a50366919.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 
Washington, DC 20549
 
Form 10-Q

 
( X )
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

OR

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

Commission File Number 1-9035

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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
 
  Large Accelerated Filer    o Accelerated Filer    x
  Non-accelerated Filer    o Smaller Reporting Company    o
                                                                                                         
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)   Yes   o    No   x

Partnership units outstanding at July 30, 2012: 4,411,692
 
 
 

 
 
Pope Resources
Index to Form 10-Q Filing
For the Quarter Ended June 30, 2012

Description
 
Page Number
   
     
   
 
4
 
5
 
6
 
7
     
 
13
     
 
37
     
 
38
     
   
     
 
38
     
 
38
     
 
41
     
 
41
     
 
41
     
 
41
     
 
42
     
 
43
 
 
 

 

 
 
 
 
 
 
 
 
P A R T  I – FINANCIAL INFORMATION
 

ITEM 1


FINANCIAL STATEMENTS

 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
3

 
 
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
           
Pope Resources, a Delaware Limited Partnership
           
June 30, 2012 and December 31, 2011
           
(in thousands)
           
   
2012
   
2011
 
ASSETS
           
Current assets
           
Partnership cash and cash equivalents
  $ 231     $ 249  
ORM Timber Funds cash and cash equivalents
    1,647       2,404  
    Cash and cash equivalents
    1,878       2,653  
Accounts receivable, net
    2,443       1,876  
Building and land held for sale
    1,279       1,255  
Current portion of contracts receivable
    13       80  
Prepaid expenses and other
    864       853  
Total current assets
    6,477       6,717  
Properties and equipment, at cost
               
Timber and roads, net of accumulated depletion
               
of $77,149 and $71,955
    149,754       154,236  
Timberland
    34,130       34,130  
Land held for development
    28,871       28,413  
Buildings and equipment, net of accumulated
               
depreciation of $5,892 and $6,203
    5,812       6,019  
Total properties and equipment, at cost
    218,567       222,798  
Other assets
               
Contracts receivable, net of current portion
    297       409  
Other
    342       484  
Total other assets
    639       893  
Total assets
  $ 225,683     $ 230,408  
                 
LIABILITIES, PARTNERS' CAPITAL AND NONCONTROLLING INTERESTS
       
Current liabilities
               
Accounts payable
  $ 2,150     $ 1,328  
Accrued liabilities
    2,269       3,021  
Current portion of environmental remediation
    833       240  
Current portion of long-term debt
    32       32  
Deferred revenue
    562       447  
Other current liabilities
    234       228  
Total current liabilities
    6,080       5,296  
Long-term liabilities
               
Long-term debt, net of current portion
    42,952       45,793  
Environmental remediation
    13,624       1,964  
Other long-term liabilities
    172       197  
Partners' capital and noncontrolling interests
               
General partners' capital (units issued and outstanding 60 and 60)
    911       1,063  
Limited partners' capital (units issued and outstanding 4,293 and 4,269)
    63,461       74,696  
Noncontrolling interests
    98,483       101,399  
Total partners' capital and noncontrolling interests
    162,855       177,158  
Total liabilities, partners' capital, and noncontrolling interests
  $ 225,683     $ 230,408  
                 
See accompanying notes to condensed consolidated financial statements.
 
 
4

 
 
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
             
Pope Resources, a Delaware Limited Partnership
                       
For the Three Months and Six Months Ended June 30, 2012 and 2011
                       
(in thousands, except per unit data)
                       
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Revenue
  $ 17,790     $ 14,269     $ 26,594     $ 31,943  
Cost of timber and land sold
    (10,355 )     (7,061 )     (14,496 )     (15,917 )
Operating expenses
    (3,081 )     (2,507 )     (5,510 )     (5,218 )
Real estate environmental remediation
    (12,500 )     (77 )     (12,500 )     (344 )
General and administrative expenses
    (1,004 )     (1,164 )     (2,168 )     (2,242 )
     Income (loss) from operations
    (9,150 )     3,460       (8,080 )     8,222  
                                 
Other income (expense)
                               
  Interest expense
    (520 )     (541 )     (1,050 )     (1,115 )
  Capitalized interest
    139       108       269       206  
  Interest income
    6       10       13       22  
     Total other expense
    (375 )     (423 )     (768 )     (887 )
                                 
Income (loss) before income taxes
    (9,525 )     3,037       (8,848 )     7,335  
Income tax expense
    (170 )     (83 )     (134 )     (139 )
     Net income (loss)
    (9,695 )     2,954       (8,982 )     7,196  
                                 
Plus:  (Income) loss attributable to noncontrolling
                               
   interests ORM Timber Funds
    400       333       893       (229 )
     Net income (loss) attributable to unitholders
    (9,295 )     3,287       (8,089 )     6,967  
Other comprehensive income adjustments
    -       -       -       -  
     Comprehensive income (loss) attributable to unitholders
    (9,295 )     3,287       (8,089 )     6,967  
                                 
Allocable to general partners
  $ (128 )   $ 46     $ (112 )   $ 97  
Allocable to limited partners
    (9,167 )     3,241       (7,977 )     6,870  
     Comprehensive income (loss) attributable to unitholders
  $ (9,295 )   $ 3,287     $ (8,089 )   $ 6,967  
                                 
Earnings (loss) per unit attributable to unitholders
                               
     Basic
  $ (2.14 )   $ 0.73     $ (1.87 )   $ 1.55  
     Diluted
  $ (2.14 )   $ 0.73     $ (1.87 )   $ 1.55  
                                 
Weighted average units outstanding
                               
     Basic
    4,351       4,329       4,348       4,318  
     Diluted
    4,351       4,331       4,348       4,320  
                                 
Distributions per unit
  $ 0.45     $ 0.25     $ 0.80     $ 0.50  
                                 
See accompanying notes to condensed consolidated financial statements.
 
 
5

 
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
           
Pope Resources, a Delaware Limited Partnership
           
Six Months Ended June 30, 2012 and 2011
           
(in thousands)
           
   
2012
   
2011
 
Net income (loss)
  $ (8,982 )   $ 7,196  
Adjustments to reconcile net income (loss) to net cash provided by operating activities
               
     Depletion
    5,133       5,897  
     Timber depletion on land sale
    -       150  
     Capitalized development activities, net of reimbursements
    (482 )     (493 )
     Equity-based compensation
    519       592  
     Depreciation and amortization
    337       351  
     Deferred taxes
    17       43  
     Cost of land sold
    -       89  
Cash flows from changes in operating accounts
               
     Accounts receivable, net
    (567 )     (273 )
     Contracts receivable
    179       128  
     Prepaid expenses and other current assets
    118       189  
     Accounts payable and accrued liabilities
    70       6  
     Deferred revenue
    115       (61 )
     Other current liabilities
    6       51  
     Environmental remediation
    12,253       (173 )
     Other long-term liabilities
    (25 )     (24 )
     Other, net
    (15 )     (1 )
       Net cash provided by operating activities
    8,676       13,667  
                 
Cash flows from investing activities
               
     Reforestation and roads
    (712 )     (488 )
     Buildings and equipment
    (64 )     (3,463 )
     Proceeds from fixed asset sale
    33       -  
     ORM Timber Fund II, Inc. land acquisition
    -       (140 )
       Net cash used in investing activities
    (743 )     (4,091 )
                 
Cash flows from financing activities
               
     Repayment of line of credit, net
    (2,824 )     (4,287 )
     Repayment of long-term debt
    (17 )     (15 )
     Debt issuance costs
    (28 )     -  
     Proceeds from option exercises
    12       516  
     Payroll taxes paid upon restricted unit vesting/option exercises
    (300 )     (226 )
     Cash distributions to unitholders
    (3,528 )     (2,191 )
     Cash distributions - ORM Timber Funds, net of distributions to Partnership
    (2,141 )     (3,312 )
     Capital call - ORM Timber Fund II, Inc.
    118       -  
       Net cash used in financing activities
    (8,708 )     (9,515 )
                 
Net decrease in cash and cash equivalents
    (775 )     61  
     Cash and cash equivalents at beginning of period
    2,653       2,423  
     Cash and cash equivalents at the end of the six-month period
  $ 1,878     $ 2,484  
                 
See accompanying notes to condensed consolidated financial statements.
 
 
6

 
 
POPE RESOURCES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2012

1.
The condensed consolidated statements of position as of June 30, 2012 and December 31, 2011 and the results of operations for the three- and six-month periods ending June 30, 2012 and 2011 have been prepared by Pope Resources, A Delaware Limited Partnership (the “Partnership”), pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). The condensed consolidated financial statements are unaudited, but, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments and accruals) necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The financial information as of December 31, 2011, is derived from the Partnership’s audited consolidated financial statements and notes thereto for the year ended December 31, 2011, and should be read in conjunction with such financial statements and notes. The results of operations for the interim periods are not indicative of the results of operations that may be achieved for the entire fiscal year ending December 31, 2012.
 
2.
The financial statements in the Partnership's 2011 annual report on Form 10-K include a summary of significant accounting policies of the Partnership and should be read in conjunction with this Quarterly Report on Form 10-Q.
 
3.
Basic net earnings (loss) per unit are calculated by dividing net income (loss) attributable to unitholders, adjusted for non-forfeitable distributions paid out to unvested restricted unitholders and Fund II preferred shareholders, by the weighted average units outstanding during the period. Diluted net earnings (loss) per unit are calculated by dividing net income attributable to unitholders, adjusted for non-forfeitable distributions paid out to unvested restricted unitholders and Fund II preferred shareholders, by the weighted average units outstanding during the year plus additional units that would have been outstanding assuming the exercise of in-the-money unit equivalents using the treasury stock method, unless the assumed exercise is antidilutive.
 
The following table shows how we arrived at basic and diluted income (loss) per unit:
 
   
Quarter Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(in thousands)
 
2012
   
2011
   
2012
   
2011
 
Net income (loss) attributable to Pope Resources' unitholders
  $ (9,295 )   $ 3,287     $ (8,089 )   $ 6,967  
Less:
                               
  Net income attributable to unvested restricted unitholders
    (27 )     (131 )     (47 )     (277 )
  Dividends paid to Fund II preferred shareholders
    (4 )     (4 )     (8 )     (8 )
    Net income (loss) for calculation of EPS
  $ (9,326 )   $ 3,152     $ (8,144 )   $ 6,682  
                                 
Weighted average units outstanding (in thousands):
                               
Basic
    4,351       4,329       4,348       4,318  
Dilutive effect of unit equivalents
    -       2       -       2  
Diluted
    4,351       4,331       4,348       4,320  
                                 
Earnings (loss) per unit: Basic
  $ (2.14 )   $ 0.73     $ (1.87 )   $ 1.55  
Earnings (loss) per unit: Diluted
  $ (2.14 )   $ 0.73     $ (1.87 )   $ 1.55  
 
As of June 30, 2012 there were no outstanding unexercised options. Options to purchase 5,500 units at prices ranging from $10.75 to $17.40 per unit were outstanding as of June 30, 2011. There were no out-of-the money options to exclude from the calculation of dilutive unit equivalents for the quarter or six months ended June 30, 2011.
 
 
7

 
 
4.  
In January 2012, the Partnership granted 20,350 restricted units pursuant to the management incentive compensation program. These restricted units vest ratably over four years with the grant date fair value equal to the market price on the date of grant. We recognized $275,000 and $152,000 of equity compensation expense in the first half of 2012 and 2011, respectively, related to restricted units granted pursuant to the management incentive compensation program. Simultaneous with the restricted unit grant to management, members of our Board of Directors received 6,000 restricted units in January 2012. Restricted units granted to directors are not part of the management incentive compensation program, but are included in the calculation of total equity compensation expense. These awards to directors vest 50% on the third anniversary and 50% on the fourth anniversary of the date of grant. Total equity compensation expense is recognized over the shorter of the vesting period or the period from the date of grant to the point of retirement eligibility. For the first half of 2012 and 2011, equity compensation expense was $519,000 and $592,000, respectively.
 
5.  
Supplemental disclosure of cash flow information: interest paid, net of amounts capitalized, totaled $718,000 and $873,000 for the first six months ended June 30, 2012 and 2011, respectively. Income taxes paid were $247,000 and $33,000 for the six months ended June 30, 2012 and 2011, respectively, due to increased taxable income from the preceding year in corporate subsidiaries.

6.  
The Partnership’s financial instruments include cash and cash equivalents and accounts receivable, for which the carrying amount of each represents fair value based on current market interest rates or their short-term nature. Carrying amounts of contracts receivable, although long-term, also approximate fair value.

The carrying value of the Partnership’s and Funds’ fixed-rate debt having a carrying value of $40.9 million as of June 30, 2012 and December 31, 2011 has been estimated based on current interest rates for similar instruments, Level 2 inputs in the Fair Value Hierarchy, to be approximately $46.3 million and $46.6 million, respectively.
 
7.  
The Partnership has two general partners: Pope MGP, Inc. and Pope EGP, Inc. In total, these two entities own 60,000 partnership units. The allocation of distributions and loss between the general and limited partners is pro rata across all units outstanding.
 
 
8

 
 
8.  
In the presentation of the Partnership’s revenue and operating income (loss) by segment all intersegment revenue and expense is eliminated to determine externally reported operating income (loss) by business segment. The tables that follow reconcile internally reported income (loss) from operations to externally reported income (loss) from operations by business segment, for the quarters and six months ended June 30, 2012 and 2011:
 
 
      Fee Timber    
Timberland
                   
Three Months Ended
 
Pope
Resources
   
ORM
Timber
   
Total Fee
   
Management
&
   
Real
             
June 30, (in thousands)
 
Timber
   
Funds
   
Timber
   
Consulting
   
Estate
   
Other
   
Consolidated
 
2012
                                         
Revenue internal
  $ 11,767     $ 5,819     $ 17,586     $ 612     $ 352     $ -     $ 18,550  
Eliminations
    (136 )     -       (136 )     (612 )     (12 )     -       (760 )
Revenue external
    11,631       5,819       17,450       -       340       -       17,790  
                                                         
Cost of timber and land sold
    (5,407 )     (4,947 )     (10,354 )     -       (1 )     -       (10,355 )
                                                         
Operating, general and
                                                       
   administrative expenses internal
    (1,113 )     (1,198 )     (2,311 )     (559 )     (13,471 )   (1,004 )     (17,345 )
Eliminations
    12       612       624       136       -       -       760  
Operating, general and
                                                       
   administrative expenses external
    (1,101 )     (586 )     (1,687 )     (423 )     (13,471 )   (1,004 )     (16,585 )
                                                         
Income (loss) from operations
                                                 
   internal
    5,247       (326 )     4,921       53       (13,120 )     (1,004 )     (9,150 )
Eliminations
    (124 )     612       488       (476 )     (12 )     -       -  
Income (loss) from operations
                                                 
   external
  $ 5,123     $ 286     $ 5,409     $ (423 )   $ (13,132 )   $ (1,004 )   $ (9,150 )
                                                         
2011
                                                       
Revenue internal
  $ 7,144     $ 4,300     $ 11,444     $ 522     $ 2,942     $ -     $ 14,908  
Eliminations
    (105 )     -       (105 )     (522 )     (12 )     -       (639 )
Revenue external
    7,039       4,300       11,339       -       2,930       -       14,269  
                                                         
Cost of timber and land sold
    (3,030 )     (3,687 )     (6,717 )     -       (344 )     -       (7,061 )
                                                         
Operating, general and
                                                       
   administrative expenses internal
    (942 )     (900 )     (1,842 )     (459 )     (922 ) **    (1,164 )     (4,387 )
Eliminations
    12       522       534       105       -       -       639  
Operating, general and
                                                       
   administrative expenses external
    (930 )     (378 )     (1,308 )     (354 )     (922 ) **    (1,164 )     (3,748 )
                                                         
Income (loss) from operations
                                                 
   internal
    3,172       (287 )     2,885       63       1,676       (1,164 )     3,460  
Eliminations
    (93 )     522       429       (417 )     (12 )     -       -  
Income (loss) from operations
                                                 
   external
  $ 3,079     $ 235     $ 3,314     $ (354 )   $ 1,664     $ (1,164 )   $ 3,460  
                                                         
*Includes $12.5 MM of environmental remediation expense
**Includes $77,000 of environmental remediation expense
 
 
9

 
 
      Fee Timber       Timberland  
 
             
Six Months Ended
 
Pope
Resources
   
ORM
Timber
   
Total
Fee
   
Management
&
   
Real
             
June 30, (in thousands)
 
Timber
   
Funds
   
 Timber
   
Consulting
   
Estate
   
Other
   
Consolidated
 
2012
                                         
Revenue internal
  $ 18,875     $ 7,355     $ 26,230     $ 1,088     $ 663     $ -     $ 27,981  
Eliminations
    (275 )     -       (275 )     (1,088 )     (24 )     -       (1,387 )
Revenue external
    18,600       7,355       25,955       -       639       -       26,594  
                                                         
Cost of timber and land sold
    (8,352 )     (6,143 )     (14,495 )     -       (1 )     -       (14,496 )
                                                         
Operating, general and
                                                       
   administrative expenses internal
    (1,986 )     (2,002 )     (3,988 )     (1,082 )     (14,327 )   (2,168 )     (21,565 )
Eliminations
    24       1,088       1,112       275       -       -       1,387  
Operating, general and
                                                       
   administrative expenses external
    (1,962 )     (914 )     (2,876 )     (807 )     (14,327 )   (2,168 )     (20,178 )
                                                         
Income (loss) from operations
                                                 
   internal
    8,537       (790 )     7,747       6       (13,665 )     (2,168 )     (8,080 )
Eliminations
    (251 )     1,088       837       (813 )     (24 )     -       -  
Income (loss) from operations
                                                 
   external
  $ 8,286     $ 298     $ 8,584     $ (807 )   $ (13,689 )   $ (2,168 )   $ (8,080 )
                                                         
2011
                                                       
Revenue internal
  $ 18,584     $ 10,436     $ 29,020     $ 1,089     $ 3,169     $ -     $ 33,278  
Eliminations
    (222 )     -       (222 )     (1,089 )     (24 )     -       (1,335 )
Revenue external
    18,362       10,436       28,798       -       3,145       -       31,943  
                                                         
Cost of timber and land sold external
    (7,538 )     (8,035 )     (15,573 )     -       (344 )     -       (15,917 )
                                                         
Operating, general and
                                                       
   administrative expenses internal
    (2,110 )     (1,790 )     (3,900 )     (1,003 )     (1,994 ) **    (2,242 )     (9,139 )
Eliminations
    27       1,089       1,116       219       -       -       1,335  
Operating, general and
                                                       
   administrative expenses external
    (2,083 )     (701 )     (2,784 )     (784 )     (1,994 ) **   (2,242 )     (7,804 )
                                                         
Income (loss) from operations
                                                 
   internal
    8,936       611       9,547       86       831       (2,242 )     8,222  
Eliminations
    (195 )     1,089       894       (870 )     (24 )     -       -  
Income (loss) from operations
                                                 
   external
  $ 8,741     $ 1,700     $ 10,441     $ (784 )   $ 807     $ (2,242 )   $ 8,222  
                                                         
*Includes $12.5 MM of environmental remediation expense
**Includes $344,000 of environmental remediation expense
 
9.  
ORM Timber Fund I, LP (Fund I), ORM Timber Fund II, Inc. (Fund II), and ORM Timber Fund III (REIT) Inc., (Fund III, and collectively with Fund I and Fund II, the Funds) were formed by Olympic Resource Management LLC (ORMLLC), a wholly owned subsidiary of Pope Resources, for the purpose of attracting capital to purchase timberlands. The objective of these Funds is to generate a return on investments through the acquisition, management, value enhancement and sale of timberland properties. Each Fund will operate for a term of ten years from the end of the respective drawdown period, with Fund I terminating in August 2017, Fund II terminating in March 2021, and Fund III with an as-yet-undefined term because its drawdown period remains open. Fund III’s drawdown period will end at the earlier of placement of all committed capital or 3 years from the date of the final close, which was on July 31, 2012.

 
Pope Resources and ORMLLC together own 20% of Fund I and Fund II and will own 5% of Fund III. The Funds are consolidated into the Partnership’s financial statements based in part on ORMLLC’s controlling role as the general partner or managing member of the Funds. The Funds’ statements of operations for the quarters ended June 30, 2012 and June 30, 2011 reflect income of $286,000 and $235,000, respectively. These operating results exclude management fees paid by the Funds to ORMLLC of $612,000 and $522,000 for second quarters of 2012 and 2011, respectively, which are eliminated in consolidation. The Funds’ statements of operation for the six months ended June 30, 2012 and 2011 reflect income of $298,000 and $1.7 million, respectively. These operating results exclude management fees paid by the Funds to ORMLLC of $1.1 million in each of the six-month periods ended June 30, 2012 and 2011, respectively, which are eliminated in consolidation.
 
 
10

 
 
 
The Partnership’s consolidated balance sheet included assets and liabilities of the Funds as of June 30, 2012 and December 31, 2011, which were as follows:
 
(in thousands)
 
June 30, 2012
   
December 31, 2011
 
Assets:
           
Cash
  $ 1,647     $ 2,404  
Other current assets
    1,106       546  
  Total current assets
    2,753       2,950  
Timber, timberland and roads (net of $16,794 and $13,729 of accumulated depletion in 2012 and 2011)
    133,581       136,313  
Other long-term assets
    119       126  
    Total assets
  $ 136,453     $ 139,389  
Liabilities and equity:
               
Current liabilities excluding long-term debt
  $ 1,796     $ 1,525  
Current portion of long-term debt
    32       32  
Long-term debt
    11,020       11,036  
  Total liabilities
    12,848       12,593  
Funds' equity
    123,605       126,796  
    Total liabilities and equity
  $ 136,453     $ 139,389  
 
10.  
The Partnership has an accrual for estimated environmental remediation costs of $14.5 million as of June 30, 2012 and $2.2 million as of December 31, 2011. The environmental remediation liability represents primarily estimated payments to be made to monitor and remedy certain areas in and around the townsite and millsite at Port Gamble, Washington, and secondarily at Port Ludlow, Washington.

The environmental liability at June 30, 2012 includes an estimate of $833,000 that management expects to expend in the next 12 months and $13.6 million thereafter. In developing its estimate of the Port Gamble environmental liability, management has employed a Monte Carlo statistical simulation model that suggests a potential aggregate range of clean-up cost from $11.9 million to $16.5 million, which corresponds to a two-standard-deviation range from the mean of possible outcomes generated by the simulation model.

In February 2011 a draft Remediation Investigation/Feasibility Study (RI/FS) was developed for Port Gamble that projected a total clean-up cost of $4.5 million. Our estimate of the Partnership’s share of this liability was slightly less than $2.0 million with the balance contributed by the other “potential liable person” (PLP) the State of Washington’s Department of Natural Resources (DNR). When the State’s environmental regulatory agency, Department of Ecology (Ecology), took this draft RI/FS out for public comment in 2011, most of the comments came from local tribes.

In June 2012, Ecology communicated to the Partnership specific components of a revised RI/FS that were beginning to crystallize and were responsive to these comments. This translated to a significantly expanded scope of the project, including larger dredge areas, more capping of underwater sediment areas, and demolition of both pilings and an old millsite wharf.  In addition, Ecology pressed the PLP’s to commit to addressing “natural resource damages” (NRD), an element of environmental law that provides for compensation to be paid as mitigation for injuries to the environment that are analogous to pain-and-suffering payments in a civil law context.
 
 
11

 

The projected cost of this significant scope expansion in the clean-up together with the layering on of NRD mitigation translates to a sizable multiple of the prior estimate for clean-up costs. As a result of this change in the scope of the clean-up and the prospect of NRD mitigation, the Partnership’s potential share of remediation costs has increased commensurately and, although the revised remediation plan has not been finalized, discussions with Ecology are far enough along that management can reasonably estimate an increase in the remediation reserve to reflect these projected costs.  The cash outflows by the Partnership to fund its share of the Port Gamble clean-up and potential related NRD mitigation will occur over a multi-year timeframe.

In conjunction with their re-examination of clean-up alternatives, Ecology successfully obtained $9 million of State funding targeted at Port Gamble, with the monies slated for acquisition of environmentally sensitive properties, rehabilitation of geoduck beds, pollution source control, habitat preservation, and clean-up sustainability. The specific apportionment of these monies between the aforementioned uses is uncertain, however, and it remains to be seen how much, if any, of these authorized funds ends up being utilized in Port Gamble. To the extent the $9 million ends up as proceeds paid to the Partnership for property acquisition, these funds will provide a meaningful liquidity source for addressing our clean-up and NRD mitigation responsibilities. Potential receipt of these funds, however, is not reflected as an offset in the $12.5 million accrual adjustment nor is it recorded as an asset.

There are also significant demolition elements of the clean-up plan such as the removal of pilings, an old wharf, and other over-water structures that represent actions we would eventually take as part of the redevelopment plan for the site. As such, the upshot of the plan with respect to these actions is primarily the acceleration of incurring costs that were eventually going to be absorbed when undertaking redevelopment and ultimate sale of the site.
 
Our current estimate of the Partnership’s share of Port Gamble clean-up and NRD mitigation, if any, is $14.3 million which necessitates an additional accrual at the end of Q2 2012 of $12.5 million. Consistent with the methodology we have used in the past to estimate this liability, we used a Monte Carlo simulation model to arrive at a mean value for a multi-variable set of clean-up scenarios.
 
In addition to the Port Gamble site, during the second quarter of 2012, management met with representatives from the Port Ludlow resort community to discuss reactions to somewhat inconclusive first quarter test results. Following that meeting, we proposed a course of action with a cost effective profile that meets the objective of cleaning up the site.  Although we are still in the midst of those discussions, we continue to closely monitor the project.  As of June 30, 2012, we have $110,000 reserved in environmental remediation for the Port Ludlow site.

11.
In July 2012, the Partnership completed the sale of its headquarters building in Poulsbo for $2.9 million.  The headquarters building and land have a cost basis of $672,000 and are reported in Building and land held for sale as of June 30, 2012.
 
 
12

 
 
ITEM 2.

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

This report contains a number of projections and statements about our expected financial condition, operating results, and business plans and objectives. These statements reflect 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 PART II, ITEM 1A below. 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 both domestically and overseas, particularly in certain parts of Asia; our ability to estimate accurately the environmental and other liabilities associated with our assets and operations; 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; our ability to consummate proposed or contracted transactions in a manner that will yield revenues; the impacts of climate change and natural disasters on our timberlands and on surrounding areas; and the potential impacts of fluctuations in foreign currency exchange rates as they affect demand for our products and customers’ ability to pay. 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 condensed consolidated financial statements and related notes 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 three private equity funds (“Funds”). When we refer to the timberland owned by the Partnership, we describe it as the Partnership’s tree farms. We refer to timberland owned by the Funds as the Funds’ tree farms. When referring collectively to the Partnership’s and Funds’ timberland we will refer to them as the Combined tree farms. 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 selling 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, and will not recognize operating income until that project is sold. In addition, within this segment we sometimes negotiate and sell conservation easements (CE’s) on Fee Timber properties to preclude future development. Our third business, which we refer to as Timberland Management & Consulting, or “TM&C,” is raising and investing capital from third parties and the Partnership for private equity timber funds, and thereafter managing those funds for the benefit of all investors.
 
 
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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 co-investment, into new timberland properties. We have closed and invested capital from two timber funds, with assets under management now totaling $171 million. Our 20% co-investments in Funds I and II, and our 5% co-investment in Fund III, which collectively totaled $28 million as of June 30, 2012, afford us a share of the Funds’ operating cash flows while also 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. We believe our co-investment strategy also boosts our credibility with existing and prospective investors by demonstrating that we have both an operational as well as a financial commitment to the Funds’ successes.

We have closed on $180 million of committed capital for Fund III, $9 million of which represents our co-investment. The Funds are consolidated into our financial statements with the income attributable to equity owned by third parties reflected in our Condensed Consolidated Statements of Comprehensive Income under the caption “Net (income) loss attributable to noncontrolling interests-ORM Timber Funds.”

Land held for sale in western Washington by our Real Estate segment represents property that has been deemed suitable for residential and commercial building sites. The markets for these resources have recently suffered along with regional and national markets, producing a decline in our sales. The challenge for our Real Estate segment centers 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 and costs of carrying and developing a property against the potential for income and positive cash flows upon sale.

We have entered into a purchase and sale agreement with two large merchant builders to acquire a combined 79 lots within our Harbor Hill project in Gig Harbor, Washington.  We expect the first lot takedown to occur in either fourth quarter of 2012 or first quarter of 2013.  Consistent with accounting guidelines, revenue will be recognized on this transaction once it is earned and we concluded we have no material continuing involvement or obligation to the purchaser.

Revenue increased from the second quarter of 2011 to the second quarter of 2012 on a 61% increase in log sale volume, offset by a 9% decline in average log price. Revenue was also aided by a 4.4 million board feet (MMBF) timber deed sale, a transaction in which we sell rights to harvest timber on our timberlands rather than harvesting and selling logs directly. The timber deed sale closed in the second quarter and yielded revenues of $1.0 million from the Partnership’s Hood Canal tree farm. Income is down due to a charge to the environmental remediation accrual, which occurs because of a change in scope and extent of the required cleanup at Port Gamble. This accrual and the related Clean-up Action Plan and Consent Decree are discussed later in this report. High log inventories in China have shown signs of decline, however demand is still lukewarm and prices have remained low. High inventories in China, low log prices, and elevated trans-ocean fuel and freight rates continue to dampen the log flow to China. We harvested 35 MMBF in the second quarter of 2012, which included the 4.4 MMBF timber deed sale, compared to 14 MMBF in the first quarter of 2012 and 19 MMBF in the second quarter of 2011. Realized log prices declined $27/MBF, or 5%, from the first to the second quarter of 2012 and $50/MBF, or 9%, from the second quarter of 2011 to the second quarter of 2012. For the six months ended June 30, 2012 and 2011, we harvested 49 MMBF. The 2012 year-to-date volume includes the 4.4 MMBF timber deed sale. Realized log prices during the six months ended June 30, 2012 declined $30/MBF, or 5%, from the same six-month period in 2011. We expect our harvest volume for the full year 2012 to be between 78 and 82 MMBF, with the final total depending on the strength or weakness of log markets. This harvest volume total includes the aforementioned 4.4 MMBF timber deed sale.

 
14

 

RESULTS OF OPERATIONS

The following table reconciles and compares key revenue and cost elements that impacted our net income for the respective quarter and year-to-date periods ended June 30, 2012 and June 30, 2011. In addition to the table’s numerical analysis, the explanatory text that follows the table describes certain of these changes by business segment.
 
         
Six Months
 
   
Quarter Ended
   
Ended
 
   
June 30,
   
June 30,
 
(in thousands)
 
Total
   
Total
 
Net income (loss) attributable to Pope Resources' unitholders:
           
2012 period
  $ (9,295 )   $ (8,089 )
2011 period
    3,287       6,967  
   Variance
  $ (12,582 )   $ (15,056 )
Detail of variance:
               
Fee Timber
               
Log volumes (A)
  $ 6,623     $ (2,295 )
Log price realizations (B)
    (1,510 )     (1,583 )
Stumpage sales
    1,026       1,026  
Production costs
    (2,495 )     281  
Depletion
    (1,142 )     764  
Other Fee Timber
    (407 )     (50 )
Timberland Management & Consulting
               
Other Timberland Management & Consulting
    (69 )     (23 )
Real Estate
               
Land and conservation easement sales
    (2,308 )     (2,308 )
Timber depletion on land sale
    150       150  
Other Real Estate
    (215 )     (182 )
Environmental remediation costs
    (12,423 )     (12,156 )
General & administrative costs
    160       74  
Net interest expense
    48       119  
Other (taxes and noncontrolling interest)
    (20 )     1,127  
Total variances
  $ (12,582 )   $ (15,056 )
                 
(A) Volume variance calculated by extending change in sales volume by the average log sales price
 
  for the comparison period.
               
(B) Price variance calculated by extending the change in average realized price by current period
         
  sales volume.
               
 
Fee Timber
 
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 ground leases for cellular communication towers, gravel mines and quarries, together with the sale of other resources from our timberlands. Our Fee Timber revenue is driven primarily by the volume of timber harvested and the average log price realized on the sale of that harvested timber. Our volume harvested is typically based on manufactured log sales to customers or exporters. However, during the second quarter of 2012, we sold rights to harvest timber (timber deed sale) from the Hood Canal Tree Farm. The metrics used to calculate volumes sold and average price realized during the reporting period exclude the timber deed sale, except where called out as including it. Harvest volumes are generally expressed in million board feet (MMBF) increments and harvest revenue and related costs are generally expressed in terms of revenue or cost per thousand board feet (MBF). Fee Timber expenses, which consist predominantly of harvest, hauling, and depletion 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.
 
 
15

 
 
When discussing our Fee Timber operations, we compare current results to both the previous quarter and the corresponding quarter of the prior year, as well as current year-to-date results to the prior year-to-date results. These comparisons provide an opportunity to note trends in log prices and patterns of harvest volumes that affect Fee Timber operating results. Revenue and operating income for the Fee Timber segment for the quarters ended June 30, 2012, March 31, 2012, and June 30, 2011 were as follows:
 
(in millions)
Quarter ended
 
Log Sale
Revenue
   
Mineral,
Cell Tower
& Other
Revenue
   
Total Fee
Timber
Revenue
   
Operating
Income
   
Harvest
Volume
(MMBF)
 
Partnership tree farms
  $ 10.3     $ 1.3     $ 11.6     $ 5.1       18.8  
Funds' tree farms
    5.8       -       5.8       0.3       11.4  
Total Fee Timber June 30, 2012
  $ 16.1     $ 1.3     $ 17.4     $ 5.4       30.2  
                                         
Partnership tree farms
  $ 6.6     $ 0.4     $ 7.0     $ 3.2       11.7  
Funds' tree farms
    1.5       -       1.5       -       2.8  
Total Fee Timber March 31, 2012
  $ 8.1     $ 0.4     $ 8.5     $ 3.2       14.5  
                                         
Partnership tree farms
  $ 6.6     $ 0.4     $ 7.0     $ 3.1       11.0  
Funds' tree farms
    4.3       -       4.3       0.2       7.8  
Total Fee Timber June 30, 2011
  $ 10.9     $ 0.4     $ 11.3     $ 3.3       18.8  
 
Comparing Q2 2012 to Q1 2012. Fee Timber revenue doubled from $8.5 million in the first quarter of 2012 to $17.4 million in the second quarter of 2012 primarily as a result of doubling harvest volume in the second quarter, only slightly offset by a decline of $27/MBF, or 5%, in realized log prices. The revenue increase was also aided by a 4.4 MMBF timber deed sale during the second quarter of 2012, which appears in the table above in the Mineral, Cell Tower, & Other Revenue column. The harvest volume increase reflects a focus on maximizing net stumpage values by selling to specific domestic sawmills rather than to a lackluster export market. The selected domestic customers were geographically situated in a way that allowed a reduction of haul costs and, in some cases, had specialty markets for Japanese lumber that allowed a higher delivered log price.

Operating income for the second quarter of 2012 increased by $2.2 million, or 69%, from first quarter 2012 results. Income increased as a result of the lift in harvest volume and profit of $765,000 from the timber deed sale, offset by a heavier mix of total harvest from the Timber Funds, which carry a higher depletion expense per MBF. Income was also offset by a 42% increase in operating expenses from the first quarter, a result of road expenses which were elevated from the first quarter of 2012 to prepare and maintain tree farms for harvesting.
 
 
16

 
 
The Funds nearly tripled revenue during the second quarter of 2012, generating $5.8 million during the second quarter compared with revenue of $1.5 million in the first quarter of 2012. The increase was driven by a fourfold harvest volume lift from nearly 3 MMBF in the first quarter of 2012 to over 11 MMBF in the second quarter of 2012. This increase in harvest volume also explained the rise in Fund operating income from $12,000 during the first quarter of 2012 to $286,000 during the second quarter of 2012. However, with higher depletion expense per MBF, the added harvest from the Timber Funds did not translate into significantly higher operating income.

Comparing Q2 2012 to Q2 2011. A 60% increase in harvest volume from the second quarter of 2011 to the second quarter of 2012 served to lift Fee Timber revenue by $6.1 million, or 54%, over the comparable period in the prior year, partially offset by a $50/MBF, or 9%, reduction in average realized log price during 2012. Operating income for the second quarter of 2012 rose $2.1 million, or 63%, over same period in 2011 due to the rise in harvest volume, the second quarter 2012 timber deed sale, and a slightly lower mix of harvest from the Timber Funds, which carry higher depletion expense per MBF.

Second quarter 2012 Fund revenue rose 35% to $5.8 million from $4.3 million for the same quarter in 2011 on a nearly 4 MMBF, or 46%, jump in harvest volume. Operating income for the period rose more modestly from $235,000 in 2011 to $286,000 in 2012 as a result of higher operating costs to prepare roads for harvesting.

Revenue and operating income for the Fee Timber segment for year-to-date periods ended June 30, 2012 and June 30, 2011 were as follows:
 
(in millions)
Six Months Ended
 
Log Sale
Revenue
   
Mineral,
Cell Tower
& Other
Revenue
   
Total Fee
Timber
Revenue
   
Operating
Income
   
Harvest
Volume
(MMBF)
 
Pope Resources Timber
  $ 16.9     $ 1.7     $ 18.6     $ 8.3       30.5  
Timber Funds
    7.3       -       7.3       0.3       14.2  
Total Fee Timber June 30, 2012
  $ 24.2     $ 1.7     $ 25.9     $ 8.6       44.7  
                                         
Pope Resources Timber
  $ 17.7     $ 0.7     $ 18.4     $ 8.7       29.9  
Timber Funds
    10.4       -       10.4       1.7       19.2  
Total Fee Timber June 30, 2011
  $ 28.1     $ 0.7     $ 28.8     $ 10.4       49.1  
 
Comparing YTD 2012 to YTD 2011. Fee Timber revenue for the first half of 2012 declined by $2.9 million, or 10%, over the comparable period in 2011. Absence of a strong Chinese log export market and weakening in prices in 2012 are primarily responsible for the decline in log prices and also served to pull down operating income $1.8 million, or 18%, from 2011 to 2012.  Operating income would have been further reduced without the lower mix of harvest from the Timber Funds, which carry a higher depletion expense and therefore lower operating income margin.
 
 
17

 
 
Log Volume

We harvested the following log volumes by species from the Combined tree farms, exclusive of the aforementioned 4.4 MMBF timber deed sale, for the quarters ended June 30, 2012, March 31, 2012, and June 30, 2011:
 
Volume (in MMBF)
 
Quarter Ended
 
Sawlogs
   
Jun-12
   
% Total
   
Mar-12
   
% Total
   
Jun-11
   
% Total
 
 
Douglas-fir
    19.3       64 %     11.1       77 %     10.1       54 %
 
Whitewood
    5.8       19 %     0.9       6 %     5.1       27 %
 
Cedar
    0.3       1 %     0.1       1 %     0.3       1 %
 
Hardwood
    1.1       4 %     0.4       2 %     0.5       3 %
Pulpwood
                                                 
 
All Species
    3.7       12 %     2.0       14 %     2.8       15 %
Total
      30.2       100 %     14.5       100 %     18.8       100 %
 
Comparing Q2 2012 to Q1 2012. Harvest volume more than doubled from the first to the second quarter of 2012. The increase reflects a seasonal bump in harvest volume as wood in higher elevations is more readily accessible in the spring and early summer. This increase was more pronounced for us than usual due to withholding even low-elevation harvest in response to lukewarm early-2012 demand from the China export log market. Douglas-fir harvest volume, as a percent of overall harvest, declined from the first to the second quarter of 2012 due to bringing the Funds’ tree farms online and this contributed to a $16/MBF, or 3%, drop in average realized log price. Harvest from the Funds’ tree farms increased from 19% of first quarter volume to 33% of second quarter volume. The Funds’ tree farms are heavier to whitewood than the Partnership tree farms and, as such, whitewood volume increased from 6% to 19% of the total second quarter harvest mix with a $14/MBF, or 3%, increase in average log price.
 
Comparing Q2 2012 to Q2 2011. Harvest volumes were up more than 11 MMBF, or 60%, from the second quarter of 2011 to the same period in 2012. The increase reflects decisions in 2011 to heavily front-load 2011 harvest to take advantage of a then-burgeoning China export log market coupled with unusually late winter conditions which prevented access to planned harvest units in the second quarter. These first quarter 2011 influences led to decreased second quarter 2011 harvest activities relative to the second quarter of 2012. The mix of volume coming from the Partnership’s and Funds’ tree farms was 59% and 41% in 2011, respectively, compared with 67% and 33% in 2012. This small shift in tree farm mix contributed to an overall decline in the relative percentage of whitewood harvest volume from 27% in 2011 to 19% in 2012. The shift is also responsible for increasing Douglas-fir harvest volumes from 54% of second quarter 2011 harvest volume to 64% of second quarter 2012 harvest volume. There was a slight decline in Pulpwood volumes from 15% of second quarter 2011 harvest to 12% of second quarter 2012 harvest due primarily to the mix of the stands harvested in the second quarter of 2012. Pulpwood prices declined 17% quarter-over-quarter as result of the closure of a major regional pulp mill, which served to increase pulpwood inventories and drive down prices. Additionally, sawmills, the low cost supplier preference of pulp mills, continue to gradually increase production, thus further suppressing the demand for, and weakening prices of, chips from whole logs.
 
 
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Comparing YTD 2012 to YTD 2011. We harvested the following log volumes by species from the Combined tree farms, exclusive of the aforementioned 4.4 MMBF timber deed sale, for the six months ended June 30, 2012 and June 30, 2011:
 
Volume (in MMBF)
 
Six Months Ended
 
Sawlogs
   
Jun-12
   
% Total
   
Jun-11
   
% Total
 
 
Douglas-fir
    30.4       68 %     29.3       60 %
 
Whitewood
    6.7       15 %     11.6       23 %
 
Cedar
    0.4       1 %     0.8       2 %
 
Hardwood
    1.5       3 %     1.1       2 %
Pulpwood
                                 
 
All Species
    5.7       13 %     6.3       13 %
Total
      44.7       100 %     49.1       100 %
 
Harvest volumes declined 4 MMBF, or 9%, in the first six months of 2012 over the same period in 2011, with substantially all of this decrease attributable to a decline in 2012 harvest from the Funds. Harvest from the Funds dropped 5 MMBF, or 26%, from 19 MMBF to 14 MMBF in 2011 and 2012, respectively. Harvest from the Partnership tree farms increased 1 MMBF, or 2%, from 30 MMBF to 31 MMBF in 2011 and 2012, respectively. This shift in harvest volume mix from 2011 to 2012 reflects particularly a change in the whitewood export log market at Astoria, Oregon where, in its incipient stage in 2011, the China market paid a very large premium for otherwise lower-valued domestic and even pulpwood whitewood logs. This situation did not re-develop in 2012, and whitewood prices in the geographies of our Funds reflected low export demand and relatively weak local domestic prices as well. This is reflected in the decline of whitewood harvest volumes from 23% of the 2011 mix to 15% of the 2012 mix and a corresponding increase in Douglas-fir volumes from 60% in 2011 to 68% in 2012. Pulpwood volumes remained static, as a relative portion of 2011 and 2012 harvest volume.

Log Prices
 
Logs from the Combined tree farms serve a number of different domestic and export markets, with domestic mills historically representing our largest market destination. This customer mix shifted, however, in the fourth quarter of 2010 when logs destined for export markets represented the largest share of our total log sales, driven by the China export log market accepting a lower quality product than what has traditionally defined an export log. As a result, significant volumes that theretofore would have been sold to domestic mills instead flowed to the China market beginning with 2010 when our export mix surged to 33% and peaked at 45% in 2011. From 2010 through the third quarter of 2011, the relative strength of the China export market was a driving force for much of our log pricing. This shifted during the fourth quarter of 2011 when oversupply abruptly reduced demand from China and we reacted by tying up contracts with domestic mills that extended into the first quarter of 2012. In the first quarter of 2012 most of our export volume was comprised of higher-value Douglas-fir logs going to Japan. This mix, however, shifted once again during the second quarter of 2012 with improved lumber demand from higher housing starts and a situation where we responded with sales to a limited number of domestic mills for high-grade Douglas-fir logs suitable for milling high-value Japanese lumber grades. This shift allowed us to realize equivalent delivered log prices while generating shorter hauls and thus a higher net log realization. This resulted in a compression of spreads between realized export and domestic log prices (hardwood data is excluded from domestic data when calculating export to domestic spreads), which decreased from $67/MBF, or 12%, during the first quarter of 2012 and $89/MBF, or 16%, during the second quarter of 2011, to $6/MBF, or 1%, in the second quarter of 2012. The spread between the export and domestic log prices of $69/MBF, or 12%, in the first half of 2011 dropped to $36/MBF, or 6%, in the first six months of 2012.
 
 
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We realized the following log prices by species for the quarters ended June 30, 2012, March 31, 2012, and June 30, 2011:
 
     
Quarter Ended
 
     
Jun-12
   
Mar-12
   
Jun-11
 
Average price realizations (per MBF):
       
Sawlogs
                   
 
Douglas-fir
  $ 571     $ 587