a50915624.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, 2014

OR

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

Commission File Number 1-9035

POPE RESOURCES, A DELAWARE
LIMITED PARTNERSHIP
(Exact name of registrant as specified in its charter)

Delaware
91-1313292
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
 
19950 7th Avenue NE, Suite 200, 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 June 30, 2014: 4,434,250
 
 
 

 
 
Pope Resources
Index to Form 10-Q Filing
For the six Months Ended June 30, 2014

Description
 
Page Number
   
     
   
 
4
 
5
 
6
 
7
     
 
13
     
 
34
     
 
34
     
   
     
 
34
     
 
34
     
 
38
     
 
38
     
 
38
     
 
38
     
 
38
     
 
39
 
 
 

 
 
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, 2014 and December 31, 2013
           
(in thousands)
           
   
2014
   
2013
 
ASSETS
           
Current assets
           
Partnership cash and cash equivalents
  $ 16,351     $ 5,704  
ORM Timber Funds cash
    1,293       1,256  
Cash and cash equivalents
    17,644       6,960  
Short-term investments
    3,000       -  
Accounts receivable, net
    2,822       1,501  
Land held for sale
    4,083       10,258  
Prepaid expenses and other
    1,569       1,660  
Total current assets     29,118       20,379  
Properties and equipment, at cost
               
Timber and roads, net of accumulated depletion
               
(2014 -  $99,484; 2013 - $92,971)     206,452       211,946  
Timberland
    44,946       44,946  
Land held for development
    27,790       27,040  
Buildings and equipment, net of accumulated
               
depreciation (2014 - $6,647; 2013 - $6,437)     6,076       6,205  
Total properties and equipment, at cost     285,264       290,137  
                 
Other assets
    452       392  
Total assets
  $ 314,834     $ 310,908  
                 
LIABILITIES, PARTNERS' CAPITAL AND NONCONTROLLING INTERESTS
               
Current liabilities
               
Accounts payable
  $ 1,959     $ 2,196  
Accrued liabilities
    2,306       4,109  
Current portion of long-term debt
    108       109  
Deferred revenue
    1,342       599  
Other current liabilities
    986       966  
Total current liabilities     6,701       7,979  
Long-term debt, net of current portion
    75,527       75,581  
Environmental remediation and other long-term liabilities
    12,542       12,734  
Partners' capital and noncontrolling interests
               
General partners' capital (units issued and outstanding 2014 - 60; 2013 - 60)
    1,098       974  
Limited partners' capital (units issued and outstanding 2014 - 4,333; 2013 - 4,312)
    77,416       68,471  
Noncontrolling interests
    141,550       145,169  
  Total partners' capital and noncontrolling interests     220,064       214,614  
Total liabilities, partners' capital and noncontrolling interests
  $ 314,834     $ 310,908  
                 
See accompanying notes to condensed consolidated financial statements.

 
4

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
                   
Pope Resources, a Delaware Limited Partnership
                       
For the Three and Six Months Ended June 30, 2014 and 2013
                       
(in thousands, except per unit data)
                       
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2014
   
2013
   
2014
   
2013
 
                         
Revenue
  $ 18,583     $ 23,197     $ 56,362     $ 39,915  
Cost of sales
    (11,377 )     (12,085 )     (30,301 )     (20,949 )
Operating expenses
    (3,619 )     (3,015 )     (6,904 )     (5,918 )
General and administrative expenses
    (450 )     (1,238 )     (1,772 )     (2,431 )
Income from operations
    3,137       6,859       17,385       10,617  
                                 
Other expense
                               
Interest expense, net
    (629 )     (343 )     (1,203 )     (698 )
                                 
Income before income taxes
    2,508       6,516       16,182       9,919  
Income tax benefit (expense)
    (69 )     2       (226 )     16  
Net income
    2,439       6,518       15,956       9,935  
                                 
Net income attributable to noncontrolling
                               
interests - ORM Timber Funds
    (593 )     (390 )     (1,869 )     (323 )
Net and comprehensive income attributable to unitholders
    1,846       6,128       14,087       9,612  
                                 
                                 
Allocable to general partners
  $ 25     $ 84     $ 193     $ 132  
Allocable to limited partners
    1,821       6,044       13,894       9,480  
Net and comprehensive income attributable to unitholders
  $ 1,846     $ 6,128     $ 14,087     $ 9,612  
                                 
Basic and diluted earnings per unit attributable
                               
to unitholders
  $ 0.41     $ 1.34     $ 3.17     $ 2.11  
                                 
Basic and diluted weighted average units outstanding
    4,391       4,369       4,389       4,367  
                                 
Distributions per unit
  $ 0.65     $ 0.45     $ 1.20     $ 0.90  
                                 
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, 2014 and 2013
           
(in thousands)
           
   
2014
   
2013
 
Net income
  $ 15,956     $ 9,935  
Adjustments to reconcile net income to net cash provided by operating activities
               
Depletion
    6,451       6,446  
Timber depletion on land sale
    -       296  
Equity-based compensation
    521       763  
Depreciation and amortization
    359       345  
Deferred taxes
    94       (97 )
Cost of land sold
    7,618       940  
Loss (gain) on disposal of property and equipment
    (1 )     57  
Cash flows from changes in operating accounts
               
Accounts receivable, net
    (1,321 )     (510 )
Prepaid expenses and other assets
    (43 )     98  
Real estate project expenditures
    (2,128 )     (1,491 )
Accounts payable and accrued liabilities
    (2,040 )     291  
Deferred revenue
    743       176  
Environmental remediation
    (214 )     (253 )
Other current and long-term liabilities
    (4 )     14  
Net cash provided by operating activities
    25,991     $ 17,010  
                 
Cash flows from investing activities
               
Purchase of short-term investments
    (3,000 )     -  
Reforestation and roads
    (1,083 )     (853 )
Buildings and equipment
    (143 )     (183 )
Proceeds from sale of property and equipment
    1       -  
Net cash used in investing activities
    (4,225 )     (1,036 )
                 
Cash flows from financing activities
               
Repayment of long-term debt
    (55 )     (57 )
Proceeds from preferred stock issuance - ORM Timber Funds
    125       -  
Payroll taxes paid on unit net settlements
    (196 )     (241 )
Cash distributions to unitholders
    (5,343 )     (3,999 )
Cash distributions - ORM Timber Funds, net of distributions to Partnership
    (5,613 )     (4,267 )
Capital call - ORM Timber Funds, net of Partnership contribution
    -       137  
Net cash used in financing activities
    (11,082 )     (8,427 )
                 
Net increase in cash and cash equivalents
    10,684       7,547  
Cash and cash equivalents at beginning of period
    6,960       3,779  
Cash and cash equivalents at end of period
  $ 17,644     $ 11,326  
                 
See accompanying notes to condensed consolidated financial statements.
 
 
 
6

 
 
POPE RESOURCES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2014

1.
The condensed consolidated balance sheets as of June 30, 2014 and December 31, 2013 and the related condensed consolidated statements of comprehensive income for the three- and six-month periods and cash flows for the six-month periods ended June 30, 2014 and 2013 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 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, 2013, is derived from the Partnership’s audited consolidated financial statements and notes thereto for the year ended December 31, 2013, 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, 2014.
 
2.
The financial statements in the Partnership’s 2013 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.  On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective on January 1, 2017.   Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Partnership is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Partnership has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

3.
Short-term investments consist of certificates of deposit maturing 180 days from the date of purchase.
 
4.
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, profits and losses between the general and limited partners is pro rata across all units outstanding.

5.
ORM Timber Fund I, LP (Fund I), ORM Timber Fund II, Inc. (Fund II), and ORM Timber Fund III (REIT) Inc. (Fund III), collectively “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 terminating on the tenth anniversary of the completion of its drawdown period.  Fund III’s drawdown period will end at the earlier of placement of all committed capital or July 31, 2015.

 
Pope Resources and ORMLLC together own 20% of Fund I and Fund II and 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 consolidated financial statements exclude management fees paid by the Funds to ORMLLC as they are eliminated in consolidation. See note 6 for a breakdown of operating results before and after such eliminations. The portion of these fees, among other items of income and expense, attributed to third-party investors is reflected as an adjustment to income in the Partnership’s Condensed Consolidated Statement of Comprehensive Income under the caption “Net income attributable to noncontrolling interests - ORM Timber Funds.”
 
 
7

 
 
 
The Partnership’s condensed consolidated balance sheet included assets and liabilities of the Funds as of June 30, 2014 and December 31, 2013, which were as follows:

(in thousands)
 
June 30, 2014
   
December 31, 2013
 
Assets:
           
Cash
  $ 1,293     $ 1,256  
Other current assets
    1,232       362  
  Total current assets
    2,525       1,618  
Timber, timberland and roads, net of accumulated depletion (2014 - $33,896; 2013 - $28,713)
    207,403       211,871  
Other long-term assets
    117       125  
    Total assets
  $ 210,045     $ 213,614  
Liabilities and equity:
               
Current liabilities excluding long-term debt
  $ 2,470     $ 1,747  
Current portion of long-term debt
    -       3  
Total current liabilities
    2,470       1,750  
Long-term debt, net of current portion
    42,980       42,980  
  Total liabilities
    45,450       44,730  
Funds' equity
    164,595       168,884  
    Total liabilities and equity
  $ 210,045     $ 213,614  

6.
In the presentation of the Partnership’s revenue and operating income (loss) by segment, all intersegment revenue and expense is eliminated to determine operating income (loss) reported externally. The following tables reconcile internally reported income (loss) from operations to externally reported income (loss) from operations by business segment, for the three and six months ended June 30, 2014 and 2013:
 
 
8

 
 
    Fee Timber                          
Three Months Ended
 
Pope
Resources
   
ORM
Timber
   
Total Fee
   
Timberland
   
Real
             
June 30, (in thousands)
 
Timber
   
Funds
   
Timber
   
Management
   
Estate
   
Other
   
Consolidated
 
2014
                                         
Revenue internal
  $ 8,884     $ 8,772     $ 17,656     $ 840     $ 1,118     $ -     $ 19,614  
Eliminations
    (161 )     -       (161 )     (840 )     (30 )     -       (1,031 )
Revenue external
    8,723       8,772       17,495       -       1,088       -       18,583  
                                                         
Cost of sales
    (4,244 )     (6,091 )     (10,335 )     -       (1,042 )     -       (11,377 )
                                                         
Operating, general and
                                                       
administrative expenses internal
    (1,430 )     (1,521 )     (2,951 )     (671 )     (998 )     (480 )     (5,100 )
Eliminations
    -       840       840       161       -       30       1,031  
Operating, general and
                                                       
administrative expenses external
    (1,430 )     (681 )     (2,111 )     (510 )     (998 )     (450 )     (4,069 )
                                                         
Income (loss) from operations
                                                 
internal
    3,210       1,160       4,370       169       (922 )     (480 )     3,137  
Eliminations
    (161 )     840       679       (679 )     (30 )     30       -  
Income (loss) from operations
                                                 
external
  $ 3,049     $ 2,000     $ 5,049     $ (510 )   $ (952 )   $ (450 )   $ 3,137  
                                                         
2013
                                                       
Revenue internal
  $ 8,552     $ 8,700     $ 17,252     $ 740     $ 6,127     $ -     $ 24,119  
Eliminations
    (140 )     -       (140 )     (740 )     (42 )     -       (922 )
Revenue external
    8,412       8,700       17,112       -       6,085       -       23,197  
                                                         
Cost of sales
    (3,499 )     (6,705 )     (10,204 )     -       (1,881 )     -       (12,085 )
                                                         
Operating, general and
                                                       
administrative expenses internal
    (1,115 )     (1,297 )     (2,412 )     (637 )     (858 )     (1,268 )     (5,175 )
Eliminations
    12       740       752       140       -       30       922  
Operating, general and
                                                       
administrative expenses external
    (1,103 )     (557 )     (1,660 )     (497 )     (858 )     (1,238 )     (4,253 )
                                                         
Income (loss) from operations
                                                 
internal
    3,938       698       4,636       103       3,388       (1,268 )     6,859  
Eliminations
    (128 )     740       612       (600 )     (42 )     30       -  
Income (loss) from operations
                                                 
external
  $ 3,810     $ 1,438     $ 5,248     $ (497 )   $ 3,346     $ (1,238 )   $ 6,859  
 
 
9

 
 
    Fee Timber                          
Six Months Ended
 
Pope
Resources
   
ORM
Timber
   
Total
   
Timberland
   
Real
             
June 30, (in thousands)
 
Timber
   
Funds
   
Fee Timber
   
Management
   
Estate
   
Other
   
Consolidated
 
2014
                                         
Revenue internal
  $ 20,182     $ 19,737     $ 39,919     $ 1,715     $ 16,817     $ -     $ 58,451  
Eliminations
    (315 )             (315 )     (1,715 )     (59 )     -       (2,089 )
Revenue external
    19,867       19,737       39,604       -       16,758       -       56,362  
                                                         
Cost of sales
    (8,154 )     (13,285 )     (21,439 )     -       (8,862 )     -       (30,301 )
                                                         
Operating, general and
                                                       
administrative expenses internal
    (2,530 )     (3,080 )     (5,610 )     (1,435 )     (1,889 )     (1,831 )     (10,765 )
Eliminations
            1,715       1,715       315       -       59       2,089  
Operating, general and
                                                       
administrative expenses external
    (2,530 )     (1,365 )     (3,895 )     (1,120 )     (1,889 )     (1,772 )     (8,676 )
                                                         
Income (loss) from operations
                                                 
internal
    9,498       3,372       12,870       280       6,066       (1,831 )     17,385  
Eliminations
    (315 )     1,715       1,400       (1,400 )     (59 )     59       -  
Income (loss) from operations
                                                 
external
  $ 9,183     $ 5,087     $ 14,270     $ (1,120 )   $ 6,007     $ (1,772 )   $ 17,385  
                                                         
2013
                                                       
Revenue internal
  $ 19,757     $ 14,078     $ 33,835     $ 1,413     $ 6,444     $ -     $ 41,692  
Eliminations
    (281 )     -       (281 )     (1,413 )     (83 )     -       (1,777 )
Revenue external
    19,476       14,078       33,554       -       6,361       -       39,915  
                                                         
Cost of sales
    (8,020 )     (10,760 )     (18,780 )     -       (2,169 )     -       (20,949 )
                                                         
Operating, general and
                                                       
administrative expenses internal
    (2,147 )     (2,502 )     (4,649 )     (1,290 )     (1,697 )     (2,490 )     (10,126 )
Eliminations
    24       1,413       1,437       281       -       59       1,777  
Operating, general and
                                                       
administrative expenses external
    (2,123 )     (1,089 )     (3,212 )     (1,009 )     (1,697 )     (2,431 )     (8,349 )
                                                         
Income (loss) from operations
                                                 
internal
    9,590       816       10,406       123       2,578       (2,490 )     10,617  
Eliminations
    (257 )     1,413       1,156       (1,132 )     (83 )     59       -  
Income (loss) from operations
                                                 
external
  $ 9,333     $ 2,229     $ 11,562     $ (1,009 )   $ 2,495     $ (2,431 )   $ 10,617  
 
7.
Basic and diluted earnings per unit are calculated by dividing net income attributable to unitholders, adjusted for non-forfeitable distributions paid out to unvested restricted unitholders and preferred shareholders of Fund II and Fund III, by the weighted average units outstanding during the period.  There were no dilutive securities outstanding during the periods presented. The following table shows how we arrived at basic and diluted income per unit:
 
 
10

 
 
   
Quarter Ended
   
Six Months Ended
 
   
June 30
   
June 30
 
(in thousands, except per unit amounts)
 
2014
   
2013
   
2014
   
2013
 
Net income attributable to Pope Resources' unitholders
  $ 1,846     $ 6,128     $ 14,087     $ 9,612  
Less:
                               
Net income attributable to unvested restricted unitholders
    (30 )     (263 )     (175 )     (410 )
Preferred share dividends - ORM Timber Funds
    (8 )     (4 )     (16 )     (8 )
Net income for calculation of EPS
  $ 1,808     $ 5,861     $ 13,896     $ 9,194  
                                 
Basic and diluted weighted average units outstanding
    4,391       4,369       4,389       4,367  
                                 
Basic and diluted earnings per unit
  $ 0.41     $ 1.34     $ 3.17     $ 2.11  
 
8.
In January 2014, the Partnership granted 9,966 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. Simultaneous with the restricted unit grant to management, members of our Board of Directors received 3,000 restricted units. 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 vesting period. We recognized $72,000 and $227,000 of equity compensation expense in the second quarter of 2014 and 2013, respectively, and $521,000 and $763,000 for the first half of 2014 and 2013, respectively, related to these incentive compensation programs.
 
9.  
Supplemental disclosure of cash flow information: interest paid, net of amounts capitalized, totaled $1.0 million and $614,000 for the first half of 2014 and 2013, respectively. During the six months ended June 30, 2014, the Partnership paid income taxes of $33,000 and received a net income tax refund of $240,000 in the first six months of 2013.

10.  
The Partnership’s financial instruments include cash and cash equivalents, short-term investments 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 based on current market rates.
 
The Partnership’s and the Funds’ fixed-rate debt collectively have a carrying value of $75.6 million and $75.7 million as of June 30, 2014 and December 31, 2013, respectively.   The estimated fair value of this debt, based on current interest rates for similar instruments (Level 2 inputs in the Fair Value Hierarchy), is approximately $80.8 million and $77.5 million, as of June 30, 2014 and December 31, 2013, respectively.
 
11.
The Partnership had an accrual for estimated environmental remediation costs of $13.0 million and $13.2 million as of June 30, 2014 and December 31, 2013, respectively. The environmental remediation liability represents management’s estimate of payments to be made to monitor and remediate certain areas in and around the townsite/millsite of Port Gamble, and at Port Ludlow, Washington.
 
In December of 2013, a consent decree and Clean-up Action Plan (CAP) related to Port Gamble were finalized with the Department of Ecology (DOE) and filed with Kitsap County Superior Court.  The scope of the clean-up in the final CAP is substantially the same as was contemplated in the second quarter of 2012 when an additional accrual of $12.5 million was recorded. Certain unresolved issues remain; principally related to the degree to which the Department of Natural Resources (DNR), the other potentially liable party (PLP) in Port Gamble, is going to participate in funding the costs of clean-up.
 
 
11

 
 
 
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 costs from $11.4 million to $15.3 million.  The $12.9 million liability recorded by the Company as of June 30, 2014 is based on the 50th percentile within the range, which management considers the best estimate of the most likely outcome.

The environmental liability at June 30, 2014 is comprised of $700,000 that management expects to expend in the next 12 months and $12.3 million thereafter and these amounts are included in other current liabilities and other long-term liabilities, respectively.

Activity in the environmental liability is as follows:

   
Balances at
   
Additions
   
Expenditures
       
   
the Beginning
   
to
   
for
   
Balance at
 
(in thousands)
 
of the Period
   
Accrual
   
Remediation
   
Period-end
 
Year ended December 31, 2012
  $ 2,203     $ 12,500     $ 761     $ 13,942  
Year ended December 31, 2013
    13,942       -       701       13,241  
Quarter ended March 31, 2014
    13,241       -       11       13,230  
Quarter ended June 30, 2014
    13,230       -       203       13,027  

 
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” within the meaning of applicable securities laws, which describe our goals, objectives and anticipated performance. These statements can be identified by words such as “anticipate,” “believe,” “expect,” “intend” and similar expressions. 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; government regulation that affects our ability to access our timberlands and harvest logs from those lands; factors that affect the timing and amounts realized from the sales, if any, of our real estate holdings; the implications of significant indirect sales to overseas customers, including regulatory and tax matters; the effect of financial market conditions on our investment portfolio and related liquidity; the effects of competition, especially from larger, better-financed competitors; 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; the impacts of climate change and natural disasters on our timberlands and on surrounding areas; and the potential impacts of fluctuations in foreign currency rates as they affect demand for our products. 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 and expectations as of the date of the report, and unless required by law, we do not 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 developers 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 development rights in the form of conservation easements (CE’s) on Fee Timber properties to preclude future development. Our third business, which we refer to as Timberland Management, is engaged in organizing and managing private equity timber funds using capital invested by third parties and the Partnership.
 
 
13

 

Our current strategy for adding timberland acreage is centered on our private equity timber fund business model. We have closed and invested capital from three timber funds, with assets under management totaling approximately $302 million based on appraisals as of December 31, 2013. Our 20% co-investments in Funds I and II, and our 5% co-investment in Fund III, which collectively totaled $32 million at time of acquisition, 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 potential future incentive fees, based upon the overall success of each fund. We also believe that this strategy allows us to maintain more sophisticated expertise in timberland acquisition, valuation, and management more cost-effectively than could be maintained for the Partnership’s timberlands alone. We believe our co-investment strategy also enhances our credibility with existing and prospective investors by demonstrating that we have both an operational and a financial commitment to the Funds’ success.

The Funds are consolidated into our financial statements, but then income or loss attributable to equity owned by third parties is removed from consolidated results in our Condensed Consolidated Statements of Comprehensive Income under the caption “Net (income) loss attributable to non-controlling interests-ORM Timber Funds” to arrive at comprehensive income attributable to unitholders of the Partnership.

The challenge for our Real Estate segment centers around how and when to “harvest” parcels of our 2,900-acre portfolio in western Washington to optimize value realization 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.
 
Second quarter highlights

·  
Harvest volume was 26 million board feet (MMBF) in Q2 2014 compared to 27 MMBF in Q2 2013, a 3% decrease.  Harvest volume for the first six months of 2014 was 56 MMBF compared to 53 MMBF for the first half of 2013, a 5% increase.

·  
Average realized log price per thousand board feet (MBF) was $630 in Q2 2014 compared to $620 per MBF in Q2 2013, a 2% increase.  For the first six months of 2014, the average realized log price per MBF was $668 compared to $615 per MBF for the first half of 2013, a 9% increase.

·  
Fund properties contributed 51% of Q2 2014 harvest volume, compared to 53% in Q2 2013.  For the first half of 2014, Fund properties contributed 52% of harvest volume, compared to 44% for the first half of 2013.

·  
As a percentage of total harvest, volume sold to export markets in Q2 2014 was 33%, unchanged from Q2 2013, while harvest volume sold to domestic markets increased slightly to 53% in Q2 2014 from 52% in Q2 2013.  For the first half of the year, the relative percentages of harvest volume sold to export and domestic markets in 2014 were 38% and 49%, respectively, compared to 30% and 56% in 2013.

·  
The percentage of total harvest comprised of Douglas-fir sawlogs dropped to 42% in Q2 2014 from 58% in Q2 2013, with a corresponding increase in the whitewood component to 37% in Q2 2014 from 23% in Q2 2013.  Similarly, for the first half of 2014, the relative mix of Douglas-fir and whitewood was 51% and 29%, respectively, compared to 64% and 18% for the first half of 2013.
 
 
14

 
 
·  
We closed on 8 single-family residential lots in Gig Harbor for a total sales price of $720,000 during Q2 2014, while in 2013’s Q2 we closed on a 2,330-acre conservation land sale for a sales price of $5.7 million.

Outlook

We expect our harvest volume for the full year 2014 to be between 90 and 94 MMBF, with the final total depending on log market conditions for the balance of the year. The projected split of this total annual harvest is approximately 52% from Partnership tree farms and 48% from Fund tree farms.  Log prices thus far in 2014 compare favorably to those realized in recent years.  However, prices softened in the second quarter, primarily resulting from declining demand from export markets.  If export log market conditions remain at current levels, soften further, or the domestic housing recovery slows down, this will translate to weaker results for the second half of the year.

In the first half of 2014, we closed on the sale of a number of Real Estate properties and although we expect to close on several more during 2014, some may slide into early 2015 due to permitting delays.

RESULTS OF OPERATIONS

The following table reconciles and compares key revenue and cost elements that impacted our net income for the respective quarters and six months ended June 30, 2014 and 2013.  The explanatory text that follows the table describes in detail certain of these changes by business segment.

Fee Timber
 
Fee Timber results include operations from 110,000 acres of timberland owned by the Partnership and 91,000 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, northwestern Oregon, and northern California. This revenue source 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 domestic mills or log export brokers. We also occasionally sell rights to harvest timber (timber deed sale) from the Combined tree farms, the revenue from which is included in the Other Revenue column on the below tables. The metrics used to calculate volumes sold and average price realized during the reporting periods exclude the timber deed sales, except where stated otherwise. Harvest volumes are generally expressed in million board feet (MMBF) increments while harvest revenue and related costs are generally expressed in terms of revenue or cost per thousand board feet (MBF). Fee Timber cost of sales, which consist predominantly of harvest, haul, and depletion costs, vary with harvest volume and the resulting revenue. Revenue and cost data related to harvest activities on timberland owned by the Funds are included in this discussion of operations. Fee Timber revenue,  is also derived from commercial thinning operations, ground leases for cellular communication towers, and royalties from gravel mines and quarries, all of which are included in Other Revenue below.
 
When discussing our Fee Timber operations, we compare the current quarter results to both the previous quarter and the corresponding quarter of the prior year, as well as the current year-to-date results to the prior year-to-date. These comparisons provide an opportunity to depict harvest volume and log price trends that affect Fee Timber operating results. Revenue and operating income for the Fee Timber segment for the quarters ended June 30, 2014, March 31, 2014, and June 30, 2013 were as follows:
 
 
15

 
 
(in millions)
Quarter ended
 
Log Sale
Revenue
   
Other
Revenue
   
Total Fee
Timber
Revenue
   
Operating
Income
   
Harvest
Volume
(MMBF)
 
Partnership tree farms
  $ 7.9     $ 0.8     $ 8.7     $ 3.0       12.7  
Funds' tree farms
    8.5       0.3       8.8       2.0       13.4  
Total Fee Timber June 30, 2014
  $ 16.4     $ 1.1     $ 17.5     $ 5.0       26.1  
                                         
Partnership tree farms
  $ 10.2     $ 0.9     $ 11.1     $ 6.1       13.9  
Funds' tree farms
    10.7       0.3       11.0       3.1       15.9  
Total Fee Timber March 31, 2014
  $ 20.9     $ 1.2     $ 22.1     $ 9.2       29.8  
                                         
Partnership tree farms
  $ 8.1     $ 0.3     $ 8.4     $ 3.8       12.9  
Funds' tree farms
    8.6       0.1       8.7       1.4       14.0  
Total Fee Timber June 30, 2013
  $ 16.7     $ 0.4     $ 17.1     $ 5.2       26.9  
 
Comparing Q2 2014 to Q1 2014. Fee Timber revenue in Q2 2014 decreased $4.6 million, or 21%, from $22.1 million in Q1 2014 to $17.5 million in Q2 2014. Weaker log prices in both the domestic and export log markets and a second quarter slowdown from our first quarter front-loading of planned annual harvest volume combined to result in a 13% reduction in harvest volume along with a 10% decrease in average realized log prices. Log inventories expanded at Asian ports earlier in the year as demand for logs failed to keep pace with log imports, which in turn pulled down domestic log prices as demand from the U.S. housing market was insufficient to offset the decline in demand from export markets. The largest component of Other Revenue in both quarters is from commercial thinning operations. Commercial thinning consists of the selective cutting of timber stands not yet of optimal harvest age.  However, they do have some commercial value, thus allowing us to earn revenue while at the same time improving the growth characteristics of the stand.
 
Comparing Q2 2014 to Q2 2013. Fee Timber revenue was up by $383,000, or 3%, from $17.1 million in Q2 2013 to $17.5 million in Q2 2014. The increase resulted from 2% higher average realized log prices, offset partially by a 3% reduction in harvest volume. Stronger overall demand pushed log prices up in the domestic market, while the decline in harvest volume is attributable to a more concentrated front-loading effort in Q1 2014 versus Q1 2013 to take advantage of strong log prices in the first quarter of 2014.
 
Revenue and operating income for the Fee Timber segment for the six months ended June 30, 2014 and 2013 were as follows:
 
(in millions)
Six Months Ended
 
Log Sale
Revenue
   
Other
Revenue
   
Total Fee
Timber
Revenue
   
Operating
Income
   
Harvest
Volume
(MMBF)
 
Partnership tree farms
  $ 18.1     $ 1.7     $ 19.9     $ 9.2       26.7  
Funds' tree farms
    19.3       0.5       19.7       5.1       29.3  
Total Fee Timber March 31, 2014
  $ 37.4     $ 2.2     $ 39.6     $ 14.3       56.0  
                                         
Partnership tree farms
  $ 18.9     $ 0.6     $ 19.5     $ 9.4       29.9  
Funds' tree farms
    14.0       0.1       14.1       2.2       23.4  
Total Fee Timber June 30, 2013
  $ 32.9     $ 0.7     $ 33.6     $ 11.6       53.3  
 
Comparing YTD 2014 to YTD 2013. Fee Timber revenue for the first half of 2014 exceeded the first six months of 2013 by $6.0 million, or 18%, moving from $33.6 million in 2013 to $39.6 million in 2014.  The improvement was due to a 5% higher harvest volume and 9% higher average realized log prices.  Both the increase in harvest volume and in average log prices resulted from stronger demand from both domestic and export markets compared to a year ago.  The increase in Other Revenue is almost entirely attributable to $1.3 million of revenue from commercial thinning operations in the first half of 2014 which had no counterpart in the first half of 2013.
 
 
16

 
 
Log Volume
 
We harvested the following log volumes by species from the Combined tree farms, exclusive of deed sales, for the quarters ended June 30, 2014, March 31, 2014, and June 30, 2013:
 
Volume (in MMBF)
 
Quarter Ended
 
Sawlogs
   
Jun-14
   
% Total
   
Mar-14
   
% Total
   
Jun-13
   
% Total
 
 
Douglas-fir
    10.9       42 %     18.0       61 %     15.7       58 %
 
Whitewood
    9.6       37 %     6.7       22 %     6.1       23 %
 
Pine
    0.5       2 %     -       0 %     -       0 %
 
Cedar
    0.8       3 %     0.7       2 %     0.4       1 %
 
Hardwood
    0.5       2 %     1.0       3 %     0.8       3 %
Pulpwood
                                               
 
All Species
    3.8       14 %     3.5       12 %     3.9       15 %
Total
      26.1       100 %     29.9       100 %     26.9       100 %
 
Comparing Q2 2014 to Q1 2014. Harvest volume decreased 3.8 MMBF, or 13%, from 29.9 MMBF in Q1 2014 to 26.1 MMBF in Q2 2014. The decrease in the second quarter reflects the very attractive log pricing early in the year which led us to front-load harvest volume in the first quarter. Whitewood harvest volume, as a percent of overall harvest, increased from 22% in Q1 2014 to 37% in Q1 2014, while Douglas-fir harvest volume registered a corresponding decrease from 61% in Q1 2014 to 42% in Q2 2014. This shift in mix from Douglas-fir to whitewood is largely attributable to an increase in whitewood harvest volume coming from the Partnership’s Columbia tree farm during Q2 2014. The small amount of Pine produced during Q2 2014 was harvested from the Funds’ northern California tree farm.
 
 Comparing Q2 2014 to Q2 2013. Harvest volume decreased 0.8 MMBF, or 3%, from 26.9 MMBF in Q2 2013 to 26.1 MMBF in Q2 2014. The decrease is attributable to the harvest front-loading effort in Q1 2014 to take advantage of strong pricing.  Douglas-fir harvest volume, as a percent of overall harvest, decreased from 58% in Q2 2013 to 42% in Q2 2014. Conversely, the component of whitewood harvest volume increased from 23% in Q2 2013 to 37% in Q2 2014.  This shift in mix from Douglas-fir to whitewood is attributable to stronger whitewood prices in Q2 2014 versus Q2 2013 than for Douglas-fir prices in Q2 2014 versus Q2 2013.
 
We harvested the following log volumes by species from the Combined tree farms, exclusive of the aforementioned timber deed sales, for the six months ended June 30, 2014 and 2013:
 
 
17

 
 
Volume (in MMBF)
 
Six Months Ended
 
Sawlogs
   
Jun-14
   
% Total
   
Jun-13
   
% Total
 
 
Douglas-fir
    28.9       51 %     34.0       64 %
 
Whitewood
    16.3       29 %     9.6       19 %
 
Pine
    0.5       1 %     -       0 %
 
Cedar
    1.5       3 %     0.8       1 %
 
Hardwood
    1.5       3 %     1.4       4 %
Pulpwood
                            0 %
 
All Species
    7.3       13 %     7.5       12 %
Total
      56.0       100 %     53.3       100 %
 
Comparing YTD 2014 to YTD 2013. Harvest volume increased 2.7 MMBF, or 5%, from 53.3 MMBF in the first six months of 2013 to 56.0 MMBF in the corresponding period of 2014.   The increase in harvest volume is attributable to stronger demand in both the domestic and export markets compared to a year ago. Douglas-fir harvest volume, as a percentage of overall harvest, decreased from 64% in the 2013 to 51% in 2014.  Conversely, the component of whitewood harvest volume increased from 18% in 2013 to 29% in 2014.  This shift in mix from Douglas-fir to whitewood is attributable to the increase in share of harvest volume coming from Fund properties from 44% in 2013 to 52% in 2014.  The Fund’s properties have a heavier component of whitewood than the Partnership properties.
 
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. Export customers consist of log brokers who sell the logs primarily to Japan, China and, to a lesser degree, Korea.

We realized the following log prices by species for the quarters ended June 30, 2014, March 31, 2014, and June 30, 2013:
 
     
Quarter Ended
 
     
Jun-14
   
Mar-14
   
Jun-13
 
Average price
       
Sawlogs
                   
 
Douglas-fir
  $ 694     $ 765     $ 697  
 
Whitewood
    653       695       620  
 
Pine
    525       -       -  
 
Cedar
    1,270       1,406       1,253  
 
Hardwood
    597       599       521  
Pulpwood
All Species
    281       269       265  
Overall
      630       701       620  
 
 
18

 
 
The following table compares the dollar and percentage change in log prices from Q1 2014 and Q2 2013 to Q2 2014:

     
Change to Q2 2014 from Quarter Ended
 
     
Mar-14
   
Jun-13
 
     
$/MBF
   
%
   
$/MBF
   
%
 
Sawlogs
Douglas-fir
  $ (71 )     -9 %   $ (3 )     0 %
 
Whitewood
    (42 )     -6 %     33       5 %
 
Pine
    n/a       n/a       n/a       n/a  
 
Cedar
    (136 )     -10 %     17       1 %
 
Hardwood
    (2 )     0 %     76       15 %
Pulpwood
All Species
    12       4 %     16       6 %
Overall
      (71 )     -10 %     10       2 %
 
Overall realized log prices in Q2 2014 were 10% lower than Q1 2014 and 2% higher than Q2 2013. Our overall average is influenced heavily by price movements for Douglas-fir and whitewood.  From Q1 2014 to Q2 2014, export log prices for these two species declined following a buildup of log inventories at Asian ports earlier in the year, which in turn also pulled down domestic log prices as demand from the U.S. housing market was not strong enough to compensate from the decline in demand from the export market. While log prices weakened from Q1 2014 to Q2 2014, log prices have generally improved in 2014 over 2013.  From Q2 2013 to Q2 2014, the slight decline in Douglas-fir prices was due to a lower quality mix of saw logs sold relative to other less valuable products from this species in the current year and whitewood log prices were up due to stronger overall demand in both the domestic and export markets.
 
The following table compares realized log prices by species for the first six months of 2014 and 2013, as well as the dollar and percentage change in log prices between the two periods:

 
     
Six Months Ended
 
     
Jun-14
               
Jun-13
 
           
∆ from Jun-14 to Jun-13
       
           
$/MBF
   
%
       
Sawlogs
Douglas-fir
 
$
738
   
$
56
     
8
%
 
$
682
 
 
Whitewood
   
670
     
62
     
10
%
   
608
 
 
Pine
   
526
     
526
     
n/a
     
-
 
 
Cedar
   
1,337
     
148
     
12
%
   
1,189
 
 
Hardwood
   
598
     
78
     
15
%
   
520
 
Pulpwood
All Species
   
275
     
0
     
0
%
   
275
 
Overall
     
668
     
53
     
9
%
   
615
 
 
Overall realized log prices increased 9%, from $615/MBF in the first six months of 2013 to $668/MBF in the corresponding period of 2014. Again, the overall average is heavily influenced by price movements for Douglas-fir and whitewood, both of which improved in the current year due to stronger demand in the domestic and export markets.

Douglas-fir: Douglas-fir is noted for its structural characteristics that make it generally preferable to other softwoods for construction grade lumber and plywood. Demand and price for Douglas-fir sawlogs have historically been driven largely by the level of new home construction in the United States. Since late 2009, however, increased demand from China has also been a driver of demand and price for Douglas-fir sawlogs. Log supply at Asian ports expanded earlier in the year when demand for logs failed to keep pace with the log volume received into Asian ports which served to lower realized Douglas-fir prices $71/MBF, or 9%, in Q2 2014 versus Q1 2014.  When comparing the current quarter to the comparable period in the prior year,  notwithstanding increased demand in both the domestic and export markets in 2014, a less valuable mix of saw logs relative to other less valuable products in this species served to slightly lower realized Douglas-fir log prices $3/MBF versus Q2 2013. The realized price increased $56/MBF, or 8%, from the first six months of 2013 as compared to the first six months of 2014 due to increased demand from both the export and domestic markets in 2014 over 2013.
 
 
19

 
 
Whitewood: Whitewood is a term used to describe several softwood species, but for us primarily refers to western hemlock. Though generally considered to be of a lower quality than Douglas-fir, these logs are also used for manufacturing construction grade lumber.  Increased supply at Asian ports due to heavy volumes exported earlier in the year served to lower realized whitewood prices $42/MBF, or 6%, in Q2 2014 versus Q1 2014.  Meanwhile, an overall increase in demand in 2014 compared to 2013 served to lift realized whitewood log prices $33/MBF, or 5%, in Q2 2014 versus Q2 2013. Similarly, the realized price increased $62/MBF, or 10%, from the first six months of 2013 to the first six months of 2014.

Pine: We have added Pine to our species mix with the acquisition of the northern California tree farm by one of our funds. Pine is a species produced primarily on the Funds’ northern California tree farm.  It is used primarily by plywood manufacturers, as well as for the production of construction grade lumber and wood chips. During Q2 2014, pine prices averaged $526/MBF. We had no pine harvest volume in the comparable periods.

Cedar: Cedar is a minor component in most timber stands in our region and is used generally to produce products for outdoor applications such as fencing, siding, and decking. Although there is a link between demand for these products and housing starts, this link is not as strong as with most other softwood species. Cedar prices tend to be seasonal, with manufacturers generally buying volume early in the year to prepare for spring sales associated with repair and remodel projects. As such, average realized log prices for cedar decreased $136/MBF, or 10%, from Q1 2014 to Q2 2014. Compared to Q2 2013, average realized cedar prices were $17/MBF, or 1%, higher in Q2 2014. Increased demand from manufacturers caused cedar prices to increase $148/MBF, or 12%, from the first six months of 2013 to the first six months of 2014.
 
Hardwood: Hardwood is an ancillary product of our Pacific Northwest log harvest volume, and at times this product’s pricing will vary inversely to harvest volume. 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 manufacture lumber for use in furniture and cabinet construction. Given the relatively small volume of hardwood logs that we produce, the quality and species attributes of the volume can have an outsized impact on our price realizations, although of course that same factor means that these variations have relatively little impact on our total Fee Timber revenues. Hardwood prices decreased $2/MBF from Q1 2014 to Q2 2014, and increased $76/MBF, or 15%, from Q2 2013 to Q2 2014.  For the first six months of 2014, hardwood prices were $78/MBF, or 15%, higher than the corresponding period in 2013.
 
Pulpwood: Pulpwood is a lower quality conifer or hardwood log unsuitable for the manufacture of lumber, but useful to produce wood chips for the pulp and paper industry. During the recession, many timberland owners deferred harvest for several years and domestic mills severely curtailed operations. Pulp mills rely on woodchips either from sawmill residuals or chipped from whole logs (pulpwood). Both of these sources were in short supply during the recession. With recent increased production at local sawmills, and commensurate increase in residual woodchips, pulp mills have become less dependent on whole logs which has led to generally declining prices for pulpwood. Notwithstanding this general trend, pulpwood prices increased $12/MBF, or 4%, from Q1 2014 to Q2 2014 and increased $16/MBF, or 6%, from Q2 2013 to Q2 2014. For the first half of 2014, pulpwood prices were unchanged from the first half of 2013.
 
 
20

 
 
Customers

The ultimate decision of whether to sell our logs into the export or domestic market is based on the net proceeds we receive after taking into account both the delivered log prices and the cost to deliver logs to the customer. As such, our reported log price realizations will reflect our properties’ proximity to customers as well as the broader log market.

The table below categorizes logs sold by customer type for the quarters ended June 30, 2014, March 31, 2014, and June 30, 2013:
 
    Q2 2014     Q1 2014     Q2 2013  
   
Volume
         
Volume
         
Volume
       
Destination
 
MMBF
   
%
   
Price
   
MMBF
   
%
   
Price
   
MMBF
   
%