, increase transportation costs, or both.  These consolidations thus may have a material adverse impact upon our Fee Timber revenue or income and, as that segment has traditionally represented our largest business unit, upon our results of operation and financial condition as a whole.  Any such material adverse impact on timber revenue and income as a result of regional mill consolidations will also indirectly affect our Timberland Management & Consulting segment in the context of raising capital for investment in Pacific Northwest-based timber funds.
 
 
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Item 1B.               UNRESOLVED SECURITIES AND EXCHANGE COMMISSION COMMENTS
 
None

Item 2.                  PROPERTIES

           The following table reconciles acreage owned as of December 31, 2010 to acreage owned as of December 31, 2009.  As noted previously, we own 20% of the Funds, and this table excludes the 61,000 acres of timberland owned by the Funds.  Properties are typically transferred from Fee Timber to the Real Estate segment at the point in time when the Real Estate segment takes over responsibility for managing the properties with the goal of maximizing the properties’ value upon disposition.
 
Description
 
2009
   
Transfers
   
Acquisitions
   
Other (1)
   
2010
 
Timberland:
                             
 Hood Canal tree farm (2)
    70,788       (312 )     -       (10 )     70,466  
 Columbia tree farm (2)
    43,625       -       2       -       43,627  
Total Timberland
    114,413       (312 )     2       (10 )     114,093  
Land held for sale:
                                       
 Bremerton - Wright Creek
    1       (1 )     -       -       -  
 Hansville - Chatham
    10       (10 )     -       -       -  
 Jefferson County
    14       (14 )     -       -       -  
 Everett - East Crest Hills
    2       -                       2  
 Timberland Ridge
    40       (40 )     -       -       -  
Subtotal land held for sale
    67       (65 )     -       -       2  
Land held for development:
                                       
 Bremerton - Wright Creek
    44       1       1       -       46  
 Gig Harbor - Harbor Hill
    251       -       -       -       251  
 Homestead
    39       -       -       -       39  
 Jefferson County
    70       143       -       -       213  
 Mason County
    -       183       -       -       183  
 Kingston - Arborwood
    356       -       -       -       356  
 Kingston - 5-Acre zoning
    366       -       -       -       366  
 Nursery Hansville
    106       -       -       -       106  
 Oak Bay
    205       -       -       -       205  
 Hansville - Chatham
    142       10       -       -       152  
 Port Gamble townsite
    167       -       -       -       167  
 Shine Canyon
    69       -       -       -       69  
 Port Ludlow - Tala Point
    256       -       -       -       256  
 Tarboo Easement
    129       -       -       -       129  
 Timberland Ridge
    95       40       -       -       135  
 Walden
    120       -       -       -       120  
 Other
    41       -       -       -       41  
Subtotal land held for development
 
2,456
      377       1       -       2,834  
Total Real Estate Acres
    2,523       312       1       -       2,836  
Grand Total Acres
    116,936       -       3       (10 )     116,929  
 
(1)
Certain parcels adjusted due to a Geographic Information Systems (GIS) reconciliation for Timberland ownership.
(2)
A subset of this property is used as collateral for the Partnership's long-term debt, excluding debt of the Funds.
 
 
19

 
 
The following table provides dwelling unit (DU) per acre zoning for the Partnership’s owned timberland and development properties as of December 31, 2010 and land sold during 2010:
 
Current Land Inventory (acres)    
2010 Land Sales
       
Zoning Designation
 
Real Estate
   
Fee Timber
   
Totals
   
Acres
   
$/Acre
   
Total Sales
 
Urban zoning
    687       -       687       -     $ -     $ -  
1 DU per 5 acres
    708       1,632       2,340       -       -       -  
1 DU per 10 acres
    131       713       844       -       -       -  
1 DU per 20 acres
    882       34,976       35,858       -       -       -  
1 DU per 40 acres
    45       2,219       2,264       -       -       -  
1 DU per 80 acres
    251       50,640       50,891       -       -       -  
Forest Resource Lands
    26       23,832       23,858       -       -       -  
Open Space
    20       81       101       -       -       -  
Historic Rural Town
    86       -       86                          
Total
    2,836       114,093       116,929       -     $ -     $ -  

Item 3.                   LEGAL PROCEEDINGS

None.

Item 4.                   (RESERVED)

 
20

 
 
PART II
 
Item 5.                   MARKET FOR REGISTRANT’S UNITS, RELATED SECURITY HOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Market Information

           Certain information respecting trades in the Partnership’s equity securities is quoted on NASDAQ and traded under the ticker symbol “POPE”.  The following table sets forth the 2008 to 2010 quarterly ranges of low and high prices, respectively, for the Partnerships units together with per unit distribution amounts by the period in which they were paid:
 
 
 
 High
 
 
 Low
 
 Distributions
 
 
Year Ended December 31, 2008
 
 
           
 First Quarter
 
 
$38.50
   
$34.01
 
$0.40
 Second Quarter
 
 
37.50
   
32.01
 
0.40
 Third Quarter
 
 
34.00
   
28.06
 
 0.40
 Fourth Quarter
   
28.48
   
15.00
 
 0.40
Year Ended December 31, 2009
 
 
           
 First Quarter
 
 
$22.89
   
$15.61
 
$0.20
 Second Quarter
 
 
28.98
   
18.52
 
  0.20
 Third Quarter
 
 
25.28
   
21.56
 
  0.20
 Fourth Quarter
   
25.25
   
22.32
 
  0.10
Year Ended December 31, 2010
 
 
           
 First Quarter
 
 
$28.89
   
$23.32
 
$0.10
 Second Quarter
 
 
28.90
   
25.02
 
  0.10
 Third Quarter
 
 
28.00
   
24.00
 
  0.25
 Fourth Quarter
   
38.61
   
26.62
 
  0.25
 
Unitholders

As of February 3, 2011, there were 4,323,263 outstanding units and this represented 262 holders of record.  Units outstanding exclude 53,223 units granted to management and members of the managing general partner’s board of directors that are currently restricted from trading.  The trading restriction for these units is lifted as the units vest.  Restricted units granted to date vest over either a four- or two-year vesting schedule.  Those grants that have a four-year vesting schedule vest either ratably over four years or 50% on the third anniversary of the grant date and the remaining 50% upon reaching the fourth anniversary.  Two-year grants vest 50% upon reaching the first anniversary of the grant date and the remainder on the second anniversary.

Distributions

All cash distributions are at the discretion of the Partnership’s managing general partner, Pope MGP, Inc. (the “Managing General Partner”).  During 2010, the Partnership made two quarterly distributions of 10 cents per unit and two of 25 cents per unit that totaled $3.2 million in the aggregate.  The Partnership also distributed $3.2 million in 2009; those amounts were paid at 20 cents per unit for the first three quarters and 10 cents per unit in the fourth quarter.

In recognition of the improvement in log prices and the resumption of higher harvest levels relative to 2009, the Partnership increased its distribution in the third quarter of 2010 to 25 cents per unit. The Managing General Partner, in its discretion, determines the amount of the quarterly distribution and regularly evaluates distribution levels. The Partnership recognizes that current economic conditions warrant continued sensitivity to the stewardship of cash balances. As such, the quarterly determination of distribution amounts, if any, will reflect the expectations of management and the Managing General Partner for the Partnership’s liquidity needs.

 
21

 
 
Equity Compensation Plan Information

The Partnership maintains the Pope Resources 2005 Unit Incentive Plan, which authorizes the granting of nonqualified equity compensation in order to provide incentives to align the interests of management with those of unitholders. Pursuant to the plan, the Partnership issues restricted unit grants with vesting ranges between two and four years on the anniversary of the grant.  The terms of these grants require that the grantee remain an employee as of the vesting date.  As of December 31, 2010 there were 64,673 unvested and outstanding restricted units of which 28,823 units are scheduled to vest in 2011. Previously, the Partnership maintained the Pope Resources 1997 Unit Option Plan pursuant to which unit options were granted for purposes similar to the 2005 incentive plan. Upon the adoption of the 2005 Unit Incentive Plan, the Partnership ceased making further awards under the 1997 plan. As of December 31, 2010 there were fully vested options outstanding for the purchase of 47,874 units with a weighted average exercise price of $14.85.  Additional information regarding equity compensation arrangements, including the new 2010 incentive compensation program, is set forth in Note 7 and Item 11 Executive Compensation.

Repurchase of Equity Securities

In December 2008 we announced a unit repurchase plan pursuant to which the Partnership was authorized to repurchase limited partner units with an aggregate value of up to $2.5 million.  Since that time, we have increased the aggregate value of units authorized for repurchase to $5 million and extended the repurchase plan to allow for repurchases through December 2011.  As of December 31, 2010, there remained an unutilized authorization for unit repurchases of $2.5 million. Partnership unit repurchases under this 2008 plan during 2010 were as follows:
 
2008 $2.5 million unit repurchase plan, following December 2010 extension
 
                         
Quarter ended:
 
31-Mar
   
30-Jun
   
30-Sep
   
31-Dec
 
Total number of units purchased
    -       -       13,316       948  
Average price paid per unit
    $0.00       $0.00       $26.70       $27.62  
Total number of units purchased as part of publicly announced plans or programs
    111,295       111,295       124,611       125,559  
$2.5 million unit repurchase extension
    -       -       -       -  
Approximate dollar value remaining to purchase units under the announced plans or programs ($000's) *
    $2,865       $2,865       $2,510       $2,484  
* Total amount of repurchase plan less cumulative repurchases
 
 
On December 31, 2010, the Partnership repurchased 334,340 units from a single shareholder, outside the scope of the formal repurchase program, for $35.50 per unit (which excludes a $0.05 per unit commission paid on settlement).  The units represent 7.2% of the total units outstanding at that time and were retired.  As of February 18, 2011 we had not made any repurchases of units since year-end.

Performance Graph

The following graph shows a five-year comparison of cumulative total unitholder returns for the Partnership, the Standard and Poor’s Forest Products Index and the Wilshire 4500 for the five years ended December 31, 2010.  The total unitholder return assumes $100 invested at the beginning of the period in the Partnership’s units, the Standard and Poor’s Forest Products Index, and the Wilshire 4500.  The graph assumes distributions are reinvested.

 
22

 
 
GRAPHIC
 
Issuance of Unregistered Securities

The Partnership did not conduct any unregistered offering of its securities in 2008, 2009, or 2010.
 
 
23

 

Item 6.                   SELECTED FINANCIAL DATA

Actual Results.  The financial information set forth below for each of the indicated years is derived from the Partnership’s audited consolidated financial statements.  This information should be read in conjunction with the audited consolidated financial statements and related notes included with this report.

(Dollars in thousands, except per unit data)
 
Year Ended December 31,
 
Statement of operations data
 
2010
   
2009
   
2008
   
2007
   
2006
 
Revenue:
                             
Fee Timber
  $ 27,674     $ 14,847     $ 23,551     $ 35,514     $ 35,260  
Timberland Management & Consulting
    31       601       944       1,344       3,670  
Real Estate
    3,487       5,030       3,683       15,037       27,320  
Total revenue
    31,192       20,478       28,178       51,895       66,250  
                                         
Operating income/(loss):
                                       
Fee Timber
    9,703       3,724       6,294       15,215       14,592  
Timberland Management & Consulting
    (1,250 )     (375 )     (543 )     (883 )     1,266  
Real Estate (1)
    (809 )     1,663       (1,111 )     5,163       13,864  
   General and Administrative
    (4,731 )     (3,733 )     (3,951 )     (4,782 )     (3,817 )
Total operating income
    2,913       1,279       689       14,713       25,905  
                                         
Net income (loss) attributable to unitholders
  $ 2,038     $ (272 )   $ 1,162     $ 15,508       24,910  
                                         
Earnings (loss) per unit – diluted
  $ 0.43     $ (0.07 )   $ 0.23     $ 3.22     $ 5.22  
                                         
Distributions per unit
  $ 0.70     $ 0.70     $ 1.60     $ 1.36     $ 1.06  
                                         
Balance sheet data
                                       
Total assets
    235,837       187,080       165,411       148,550       180,282  
Long-term debt, net of current portion
    50,468       28,659       28,169       29,385       30,866  
Partners’ capital
    70,990       83,126       87,817       96,644       87,605  
Debt to total capitalization (2)
    36 %     26 %     25 %     24 %     27 %
 
(1)  
Real Estate operating loss in 2010, 2009, 2007, and 2006 includes $875,000, $30,000, $1,878,000, and $260,000, respectively, of environmental remediation charges.
(2)  
Debt-to-total-capitalization ratio is calculated as the long-term debt of the partnership, excluding debt of the Funds, divided by Partner’s capital
 
 
24

 
 
Free cash flow, a non-GAAP measure, provides users of financial statements an indication of liquidity and earnings performance. Since this measure starts with cash provided by operations, it does not include the increases or decreases resulting from changes in working capital that are included in operating cash flow presented on the Statement of Cash Flows. The Partnership has used the method detailed below for calculating free cash flow. Management recognizes that there are varying methods of calculating free cash flow and has provided the calculation below to aid investors that are attempting to reconcile between those different methods.
 
(Dollars in thousands, except per unit data)
 
Year Ended December 31,
Free cash flow (3):
    2010       2009       2008       2007       2006  
Cash provided by operations (4)
  $ 8,950     $ 662     $ 3,952     $ 12,113     $ 33,114  
Plus:
                                       
Net loss attributable to noncontrolling interests (5)
    1,218       950       1,018       402       69  
Less:
                                       
Principal payments
    (1,038 )     (1,418 )     (1,342 )     (1,481 )     (1,675 )
Change in operating accounts and non-cash charges (6)
    (3,295 )     (585 )     44       2,528       (4,004 )
Capital expenditures, excluding
                                       
     timberland acquisitions (7)
    (941 )     (1,224 )     (1,715 )     (2,294 )     (1,720 )
Free cash flow
    4,894       (1,615 )     1,957       11,268       25,784  
                                         
Other data
                                       
Acres owned/managed (thousands)
    175       150       405       430       433  
Fee timber harvested (MMBF)
    53       32       38       55       55  
 
(3)  
Management considers free cash flow, a non-GAAP measure, to be a relevant and meaningful indicator of liquidity and earnings performance commonly used by investors, financial analysts and others in evaluating companies in its industry and, as such, has provided this information in addition to the generally accepted accounting principle-based presentation of cash provided by operating activities.
(4)  
In the third quarter of 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 end of the third quarter, these expenditures were reported within investing activities within the Partnership’s statement of cash flows.  Presentation of prior periods has been revised for consistent treatment of these expenditures for all periods presented.
(5)  
Backs out the impact of the Funds and IPMB on Pope Resources’ free cash flow.
(6)  
Non-cash charges exclude cost of land sold, depletion, depreciation and amortization, and capitalized development activities.
(7)  
Fund II acquired 25,000 and 12,000 acres of timberland in 2010 and 2009, respectively, and the Partnership acquired 1,180 acres of timberland in 2008.  Fund I acquired 24,000 acres of timberland in 2006.  The cost of these acquisitions was not included in the calculation of free cash flow.
 
 
25

 
 
Item 7.                   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 management’s estimates based upon our current goals, in light of management’s knowledge of existing circumstances and expectations about future developments.  Statements about expectations and future performance are “forward looking statements” which describe our goals, objectives and anticipated performance.  These statements 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 “Risk Factors” in Item 1A above.  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; government regulation that affects our ability to access our timberlands and harvest logs from those lands; the implications of significant indirect sales to overseas customers, including currency translation, regulatory and tax matters; 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; and the impacts of climate change and natural disasters on our timberlands and on surrounding areas. From time to time we identify other risks and uncertainties 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 Partnership’s audited consolidated financial statements included with this report.

EXECUTIVE OVERVIEW

Pope Resources, A Delaware Limited Partnership (“we” or 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.  This segment includes timberlands owned directly by the Partnership and operations of the Funds.   Operations in this segment consist of growing timber to be harvested as logs for sale to export brokers 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, entitlements, and, in some cases, installing infrastructure for raw land development and then realizing that land’s value by the selling 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 is raising and investing capital from third parties for private equity timber funds and managing the timberland owned by both these funds and unaffiliated owners.

As of December 31, 2010, we owned 114,000 acres of timberland in western Washington, 61,000 acres of timberland for the Funds in Washington and Oregon, plus 2,800 acres of real estate held for sale or development.  Our third-party services have historically been conducted in Washington, Oregon, and California.

Net income attributable to unitholders for the year ended December 31, 2010 totaled $2.0 million, or $0.43 per diluted ownership unit, on revenues of $31.2 million.  For the corresponding period in 2009, net loss attributable to unitholders totaled $272,000, or $0.07 per diluted ownership unit, on revenues of $20.5 million.  For the year ended December 31, 2010, cash flow from operations was $9.0 million, compared to $662,000 in 2009.  Net income attributable to unitholders for the quarter ended December 31, 2010 totaled $1.7 million, or $0.35 per diluted ownership unit, on revenues of $8.5 million.  This compares to net loss attributable to unitholders for the quarter ended December 31, 2009 that totaled $376,000, or $0.08 per diluted ownership unit, on revenues of $5.2 million.   

 
26

 
 
Our revenues, net income and cash flows increased in 2010 from 2009 and 2008 primarily as a result of an increase in demand for logs in Asian markets, specifically China and Korea.  Increased export lumber demand from China also contributed indirectly by helping our sawmill customers increase lumber exports at a time when domestic lumber demand is still soft due to depressed housing markets.  Macroeconomic factors that reflect or influence the health of the U.S. housing market and have a bearing on our business revolve around employment growth, tight credits markets, and the supply of foreclosed homes.  These factors resulted in record low housing starts in 2009, which negatively impacted our revenues, net income and cash flow.  While these macroeconomic factors did not materially improve in 2010, their impact in 2010 on our business was overshadowed by the strength of log export markets and the performance of the U.S. Dollar against currencies of our competitors and customers.
 
Currency exchange rates influence the competitiveness of our logs in Asian export markets as well as the competitiveness of our domestic sawmill customers in the context of their Asian lumber exports relative to imported lumber from Canada, Europe, or the Southern Hemisphere.  Our export logs are sold to domestic intermediaries who then export the logs.  Exchange rates impact the ability of these intermediaries to compete in Asian markets with logs that originate from Canada, Russia, or the Southern Hemisphere.  In 2010, the U.S. Dollar weakened against the Canadian, Australian and New Zealand Dollars, the Japanese Yen and Korean Won, while strengthening against the Russian Ruble.  This relative currency weakness increased the attractiveness of our logs to Asian markets, particularly in China, whose Yuan is indexed to the U.S. Dollar.

As an owner and manager of timberland, we focus keenly on three “product” markets: lumber, logs, and timberland.  Each of these markets has unique and distinct attributes such that the respective product prices do not move up or down in lockstep with each other.  Generally, the lumber market is the most volatile as it responds quickly (even daily) to changes in housing-driven demand and to changes in lumber inventories.  We do not manufacture lumber, but the price of finished lumber affects the demand and pricing for logs.  Although the lumber market is volatile, it can provide considerable information about trends that will affect our harvest decisions.  Log markets are affected by what is happening in the spot lumber markets, but pricing shifts typically adjust monthly rather than daily.  Log price volatility is also moderated because logs are used to produce products besides lumber (especially pulp).  The market for timberland tends to be less volatile, with pricing that lags behind both lumber and log markets.  This is a function of the longer time horizons utilized by timberland investors, where the short-swing fluctuations of log or lumber prices are moderated in acquisition modeling.  We closely monitor the lumber market because activity there can presage log price changes.  We are constant participants in the log market as we negotiate delivery prices to our customers.  The timberland market is important as we are constantly evaluating our own portfolio and its underlying value, as well as the opportunities to adjust that portfolio through either the acquisition or disposition of such land.

Our current strategy for adding timberland acreage is centered on our private equity timber fund business model, which consists of raising investment capital from third-party investors and investing that capital, along with our own capital co-investment, into new timberland properties.  We have raised two timber funds that have a combined $150 million in assets under management.  Our 20% co-investment in the Funds, which totals $28 million, affords us a share of the Funds’ operating cash flows while allowing us to earn 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.

 
27

 
 
Our consolidated revenue in 2010, 2009, and 2008, on a percentage basis by segment, was as follows:

Segment
2010
2009
2008
Fee Timber
89%
72%
84%
Timberland Management & Consulting
-%
  3%
  3%
Real Estate
11%
25%
13%

Additional segment financial information is presented in Note 12 to the Partnership’s Consolidated Financial Statements included with this report.

Outlook

We plan to increase harvest volumes in 2011 above the 53 MMBF harvested in 2010.  Harvest volume deferred from 2008 to 2010, which totals 50 MMBF, provides us the flexibility to respond to strength in log markets by increasing our harvest level above our current sustainable harvest level of 70 MMBF, which includes 27 MMBF from the Funds.  Export log markets are anticipated to offset continued weakness in domestic demand for logs, lumber, and land in 2011.  Log markets in early 2011 have risen significantly from the end of 2010.   To the extent this strength continues we may choose to increase harvest levels on both the Partnership and Fund properties above our current plan.

We are also anticipating operating results for our Real Estate segment will approximate 2010, as the market for developable land is expected to remain extremely weak in 2011.  Until the market improves, we expect to concentrate our Real Estate activities primarily on conservation sales, the sale of CE’s, and securing entitlements to our properties while deferring spending on infrastructure improvements wherever possible.

General & Administrative costs in 2011 are expected to decline from 2010, reflecting non-recurring consultant costs to establish a new incentive compensation program and greater initial accrual costs for the multi-year performance cycles.
 
RESULTS OF OPERATIONS

The following table reconciles net income (loss) attributable to unitholders for the years ended December 31, 2010 to 2009 and 2009 to 2008.  In addition to the table’s numeric analysis, the explanatory text that follows describes many of these changes by business segment.

 
28

 
 
YEAR TO YEAR COMPARISONS
(Amounts in $000's)
             
   
2010 vs. 2009
   
2009 vs. 2008
 
             
   
Total
   
Total
 
Net income (loss) attributable to unitholders:
           
2010 period
  $ 2,038        
2009 period
  $ (272 )   $ (272 )
2008 period
          $ 1,162  
   Variance
  $ 2,310     $ (1,434 )
                 
Detail of earnings variance:
               
Fee Timber
               
Log price realizations (A)
    4,028     $ (3,116 )
Log volumes (B)
    8,421       (2,673 )
Depletion
    (3,168 )     1,469  
Production costs
    (2,905 )     1,439  
Other Fee Timber
    (397 )     311  
Timberland Management & Consulting
               
Management fee changes
    (531 )     (317 )
Other Timberland Management & Consulting
    (344 )     485  
Real Estate
               
Land and conservation easement sales
    (1,199 )     1,433  
Environmental remediation liability
    (845 )     (30 )
Timber depletion on HBU sale
    6       478  
Other Real Estate
    (434 )     893  
General & administrative costs
    (998 )     218  
Net interest expense
    (137 )     (782 )
Debt extinguishment costs
    (113 )     (1,137 )
Other (taxes, noncontrolling interests, impairment)
    926       (105 )
Total change in earnings
  $ 2,310     $ (1,434 )
 
(A)
Price variance calculated by extending the change in average price realized by current period volume.
(B)
Volume variance calculated by extending change in sales volume by the average log sales price for the the comparison period.
 
 
29

 
 
Fee Timber

Revenue and Operating Income

Fee Timber results include operations from 114,000 acres of timberland owned by the Partnership and 61,000 acres of timberland 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 the lease of cellular communication towers together with the sale of gravel and other resources from our timberlands.  Revenue from sales of timberland tracts will also appear periodically 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.  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.
 
Revenue and operating income for the Fee Timber segment for each year in the three-year period ended December 31, 2010, are as follows:
                               
($ Million)   
Year ended   
 
Log Sale
Revenue
   
Mineral, Cell
Tower & Other
Revenue
   
Total Fee
Timber
Revenue
   
Operating
Income
(Loss)
   
Harvest
Volume
(MBF)
 
Pope Resources Timber
  $ 20.7     $ 1.6     $ 22.3     $ 9.5       42,277  
Timber Funds
    5.1       0.3       5.4       0.2       10,722  
Total Fee Timber 2010
  $ 25.8     $ 1.9     $ 27.7     $ 9.7       52,999  
                                         
Pope Resources Timber
  $ 13.3     $ 1.5     $ 14.8     $ 4.0       32,461  
Timber Funds
    -       -       -       (0.3 )     -  
Total Fee Timber 2009
  $ 13.3     $ 1.5     $ 14.8     $ 3.7       32,461  
                                         
Pope Resources Timber
  $ 16.7     $ 2.0     $ 18.7     $ 6.7       32,455  
Timber Funds
    2.4       2.4 *     4.8       (0.4 )     5,293  
Total Fee Timber 2008
  $ 19.1     $ 4.4     $ 23.5     $ 6.3       37,748  
                                         
*Conservation easement sale revenue
                                 
 
Fiscal Year 2010 compared to 2009.  Revenue and operating income increased in 2010 from 2009 due to a 63% increase in harvest volume and a $76 per MBF, or 19%, increase in log prices.  Harvest volume increased as both export log markets strengthened relative to 2009 and new export lumber markets to China emerged. The planned harvest for 2010 was 32 MMBF from the Partnership timberlands and no harvest from the Funds, however we responded to improved export and domestic market conditions by harvesting more volume.
 
Our harvest in 2010 consisted of a relatively high 19.8% of the log volume from the Funds’ tree farms, which were purchased much later than the Partnership’s properties.  The Funds’ tree farms have a much higher cost basis and, as such, higher per-unit depletion charge. This resulted in only 2.1% of our Fee Timber operating income coming from the operations of the Funds’ timberlands.
 
Fiscal Year 2009 compared to 2008.  Revenue and operating income decreased in 2009 from 2008 due to a 14% lower harvest volume and a $96 per MBF, or 19%, decline in log prices.  The decrease in 2009 harvest volume from 2008 was due to continuing weak log markets which caused us to reduce harvest levels in 2009 below our planned harvest level.  We originally planned to harvest 37 MMBF in 2009, but as 2009 progressed and log markets weakened below the levels that we had forecasted, we decided to defer additional harvested volume resulting in a 38% harvest deferral in 2009.  Log prices declined in 2009 due in part to a decision to harvest a higher proportion of low quality stands that had a higher proportion of lower valued pulpwood.  This decision was made in order to preserve more of our higher valued stands that contained more sawlog volume for a point in the future where sawlog prices are higher.
 
 
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The CE sale completed by Fund I in 2008 is accounted for in the Fee Timber segment due to our policy of including all operations of the Funds in the Fee Timber segment.  CE sales and land sales from the Hood Canal and Columbia tree farms made to buyers that plan to preserve the land from future development are accounted for in the Real Estate segment.
 
ORM Timber Funds.  Due to the Partnership’s management and control of the Funds, they are consolidated into our financial statements, with the 80% of these Funds owned by third parties reflected in our Statement of Operations under the caption “Net loss attributable to noncontrolling interest-ORM Timber Funds.” Fund II acquired its first properties in October 2009 and, as result, had minimal impact on the consolidated segment performance in 2009 and 2008.  We deferred harvesting from each of the Funds’ tree farms in 2009 and the first quarter of 2010 in anticipation of weak log markets.  However, we began harvesting from the Funds’ tree farms during the second quarter of 2010 in response to improvements to domestic and export log markets and continued harvesting through the end of year to take advantage of higher prices.  We harvested 11 MMBF from the Funds’ tree farms in 2010, no volume in 2009, and 5 MMBF in 2008.  The Funds collectively generated revenue of $5.4 million in 2010 compared with $28,000 of revenue in 2009 and $4.8 million of revenue generated in 2008.  The 2010 operating income of $166,000 for the Funds is a $460,000 improvement over 2009’s operating loss of $294,000 as a result of a 10.7 MMBF increase in harvest volume and a small Fund I land sale in 2010. Fund operating income as a percentage of revenue reflects the high basis relative to the historic Partnership timberlands and, as a result, higher depletion expense than the Partnership timberlands.
 
Log Volume

Log volume sold for each year in the three-year period ended December 31, 2010 was as follows:
             
Volume (in MBF)
2010
% Total
2009
% Total
2008
% Total
Sawlogs
           
Douglas-fir
34,978
66%
22,383
69%
24,913
66%
Whitewood
7,096
13%
1,080
3%
3,121
8%
Cedar
865
2%
827
2%
795
2%
Hardwoods
941
2%
835
3%
977
3%
Pulpwood
           
All Species
9,119
17%
7,336
23%
7,942
21%
             
Total
52,999
100%
32,461
100%
37,748
100%

Fiscal Year 2010 compared to 2009.  Harvest volume increased 63% from 2009 to 2010.  Strong Chinese export markets, and to a lesser extent Korean markets, prompted our decision to increase harvest volume above 2009’s level.  This strong export market has helped support domestic sawlog prices despite a soft domestic lumber market as domestic sawmills have had to increase log prices to compete for volume diverted to export markets.  Many of our sawmill customers are able to afford higher log prices due to the emergence of a new export lumber market in China, for which many of these customers are producing a significant proportion of their overall lumber volume.  Log volumes harvested in 2009 included a higher proportion of pulpwood due to our decision to focus harvest on lower quality timber stands to conserve higher value sawlog volume for better market conditions.

Fiscal Year 2009 compared to 2008.  Log volume decreased 14% in 2009 from the 2008 harvest as management sought to preserve our asset value while log, lumber, and housing markets continued to decline throughout 2009.  We would generally expect the proportion of harvest going to pulpwood markets to average between 10% and 15%.  However, in 2009 and 2008 we concentrated our harvest on lower quality timber stands to sell logs into pulpwood markets which were not as dramatically impacted as other log markets by the downturn in housing. As such, pulpwood represented a relatively higher-than-normal proportion of harvest volume for both 2009 and 2008. This shift in weighting of our sort mix lowered the average realized price per MBF below what it might otherwise have been, but allowed more valuable stands to continue to grow in both volume and value.
      
 
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Log Prices

Logs from the Partnership’s tree farms serve a number of different domestic and export markets, with domestic mills historically representing our largest market segment. Throughout 2010, the relative strength of the Chinese export market has been a driving force for much of our log pricing. In contrast to the Japanese export market that has historically only diverted logs to Asia at the top end of the quality spectrum, the Chinese market accepts a log quality that is comparable to that which typically goes to the domestic market. Logs flowing from the Pacific Northwest to China in 2010 increased almost nine-fold from volumes shipped in the comparable period in 2009. Notwithstanding the low level of domestic housing starts, this increased export demand helped to keep upward pressure on domestic log prices throughout 2010.
 
We have categorized our sawlog volume by species, which is a significant driver of price realized as indicated by the table below.  The average log price realized by species for each year in the three-year period ended December 31, 2010 was as follows:
 
     
Fiscal Year
 
            ∆ from 2009 to 2010    
 
 
     
2010
   
$/MBF
   
%
   
2009
 
Sawlogs
Douglas-fir
  $ 528     $ 93       21 %   $ 435  
 
Whitewood
    446       137       44 %     309  
 
Cedar
    917       100       12 %     817  
 
Hardwood
    502       56       13 %     446  
Pulpwood
All Species
    311       15       5 %     296  
Overall
      486       76       19 %     410  
                                   
     
Fiscal Year
 
             
∆ from 2008 to 2009
         
        2009    
$/MBF
   
%
      2008  
Sawlogs
Douglas-fir
  $ 435     $ (102 )     -19 %   $ 537  
 
Whitewood
    309       (103 )     -25 %     412  
 
Cedar
    817       (428 )     -34 %     1,245  
 
Hardwood
    446       (192 )     -30 %     638  
Pulpwood
All Species
    296       (63 )     -18 %     359  
Overall
      410       (96 )     -19 %     506  
 
The overall log price realized in 2010 increased $76/MBF, or 19%, compared to 2009, primarily due to the same export/domestic market dynamics mentioned above. In addition, the 2009 average log price reflected a high percentage of low value pulpwood compared to that seen in 2010’s totals, 23% vs. 17%, respectively.  Notwithstanding the overall improvements in year-over-year average log prices from 2009 to 2010, the increase was not sufficient to recover the $96/MBF decline in the average price between 2008 and 2009.
 
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 has historically been very dependent upon the level of new home construction in the U.S.  Douglas-fir log prices realized in 2010 reflect some softening of this direct link between Douglas-fir sawlog prices and domestic housing starts with the dramatic increase in demand for all log species from China.

 
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The rally in Douglas-fir sawlogs began in early 2010 with participants in the domestic supply chain for lumber increasing demand for logs in response to declining inventories.  This increase in domestic demand coincided with an increase in export market demand from China, and to a lesser extent Korea.  Single-family home starts remained at approximately 500,000 units during 2010, compared to approximately 1.7 million at its peak in 2005.  The aforementioned inventory issue was largely addressed by domestic producers in the first quarter of 2010 and with the continued softness in housing starts, we saw sawmills quickly return in the second quarter to lower production levels.  In the absence of strong export market demand this would have caused a deeper decline in log prices. There was, however, continued strength in the export market to China which created competition for Douglas-fir sawlogs.  The 2010 price realized on Douglas-fir sawlogs was up $93/MBF, or 21%, from 2009 as a result of the aforementioned competition between domestic mills and export markets.  This increase nearly reversed the $102/MBF, or 19%, decline in price from 2008 to 2009.

Whitewood: “Whitewood” is a term used to describe several softwood species, but for us primarily refers to western hemlock and spruce.  Though generally considered to be of a lower quality than Douglas-fir, these logs are also used for manufacturing lumber and plywood.  In addition, the same export market conditions described above have provided for strong whitewood export log demand in China as well as the traditional, but more modest export market for whitewood logs to Korea.  The price realized on whitewood sawlogs in 2010 was up $137/MBF, or 44%, versus 2009, also driven by the relative strength in the export log markets in 2010 compared to 2009.  The 2010 increase was a large improvement over the $103/MBF, or 25%, decline in price from 2008 to 2009. 

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. A small spike in demand from buyers in 2010 helped drive a $100/MBF, or 12%, increase in cedar prices over 2009.  While the 2010 increase was welcome, it did not come close to clawing back the $428/MBF, or 34%, decline we saw in cedar prices from 2008 to 2009.

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 as well as hardwood chips for the pulp and paper industry.  In 2010, hardwood sawlog prices increased $56/MBF, or 13%, when compared to 2009 in response to the continued modest demand for lumber, which came at a time when some mills had relatively low inventories 2010.  This was a modest improvement over the $192/MBF, or 30%, decline in price from 2008 to 2009.

Pulpwood:  Pulpwood 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 pulpwood sold directly to pulp mills. Pulpwood prices were up $15/MBF, or 5%, when compared to the comparable period in 2009.  The 2010 increase did not quite return pulpwood prices to those realized in 2008 of $359/MBF but it was a meaningful directional improvement over the $63/MBF, or 18%, decline in pulpwood price from 2008 to 2009.

Customers

Annual harvest volume and average price paid each year in the three-year period ended December 31, 2010 was as follows:

 
33

 
 
   
2010
   
2009
   
2008
 
Destination
 
Volume
   
%
   
Price
   
Volume
   
%
   
Price
   
Volume
   
%
   
Price
 
Export brokers
    17,673       33 %   $ 526       4,876       15 %   $ 581       5,615       15 %   $ 610  
Domestic mills
    26,207       50 %     520       20,249       62 %     410       24,191       64 %     531  
Pulpwood
    9,119       17 %     311       7,336       23 %     296       7,942       21 %     359  
Total
    52,999       100 %   $ 486       32,461       100 %   $ 410       37,748       100 %   $ 506  
 
Fiscal Year 2010 compared to 2009. Logs sold to export brokers increased to 33% from 15% of volume in 2010 and 2009, respectively, while volume sold to domestic mills declined to 50% from 62% in 2010 and 2009, respectively.  This is a direct result of volume diverted to the Chinese and Korean export markets.  Export volumes generated a $61/MBF, or 10%, price decrease as a result of the shift from high-quality and high-priced logs sold to Japan in 2009 versus lower quality logs sold into Chinese and Korean markets in 2010.  Logs sold to domestic mills increased in price by $116/MBF, or 28%, as domestic mills competed for log volume with the Chinese and Korean export markets.  As a percentage of overall volume, we directed fewer logs to the pulpwood market in 2010 compared to 2009, although prices increased $15/MBF, or 5%.  As discussed earlier, this was a result of harvesting lower quality timber in 2009 with a higher proportion of pulpwood to preserve higher quality sawlogs for a later time when markets improved.

Fiscal Year 2009 compared to 2008. Volumes by destination showed little relative change in 2009 compared with 2008.  Export brokers represent those log buyers that purchase our logs and then resell them to customers in Japan, China, and Korea.  This market channel accounted for 15% of both our 2009 and 2008 harvest.  Domestic mills purchased 62% of harvest volumes in 2009 versus 64% in 2008.  Pulp mills purchased 23% of our harvest volume in 2009 as compared to 21% of 2008.

Log prices realized from export broker sales declined $29/MBF, or 5%, from 2008 to 2009 as the export market shifted from higher priced logs sent to Japan in 2008 to lower priced logs sent to China and Korea in 2009.  Log prices realized from domestic mills dropped $121/MBF, or 23%, during that same period as result of the contraction in the housing market which rippled through to domestic sawmills and other wood product manufacturers.  Pulpwood prices decreased $63/MBF, or 18%, between 2008 and 2009.   Pulpwood prices were artificially high in 2008 as a result of chip shortages early in that year from sawmill downtime.

The export market for logs in the Pacific Northwest has been migrating over the last couple years from a market highly focused on Japan to a market that includes more volume to China and Korea.  This change in the export market has resulted in a decline in the premium earned from the sale of logs to the export market while at the same time increasing export market demand for logs sourced in the Pacific Northwest.  Sawlogs sold to Korea and China are not of the high quality demanded by the Japanese market and, as a result, do not command the premium pricing generally attributed to the Japanese market. However, this new source of demand for sawlogs in the Pacific Northwest will continue to exert pricing pressure on domestic mills that have been competing with this new and growing offshore source of demand for Pacific Northwest sawlogs.  These new outlets for lower quality logs have helped to diversify our customer mix away from domestic mills that are more heavily dependent on the U.S. housing market.
 
Another way to look at the impact of these growing export markets is to combine the domestic and export log volumes, which increased $79/MBF, or 18%, in value between 2009 and 2010, from $443/MBF in 2009 to $522/MBF in 2010.  This nearly approaches the 19% decline in value between 2008 and 2009 of these combined export and domestic log volumes, which declined from $545/MBF in 2008 to $522/MBF in 2009.  Over the two-year period from 2008 to 2010, the combined value of export and domestic logs declined by 4%.  This decline would have been much steeper had we not had access to these higher levels of export log demand in China and Korea.

 
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Harvest Volumes and Seasonality

The Partnership owns 114,000 acres of timberland in western Washington and the Funds own collectively 61,000 acres of timberland in western Washington and western Oregon.  We are able to conduct year-round harvest activities on the Hood Canal tree farm and 12,000 acres of the Funds’ properties because these properties are concentrated at low elevations.  In contrast, the Columbia tree farm and the balance of the Funds’ acres are at a higher elevation where harvest activities are generally not possible during the winter months when snow precludes access to the lands.  Generally, we concentrate our harvests from the Hood Canal tree farm in those months when weather limits operations on other properties, thus taking advantage of reduced competition for log supply to our customers and improving prices realized.  As such, when these various tree farms are combined, we can operate so that the pattern of quarterly volumes harvested is flatter than would be the case if looking at one tree farm in isolation.

The percentage of annual harvest volume by quarter for each year in the three-year period ended December 31, 2010 was as follows:
 
Year ended
    Q1       Q2       Q3       Q4  
2010
    22 %     27 %     30 %     21 %
2009
    27 %     22 %     20 %     31 %
2008
    25 %     38 %     31 %     6 %

We entered 2010 with a plan to defer harvest volume in response to our expectation of continued weakness in log markets resulting from a slowdown in housing.  That plan called for no harvest from the Funds.  However, as the year progressed and export and domestic markets showed improvement, we gradually increased harvest volume commensurate with the increase in demand, which hit its peak in the third quarter.  By the third quarter of 2010, we had gained confidence in the impact of the China log market and added volume to meet the surges in export and domestic demand.

In 2009, our harvest was weighted to the first and fourth quarters to take advantage of higher seasonal prices.  For 2009, we pushed more than the usual amount of our harvest into the fourth quarter to take advantage of an uptick in market demand and increased prices driven by depleted inventories throughout the supply chain.  The absence of company owned mills requiring volume and less concern with quarterly earnings fluctuations allows us to maximize value by making market timing adjustments.  Furthermore, our practice of permitting excess harvest units provides maximum flexibility to make changes to harvest volumes.

Harvest volumes in 2008 were weighted to the first three quarters of the year.  The precipitous fall-off in the fourth quarter of that year reflects the impact associated with the financial meltdown of 2008.

Cost of Sales

    Cost of sales for the Fee Timber segment consists of harvest and haul costs and depletion expense.  Harvest, haul, and depletion all vary directly with actual harvest volume.  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, together with capitalized road expenditures, by the estimated volume of merchantable timber available for harvest at the beginning of that year.  The depletion rate is applied to the volume harvested in a given period to calculate depletion expense for that period.  Depletion expense is calculated by first deriving a depletion rate as follows:

Depletion rate =    Accumulated cost of timber and capitalized road expenditures
Estimated volume of 35-year-and-older merchantable timber

 
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Each year, the depletion rate is adjusted to account for “layers” of harvest volume exiting the pool and new “layers” of 35-year old timber volume and cost entering the pool.  The depletion rate is then applied to future volume harvested to calculate depletion expense.
 
Fee Timber cost of sales for each year in the three-year period ended December 31, 2010 was as follows:
 
                 
       
Cost of
       
($ Million)
 
Harvest, Haul
 
Conservation
     
Total Cost
Year ended
 
and Other
 
Easement Sale
 
Depletion
 
of Sales
2010
 
$8.9
 
-
 
$5.2
 
$14.1
2009
 
  6.0
 
-
 
  2.0
 
    8.0
2008
 
  7.5
 
2.2
 
  3.4
 
  13.1
 
Cost of sales increased $6.1 million in 2010 from 2009 primarily as a result of a 63% harvest volume increase from 32 MMBF in 2009 to 53 MMBF in 2010, and because we harvested a significant portion of our 2010 harvest from the Funds’ timberlands, which have a much higher depletion rate than the Partnership’s legacy properties.  Depletion expense increased $3.2 million in 2010 relative to 2009.  Of this increase, $2.5 million is due to harvest of 11 MMBF from the Funds’ tree farms that did not occur in 2009 and $639,000 is due to the harvest volume increase from the Hood Canal and Columbia tree farms. Fee Timber cost of sales decreased $5.1 million in 2009 from 2008 as a result of a 5 MMBF decline in harvest volume in 2009 from 2008 and the non-recurring costs incurred in connection with the CE sale in 2008.   

Fee Timber cost of sales, expressed on a per MBF basis for each year in the three-year period ended December 31, 2010, was as follows:
 
           
 Year ended   
Harvest, Haul
and Other
Depletion
 
Total Cost of Sales *
2010
$167
 
$98
 
$265
2009
  184
 
  62
 
  246
2008
  198
 
  91
 
  289
     
* Total excludes cost of conservation easement sale in 2008
   
 
Harvest costs vary based upon the physical site characteristics of acreage harvested.  Harvest units that are difficult to access, or that are located on steep hillsides requiring cable harvest systems, are more expensive to harvest.  Haul costs vary based upon the distance between the harvest site and the customer’s location.  Harvest, haul and other costs per MBF decreased $17/MBF in 2010 relative to 2009.  This reduction is attributable to a decrease in pulpwood volume harvested which carries a higher harvest cost per MBF than sawlogs.  Per MBF harvest and haul costs were lower in 2009 relative to 2008 due to the selection of less expensive harvest units in the face of weak log pricing.

We use a pooled depletion rate for volume harvested from the Hood Canal and Columbia tree farms that divides the combined book basis of the merchantable timber for both tree farms by the combined merchantable volume for both tree farms.  On the other hand, for the Funds we calculate separate depletion rates for each of the six Fund tree farms and then present them for this report in terms of a blended aggregate rate.  In 2009, we use and report the pooled depletion rate for volume harvested from the Hood Canal and Columbia tree farms as we had no timber harvest from the Funds’ tree farms.  In 2008, we report two separate depletion rates, the pooled rate for the Hood Canal and Columbia tree farms and a separate blended rate for volume harvested from tree farms owned by Fund I.
 
Depletion expense resulting from timber harvest for each year in the three-year period ended December 31, 2010 was made up of the following:
 
 
36

 
 
                   
   
Year ended December 31, 2010
 
   
Pooled
   
Funds
   
Total
 
Volume harvested (MBF)
    42,277       10,722       52,999  
Rate/MBF
  $ 62     $ 236     $ 98  
Depletion expense (000's)
  $ 2,640     $ 2,529     $ 5,169  
 
             
   
Year ended December 31, 2009
 
   
Pooled
   
Total
 
Volume harvested (MBF)
    32,461       32,461  
Rate/MBF
  $ 62     $ 62  
Depletion expense (000's)
  $ 2,001     $ 2,001  
 
                   
   
Year ended December 31, 2008
 
   
Pooled
   
Fund I
   
Total
 
Volume harvested (MBF)
    32,455       5,293       37,748  
Rate/MBF
  $ 65     $ 254     $ 91  
Depletion expense (000's)
  $ 2,094     $ 1,343     $ 3,437  
                         
 
We harvested 53 MMBF of timber in 2010, with 11 MMBF of the total attributable to the Funds’ timberlands.  This compares to harvest of 32 MMBF in 2009, solely from the Partnership’s timberlands, and harvest of 38 MMBF in 2008, with 5 MMBF of the 2008 total attributable to the Fund I timberlands.  The Funds’ depletion expense in 2010 and Fund I depletion expense in 2008 represent harvest from timberlands owned by the Funds that reflects a higher depletion rate than our combined pool of depletion costs for the Hood Canal and Columbia tree farms.  The “Pooled” depletion consists primarily of historical timber cost that has been owned by the Partnership for many decades, as well as the Columbia tree farm property that was acquired in 2001. Depletion for the Funds’ timber volume is derived from the cost of timber acquired more recently at a higher overall cost and, therefore, carries a higher depletion rate.

Depletion expense is generated from the harvest and sale of timber and periodically from Real Estate sales when land is sold with standing timber.  Depletion expense generated from Real Estate sales, as was the case in 2008, is excluded from the Fee Timber depletion analysis.
 
Operating Expenses

Fee Timber operating expenses for each of the three years ended December 31, 2010, 2009, and 2008 were $3.8 million, $3.1 million, and $4.2 million, respectively.
 
                   
($ Million)  Year ended
 
2010
   
2009
   
2008
 
Operating Expenses
  $ 3.8     $