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, 2019
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 | Emerging growth company o | |
Non-accelerated Filer o | Smaller Reporting Company o | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.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
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Depositary Receipts (Units) | POPE | NASDAQ Capital Market |
Partnership units outstanding at July 31, 2019: 4,355,114
Pope Resources
Index to Form 10-Q Filing
For the Six Months Ended June 30, 2019
Description | Page Number |
PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
Pope Resources, a Delaware Limited Partnership
June 30, 2019 and December 31, 2018
(in thousands)
See accompanying notes to condensed consolidated financial statements.
2019 | 2018 | ||||||
ASSETS | |||||||
Current assets | |||||||
Partnership cash | $ | 1,690 | $ | 1,784 | |||
ORM Timber Funds cash | 3,517 | 3,330 | |||||
Cash | 5,207 | 5,114 | |||||
Restricted cash | 773 | 943 | |||||
Total cash and restricted cash | 5,980 | 6,057 | |||||
Accounts receivable, net | 4,884 | 4,670 | |||||
Contract assets | 2,650 | 2,872 | |||||
Land held for sale | 7,857 | 5,697 | |||||
Prepaid expenses and other current assets | 741 | 1,070 | |||||
Total current assets | 22,112 | 20,366 | |||||
Properties and equipment, at cost | |||||||
Timber and roads | 381,322 | 377,970 | |||||
Timberland | 77,050 | 74,267 | |||||
Land held for development | 20,655 | 20,891 | |||||
Buildings and equipment, net of accumulated depreciation (2019 - $7,917; 2018 - $8,223) | 5,601 | 5,500 | |||||
Total property and equipment, at cost | 484,628 | 478,628 | |||||
Other assets | 7,635 | 9,255 | |||||
Total assets | $ | 514,375 | $ | 508,249 | |||
LIABILITIES, PARTNERS’ CAPITAL AND NONCONTROLLING INTERESTS | |||||||
Current liabilities | |||||||
Accounts payable | $ | 2,957 | $ | 2,379 | |||
Accrued liabilities | 4,258 | 5,191 | |||||
Current portion of long-term debt - Partnership | 130 | 128 | |||||
Deferred revenue | 378 | 336 | |||||
Current portion of environmental remediation liability | 847 | 1,082 | |||||
Other current liabilities | 1,326 | 865 | |||||
Total current liabilities | 9,896 | 9,981 | |||||
Long-term debt, net of unamortized debt issuance costs and current portion - Partnership | 98,740 | 93,928 | |||||
Long-term debt, net of unamortized debt issuance costs - Funds | 57,324 | 57,313 | |||||
Environmental remediation and other long-term liabilities | 8,064 | 8,427 | |||||
Partners’ capital and noncontrolling interests | |||||||
General partners' capital (units issued and outstanding 2019 - 60; 2018 - 60) | 910 | 944 | |||||
Limited partners' capital (units issued and outstanding 2019 - 4,260; 2018 - 4,253) | 53,436 | 56,533 | |||||
Noncontrolling interests | 286,005 | 281,123 | |||||
Total partners’ capital and noncontrolling interests | 340,351 | 338,600 | |||||
Total liabilities, partners’ capital and noncontrolling interests | $ | 514,375 | $ | 508,249 | |||
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CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
Pope Resources, a Delaware Limited Partnership
Six Months Ended June 30, 2019 and 2018
(in thousands, except per unit data)
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||
Revenue | $ | 27,975 | $ | 27,912 | $ | 53,017 | $ | 52,899 | |||||||
Cost of sales | (20,835 | ) | (14,575 | ) | (37,443 | ) | (26,875 | ) | |||||||
Operating expenses | (5,175 | ) | (5,225 | ) | (9,469 | ) | (9,334 | ) | |||||||
Environmental remediation expense | — | (2,900 | ) | — | (2,900 | ) | |||||||||
General and administrative expenses | (1,776 | ) | (1,403 | ) | (3,540 | ) | (3,024 | ) | |||||||
Income from operations | 189 | 3,809 | 2,565 | 10,766 | |||||||||||
Interest expense, net | (1,450 | ) | (1,248 | ) | (2,965 | ) | (2,392 | ) | |||||||
Income (loss) before income taxes | (1,261 | ) | 2,561 | (400 | ) | 8,374 | |||||||||
Income tax benefit (expense) | 59 | (29 | ) | (35 | ) | (127 | ) | ||||||||
Net and comprehensive income (loss) | (1,202 | ) | 2,532 | (435 | ) | 8,247 | |||||||||
Net and comprehensive (income) loss attributable to noncontrolling interests - ORM Timber Funds | 3,382 | (2,391 | ) | 5,910 | (2,388 | ) | |||||||||
Net and comprehensive loss attributable to noncontrolling interests - Real Estate | 25 | 58 | 41 | 58 | |||||||||||
Net and comprehensive income attributable to unitholders | $ | 2,205 | $ | 199 | $ | 5,516 | $ | 5,917 | |||||||
Allocable to general partners | $ | 31 | $ | 3 | $ | 77 | $ | 82 | |||||||
Allocable to limited partners | 2,174 | 196 | 5,439 | 5,835 | |||||||||||
Net and comprehensive income attributable to unitholders | $ | 2,205 | $ | 199 | $ | 5,516 | $ | 5,917 | |||||||
Basic and diluted earnings per unit attributable to unitholders | $ | 0.50 | $ | 0.04 | $ | 1.25 | $ | 1.35 | |||||||
Basic and diluted weighted average units outstanding | 4,323 | 4,320 | 4,324 | 4,320 | |||||||||||
Distributions per unit | $ | 1.00 | $ | 0.70 | $ | 2.00 | $ | 1.40 | |||||||
See accompanying notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL AND NONCONTROLLING INTERESTS (Unaudited)
Pope Resources, a Delaware Limited Partnership
Six Months Ended June 30, 2019 and 2018
(in thousands)
Attributable to Pope Resources | ||||||||||||||||||
Units | General Partners | Limited Partners | Noncontrolling Interests | Total | ||||||||||||||
December 31, 2018 | 4,313 | $ | 944 | $ | 56,533 | $ | 281,123 | $ | 338,600 | |||||||||
Net income (loss) | — | 46 | 3,265 | (2,544 | ) | 767 | ||||||||||||
Cash distributions | — | (61 | ) | (4,305 | ) | (3,076 | ) | (7,442 | ) | |||||||||
Capital call | — | — | — | 17,259 | 17,259 | |||||||||||||
Preferred stock issuance | — | — | — | 125 | 125 | |||||||||||||
Equity-based compensation | 17 | 8 | 585 | — | 593 | |||||||||||||
Units issued under distribution reinvestment plan | — | — | 24 | — | 24 | |||||||||||||
Unit repurchases | (3 | ) | — | (166 | ) | — | (166 | ) | ||||||||||
Payroll taxes paid on unit net settlements | (1 | ) | (1 | ) | (78 | ) | — | (79 | ) | |||||||||
March 31, 2019 | 4,326 | $ | 936 | $ | 55,858 | $ | 292,887 | $ | 349,681 | |||||||||
Net income (loss) | — | 31 | 2,174 | (3,407 | ) | (1,202 | ) | |||||||||||
Cash distributions | — | (60 | ) | (4,299 | ) | (3,475 | ) | (7,834 | ) | |||||||||
Equity-based compensation | 1 | 3 | 194 | — | 197 | |||||||||||||
Units issued under distribution reinvestment plan | — | — | 9 | — | 9 | |||||||||||||
Unit repurchases | (7 | ) | — | (500 | ) | — | (500 | ) | ||||||||||
June 30, 2019 | 4,320 | $ | 910 | $ | 53,436 | $ | 286,005 | $ | 340,351 | |||||||||
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Attributable to Pope Resources | ||||||||||||||||||
Units | General Partners | Limited Partners | Noncontrolling Interests | Total | ||||||||||||||
December 31, 2017 | 4,311 | $ | 1,028 | $ | 63,519 | $ | 176,079 | $ | 240,626 | |||||||||
Net income (loss) | — | 79 | 5,639 | (3 | ) | 5,715 | ||||||||||||
Cash distributions | — | (42 | ) | (3,010 | ) | (3,481 | ) | (6,533 | ) | |||||||||
Capital call | — | — | — | 92,280 | 92,280 | |||||||||||||
Equity-based compensation | 15 | 7 | 516 | — | 523 | |||||||||||||
Units issued under distribution reinvestment plan | 1 | — | 59 | — | 59 | |||||||||||||
Unit repurchases | (4 | ) | — | (292 | ) | — | (292 | ) | ||||||||||
Payroll taxes paid on unit net settlements | (1 | ) | (1 | ) | (101 | ) | — | (102 | ) | |||||||||
March 31, 2018 | 4,322 | $ | 1,071 | $ | 66,330 | $ | 264,875 | $ | 332,276 | |||||||||
Net income | — | 3 | 196 | 2,333 | 2,532 | |||||||||||||
Cash distributions | — | (43 | ) | (3,008 | ) | (2,842 | ) | (5,893 | ) | |||||||||
Equity-based compensation | — | 3 | 196 | — | 199 | |||||||||||||
Units issued under distribution reinvestment plan | 1 | — | 61 | — | 61 | |||||||||||||
Unit repurchases | (5 | ) | — | (361 | ) | — | (361 | ) | ||||||||||
June 30, 2018 | 4,318 | $ | 1,034 | $ | 63,414 | $ | 264,366 | $ | 328,814 | |||||||||
See accompanying notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Pope Resources, a Delaware Limited Partnership
Six Months Ended June 30, 2019 and 2018
(in thousands)
2019 | 2018 | ||||||
Net income (loss) | $ | (435 | ) | $ | 8,247 | ||
Adjustments to reconcile net income (loss) to net cash provided by operating activities | |||||||
Depletion | 15,578 | 14,141 | |||||
Equity-based compensation | 790 | 722 | |||||
Depreciation and amortization | 398 | 285 | |||||
Cost of land sold | 376 | 75 | |||||
Other | (28 | ) | 36 | ||||
Cash flows from changes in operating accounts | |||||||
Accounts receivable, net | (214 | ) | 2,547 | ||||
Prepaid expenses, contract assets, and other assets | 1,158 | (6,966 | ) | ||||
Real estate project expenditures | (2,298 | ) | (1,232 | ) | |||
Accounts payable and accrued liabilities | (205 | ) | (2,447 | ) | |||
Environmental remediation accruals | — | 2,900 | |||||
Environmental remediation payments | (361 | ) | (885 | ) | |||
Other current and long-term liabilities | 266 | 906 | |||||
Net cash provided by operating activities | 15,025 | 18,329 | |||||
Cash flows from investing activities | |||||||
Reforestation and roads | (1,728 | ) | (1,861 | ) | |||
Capital expenditures | (419 | ) | (462 | ) | |||
Proceeds from sale of property and equipment | 142 | 4 | |||||
Proceeds from insurance recovery | 365 | — | |||||
Investment in unconsolidated real estate joint venture | — | (250 | ) | ||||
Acquisitions of timberland - Partnership | (225 | ) | (6,355 | ) | |||
Acquisitions of timberland - Funds | (19,344 | ) | (108,364 | ) | |||
Net cash used in investing activities | (21,209 | ) | (117,288 | ) | |||
Cash flows from financing activities | |||||||
Line of credit borrowings | 8,886 | 24,300 | |||||
Line of credit repayments | (6,986 | ) | (4,500 | ) | |||
Proceeds from issuance of long-term debt | 3,000 | — | |||||
Repayment of long-term debt | (64 | ) | (61 | ) | |||
Payment of debt issuance costs and prepayment penalty | (125 | ) | — | ||||
Proceeds from unit issuances - distribution reinvestment plan | 33 | 120 | |||||
Unit repurchases | (666 | ) | (653 | ) | |||
Proceeds from preferred stock issuance - ORM Timber Funds | 125 | — | |||||
Payroll taxes paid on unit net settlements | (79 | ) | (102 | ) | |||
Cash distributions to unitholders | (8,725 | ) | (6,103 | ) | |||
Cash distributions - ORM Timber Funds, net of distributions to Partnership | (6,551 | ) | (6,323 | ) | |||
Capital call - ORM Timber Funds, net of Partnership contribution | 17,259 | 92,280 | |||||
Net cash provided by financing activities | 6,107 | 98,958 | |||||
Net increase (decrease) in cash and restricted cash | (77 | ) | (1 | ) | |||
Cash and restricted cash at beginning of period | 6,057 | 5,284 | |||||
Cash and restricted cash at end of period | $ | 5,980 | $ | 5,283 | |||
See accompanying notes to condensed consolidated financial statements.
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POPE RESOURCES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2019
1. | The condensed consolidated balance sheets as of June 30, 2019, and December 31, 2018, and the related condensed consolidated statements of comprehensive income, partners’ capital, and cash flows for the six-month periods ended June 30, 2019, and 2018, 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, 2018, is derived from the Partnership’s audited consolidated financial statements and notes thereto for the year ended December 31, 2018, 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, 2019. |
2. | The financial statements in the Partnership’s 2018 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. |
In February 2016, the FASB established Topic 842, Leases, which requires lessees to recognize leases on the balance sheet and disclose certain information about leasing arrangements. Topic 842 was subsequently amended by ASU No. 2018-01, Land Easement Practical Expedient for Transition to Topic 842; ASU No. 2018-10, Codification Improvements to Topic 842, Leases; and ASU No. 2018-11, Targeted Improvements. The new standard establishes a right-of-use (ROU) model that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases are classified as financing or operating, with classification affecting the pattern and classification of expense recognition in the income statement. For lessors, leases are classified as a sales-type, direct financing, or operating lease.
The Partnership adopted this new standard effective January 1, 2019 and utilized the effective date as the date of initial application. Consequently, financial information was not updated, and the disclosures required under the new standard are not provided for dates and periods prior to January 1, 2019. The new standard provides a number of optional practical expedients in transition. We elected the ‘package of practical expedients’, which permits us to not reassess under the new standard our prior conclusions about lease identification, lease classification, and initial direct costs. We did not elect the use-of-hindsight or the practical expedient pertaining to land easements, the latter not being applicable to us.
The Partnership recognized a ROU asset and lease liability of $294,000 as of January 1, 2019 in connection with the adoption of this standard and all of its leases continue to be classified as operating leases. Accordingly, the adoption of this standard did not have a cumulative effect, or material effect, on the Partnership’s consolidated financial statements.
3. | Revenue is measured based on the consideration specified in a contract with a customer. The Partnership recognizes revenue when it satisfies a performance obligation by transferring control over a product or service to a customer. Included in “Accounts receivable, net” are $3.9 million and $3.0 million of receivables from contracts with customers as of June 30, 2019, and December 31, 2018, respectively. |
Significant changes in the contract asset balance during the period were as follows, and there were no contract liabilities as of June 30, 2019, and December 31, 2018 (in thousands):
Contract assets, December 31, 2018 | $ | 3,829 | |
Revenue recognized from changes in estimates of variable consideration | 194 | ||
Transferred to receivables from contract assets | (1,373 | ) | |
Contract assets, June 30, 2019 | $ | 2,650 | |
The contract assets in the table above represent rights to consideration for timber deeds transferred to the customer and are related primarily to the Funds Timber segment. These contracts provide the customer the legal right to harvest timber on the Partnership’s and Funds’ property. The value of a timber deed contract is determined based on the estimated timber volume by tree species multiplied by the contracted price. The contract consideration is considered variable because the timber volume by species is an estimate until the harvest is completed. The contract assets are transferred to receivables
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when the rights to consideration become due under the contract. Customers may harvest the timber at their discretion, within a time period and operational parameters stated in the contract.
The following is a description of principal activities, separated by reportable segments, from which the Partnership generates its revenue.
Partnership Timber and Funds Timber
Log sale revenue in these two segments is recognized when control is transferred, and title and risk of loss passes to the customer, which typically occurs when logs are delivered to the customer. Revenue in these two segments is earned primarily from the harvest and sale of logs from the Partnership’s and Funds’ timberland. Other revenue in these segments is generated from the sale of rights to harvest timber (timber deed sales), commercial thinning, ground leases for cellular communication towers, royalties from gravel mines and quarries, and land use permits. Timber deed sales are generally structured so that the customer pays a contracted price per volume, measured in thousands of board feet (MBF), and revenue is recognized when control is transferred to the customer, which generally occurs on the effective date of the contract. Commercial thinning consists of the selective cutting of timber stands that have not yet reached optimal harvest age. However, this timber does have some commercial value and revenue is based on the volume harvested. Royalty revenue from gravel mines and quarries is recognized monthly based on the quantity of material extracted.
The following table presents log sale and other revenue for the Partnership Timber and Funds Timber segments:
(in thousands) | Quarter ended June 30, | Six Months Ended June 30, | |||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||
Partnership Timber | |||||||||||||||
Log sale revenue | $ | 13,685 | $ | 5,039 | $ | 28,407 | $ | 19,674 | |||||||
Other revenue | 515 | 531 | 964 | 1,034 | |||||||||||
Total revenue | $ | 14,200 | $ | 5,570 | $ | 29,371 | $ | 20,708 | |||||||
Funds Timber | |||||||||||||||
Log sale revenue | $ | 11,417 | $ | 8,494 | $ | 20,277 | $ | 18,003 | |||||||
Timber deed sale revenue | 194 | 8,865 | 194 | 8,865 | |||||||||||
Other revenue | 1,139 | 558 | 1,719 | 590 | |||||||||||
Total revenue | $ | 12,750 | $ | 17,917 | $ | 22,190 | $ | 27,458 | |||||||
Timberland Investment Management (TIM)
Fee revenue generated by the TIM segment for managing the Funds includes fixed components related to invested capital and acres under management, and a variable component related to harvest volume from the Funds’ tree farms. These fees, which represent an expense in the Funds Timber segment, are eliminated in consolidation. The TIM segment occasionally earns revenue from providing timberland management-related consulting services to third-parties and recognizes such revenue as the related services are provided.
Real Estate
The Real Estate segment’s activities consist of investing in and later selling improved properties, holding properties for later development and sale, and managing commercial properties. Revenue is generated primarily from sales of land, sales of development rights known as conservation easements (CE’s), sales of unimproved land from the Partnership’s timberland portfolio, and residential and commercial rents. Revenue on real estate sales is recorded on the date the sale closes. When a real estate transaction is closed with obligations to complete infrastructure or other construction, the portion of the total contract allocated to the post-closing obligations may be recognized over time as that work is performed, provided the customer either simultaneously receives and consumes the benefits as we perform under the contract, our performance creates or enhances the asset controlled by the customer, or we do not create an asset with an alternative use to the customer and we have an enforceable right to payment for the performance completed. Progress towards the satisfaction of our performance obligations is generally measured based on costs incurred relative to the total cost expected to be incurred for the performance obligations.
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The following table breaks down revenue for the Real Estate segment:
(in thousands) | Quarter ended June 30, | Six Months Ended June 30, | |||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||
Development rights (CE) | $ | — | $ | 3,730 | $ | — | $ | 3,730 | |||||||
Residential land sales | 645 | 151 | 645 | 151 | |||||||||||
Unimproved land | — | 125 | 22 | 125 | |||||||||||
Total land sales | 645 | 4,006 | 667 | 4,006 | |||||||||||
Rentals and other | 380 | 419 | 789 | 727 | |||||||||||
Total revenue | $ | 1,025 | $ | 4,425 | $ | 1,456 | $ | 4,733 | |||||||
4. | The Partnership is both a lessee and a lessor. A contract is determined to contain a lease if there is an identified asset to which the lessee has the right to substantially all of the economic benefits and has control over how the asset is used throughout the contract period. The Partnership elected the practical expedients to not separate lease and non-lease components for all of its leases. |
Lessee lease information
As a lessee, the Partnership’s leases consist of office equipment and office space and are classified as operating leases. Leases for some printers have a variable payment for printing in excess of a page allowance set in the lease contract. The discount rate for leases was determined based on Northwest Farm Credit Services’ (NWFCS), the Partnership’s lender, cost of funds for the lease period plus a margin of 1.60%, as provided for in the Partnership’s credit agreement with NWFCS.
The following table presents the balances of our right-of-use assets and lease liabilities and the balance sheet captions in which they are reported (in thousands):
June 30, 2019 | Balance Sheet caption | ||||
Right of use assets | $ | 224 | Other assets | ||
Lease liability - current | $ | 137 | Other current liabilities | ||
Lease liability - long-term | $ | 87 | Environmental remediation and other long-term liabilities | ||
The following table presents the components of lease costs and other lease information for the quarter ended June 30, 2019:
In thousands, except weighted-average information | Quarter ended June 30, | Six months ended June 30, | |||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||
Lease cost | |||||||||||||||
Operating lease cost | $ | 54 | $ | — | $ | 101 | $ | — | |||||||
Variable lease cost | 2 | — | 4 | — | |||||||||||
Total lease cost | $ | 56 | $ | — | $ | 105 | $ | — | |||||||
Other lease information | |||||||||||||||
Cash paid for amounts included in the measurement of lease liabilities | $ | 56 | $ | — | $ | 105 | $ | — | |||||||
Right-of-use asset obtained in exchange for new leases | $ | — | $ | — | $ | 17 | $ | — | |||||||
Weighted-average remaining lease term in years | 1.8 | ||||||||||||||
Weighted average discount rate | 4.2 | % | |||||||||||||
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Payments due under lease contracts for the next five years and thereafter are as follows (in thousands):
2019 | $ | 143 | |
2020 | 69 | ||
2021 | 18 | ||
2022 | 2 | ||
2023 | — | ||
Thereafter | — | ||
Unamortized discount | (8 | ) | |
Total lease liability at June 30, 2019 | $ | 224 | |
Lessor lease information
As a lessor, the Partnership’s leases consist of leases of commercial and residential real estate, reported in the Real Estate segment under “rentals and other”, and land leases on the Partnership’s and Funds’ timberland for cellular communication towers (Tower Leases), reported in the Partnership Timber and Funds Timber segments under “other revenue”. All these leases are classified as operating leases. Tower Leases have a variable payment component for revenue sharing from subleases of space on the tower. Tower Leases typically have a five-year term and two to five automatic five-year extensions.
Commercial real estate leases have non-lease components of taxes, insurance and common area maintenance. Tower Leases have non-lease components for real property taxes related to tenant improvements.
The following table presents the components of lease income for the three and six months ended June 30, 2019 (in thousands):
(in thousands) | Quarter ended June 30, | Six months ended June 30, | |||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||
Lease Income | |||||||||||||||
Operating lease income | $ | 406 | $ | — | $ | 809 | $ | — | |||||||
Variable lease income | 12 | — | 32 | — | |||||||||||
Total lease income | $ | 418 | $ | — | $ | 841 | $ | — | |||||||
Buildings subject to operating leases had a cost of $2.1 million and accumulated depreciation of $1.2 million at June 30, 2019.
Lease income at June 30, 2019, based on payments due by period under the lease contracts, are presented in the following table (in thousands):
2019 | $ | 842 | |
2020 | 732 | ||
2021 | 669 | ||
2022 | 613 | ||
2023 | 570 | ||
Thereafter | 3,784 | ||
Total | $ | 7,210 | |
5. | The Partnership has two general partners: Pope MGP, Inc. and Pope EGP, Inc. In total, these two entities own 60,000 limited partner units. The allocation of distributions, profits, and losses among the general and limited partners is pro rata across all units outstanding. |
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6. | ORM Timber Fund II, Inc. (Fund II), ORM Timber Fund III (REIT) Inc. (Fund III), and ORM Timber Fund IV LLC (Fund IV), collectively “the Funds”, were formed by Olympic Resource Management LLC (ORMLLC), a wholly owned subsidiary of the Partnership, for the purpose of raising 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 is organized to operate for a specific term from the end of its respective investment period; 10 years for each of Fund II and Fund III, and 15 years for Fund IV. Fund II and Fund III are scheduled to terminate in March 2021 and December 2025, respectively. Fund IV will terminate on the fifteenth anniversary of the end of its investment period, which will occur on the earlier of placement of all committed capital or December 31, 2019, subject to certain extension provisions. |
Pope Resources and ORMLLC together own equity interests totaling 20% of Fund II, 5% of Fund III, and 15% of Fund IV. The Funds are considered variable interest entities because their organizational and governance structures are the functional equivalent of a limited partnership. As the managing member of the Funds, the Partnership is the primary beneficiary of each of the Funds as it has the authority to direct the activities that most significantly impact their economic performance, as well as the right to receive benefits and the obligation to absorb losses that could potentially be significant to the Funds. Accordingly, the Funds are consolidated into the Partnership’s financial statements. The obligations of each of the Funds are non-recourse to the Partnership.
In January 2019, Fund IV closed on the acquisition of 7,100 acres of timberland in south central Washington for $20.3 million, of which the Partnership’s share was $3.0 million. At December 31, 2018, Fund IV had paid a deposit of $1.0 million in connection with the transaction, which was included in other assets. The purchase price was allocated $17.5 million to timber and roads, and $2.8 million to the underlying land.
The assets and liabilities of the Funds as of June 30, 2019, and December 31, 2018, were as follows:
(in thousands) | June 30, 2019 | December 31, 2018 | |||||
Assets: | |||||||
Cash | $ | 3,517 | $ | 3,330 | |||
Contract assets | 2,583 | 2,780 | |||||
Other current assets | 2,283 | 2,151 | |||||
Total current assets | 8,383 | 8,261 | |||||
Properties and equipment, net of accumulated depreciation | 368,815 | 360,163 | |||||
Other long-term assets | — | 1,962 | |||||
Total assets | $ | 377,198 | $ | 370,386 | |||
Liabilities and equity: | |||||||
Current liabilities | $ | 3,916 | $ | 3,237 | |||
Long-term debt, net of unamortized debt issuance costs | 57,324 | 57,313 | |||||
Other long-term liabilities | — | 300 | |||||
Funds’ equity | 315,958 | 309,536 | |||||
Total liabilities and equity | $ | 377,198 | $ | 370,386 | |||
7. | Other assets consisted of the following at June 30, 2019 and December 31, 2018: |
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(in thousands) | June 30, 2019 | December 31, 2018 | |||||
Investment in Real Estate joint venture entity | $ | 5,863 | $ | 5,891 | |||
Advances to Real Estate joint venture entity | 934 | 804 | |||||
Deferred tax assets, net | 553 | 541 | |||||
Right-of-use assets | 224 | — | |||||
Contract assets | — | 957 | |||||
Note receivable | 52 | 57 | |||||
Deposits for acquisitions of timberland | 9 | 1,005 | |||||
Total | $ | 7,635 | $ | 9,255 | |||
8. | 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. |
In the fourth quarter of 2018, the Partnership changed its method of reporting costs incurred by the Partnership Timber segment on behalf of the TIM segment, and reclassified $123,000 of operating expenses for the second quarter of 2018 and $232,000 for the first six months of 2018 from the Partnership Timber segment to the TIM segment to conform to the current year presentation.
Quarter ended June 30, (in thousands) | Partnership Timber | Funds Timber | Timberland Investment Management | Real Estate | Other | Consolidated | ||||||||||||||||||
2019 | ||||||||||||||||||||||||
Revenue - internal | $ | 14,389 | $ | 12,750 | $ | 1,479 | $ | 1,148 | $ | — | $ | 29,766 | ||||||||||||
Eliminations | (189 | ) | — | (1,479 | ) | (123 | ) | — | (1,791 | ) | ||||||||||||||
Revenue - external | 14,200 | 12,750 | — | 1,025 | — | 27,975 | ||||||||||||||||||
Cost of sales | (6,811 | ) | (13,237 | ) | — | (787 | ) | — | (20,835 | ) | ||||||||||||||
Operating, general and administrative expenses - internal | (1,769 | ) | (2,749 | ) | (1,243 | ) | (1,179 | ) | (1,802 | ) | (8,742 | ) | ||||||||||||
Eliminations | 234 | 1,430 | 67 | 34 | 26 | 1,791 | ||||||||||||||||||
Operating, general and administrative expenses - external | (1,535 | ) | (1,319 | ) | (1,176 | ) | (1,145 | ) | (1,776 | ) | (6,951 | ) | ||||||||||||
Income (loss) from operations - internal | 5,809 | (3,236 | ) | 236 | (818 | ) | (1,802 | ) | 189 | |||||||||||||||
Eliminations | 45 | 1,430 | (1,412 | ) | (89 | ) | 26 | — | ||||||||||||||||
Income (loss) from operations - external | $ | 5,854 | $ | (1,806 | ) | $ | (1,176 | ) | $ | (907 | ) | $ | (1,776 | ) | $ | 189 | ||||||||
2018 | ||||||||||||||||||||||||
Revenue - internal | $ | 5,693 | $ | 17,917 | $ | 1,140 | $ | 4,542 | $ | — | $ | 29,292 | ||||||||||||
Eliminations | (123 | ) | — | (1,140 | ) | (117 | ) | — | (1,380 | ) | ||||||||||||||
Revenue - external | 5,570 | 17,917 | — | 4,425 | — | 27,912 | ||||||||||||||||||
Cost of sales | (1,994 | ) | (11,870 | ) | — | (711 | ) | — | (14,575 | ) | ||||||||||||||
Operating, general and administrative expenses - internal | (1,837 | ) | (2,525 | ) | (1,055 | ) | (1,163 | ) | (1,428 | ) | (8,008 | ) | ||||||||||||
Eliminations | 42 | 1,140 | 139 | 34 | 25 | 1,380 | ||||||||||||||||||
Operating, general and administrative expenses -external | (1,795 | ) | (1,385 | ) | (916 | ) | (1,129 | ) | (1,403 | ) | (6,628 | ) | ||||||||||||
Environmental remediation | — | — | — | (2,900 | ) | — | (2,900 | ) | ||||||||||||||||
Income (loss) from operations - internal | 1,862 | 3,522 | 85 | (232 | ) | (1,428 | ) | 3,809 | ||||||||||||||||
Eliminations | (81 | ) | 1,140 | (1,001 | ) | (83 | ) | 25 | — | |||||||||||||||
Income (loss) from operations - external | $ | 1,781 | $ | 4,662 | $ | (916 | ) | $ | (315 | ) | $ | (1,403 | ) | $ | 3,809 | |||||||||
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Six Months Ended June 30, (in thousands) | Partnership Timber | Funds Timber | Timberland Investment Management | Real Estate | Other | Consolidated | ||||||||||||||||||
2019 | ||||||||||||||||||||||||
Revenue - internal | $ | 29,761 | $ | 22,190 | $ | 2,842 | $ | 1,699 | $ | — | $ | 56,492 | ||||||||||||
Eliminations | (390 | ) | — | (2,842 | ) | (243 | ) | — | (3,475 | ) | ||||||||||||||
Revenue - external | 29,371 | 22,190 | — | 1,456 | — | 53,017 | ||||||||||||||||||
Cost of sales | (13,999 | ) | (22,376 | ) | — | (1,068 | ) | — | (37,443 | ) | ||||||||||||||
Operating, general and administrative expenses - internal | (3,086 | ) | (5,238 | ) | (2,533 | ) | (2,035 | ) | (3,592 | ) | (16,484 | ) | ||||||||||||
Eliminations | 479 | 2,741 | 136 | 67 | 52 | 3,475 | ||||||||||||||||||
Operating, general and administrative expenses - external | (2,607 | ) | (2,497 | ) | (2,397 | ) | (1,968 | ) | (3,540 | ) | (13,009 | ) | ||||||||||||
Income (loss) from operations - internal | 12,676 | (5,424 | ) | 309 | (1,404 | ) | (3,592 | ) | 2,565 | |||||||||||||||
Eliminations | 89 | 2,741 | (2,706 | ) | (176 | ) | 52 | — | ||||||||||||||||
Income (loss) from operations - external | $ | 12,765 | $ | (2,683 | ) | $ | (2,397 | ) | $ | (1,580 | ) | $ | (3,540 | ) | $ | 2,565 | ||||||||
2018 | ||||||||||||||||||||||||
Revenue - internal | $ | 20,940 | $ | 27,458 | $ | 2,164 | $ | 4,985 | $ | — | $ | 55,547 | ||||||||||||
Eliminations | (232 | ) | — | (2,164 | ) | (252 | ) | — | (2,648 | ) | ||||||||||||||
Revenue - external | 20,708 | 27,458 | — | 4,733 | — | 52,899 | ||||||||||||||||||
Cost of sales | (7,020 | ) | (18,822 | ) | — | (1,033 | ) | — | (26,875 | ) | ||||||||||||||
Operating, general and administrative expenses - internal | (3,347 | ) | (4,331 | ) | (2,131 | ) | (2,118 | ) | (3,079 | ) | (15,006 | ) | ||||||||||||
Eliminations | 92 | 2,164 | 268 | 69 | 55 | 2,648 | ||||||||||||||||||
Operating, general and administrative expenses - external | (3,255 | ) | (2,167 | ) | (1,863 | ) | (2,049 | ) | (3,024 | ) | (12,358 | ) | ||||||||||||
Environmental remediation | — | — | (2,900 | ) | — | (2,900 | ) | |||||||||||||||||
Income (loss) from operations - internal | 10,573 | 4,305 | 33 | (1,066 | ) | (3,079 | ) | 10,766 | ||||||||||||||||
Eliminations | (140 | ) | 2,164 | (1,896 | ) | (183 | ) | 55 | — | |||||||||||||||
Income (loss) from operations - external | $ | 10,433 | $ | 6,469 | $ | (1,863 | ) | $ | (1,249 | ) | $ | (3,024 | ) | $ | 10,766 | |||||||||
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9. | 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 the Funds, 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 earnings per unit: |
Quarter Ended June 30, | Six Months Ended June 30, | ||||||||||||||
(in thousands, except per unit amounts) | 2019 | 2018 | 2019 | 2018 | |||||||||||
Net and comprehensive income attributable to Pope Resources’ unitholders | $ | 2,205 | $ | 199 | $ | 5,516 | $ | 5,917 | |||||||
Less: | |||||||||||||||
Non-forfeitable distributions paid to unvested restricted unitholders | (38 | ) | (27 | ) | (76 | ) | (53 | ) | |||||||
Preferred share dividends - ORM Timber Funds | (12 | ) | (8 | ) | (23 | ) | (16 | ) | |||||||
Net and comprehensive income for calculation of earnings per unit | $ | 2,155 | $ | 164 | $ | 5,417 | $ | 5,848 | |||||||
Basic and diluted weighted average units outstanding | 4,323 | 4,320 | 4,324 | 4,320 | |||||||||||
Basic and diluted net earnings per unit | $ | 0.50 | $ | 0.04 | $ | 1.25 | $ | 1.35 | |||||||
10. | In the first quarter of 2019, the Partnership issued 11,504 restricted units pursuant to the management incentive compensation program and 3,600 restricted units to members of the Board of Directors. These restricted units vest ratably over four years with the grant date fair value equal to the market price on the date of grant. During the six months ended June 30, 2019, 854 units were granted with no restrictions to certain board members who elected to receive their quarterly board compensation in the form of units rather than cash. Units granted to directors are included in the calculation of total equity compensation expense which is recognized over the vesting period, for restricted units, or immediately for unrestricted units. Grants to retirement-eligible individuals on the date of grant are expensed immediately. The Partnership recognized $197,000 and $199,000 of equity compensation expense in the second quarter of 2019 and 2018, respectively, and $790,000 and $722,000 for the six months ended June 30, 2019 and 2018, respectively, related to these compensation programs. |
11. | Supplemental disclosure of cash flow information: interest paid, net of amounts capitalized, totaled $2.1 million and $2.0 million during the first six months of 2019 and 2018, respectively. Income taxes paid totaled $30,000 and $564,000 for the first six months of 2019 and 2018, respectively. |
12. | The Partnership’s financial instruments include cash, accounts receivable, and a note receivable, included in other assets, for which the carrying amount of each represents fair value based on current market interest rates or their short-term nature. |
Collectively, the Partnership’s and the Funds’ fixed-rate debt has a carrying value of $125.5 million as of June 30, 2019 and December 31, 2018. 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 $132.0 million and $126.3 million as of June 30, 2019 and December 31, 2018, respectively.
13. | The Partnership had an accrual for estimated environmental remediation costs of $8.7 million and $9.1 million as of June 30, 2019 and December 31, 2018, respectively. The environmental remediation liability represents management’s estimate of payments to be made to remedy and monitor certain areas in and around Port Gamble Bay, Washington. The liability at June 30, 2019 is comprised of $847,000 that management expects to expend in the next 12 months and $7.9 million thereafter. |
In December 2013, a consent decree and Clean-up Action Plan (CAP) related to Port Gamble Bay were finalized with the Washington State Department of Ecology (DOE) and filed with Kitsap County Superior Court. Construction activity commenced in late September 2015 and the required in-water portion of the cleanup was completed in January 2017. By the end of the third quarter of 2017, the sediments dredged from the Bay were moved to their permanent storage location on property owned by the Partnership a short distance from the town of Port Gamble. This effectively concluded the component of the project related to the in-water cleanup of Port Gamble Bay.
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In February 2018, the Partnership and DOE entered into an agreed order with respect to the millsite under which the Partnership has performed a remedial investigation and feasibility study (RI/FS) and drafted a CAP. As with the in-water portion of the project, the CAP defines the scope of the remediation activity for the millsite.
As disclosed previously, certain environmental laws allow state, federal, and tribal trustees (collectively, the Trustees) to bring suit against property owners to recover damages for injuries to natural resources. Like the liability that attaches to current property owners in the cleanup context, liability for natural resource damages (NRD) can attach to a property owner simply because an injury to natural resources resulted from releases of hazardous substances on that owner’s property, regardless of culpability for the release. In the case of Port Gamble, the Trustees are alleging that the Partnership has NRD liability because of releases that occurred on its property. The Partnership has been in discussions with the Trustees regarding their claims and the alleged conditions in Port Gamble Bay, and has also been discussing restoration alternatives that might address the damages the Trustees allege. These discussions have progressed to the point where management has identified a short list of restoration projects that may resolve the Trustees’ NRD claims.
The RI/FS and CAP for the millsite will be reviewed by DOE prior to being finalized, which will be codified in a consent decree. For the NRD component of the project, discussions with the Trustees are continuing, and management expects those discussions will ultimately result in a settlement agreement. At present, management expects the CAP and consent decree for the millsite and the NRD settlement agreement to be finalized in 2019. In both cases, it is reasonably possible that cost estimates could change as a result of changes to either the millsite cleanup or the NRD restoration components of the liability, or both. Management currently expects the millsite cleanup and NRD restoration projects to occur over the next two to three years.
Finally, there will be a monitoring period that is expected to be approximately 15 years during which the Partnership will monitor conditions in the Bay, on the millsite, and at the storage location of the dredged and excavated sediments. During this monitoring phase, conditions may arise that require corrective action, and monitoring protocols may change over time. In addition, extreme weather events could cause damage to the sediment caps that would need to be repaired. These factors could result in additional costs.
Activity in the environmental liability is as follows:
(in thousands) | Balance at Beginning of the Period | Additions to Accrual | Expenditures for Remediation | Balance at Period-end | |||||||||||
Year ended December 31, 2017 | $ | 12,770 | $ | — | $ | (7,791 | ) | $ | 4,979 | ||||||
Year ended December 31, 2018 | 4,979 | 5,600 | (1,496 | ) | 9,083 | ||||||||||
Quarter ended March 31, 2019 | 9,083 | — | (158 | ) | 8,925 | ||||||||||
Quarter ended June 30, 2019 | 8,925 | — | (203 | ) | 8,722 | ||||||||||
14. | In April 2019, the Partnership refinanced a $9.8 million debt tranche with Northwest Farm Credit Services that was originally due in September 2019. As refinanced, this debt has an ultimate maturity of April 2031. The $9.8 million refinancing is divided into three tranches with fixed rates, gross of patronage rebates, for specific periods, as follows: |
• | $3.0 million at 4.35% through April 2027 |
• | $3.0 million at 4.51% through April 2029 |
• | $3.8 million at 4.60% through April 2031 |
On the expiration of the fixed-rate periods, the tranches can be repaid or refinanced without penalty, or revert to a floating rate or be fixed at then-current rates for periods not to exceed the ultimate maturity of April 2031. The Partnership paid a prepayment fee of $61,000 in connection with this refinancing.
15. | In August 2019, the Partnership closed on the sale of 65 residential lots from its Harbor Hill project in Gig Harbor, Washington, for $12.0 million. |
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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 expectations, 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. Some of 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. 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 four primary businesses: Partnership Timber, Funds Timber, Timberland Investment Management, and Real Estate.
By far the most significant segments, in terms of owned assets and operations, are our two timber segments, which we refer to as Partnership Timber and Funds Timber. These segments include timberlands owned directly by the Partnership and three private equity funds (“Fund II”, “Fund III”, and “Fund IV”, collectively, the “Funds”), respectively. We refer to the timberland owned by the Partnership as the Partnership’s tree farms, and our Partnership Timber segment reflects operations from those properties. We refer to timberland owned by the Funds as the Funds’ tree farms, and operations from those properties are reported in our Funds Timber segment. When referring collectively to the Partnership’s and Funds’ timberland, we refer to them as the Combined tree farms. Operations in each of these segments consist of growing timber and manufacturing logs for sale to domestic wood products manufacturers and log export brokers.
Our Timberland Investment Management segment is engaged in organizing and managing private equity timber funds using capital invested by third parties and the Partnership. The Funds are consolidated into our financial statements, but then income or loss attributable to equity owned by third parties is subtracted from consolidated results in our Condensed Consolidated Statements of Comprehensive Income under the caption “Net and comprehensive (income) loss attributable to non-controlling interests-ORM Timber Funds” to arrive at “Net and comprehensive income attributable to unitholders”.
Our current strategy for adding timberland acreage is centered primarily on our private equity timber fund business model. However, where it does not conflict with exclusivity provisions with the Funds, we acquire smaller timberland parcels from time to time to add on to the Partnership’s existing tree farms. In addition, during periods when the Funds’ committed capital is fully invested, we may look to acquire larger timberland properties for the Partnership. Our three active timber funds have assets under management totaling approximately $545 million as of June 30, 2019 based on the most recent appraisals. Through our 20% co-investment in Fund II, our 5% co-investment in Fund III, and our 15% co-investment in Fund IV, we have deployed $51 million of Partnership capital. Fund IV, launched in December 2016, is still in its investment period and has not yet placed all of its committed capital. Our co-investment affords 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 on a more cost-effective basis than we could for the Partnership’s timberlands alone. We believe our co-investment strategy also enhances our credibility with existing and prospective Fund investors by demonstrating that we have both an operational and a financial commitment to the Funds’ success.
Our Real Estate segment’s activities primarily include securing permits and entitlements, and in some cases, installing infrastructure for raw land development and then realizing that land’s value by selling larger parcels to developers who, in turn, seek to take the land further up the value chain by either selling homes to retail buyers or lots to developers of commercial
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property. More recently, we have acquired and developed other real estate properties (not previously owned by the Partnership), either on our own or by partnering with another developer in a joint venture. Since these projects often 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 Partnership Timber properties which preclude future development, but allow continued timber operations. The strategy for our Real Estate segment centers around how and when to “harvest”, or sell, a parcel of land to realize its optimal value. In doing so, we seek to balance the long-term risks and costs of carrying and developing a property against the potential for income and cash flows upon sale. Land held for development by our Real Estate segment represents property in western Washington that has been deemed suitable for residential and commercial building sites. Land held for sale includes those properties in the development portfolio that we expect to sell in the next 12 months.
Adjusted EBITDDA
We use Adjusted EBITDDA as a supplemental measure of segment performance. We define Adjusted EBITDDA as earnings before interest, taxes, depletion, depreciation, amortization, gain or loss on timberland sold, and environmental remediation expense. In addition, we reflect Adjusted EBITDDA on an internal reporting basis without eliminating inter-segment activity, which has no net impact on total Adjusted EBITDDA. Accordingly, fees earned from managing the Funds are reflected in the Timberland Investment Management segment and this same amount is reflected as expense in the Funds Timber segment. We believe Adjusted EBITDDA captures the ongoing operations of each of our segments and is a useful supplemental metric to assess the segments’ financial performance. Our definition of Adjusted EBITDDA may be different from similarly titled measures reported by other companies, including those in our industry. Adjusted EBITDDA is not necessarily indicative of the Adjusted EBITDDA that may be generated in future periods. Adjusted EBITDDA is a non-GAAP performance measure which is reconciled to the GAAP measure of operating income in the table below.
Quarter ended June 30, (in thousands) | Partnership Timber | Funds Timber | Timberland Investment Management | Real Estate | Other | Consolidated | ||||||||||||||||||
2019 | ||||||||||||||||||||||||
Income (loss) from operations - external | $ | 5,854 | $ | (1,806 | ) | $ | (1,176 | ) | $ | (907 | ) | $ | (1,776 | ) | $ | 189 | ||||||||
Reversal of segment eliminations | (45 | ) | (1,430 | ) | 1,412 | 89 | (26 | ) | — | |||||||||||||||
Income (loss) from operations - internal | 5,809 | (3,236 | ) | 236 | (818 | ) | (1,802 | ) | 189 | |||||||||||||||
Depletion, depreciation, and amortization | 1,806 | 7,344 | 23 | 65 | — | 9,238 | ||||||||||||||||||
Adjusted EBITDDA | $ | 7,615 | $ | 4,108 | $ | 259 | $ | (753 | ) | $ | (1,802 | ) | $ | 9,427 | ||||||||||
2018 | ||||||||||||||||||||||||
Income (loss) from operations - external | $ | 1,781 | $ | 4,662 | $ | (916 | ) | $ | (315 | ) | $ | (1,403 | ) | $ | 3,809 | |||||||||
Reversal of segment eliminations | 81 | (1,140 | ) | 1,001 | 83 | (25 | ) | — | ||||||||||||||||
Income (loss) from operations - internal | 1,862 | 3,522 | 85 | (232 | ) | (1,428 | ) | 3,809 | ||||||||||||||||
Depletion, depreciation, and amortization | 511 | 8,946 | 17 | 68 | 11 | 9,553 | ||||||||||||||||||
Environmental remediation | — | — | — | 2,900 | — | 2,900 | ||||||||||||||||||
Adjusted EBITDDA | $ | 2,373 | $ | 12,468 | $ | 102 | $ | 2,736 | $ | (1,417 | ) | $ | 16,262 | |||||||||||
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Six Months Ended June 30, (in thousands) | Partnership Timber | Funds Timber | Timberland Investment Management | Real Estate | Other | Consolidated | ||||||||||||||||||
2019 | ||||||||||||||||||||||||
Income (loss) from operations - external | $ | 12,765 | $ | (2,683 | ) | $ | (2,397 | ) | $ | (1,580 | ) | $ | (3,540 | ) | $ | 2,565 | ||||||||
Reversal of segment eliminations | (89 | ) | (2,741 | ) | 2,706 | 176 | (52 | ) | — | |||||||||||||||
Income (loss) from operations - internal | 12,676 | (5,424 | ) | 309 | (1,404 | ) | (3,592 | ) | 2,565 | |||||||||||||||
Depletion, depreciation, and amortization | 3,447 | 12,279 | 42 | 132 | 12 | 15,912 | ||||||||||||||||||
Adjusted EBITDDA | $ | 16,123 | $ | 6,855 | $ | 351 | $ | (1,272 | ) | $ | (3,580 | ) | $ | 18,477 | ||||||||||
2018 | ||||||||||||||||||||||||
Income (loss) from operations - external | $ | 10,433 | $ | 6,469 | $ | (1,863 | ) | $ | (1,249 | ) | $ | (3,024 | ) | $ | 10,766 | |||||||||
Reversal of segment eliminations | 140 | (2,164 | ) | 1,896 | 183 | (55 | ) | — | ||||||||||||||||
Income (loss) from operations - internal | 10,573 | 4,305 | 33 | (1,066 | ) | (3,079 | ) | 10,766 | ||||||||||||||||
Depletion, depreciation, and amortization | 1,836 | 12,369 | 27 | 136 | 25 | 14,393 | ||||||||||||||||||
Environmental remediation | — | — | — | 2,900 | — | 2,900 | ||||||||||||||||||
Adjusted EBITDDA | $ | 12,409 | $ | 16,674 | $ | 60 | $ | 1,970 | $ | (3,054 | ) | $ | 28,059 | |||||||||||
Outlook
We expect 2019 harvest volume will range between 61-65 MMBF for the Partnership, and 78-82 MMBF for the Funds, including timber deed sales. The Partnership volume includes 4-8 MMBF of volume from timber located on real estate properties that is not factored into our long-term, sustainable harvest plan of 57 MMBF. On a look-through basis, accounting for Partnership’s share of the Funds’ results based on its ownership interest in fund, total 2019 harvest volume, including timber deed sales, is expected to be 72-76 MMBF. We expect choppiness at best in log prices over the balance of 2019 with no predictability to easing of U.S. - China trade tensions, although this uncertainty may be mitigated by some weather-related shutdowns as the summer fire season progresses.
In addition to the recently completed sale of the remaining 65 residential lots from our Harbor Hill project in Gig Harbor, Washington, over the second half of 2019 we expect the Partnership to close on the sale of a parcel of timberland in Kitsap County, Washington and an assortment of conservation easement, industrial lot, and residential lot sales.
Timber - Overall
Operations. As of June 30, 2019, overall Timber results include operations on 120,000 acres of timberland owned by the Partnership (Partnership Timber) in western Washington, and 141,000 acres of timberland owned by the Funds (Funds Timber) in western Washington, northwestern Oregon, southwestern Oregon, and northern California.
Timber revenue is earned primarily from the harvest and sale of logs from these timberlands and is driven primarily by the volume of timber harvested and the average log price realized on the sale of those logs. Our harvest volume typically represents delivered log sales to domestic mills and log export brokers. We also occasionally sell rights to harvest timber (timber deed sales) from the Combined tree farms. The metrics used to calculate volumes sold and average price realized during the reporting periods exclude 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).
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. The ultimate decision of whether to sell our logs to the domestic or export 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.
Revenue in our Partnership Timber and Funds Timber segments 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
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other revenue in the tables that follow, and timber deed sales. Commercial thinning consists of the selective cutting of timber stands not yet of optimal harvest age. The smaller diameter logs harvested in these operations do, however, have some commercial value, thus allowing us to earn revenue while at the same time improving the projected value at harvest of the remaining timber in the stand.
Log Prices. During Q2 2019, log prices in the Pacific Northwest decreased slightly from prices realized during Q1 2019, but prices in both quarters were substantially lower than the record highs realized during the first half of 2018. For the Partnership, the overall realized log price for Q2 2019 decreased 2% and 15% relative to Q1 2019 and Q2 2018, respectively. For the Funds, the overall realized log price decreased 7% and 17% relative to Q1 2019 and Q2 2018, respectively.
Log prices in the first half of 2019 were weak in the face of ample supply and weak demand relative to the same period of 2018. West Coast softwood lumber production during Q2 2019 increased 4% from Q1 2019 and decreased 6% from Q2 20181. Lumber inventories have remained high by historical standards in the first half of 2019, as the rate of lumber take-away for new home construction remains tepid. Producers have responded with production curtailments leading to reduced demand for sawlogs.
West Coast break-bulk log exports in Q2 2019 were 3% above Q1 2019 and 28% below Q2 20182, driven primarily by a softening China market related to heightened trade tensions between the U.S. and China. Tariffs on softwood logs from the Pacific Northwest (PNW) region include 5% on Douglas-fir and western hemlock logs (most impactful to us), 10% for spruce logs, 25% for pine logs, and 10% for softwood lumber. Continued trade uncertainty has caused PNW log exporters to remain hesitant to purchase logs given the possibility that they could accumulate excessive log inventories and then be unable to sell them to China due to an increase in the export tariff rate. This has caused a decrease in logs diverted to the export market and conversely an increase in logs available to the domestic market, with both factors contributing to downward pressure on log prices.
Partnership Timber
Partnership Timber operating results for the quarters ended June 30, 2019, March 31, 2019, and June 30, 2018, and the six months ended June 30, 2019, and June 30, 2018, were as follows:
Six Months Ended | |||||||||||||||||||
Q2 2019 | Q1 2019 | Q2 2018 | Jun-19 | Jun-18 | |||||||||||||||
Partnership | |||||||||||||||||||
Overall log price per MBF | $ | 618 | $ | 629 | $ | 726 | $ | 623 | $ | 765 | |||||||||
Total volume (in MMBF) | 22.2 | 23.4 | 6.9 | 45.6 | 25.7 | ||||||||||||||
(in thousands) | |||||||||||||||||||
Log sale revenue | $ | 13,685 | $ | 14,722 | $ | 5,039 | $ | 28,407 | $ | 19,674 | |||||||||
Other revenue | 515 | 449 | 531 | 964 | 1,034 | ||||||||||||||
Total revenue | 14,200 | 15,171 | 5,570 | 29,371 | 20,708 | ||||||||||||||
Cost of sales | (6,811 | ) | (7,188 | ) | (1,994 | ) | (13,999 | ) | (7,020 | ) | |||||||||
Operating expenses | (1,535 | ) | (1,072 | ) | (1,795 | ) | (2,607 | ) | (3,255 | ) | |||||||||
Operating income | $ | 5,854 | $ | 6,911 | $ | 1,781 | $ | 12,765 | $ | 10,433 | |||||||||
Operating Income
Comparing Q2 2019 to Q1 2019. Operating income decreased by $1.1 million, or 15%, from Q1 2019, driven by decreases of 5% in total harvest volume and 2% in the weighted-average realized log price and a $463,000 increase in operating expenses.
1 Random Lengths Yardstick, June 2019
2 Jones Stevedoring Company Monthly Breakbulk Log Export Report, June 2019
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Comparing Q2 2019 to Q2 2018. Operating income increased $4.1 million, or more than threefold, from Q2 2018, driven by a 15.3 MBF, or 222%, increase in total harvest volume, which was partially offset by a 15% decrease in the average realized log price.
Comparing YTD 2019 to YTD 2018. Operating income increased $2.3 million, or