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POPE 10-Q Q2 2015


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, 2015

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)
 
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 July 31, 2015: 4,336,323




Pope Resources
Index to Form 10-Q Filing
For the Six Months Ended June 30, 2015

Description
Page Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




P A R T  I – FINANCIAL INFORMATION
ITEM 1
FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
Pope Resources, a Delaware Limited Partnership
June 30, 2015 and December 31, 2014
(in thousands)
 
2015
 
2014
ASSETS
 
 
 
Current assets
 
 
 
Partnership cash and cash equivalents
$
16,532

 
$
14,505

ORM Timber Funds cash
6,591

 
9,523

Cash and cash equivalents
23,123

 
24,028

Short-term investments
—

 
1,000

Accounts receivable, net
1,022

 
2,419

Land and timber held for sale
2,526

 
7,160

Prepaid expenses and other
5,380

 
2,873

    Total current assets
32,051

 
37,480

Properties and equipment, at cost
 

 
 

   Timber and roads, net of accumulated depletion (2015 -  $98,227; 2014 - $93,359)
225,737

 
227,144

Timberland
48,272

 
47,933

Land held for development
28,879

 
26,040

Buildings and equipment, net of accumulated depreciation (2015 - $7,133; 2014 - $6,849)
5,920

 
6,039

    Total property and equipment, at cost
308,808

 
307,156

 
 
 
 
Other assets
527

 
441

Total assets
$
341,386

 
$
345,077

 
 
 
 
LIABILITIES, PARTNERS' CAPITAL AND NONCONTROLLING INTERESTS
 

 
 

Current liabilities
 

 
 

Accounts payable
$
829

 
$
1,293

Accrued liabilities
3,372

 
3,196

Current portion of long-term debt
5,111

 
5,109

Deferred revenue
731

 
668

Current portion of environmental remediation liability
12,488

 
3,700

Other current liabilities
308

 
248

    Total current liabilities
22,839

 
14,214

Long-term debt, net of current portion
84,816

 
84,872

Environmental remediation and other long-term liabilities
8,733

 
18,362

Partners' capital and noncontrolling interests
 

 
 

General partners' capital (units issued and outstanding 2015 - 60; 2014 - 60)
1,049

 
1,003

Limited partners' capital (units issued and outstanding 2015 - 4,238; 2014 - 4,224)
66,433

 
63,213

Noncontrolling interests
157,516

 
163,413

    Total partners' capital and noncontrolling interests
224,998

 
227,629

Total liabilities, partners' capital and noncontrolling interests
$
341,386

 
$
345,077

See accompanying notes to condensed consolidated financial statements.

3


CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
Pope Resources, a Delaware Limited Partnership
For the Three and Six Months Ended June 30, 2015 and 2014
(in thousands, except per unit data)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Revenue
$
13,904

 
$
18,583

 
$
40,812

 
$
56,362

Cost of sales
(8,815
)
 
(11,377
)
 
(23,312
)
 
(30,301
)
Operating expenses
(3,711
)
 
(3,619
)
 
(6,859
)
 
(6,904
)
General and administrative expenses
(1,198
)
 
(450
)
 
(2,388
)
 
(1,772
)
Income from operations
180

 
3,137

 
8,253

 
17,385

 
 
 
 
 
 
 
 
Interest expense, net
(777
)
 
(629
)
 
(1,522
)
 
(1,203
)
 
 
 
 
 
 
 
 
Income (loss) before income taxes
(597
)
 
2,508

 
6,731

 
16,182

Income tax expense
(28
)
 
(69
)
 
(368
)
 
(226
)
Net income (loss)
(625
)
 
2,439

 
6,363

 
15,956

 
 
 
 
 
 
 
 
Net (income) loss attributable to noncontrolling interests - ORM Timber Funds
914

 
(593
)
 
1,735

 
(1,869
)
Net and comprehensive income attributable to unitholders    
$
289

 
$
1,846

 
$
8,098

 
$
14,087

 
 
 
 
 
 
 
 
Allocable to general partners
$
4

 
$
25

 
$
113

 
$
193

Allocable to limited partners
285

 
1,821

 
7,985

 
13,894

Net and comprehensive income attributable to unitholders
$
289

 
$
1,846

 
$
8,098

 
$
14,087

 
 
 
 
 
 
 
 
Basic and diluted earnings per unit attributable to unitholders
$
0.06

 
$
0.41

 
$
1.87

 
$
3.17

 
 
 
 
 
 
 
 
Basic and diluted weighted average units outstanding
4,298

 
4,391

 
4,296

 
4,389

 
 
 
 
 
 
 
 
Distributions per unit
$
0.65

 
$
0.65

 
$
1.30

 
$
1.20

See accompanying notes to condensed consolidated financial statements.

4


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Pope Resources, a Delaware Limited Partnership
Six Months Ended June 30, 2015 and 2014
(in thousands)

 
2015
 
2014
Net income
$
6,363

 
$
15,956

Adjustments to reconcile net income to net cash provided by operating activities
 

 
 

Depletion
4,948

 
6,451

Equity-based compensation
580

 
521

Excess tax benefit of equity-based compensation
(5
)
 
—

Depreciation and amortization
314

 
359

Deferred taxes
203

 
94

Cost of land sold
6,503

 
7,618

Gain on disposal of property and equipment
—

 
(1
)
Cash flows from changes in operating accounts
 

 
 

Accounts receivable, net
1,397

 
(1,321
)
Prepaid expenses and other assets
(2,735
)
 
(43
)
Real estate project expenditures
(4,615
)
 
(2,128
)
Accounts payable and accrued liabilities
(288
)
 
(2,040
)
Deferred revenue
64

 
743

Environmental remediation
(572
)
 
(214
)
Other current and long-term liabilities
35

 
(4
)
Net cash provided by operating activities
12,192

 
25,991

 
 
 
 
Cash flows from investing activities
 

 
 

Purchase of short-term investments
—

 
(3,000
)
Maturity of short-term investments
1,000

 
—

Reforestation and roads
(1,098
)
 
(1,083
)
Buildings and equipment
(166
)
 
(142
)
Acquisition of timberland
(2,876
)
 
—

Net cash used in investing activities
(3,140
)
 
(4,225
)
 
 
 
 
Cash flows from financing activities
 

 
 

Repayment of long-term debt
(55
)
 
(55
)
Proceeds from preferred stock issuance - ORM Timber Funds
—

 
125

Payroll taxes paid on unit net settlements
(107
)
 
(196
)
Excess tax benefit of equity-based compensation
5

 
—

Cash distributions to unitholders
(5,637
)
 
(5,343
)
Cash distributions - ORM Timber Funds, net of distributions to Partnership
(4,163
)
 
(5,613
)
Net cash used in financing activities
(9,957
)
 
(11,082
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
(905
)
 
10,684

Cash and cash equivalents at beginning of period
24,028

 
6,960

Cash and cash equivalents at end of period
$
23,123

 
$
17,644

See accompanying notes to condensed consolidated financial statements.


5


POPE RESOURCES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2015

1.
The condensed consolidated balance sheets as of June 30, 2015 and December 31, 2014 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, 2015 and 2014 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, 2014, is derived from the Partnership’s audited consolidated financial statements and notes thereto for the year ended December 31, 2014, 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, 2015.

2.
The financial statements in the Partnership’s 2014 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, 2018.   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.

On April 7, 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance costs, which requires debt issuance costs to be presented in the balance sheet as a direct deduction from the associated liability. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2015, though early adoption is permitted, and the new guidance is to be applied on a retrospective basis. As of June 30, 2015, the Partnership has $242,000 in debt issuance costs that will be reclassified from other assets to long-term debt, net of current portion on the balance sheet when it adopts this standard.

3.
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.

4.
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 investment period. Fund I has sold all its timberland holdings and will terminate in 2015, prior to its scheduled termination in August 2017. Fund II is scheduled to terminate in March 2021 and Fund III will terminate on the tenth anniversary of the completion of its investment period.  Fund III’s investment period will end at the earlier of placement of all committed capital or July 31, 2016.

Pope Resources and ORMLLC together own 20% of Funds I and 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 5 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) loss attributable to noncontrolling interests - ORM Timber Funds.”

The Partnership’s condensed consolidated balance sheet included assets and liabilities of the Funds as of June 30, 2015 and December 31, 2014, which were as follows:
 

6


(in thousands)
June 30, 2015
 
December 31, 2014
Assets:
Cash
$
6,591

 
$
9,523

Other current assets
696

 
1,108

Total current assets
7,287

 
10,631

Properties and equipment, net of accumulated depletion and depreciation (2015 - $30,676; 2014 - $26,738)
226,863

 
230,123

Other long-term assets
145

 
156

Total assets
$
234,295

 
$
240,910

Liabilities and equity:
 

 
 

Current liabilities
$
2,161

 
$
1,891

Long-term debt
57,380

 
57,380

Total liabilities
59,541

 
59,271

Funds' equity
174,754

 
181,639

Total liabilities and equity
$
234,295

 
$
240,910


5.
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, 2015 and 2014:

7


 
Fee Timber
 
 
Three Months Ended
Pope
ORM
Timber
Total Fee
 
Timberland
 
Real
 
 
 
 
June 30,
(in thousands)
Resources
Funds
Timber
 
Management
 
Estate
 
Other
 
Consolidated
2015
 
 
 
 
 
 
 
 
 
 
 
Revenue - internal
$
4,835

$
4,501

$
9,336

 
$
767

 
$
4,665

 
$
—

 
$
14,768

Eliminations
(64
)
—

(64
)
 
(767
)
 
(33
)
 
—

 
(864
)
Revenue - external
4,771

4,501

9,272

 
—

 
4,632

 
—

 
13,904

 
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
(2,301
)
(3,537
)
(5,838
)
 
—

 
(2,977
)
 
—

 
(8,815
)
 
 
 
 
 
 
 
 
 
 
 
 
Operating, general and administrative expenses - internal
(1,206
)
(1,407
)
(2,613
)
 
(849
)
 
(1,084
)
 
(1,227
)
 
(5,773
)
Eliminations
—

767

767

 
64

 
4

 
29

 
864

Operating, general and administrative expenses - external
(1,206
)
(640
)
(1,846
)
 
(785
)
 
(1,080
)
 
(1,198
)
 
(4,909
)
 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - internal
1,328

(443
)
885

 
(82
)
 
604

 
(1,227
)
 
180

Eliminations
(64
)
767

703

 
(703
)
 
(29
)
 
29

 
—

 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - external
$
1,264

$
324

$
1,588

 
$
(785
)
 
$
575

 
$
(1,198
)
 
$
180

 
 
 
 
 
 
 
 
 
 
 
 
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


8


 
Fee Timber
 
 
Six Months Ended
Pope
ORM
Timber
Total Fee
 
Timberland
 
Real
 
 
 
 
June 30,
(in thousands)
Resources
Funds
Timber
 
Management
 
Estate
 
Other
 
Consolidated
2015
 
 
 
 
 
 
 
 
 
 
 
Revenue - internal
$
13,707

$
11,657

$
25,364

 
$
1,601

 
$
15,661

 
$
—

 
$
42,626

Eliminations
(146
)
—

(146
)
 
(1,601
)
 
(67
)
 
—

 
(1,814
)
Revenue - external
13,561

11,657

25,218

 
—

 
15,594

 
—

 
40,812

 
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
(5,908
)
(9,532
)
(15,440
)
 
—

 
(7,872
)
 
—

 
(23,312
)
 
 
 
 
 
 
 
 
 
 
 
 
Operating, general and administrative expenses - internal
(2,301
)
(2,630
)
(4,931
)
 
(1,660
)
 
(2,024
)
 
(2,446
)
 
(11,061
)
Eliminations
—

1,601

1,601

 
146

 
9

 
58

 
1,814

Operating, general and administrative expenses - external
(2,301
)
(1,029
)
(3,330
)
 
(1,514
)
 
(2,015
)
 
(2,388
)
 
(9,247
)
 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - internal
5,498

(505
)
4,993

 
(59
)
 
5,765

 
(2,446
)
 
8,253

Eliminations
(146
)
1,601

1,455

 
(1,455
)
 
(58
)
 
58

 
—

Income (loss) from operations - external
$
5,352

$
1,096

$
6,448

 
$
(1,514
)
 
$
5,707

 
$
(2,388
)
 
$
8,253

 
 
 
 
 
 
 
 
 
 
 
 
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



9


6.
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 the calculation of basic and diluted income per unit:

 
Quarter Ended 
 June 30,
 
Six Months Ended 
 June 30,
(in thousands, except per unit amounts)
2015
 
2014
 
2015
 
2014
Net income attributable to Pope Resources' unitholders
$
289

 
$
1,846

 
$
8,098

 
$
14,087

Less:
 

 
 

 
 

 
 

Net income attributable to unvested restricted unitholders
(25
)
 
(30
)
 
(37
)
 
(175
)
Preferred share dividends - ORM Timber Funds
(8
)
 
(8
)
 
(16
)
 
(16
)
Net income for calculation of EPS
$
256

 
$
1,808

 
$
8,045

 
$
13,896

 
 
 
 
 
 
 
 
Basic and diluted weighted average units outstanding
4,298

 
4,391

 
4,296

 
4,389

 
 
 
 
 
 
 
 
Basic and diluted earnings per unit
$
0.06

 
$
0.41

 
$
1.87

 
$
3.17


7.
In the first quarter of 2015, the Partnership granted 7,550 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 4,500 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. Grants to retirement-eligible individuals on the date of grant are expensed immediately. We recognized $242,000 and $72,000 of equity compensation expense in the second quarter of 2015 and 2014, respectively, and $580,000 and $521,000 for the six months ended June 30, 2015 and 2014, respectively, related to these incentive compensation programs.

8.
Supplemental disclosure of cash flow information: interest paid, net of amounts capitalized, totaled $1.4 million and $1.0 million for the first six months of 2015 and 2014, respectively. The Partnership paid income taxes of $205,000 and $33,000 during the first six months of 2015 and 2014, respectively.

9.
The Partnership’s financial instruments include cash and cash equivalents, short-term investments and accounts receivable, as well as $4.4 million of funds held in escrow included in prepaid expenses and other current assets, 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 $90.0 million as of June 30, 2015 and December 31, 2014.   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 $94.7 million and $96.0 million, as of June 30, 2015 and December 31, 2014, respectively.

10.
The Partnership had an accrual for estimated environmental remediation costs of $21.1 million and $21.7 million as of June 30, 2015 and December 31, 2014, respectively. The environmental remediation liability represents management’s estimate of payments to be made to monitor and remediate certain areas in and around Port Gamble Bay, 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. During the second quarter of 2015, there were two developments with respect to the project: additional cost information obtained from contractor bids for the construction work, and an unfavorable litigation outcome. These two developments offset one another, resulting in no change to the overall estimated project liability, other than for payments made during the quarter.

The design of the remediation project was substantially completed in the second quarter of 2015 and the Partnership received bids from contractors to complete the remediation work. Management's cost estimates for the project are based on these bids.

10


In addition, on June 8, 2015, Kitsap County Superior Court ruled on summary judgment that Washington’s Department of Natural Resources (DNR) did not qualify as an owner or operator of the site and therefore did not have liability under Washington’s Model Toxics Control Act (MTCA). The effect of the court’s ruling is to absolve DNR of any responsibility to contribute to the cost of cleanup at Port Gamble. The Court issued its ruling without making findings of fact or conclusions of law. Management has appealed the Superior Court’s ruling, and believes it has a strong case for overturning the lower court’s decision. While management remains optimistic about the appeal process and the ultimate outcome of this litigation, management has adjusted the liability to reflect its best estimate of the cost of the project without any contribution by DNR.

The environmental remediation liability also includes estimated costs related to a separate remediation effort within the resort community of Port Ludlow. The liability for this project consists primarily of ongoing monitoring activity.

The environmental liability at June 30, 2015 is comprised of $12.5 million that management expects to expend in the next 12 months and $8.6 million thereafter.

Activity in the environmental liability is as follows:
 
 
Balance at
the Beginning
 
Additions
to
 
Expenditures
for
 
Balance at
(in thousands)
of the Period
 
Accrual
 
Remediation
 
Period-end
Year ended December 31, 2013
$
13,942

 
$
—

 
$
701

 
$
13,241

Year ended December 31, 2014
13,241

 
10,000

 
1,590

 
21,651

Quarter ended March 31, 2015
21,651

 
—

 
286

 
21,365

Quarter ended June 30, 2015
$
21,365

 
$
—

 
$
286

 
$
21,079


11.
On August 6, 2015, the Partnership closed on the sale of a multi-family residential parcel for $4.2 million from its Harbor Hill project in Gig Harbor, Washington.


11



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; factors that affect our ability to estimate accurately the extent of our environmental liabilities and the cost of remediating the known areas of exposure; 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 the three private equity funds (“Fund I”, “Fund II”, and “Fund III”, collectively, the “Funds”). Fund I’s assets were sold in 2014, and the fund is expected to terminate in 2015. 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’ timberlands 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 domestic manufacturers and export brokers. The second most significant business in terms of total assets owned is the development and sale of real estate. Real Estate activities primarily take the form of securing permits, entitlements, and, in some cases, installing infrastructure for raw land development and then realizing that land’s value 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 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.

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 $312 million as of June 30, 2015 based on the most recent appraisals. Our 20% co-investments in Funds I and II, and our 5% co-investment in Fund III, which collectively totaled $35 million at time of acquisition, afford us a share of the Funds’ operating cash flows

12


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 sophisticated expertise in timberland acquisition, valuation, and management more cost-effectively than we could maintain 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 2,500-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 15 million board feet (MMBF) in Q2 2015 compared to 26 MMBF in Q2 2014, a 42% decrease. Harvest volume for the first six months of 2015 was 40 MMBF compared to 56 MMBF for 2014, a 29% decrease. These harvest volume figures do not include timber deed sales of 0.6 MMBF sold by Fund III in Q1 2015. The harvest volume and log price realization metrics cited below also exclude these timber deed sales.
•
Average realized log price per thousand board feet (MBF) was $562 in Q2 2015 compared to $630 per MBF in Q2 2014, an 11% decrease. For the first six months of 2015, the average realized log price was $591 per MBF compared to $668 per MBF for 2014, a 12% decrease.
•
Fund properties contributed 52% of Q2 2015 harvest volume, compared to 51% in Q2 2014. For the first six months of 2015, Fund properties contributed 50% of harvest volume, compared to 52% for 2014.
•
As a percentage of total harvest, volume sold to export markets in Q2 2015 decreased to 14% from 33% in Q2 2014, with a correspondingly larger increase in the mix of volume sold to domestic markets to 68% in Q2 2015 from 51% in Q2 2014. For the first six months of 2015, the relative percentages of volume sold to export and domestic markets were 17% and 61%, respectively, compared to 38% and 46%, respectively, in 2014. Hardwood and pulpwood log sales make up the balance of total harvest volume.
•
The percentage of total harvest comprised of Douglas-fir sawlogs increased to 52% in Q2 2015 from 42% in Q2 2014, with a corresponding decrease in the whitewood sawlog component to 20% in Q2 2015 from 37% in Q2 2014. For the first six months of 2015, the relative mix of Douglas-fir and whitewood sawlogs was 48% and 23%, respectively, compared to 51% and 29%, respectively, for 2014.
•
During Q2 2015 we closed on the sale of 33 residential lots from our Harbor Hill project in Gig Harbor, Washington, for $3.3 million as well as a 175-acre conservation land sale for $920,000.

Outlook

Log prices for 2015 reached what we expect to be their lowest point in the second quarter. Due to this weaker pricing environment, we have deferred a portion of our harvest and expect total annual log harvest and stumpage sale volume of between 85 and 90 MMBF for 2015. The majority of this reduction is attributable to tree farms owned by the Funds that are located in areas more strongly influenced by the export market. We expect that log markets will continue to be volatile over the next several quarters, with a strengthening trend overall. This volatility will influence our harvest decisions as the year unfolds.

We expect additional land sales from our Real Estate segment over the remainder of 2015, although the timing of these transactions could be impacted by permitting or other 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, 2015 and 2014.  The explanatory text that follows the table describes in detail certain of these changes by business segment.

13


 
Quarter Ended
 
Six Months
Ended
(in thousands)
June 30,
 
June 30,
Net income attributable to Pope Resources' unitholders:
 
 
 
2015 period
$
289

 
$
8,098

2014 period
1,846

 
14,087

Variance
$
(1,557
)
 
$
(5,989
)
Detail of variance:
 

 
 

Fee Timber
 

 
 

Log volumes (A)
$
(6,930
)
 
$
(10,955
)
Log price realizations (B)
(1,027
)
 
(3,049
)
Timber deed sales
19

 
230

Production costs
3,140

 
4,416

Depletion
1,357

 
1,583

Other Fee Timber
(20
)
 
(47
)
Timberland Management
(275
)
 
(394
)
Real Estate
 

 
 

Land sales
1,644

 
(4,482
)
Conservation easement sales
—

 
4,311

Timber depletion on land sale
194

 
(139
)
Other Real Estate
(311
)
 
10

General & administrative costs
(748
)
 
(616
)
Net interest expense
(148
)
 
(319
)
Income taxes
41

 
(142
)
Noncontrolling interests
1,507

 
3,604

Total variances
$
(1,557
)
 
$
(5,989
)
(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 on 111,000 acres of timberland owned by the Partnership and 80,000 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 timber. Our harvest volume is based typically on manufactured log sales to domestic mills and log export brokers. We also occasionally sell rights to harvest timber (timber deed sale) from the Combined tree farms. 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 revenue is also derived from commercial thinning operations, ground leases for cellular communication towers, and royalties from gravel mines and quarries, all of which, along with timber deed sales, are included in other revenue below. 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 remaining stand of timber.

14



Revenue and operating income for the Fee Timber segment for the quarters ended June 30, 2015, March 31, 2015, and June 30, 2014 were as follows:
 
(in millions)
Quarter ended
 
Log Sale
Revenue
 
Other
Revenue
 
Total Fee
Timber
Revenue
 
Operating
Income
 
Harvest
Volume
(MMBF)
 
Timber Deed Sale Volume (MMBF)
Partnership
 
$
4.1

 
$
0.7

 
$
4.8

 
$
1.3

 
7.2

 
—

Funds
 
4.3

 
0.2

 
4.5

 
0.3

 
7.9

 
—

Total June 2015
 
$
8.4

 
$
0.9

 
$
9.3

 
$
1.6

 
15.1

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
Partnership
 
$
8.3

 
$
0.5

 
$
8.8

 
$
4.1

 
12.5

 
—

Funds
 
6.7

 
0.4

 
7.1

 
0.8

 
12.0

 
0.6

Total March 2015
 
$
15.0

 
$
0.9

 
$
15.9

 
$
4.9

 
24.5

 
0.6

 
 
 
 
 
 
 
 
 
 
 
 
 
Partnership
 
$
7.9

 
$
0.8

 
$
8.7

 
$
3.0

 
12.7

 
—

Funds
 
8.5

 
0.3

 
8.8

 
2.0

 
13.4

 
—

Total June 2014
 
$
16.4

 
$
1.1

 
$
17.5

 
$
5.0

 
26.1

 
—

 
Operating Income
 
Comparing Q2 2015 to Q1 2015.  Operating income decreased $3.3 million, or 67%, from $4.9 million in Q1 2015 to $1.6 million in Q2 2015 as a result of a 38% decrease in harvest volume, an 8% decrease in average realized log prices, and a $362,000 increase in operating expenses. Offsetting a portion of the decrease in harvest volume and prices was a 39% reduction in cost of sales due to the decline in harvest volume.
 
Comparing Q2 2015 to Q2 2014.  Operating income decreased $3.4 million, or 68%, from $5.0 million in Q2 2014 to $1.6 million in Q2 2015, primarily as a result of a 42% decrease in harvest volume and an 11% decrease in average realized log prices. This was offset partially by a 44% decrease in cost of sales and a $265,000 decrease in operating expenses due primarily to the decline in harvest volume.
 
Revenue
 
Comparing Q2 2015 to Q1 2015.  Log sale revenue in Q2 2015 decreased $6.6 million, or 44%, from $15.0 million in Q1 2015 to $8.4 million in Q2 2015. Trends that developed during Q1 2015 continued to dampen log prices during Q2 2015 and we responded by decreasing our harvest volume 38% from Q1 2015 to Q2 2015. Demand from the export market remained weak due to the strength of the U.S. dollar, as well as competition in Japan from European-sourced products and the continued effects in China of reduced credit availability and high log inventories at its ports. Logs that have recently been directed to the export market were diverted to the domestic market, which itself was already well-supplied due to the unseasonably mild weather in the Pacific Northwest during the first half of the year. These regional weather conditions afforded timberland owners excellent access to timber not typically available in the first half of the year. An ongoing, lackluster recovery in the U.S. housing market added further downside price pressure due to weak demand for lumber, which in turn reduced the price that mills were willing to pay for logs. In response to these market conditions, we decided to defer harvest volume to future periods when log prices improve.

Comparing Q2 2015 to Q2 2014.  Log sale revenue in Q2 2015 decreased $8.0 million, or 49%, from $16.4 million in Q2 2014 to $8.4 million in Q2 2015, primarily as a result of a 42% decrease in harvest volume and an 11% decrease in average realized log prices. Factors affecting the log market during Q2 2015, as described in the above paragraph, were in stark contrast to the strong log markets we experienced during Q2 2014 which followed a multi-year cyclical high during the first quarter of 2014. The decrease in other revenue from Q2 2014 to Q2 2015 was primarily attributable to a $260,000 reduction in commercial thinning activity.
 
Revenue and operating income for the Fee Timber segment for the six months ended June 30, 2015 and 2014 were as follows:

15


 
(in millions) Six Months Ended
 
Log Sale Revenue
 
Other Revenue
 
Total Fee Timber Revenue
 
Operating Income
 
Harvest Volume (MMBF)
 
Timber Deed Sale Volume (MMBF)
Partnership
 
$
12.4

 
$
1.2

 
$
13.6

 
$
5.4

 
19.7

 
—

Funds
 
11.0

 
0.6

 
11.6

 
1.1

 
19.9

 
0.6

Total June 2015
 
$
23.4

 
$
1.8

 
$
25.2

 
$
6.5

 
39.6

 
0.6

 
 
 
 
 
 
 
 
 
 
 
 
 
Partnership
 
$
18.1

 
$
1.8

 
$
19.9

 
$
9.2

 
26.7

 
—

Funds
 
19.3

 
0.4

 
19.7

 
5.1

 
29.3

 
—

Total June 2014
 
$
37.4

 
$
2.2

 
$
39.6

 
$
14.3

 
56.0

 
—

 
Operating Income
 
Comparing YTD 2015 to YTD 2014.  Operating income decreased by $7.8 million, or 55%, from $14.3 million in the first six months of 2014 to $6.5 million in the first six months of 2015, primarily as a result of a 29% decrease in harvest volume, a 12% decrease in average realized log prices, and a $436,000 decrease in other revenue attributable to reduced commercial thinning activity. This was offset partially by a 28% decrease in cost of sales and a $565,000 decrease in operating expenses due primarily to the decline in harvest volume.
 
Revenue
 
Comparing YTD 2015 to YTD 2014.  Log sale revenue decreased $14.0 million, or 37%, from $37.4 million in first half of 2014 to $23.4 million in the first half of 2015. The reduction in revenue was the result of a 29% decrease in harvest volume and a 12% decrease in average realized log prices. Log markets during the first half of 2014, particularly in the first quarter, were at a multi-year cyclical high due to strong demand from the export market to Asia, combined with a slowly strengthening domestic market as U.S. housing starts rose to a rate of 1 million units per year. In contrast, export markets in the first half of 2015 have been impacted negatively by unfavorable currency exchange rates, tight credit conditions in China, and high log inventories at Asian ports. These factors combined to drive down export demand and prices. Domestic markets have been affected by unseasonably mild weather in the Pacific Northwest, high log and lumber inventories, and sluggish lumber prices. The $436,000 decrease in other revenue in 2015 compared to 2014 was due primarily to a reduction in commercial thinning revenue.

Log Volume

We harvested the following log volumes by species from the Combined tree farms, exclusive of timber deed sales, for the quarters ended June 30, 2015, June 30, 2014, and March 31, 2015:
 
Volume (in MMBF)
Quarter Ended
 
 
Jun-15
% Total
 
Mar-15
% Total

 
Jun-14
% Total
Sawlogs
Douglas-fir
7.8

52
%
 
11.3

46
%
 
10.9

42
%
 
Whitewood
3.0

20
%
 
6.0

25
%
 
9.6

37
%
 
Pine
1.1

7
%
 
—

—
%
 
0.5

2
%
 
Cedar
0.5

3
%
 
1.3

5
%
 
0.8

3
%
 
Hardwood
0.4

3
%
 
1.5

6
%
 
0.5

2
%
Pulpwood
All Species
2.3

15
%
 
4.4

18
%
 
3.8

14
%
Total
 
15.1

100
%
 
24.5

100
%
 
26.1

100
%
 
Comparing Q2 2015 to Q1 2015. Harvest volume decreased 9.4 MMBF, or 38%, from 24.5 MMBF in Q1 2015 to 15.1 MMBF in Q2 2015. This reduction in harvest volume resulted from deteriorating conditions in both the domestic and export log markets which led us to defer harvest volume until later in the year or, in some cases, next year. In a typical year, we front-load a portion of our annual harvest volume to take advantage of generally stronger log market conditions in the first

16


quarter when winter weather limits access to higher elevation timberlands. Our abundance of lower elevation timberlands affords us this opportunity. This year, however, the Pacific Northwest experienced unseasonably mild weather conditions, largely removing this seasonal opportunity. Looking forward to the balance of the year, these same lower elevation timberlands may allow us to harvest later in the year when harvest activities are curtailed due to extreme fire conditions on higher elevation properties. Lower elevation timberlands subject to marine influence are often able to be harvested in hot, dry conditions when log prices may be elevated due to restricted log supply.

Douglas-fir harvest volume, as a percent of overall harvest, increased from 46% in Q1 2015 to 52% in Q2 2015. Conversely, the component of whitewood harvest volume decreased from 25% in Q1 2015 to 20% in Q2 2015. This shift in species mix was partly attributable to better market demand for Douglas-fir and to mitigate the effect of a weak whitewood market. Pine harvest volume, as a percent of overall harvest, increased from 0% in Q1 2015 to 7% in Q2 2015. The pine volume in Q2 2015 originated almost exclusively from Fund III’s northern California tree farm.
 
 Comparing Q2 2015 to Q2 2014. Harvest volume decreased 11 MMBF, or 42%, from 26.1 MMBF in Q2 2014 to 15.1 MMBF in Q2 2015. The decrease is due to our response to weaker domestic and export markets in Q2 2015 as compared to Q2 2014. Douglas-fir harvest volume, as a percent of overall harvest, increased from 42% in Q2 2014 to 52% in Q2 2015. Conversely, the component of whitewood harvest volume decreased from 37% in Q2 2014 to 20% in Q2 2015. This shift in species mix is in response to market conditions wherein Douglas-fir log prices during Q2 2015 were not affected as dramatically as whitewood by the decrease in demand from China. Pine harvest volume increased from 2% in Q2 2014 to 7% in Q2 2015, almost all of which came from Fund III’s northern California tree farm where the decline in harvest volume in Q2 2015 was more muted than for the Combined tree farms.
 
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, 2015 and 2014:

Volume (in MMBF)
Six Months Ended
 
 
Jun-15
% Total
 
Jun-14
% Total
Sawlogs:
Douglas-fir
19.1

48
%
 
28.9

51
%
 
Whitewood
9.0

23
%
 
16.3

29
%
 
Pine
1.1

3
%
 
0.5

1
%
 
Cedar
1.8

4
%
 
1.5

3
%
 
Hardwood
1.9

5
%
 
1.5

3
%
Pulpwood:
All Species
6.7

17
%
 
7.3

13
%
Total
 
39.6

100
%
 
56.0

100
%
 
Comparing YTD 2015 to YTD 2014. Harvest volume decreased 16.4 MMBF, or 29%, from 56.0 MMBF in the first six months of 2014 to 39.6 MMBF in 2015. The decrease in harvest volume is attributable to our decision to defer harvest volume in light of weaker domestic and export markets in 2015 as compared to 2014. Douglas-fir and whitewood harvest volume, as a percentage of overall harvest, decreased from 51% and 29%, respectively, in 2014 to 48% and 23%, respectively, in 2015.  Conversely, the component of pulpwood and the minor species harvest volume increased from 13% and 7%, respectively, in 2014 to 17% and 12%, respectively, in 2015.  This shift in species mix was a function of harvest units selected in 2015 that contained a higher component of pulpwood and minor species than those in 2014.
 
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.


17


We realized the following log prices by species for the quarters ended June 30, 2015, March 31, 2015, and June 30, 2014:
 
 
 
Quarter Ended
 
 
Jun-15
 
Mar-15
 
Jun-14
Average price realizations (per MBF):
 
 
Sawlogs:
Douglas-fir
$
608

 
$
644

 
$
694

 
Whitewood
541

 
555

 
653

 
Pine
552

 
n/a

 
525

 
Cedar
1,120

 
1,509

 
1,270

 
Hardwood
532

 
646

 
597

Pulpwood:
All Species
322

 
328

 
281

Overall
 
562

 
609

 
630


The following table compares the dollar and percentage change in log prices from each of Q1 2015 and Q2 2014 to Q2 2015:
   
 
 
Change to Q2 2015 from Quarter Ended
 
 
Mar-15
 
Jun-14
 
 
$/MBF
 
%
 
$/MBF
 
%
Sawlogs:
Douglas-fir
$
(36
)
 
(6
%)
 
$
(86
)
 
(12
%)
 
Whitewood
(14
)
 
(3
%)
 
(112
)
 
(17
%)
 
Pine
 n/a

 
 n/a

 
27

 
5.1
%
 
Cedar
(389
)
 
(26
%)
 
(150
)
 
(12
%)
 
Hardwood
(114
)
 
(18
%)
 
(65
)
 
(11
%)
Pulpwood:
All Species
(6
)
 
(2
%)
 
41

 
15
%
Overall
 
(47
)
 
(8
%)
 
(68
)
 
(11
%)
 
Overall realized log prices in Q2 2015 were 8% lower than Q1 2015 and 11% lower than Q2 2014. Our overall average is influenced heavily by price movements for our two most prevalent species on the Combined tree farms, Douglas-fir and whitewood, and the relative mix of harvest volume between those two species. From Q1 2015 to Q2 2015, log prices for these two species declined 6% and 3%, respectively, due to continued deterioration in the fundamentals of the export and domestic markets. The minor species of cedar and hardwood, though only 6% of Q2 2015 production, had significant price decreases which contributed to the overall decrease in average log price. In the case of cedar, the 26% decrease in price is because 45% of the Q2 2015 cedar volume was lower-value incense cedar produced on Fund III’s northern California tree farm, while in Q1 2015 all cedar volume was higher-value western red cedar produced primarily on the Partnership tree farms. In the case of hardwood, the price decrease is attributable to a lower proportion of higher-priced domestic sawlogs from Q1 2015 to Q2 2015.

From Q2 2014 to Q2 2015, the decline in average realized log prices was attributable primarily to a decrease of 12% and 17% for Douglas-fir and whitewood, respectively, due to weaker domestic and export markets in 2015 versus 2014. A 15% increase in pulpwood price served to partially offset the Douglas-fir and whitewood declines.
 

18


The following table compares realized log prices by species for the first six months of 2015 and 2014, as well as the dollar and percentage change in log prices between the two periods:
 
 
 
Six Months Ended
 
 
Jun-15
 
 
 
 
 
Jun-14
 
 
 

 
∆ from Jun-15 to Jun-14
 
 

 
 
 
 
$/MBF
 
%
 
 
Sawlogs:
Douglas-fir
$
629

 
$
(109
)
 
(15
%)
 
$
738

 
Whitewood
550

 
(120
)
 
(18
%)
 
670

 
Pine
551

 
25

 
5
%
 
526

 
Cedar
1,398

 
61

 
5
%
 
1,337

 
Hardwood
623

 
25

 
4
%
 
598

Pulpwood:
All species
326

 
51

 
19
%
 
275

Overall
 
591

 
(77
)
 
(12
%)
 
668

 
Overall realized log prices decreased 12% in the first six months of 2015 compared to the corresponding period of 2014. The overall average is influenced heavily by Douglas-fir and whitewood prices, which were down 15% and 18%, respectively. This weakness was offset partially by a 19% increase in pulpwood prices.

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, 2015, March 31, 2015, and June 30, 2014:

 
Q2 2015
 
Q1 2015
 
Q2 2014
 
Volume
 
 

 
Volume
 
 
 
Volume
 
 
Destination
MMBF
%
 
Price
 
MMBF
%
 
Price
 
MMBF
%
 
Price
Export brokers
2.1

14
%
 
$
604

 
4.7

19
%
 
$
665

 
8.5

33
%
 
$
722

Domestic mills
10.3

68
%
 
608

 
13.9

57
%
 
676

 
13.3

51
%
 
672

Hardwood
0.4

3
%
 
532

 
1.5

6
%
 
646

 
0.5

2
%
 
597

Pulpwood
2.3

15
%
 
322

 
4.4

18
%
 
328

 
3.8

14
%
 
281

Subtotal
15.1

100
%
 
562

 
24.5

100
%
 
609

 
26.1

100
%
 
630

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Timber deed sale
—

 

 
—

 
0.6

 

 
389

 
—

 

 
—

Total
15.1

 

 
 

 
25.1

 

 
 

 
26.1

 

 
 

 
Comparing Q2 2015 to Q1 2015. Volume sold to the export market decreased to 14% of Q2 2015 harvest volume compared to 19% of Q1 2015 volume. Conversely, volume sold to the domestic market increased to 68% of Q2 2015 harvest volume compared to 57% of Q1 2015 harvest volume. This shift is reflective of reduced demand in the export market as well as the harvest of 3.2 MMBF of volume from Fund III’s northern California tree farm, compared to only negligible harvest volume in Q1 2015, all of which was delivered to the domestic market in both periods. In addition, timber deed sale volume declined from 0.6 MMBF of volume in Q1 2015 on Fund III’s southwest Washington tree farm to none in Q2 2015. This is reflective of the tree farm transitioning from timber deed sales to delivered log sales in 2015.

Comparing Q2 2015 to Q2 2014. Volume sold to export brokers as a percentage of total harvest decreased from 33% in Q2 2014 to 14% in Q2 2015. Conversely, volume sold to the domestic market increased from 51% in Q2 2014 to 68% in Q2

19


2015. This large shift in customer mix is attributable to better realized prices in the domestic market as compared to the export market during Q2 2015 due to reduced export demand.

The table below categorizes logs sold by customer type for the six-month periods ended June 30, 2015 and 2014:

 
Six Months Ended
 
June 2015
 
June 2014
 
Volume
 
 
Volume
 
Destination
MMBF
%
Price
 
MMBF
%
Price
Export brokers
6.8

17
%
$
646

 
21.0

38
%
$
765

Domestic mills
24.2

61
%
647

 
26.2

46
%
704

Hardwood
1.9

5
%
623

 
1.5

3
%
598

Pulpwood
6.7

17
%
326

 
7.3

13
%
275

Subtotal
39.6

100
%
591

 
56.0

100
%
668

 
 
 
 
 
 
 
 
Timber deed sale
0.6

 

389

 
—

 
—

Total
40.2

 

 

 
56.0

 
 

 
Comparing YTD 2015 to YTD 2014. Volume sold to export brokers as a percentage of total harvest decreased from 38% in the first six months of 2014 to 17% in 2015.  Conversely, volume sold to the domestic market increased from 46% in the first six months of 2014 to 61% in the comparable period of 2015. Timber deed sales volume of 0.6 MMBF during the first six months of 2015 represented the conclusion of timber deed sale activity on Fund III’s southwest Washington tree farm during Q1 2015 that started in the second half of 2014, as that tree farm transitions to delivered log sales.

Cost of Sales
 
Fee Timber cost of sales, which consist predominantly of harvest, haul and depletion costs, vary with harvest volume.  Commercial thinning costs are the primary component of Other cost of sales in the tables below.
 
Fee Timber cost of sales for the quarters ended June 30, 2015, March 31, 2015, and June 30, 2014, was as follows, with the first table expressing these costs in total dollars and the second table expressing those costs that are driven by volume on a per MBF basis:
 
(in thousands) Quarter Ended
 
Harvest, Haul and Tax
 
Depletion
 
Other
 
Total Fee Timber Cost of Sales
 
Harvest Volume (MMBF)
 
Timber Deed Sale Volume (MMBF)
Partnership
 
$
1,669

 
$
348

 
$
284

 
$
2,301

 
7.2

 
—

Funds
 
2,189

 
1,309

 
39

 
3,537

 
7.9

 
—

Total June 2015
 
$
3,858

 
$
1,657

 
$
323

 
$
5,838

 
15.1

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
Partnership
 
$
2,908

 
$
582

 
$
117

 
$
3,607

 
12.5

 
—

Funds
 
3,136

 
2,629

 
230

 
5,995

 
12.0

 
0.6

Total March 2015
 
$
6,044

 
$
3,211

 
$
347

 
$
9,602

 
24.5

 
0.6

 
 
 
 
 
 
 
 
 
 
 
 
 
Partnership
 
$
3,249

 
$
605

 
$
390

 
$
4,244

 
12.7

 
—

Funds
 
3,505

 
2,409

 
177

 
6,091

 
13.4

 
—