WASHINGTON, D.C.  20549

 

 

FORM 10-Q

 

 

 

 

CROWN PACIFIC PARTNERS, L.P.

(Exact name of registrant as specified in its charter)

 

 

 

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  ý     No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  ý     No  o

 

 

 

CROWN PACIFIC PARTNERS, L.P.

FORM 10-Q

INDEX

 

PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)
	Consolidated Statements of Operations – Three and Six Month Periods Ended June 30, 2004 and 2003
	Consolidated Balance Sheets – June 30, 2004 and December 31, 2003
	Consolidated Statements of Cash Flows – Six Months Ended June 30, 2004 and 2003
	Notes to Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II - OTHER INFORMATION
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
Signatures

 

1

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Crown Pacific Partners, L.P.

(Debtor-in-Possession)

Consolidated Statements of Operations

(In thousands, except unit and per unit data)

(Unaudited)

 

 

		For the Three Months Ended June 30,
		2004			2003
Revenues		$	106,836		$	60,179
Operating costs:
Cost of products sold		87,009			55,313
Loss on disposal of assets		—			1,269
Selling, general and administrative expenses		5,309			6,220
Operating income (loss)		14,518			(2,623		)
Interest expense (excluding contractual interest expense of $12,875 and $0)		180			12,068
Amortization of debt issuance costs		752			640
Other income, net		(289		)	(25		)
Income (loss) from operations before reorganization items		13,875			(15,306		)
Reorganization items:
Professional fees		(1,382		)	(4,860		)
Impairment of assets		(216		)	—
Other		(286		)	(218		)
		(1,884		)	(5,078		)
Income (loss) before discontinued operations		11,991			(20,384		)
Loss on discontinued operations (including gain (loss) on disposal of ($1,198) and $4)		(1,081		)	(519		)
Net income (loss)		$	10,910		$	(20,903	)
Basic and diluted loss per limited partner unit before discontinued operations		$	—		$	(0.66	)
Basic and diluted loss per limited partner unit from discontinued operations		—			(0.02		)
Basic and diluted net loss per limited partner unit		$	—		$	(0.68	)
Weighted average units outstanding		30,527,030			30,527,030

 

See accompanying Notes to Consolidated Financial Statements.

 

2

 

Crown Pacific Partners, L.P.

(Debtor-in-Possession)

Consolidated Statements of Operations

(In thousands, except unit and per unit data)

(Unaudited)

 

		For the Six Months Ended June 30,
		2004			2003
Revenues		$	189,383		$	126,291
Operating costs:
Cost of products sold		156,519			115,819
(Gain) loss on disposal of assets		(18		)	794
Selling, general and administrative expenses		10,713			11,567
Operating income (loss)		22,169			(1,889		)
Interest expense (excluding contractual interest expense of $25,611 and $0)		448			24,020
Amortization of debt issuance costs		1,220			1,063
Other income, net		(343		)	(154		)
Income (loss) from operations before reorganization items		20,844			(26,818		)
Reorganization items:
Professional fees		(3,397		)	(4,860		)
Impairment of assets		(216		)	—
Other		(394		)	(218		)
		(4,007		)	(5,078		)
Income (loss) before discontinued operations		16,837			(31,896		)
Loss on discontinued operations (including gain (loss) on disposal of ($1,198) and $4)		(602		)	(5,522		)
Net income (loss)		$	16,235		$	(37,418	)
Basic and diluted loss per limited partner unit before discontinued operations		$	—		$	(1.03	)
Basic and diluted loss per limited partner unit from discontinued operations		—			(0.18		)
Basic and diluted net loss per limited partner unit		$	—		$	(1.21	)
Weighted average units outstanding		30,527,030			30,527,030

 

See accompanying Notes to Consolidated Financial Statements.

 

3

 

Crown Pacific Partners, L.P.

(Debtor-in-Possession)

Consolidated Balance Sheets

(In thousands, except unit data)

(Unaudited)

 

		June 30,			December 31,
		2004			2003
Assets
Current assets:
Cash and cash equivalents		$	10,446		$	11,028
Accounts receivable, net of allowance of $992 and $862		50,704			43,993
Notes receivable		498			558
Inventories		31,339			27,943
Deposits on timber cutting contracts		2,610			516
Prepaid and other current assets		11,430			12,305
Total current assets		107,027			96,343
Property, plant and equipment, net of accumulated depreciation of $44,880 and $44,390		38,470			41,476
Timber, timberlands and roads, net		299,836			302,737
Other assets		4,710			5,930
Total assets		$	450,043		$	446,486
Liabilities and Partners’ Deficit
Liabilities not subject to compromise:
Current liabilities:
Revolving credit facility		$	14,127		$	23,370
Accounts payable		5,950			4,291
Accrued expenses		7,422			9,194
Current portion of long-term debt		96			123
Total current liabilities		27,595			36,978
Long-term debt		21			86
Other non-current liabilities		—			270
		27,616			37,334
Liabilities subject to compromise		544,243			547,203
Total liabilities		571,859			584,537
Partners’ deficit:
General partners		(121,816		)	(138,051		)
Limited partners (30,527,030 units outstanding at June 30, 2004 and December 31, 2003)		—			—
Total partners’ deficit		(121,816		)	(138,051		)
Total liabilities and partners’ deficit		$	450,043		$	446,486

 

See accompanying Notes to Consolidated Financial Statements.

 

4

 

Crown Pacific Partners, L.P.

(Debtor-in-Possession)

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

		For the Six Months Ended June 30,
		2004			2003
Cash flows from operating activities:
Net income (loss)		$	16,235		$	(37,418	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depletion, depreciation and amortization		9,851			11,283
Deferred interest		—			2,402
Non-cash reorganization items		216			218
Loss on purchase commitments		—			413
Impairment of goodwill		—			5,502
Loss on disposal of assets		1,179			780
Net change in current assets and current liabilities:
Accounts and notes receivable		(16,304		)	4,694
Inventories		(7,329		)	5,148
Deposits on timber cutting contracts		(2,094		)	105
Prepaid and other current assets		150			(2,852		)
Accounts payable and accrued expenses		423			9,485
Net cash provided by (used in) operating activities		2,327			(240		)
Cash flows from investing activities:
Additions to timberlands		(2,605		)	(2,990		)
Additions to timber cutting rights		(10		)	(629		)
Additions to equipment		(300		)	(1,111		)
Proceeds from sale of assets		12,320			7,143
Principal payments received on notes		—			67
Net cash provided by investing activities		9,405			2,480
Cash flows from financing activities:
Net decrease in short-term borrowings		(9,221		)	(6,876		)
Repayments of long-term debt		(3,093		)	(44		)
Net cash used in financing activities		(12,314		)	(6,920		)
Net decrease in cash and cash equivalents		(582		)	(4,680		)
Cash and cash equivalents at beginning of period		11,028			12,993
Cash and cash equivalents at end of period		$	10,446		$	8,313
Supplemental Cash Flow Information
Cash paid for reorganization items		$	3,520		$	—
Cash paid for interest		$	448		$	8,083

 

See accompanying Notes to Consolidated Financial Statements.

 

5

 

CROWN PACIFIC PARTNERS, L.P.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1: Organization and Basis of Presentation

 

Crown Pacific Partners, L.P. (the “Partnership”), a Delaware limited partnership, through its 99% owned subsidiary, Crown Pacific Limited Partnership (the “Operating Partnership”), was formed in 1994 to acquire, own and operate timberlands and wood product manufacturing facilities located in the Northwest United States. The Partnership’s business consists primarily of growing and harvesting timber for sale as logs in domestic and export markets and the manufacturing, selling and distribution of lumber and other wood products.

 

During the second quarter of 2003, the Partnership was unable to meet the financial covenants and scheduled interest payments pursuant to its bank loan and senior note agreements. In addition, the Partnership was unable to successfully negotiate a recapitalization with its bank lenders and senior note holders.  Therefore, on June 29, 2003, the Partnership and all but one of its subsidiaries, Klamath Northern Railway, Co., each filed voluntary petitions for relief under Chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Arizona in Phoenix, Arizona (the “Bankruptcy Court”), case numbers 03-11258-PHX-RJH through 03-11263-PHX-RJH.  These cases are jointly administered under case number 03-11258-PHX-RJH.  The Partnership and its subsidiaries currently manage their properties and operate their businesses as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code.  See Note 2 also.

 

The Partnership has experienced net losses in thirteen of the last fifteen fiscal quarters, and would have reported a net loss in each of the first and second quarters of 2004 if $12.7 million and $12.9 million, respectively, of contractual interest expense had been recognized. The accompanying consolidated financial statements have been prepared assuming that the Partnership will continue as a going concern, and in accordance with Statement of Position 90-7 (“SOP 90-7”), “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code.” As a result of the Chapter 11 filing, there is no assurance that the carrying amounts of assets will be realized or that the liabilities will be settled for the amounts recorded.  Until a plan of reorganization is confirmed by the Bankruptcy Court, the Partnership is not able to determine the ultimate disposition of its assets and liabilities.  All significant intercompany transactions and balances have been eliminated in consolidation.  Certain prior period reclassifications have been made to conform to the current period presentation.

 

Note 2: Chapter 11 Bankruptcy Reorganization

 

During the first two quarters of 2004, the following occurred under the jurisdiction of the Bankruptcy Court:

 

•                  Negotiations on a consensual plan of re-organization with representatives of the senior note holders and acquisition facility banks continued.

•                  A marketing process was conducted regarding the Partnership’s Manufacturing Segment and Alliance Lumber Segment assets.

•                  In April 2004, the Partnership closed the sale of its Alliance Lumber Segment operations in Las Vegas, Nevada.  See Note 10 also.

•                  In June 2004, the Partnership filed motions with the Bankruptcy Court to dispose of the Partnership’s remaining Alliance Lumber Segment operations in Reno, Nevada and in Phoenix, Arizona.  See Note 11 also.

 

See Note 11 also for events in the bankruptcy process which occurred subsequent to June 30, 2004.

 

The creditors on the acquisition facility and senior notes assert that their debt is collateralized by the Partnership’s timberlands and certain real property and equipment associated with its Manufacturing Segment. The remaining liabilities subject to compromise are generally unsecured.  The Chapter 11 filing constitutes a

 

6

 

default or event of default under a number of the Partnership’s debt, lease and other contractual relationships.  While the Partnership is under bankruptcy protection, any scheduled interest or principal payments on debt are deferred and creditors are generally prohibited from pursuing collection of their pre-petition claims by the automatic stay provisions of the Bankruptcy Code.  In accordance with SOP 90-7, the Partnership discontinued accruing interest on its term debt effective June 30, 2003, because it is not probable it will be paid during the bankruptcy proceedings or be an allowed claim.  An additional $12.9 million and $25.6 million, respectively, of interest expense would have been recognized in the three and six month periods ended June 30, 2004, if not for the Chapter 11 bankruptcy petition.

 

On November 10, 2003, a hearing was held in the Bankruptcy Court on a motion from the Partnership, which was opposed by the creditors, to extend the period of exclusivity in which only the Partnership may present a plan of reorganization to the Bankruptcy Court.  At the hearing, the Bankruptcy Court denied the Partnership’s motion, thereby ending the period within which the Partnership had the exclusive right to propose a reorganization plan.  The Partnership is negotiating with the major creditor constituents in its Chapter 11 proceedings, and has begun a process by which the Partnership’s assets and operations will likely be sold or otherwise divested in order to satisfy creditor claims. Management anticipates that the Partnership will file a consensual Chapter 11 plan, jointly with these creditor constituents, that will likely further this divestiture process. It appears highly unlikely that the claims of the holders of the acquisition facility bank debt and senior notes will be satisfied in full. Accordingly, the Chapter 11 plan that is currently under negotiation contemplates the extinguishment of the Partnership units with no recovery to holders of units, and any plan that is ultimately confirmed by the Bankruptcy Court will likely extinguish the equity units. Further, it is likely that any plan that is ultimately confirmed will, in conjunction with any pre-confirmation asset dispositions, result in the disposition of all of the Partnership’s operations and associated assets.

 

Note 3:  Debtor-in-Possession Credit Facility

 

On July 17, 2003 the Bankruptcy Court entered a final financing order approving a $40 million debtor-in-possession credit facility (“DIP Revolver”) with CIT Group/Business Credit (“CIT”).  The $40 million limit is subject to a borrowing base and is collateralized by accounts receivable, inventory and substantially all personal property. The DIP Revolver bears interest at either (a) the Chase Bank Prime Rate plus 0.5% or (b) LIBOR plus 3%, at the option of the Partnership.  Any LIBOR loans are made for fixed one, two or three month terms.  The DIP Revolver terminates on January 1, 2005 or upon the effective date of a Bankruptcy Court approved plan of reorganization and contains certain covenants and restrictions.  As of June 30, 2004, there was $14.1 million outstanding at an interest rate of 4.5% and approximately $25.9 million remained available o n the DIP Revolver.  However, subsequent to June 30, 2004, borrowings and availability under the DIP Revolver have been reduced by the disposition of assets and operations discussed in Note 11.  As of June 30, 2004, the Partnership was in compliance with all of the covenants of the DIP Revolver.

 

Note 4:  Liabilities Subject to Compromise

 

Pursuant to the bankruptcy proceedings, the Partnership has classified certain liabilities which existed prior to the June 29, 2003 bankruptcy petition filing as liabilities subject to compromise in accordance with SOP 90-7.  Disposition and settlement of such liabilities is under the jurisdiction of the Bankruptcy Court.  Certain accounts payable and accrued expenses classified as liabilities subject to compromise have been satisfied through the disposition of the Partnership’s Alliance Lumber operations in Las Vegas, Nevada in April 2004, and additional portions of these liabilities have been further satisfied through the dispositions recorded in July and August of 2004 (see Note 11).

 

7

 

The following table summarizes the pre-petition liabilities that are included as liabilities subject to compromise on the accompanying consolidated balance sheets (in thousands):

 

		June 30, 2004			December 31, 2003
Acquisition facility principal		$	112,372		$	112,372
Senior notes principal		400,658			400,658
Adequate protection payments(1)		(6,000		)	(3,000		)
Accrued interest		21,039			21,039
Deferred enhanced interest		4,927			4,927
Make whole fees and interest		6,360			6,360
Accounts payable		1,163			1,419
Other accrued expenses		3,724			3,428
Total		$	544,243		$	547,203

 

(1)          In October 2003, the Partnership agreed to pay $0.5 million per month, retroactive to July 2003, to the acquisition facility banks and senior note holders as adequate protection payments related to their asserted collateral.  Such payments are to be applied to reduce, on a dollar-for-dollar basis, the aggregate allowed secured claims of the senior note holders and the acquisition facility banks.  The method for allocating the adequate protection payments will be determined by the Bankruptcy Court and, therefore, the Partnership is not able to apply these payments to specific debt components at this time.

 

Note 5: Inventories

 

All inventories, consisting primarily of logs, lumber and building materials, are stated at the lower of average cost or market and consisted of the following (in thousands):

 

		June 30, 2004			December 31, 2003
Lumber		$	4,106		$	3,554
Logs		2,390			1,887
Supplies		3,383			3,326
Manufacturing inventory		9,879			8,767
Distribution products		21,460			19,176
Total		$	31,339		$	27,943

 

Note 6:  Timber, Timberlands and Roads, Net

 

The Partnership updates its timber inventory system annually for changes in estimated volume due to timber verification cruises, timber growth factors and actual harvest levels by species.  The changes to estimated timber volume, along with changes in book value from capitalized expenditures, impairment adjustments and any timber purchase or sale transactions result in a change in estimated depletion rates. The revised estimate made at the beginning of 2004 decreased depletion expense for the three and six month periods ended June 30, 2004 by $0.1 million and $0.3 million, respectively, compared to the depletion rates that were in effect in the comparable periods of 2003, applied to the actual volume harvested in the three and six month periods ended June 30, 2004.

 

Note 7: Allocation of Partnership Losses

 

The Partnership Agreement provides that profit and losses are generally allocated 1.01% to the General Partner interest and 98.99% to the Limited Partner interest.  In addition, the Partnership Agreement specifies that net losses are not allocated to the Limited Partner Interest to the extent doing so would result in (or increase) a deficit balance in their capital accounts. At that point, net losses are allocated 100% to the General Partner interest.  In the third quarter of 2003, the Limited Partners’ capital accounts were reduced to zero, and subsequent income and losses have been allocated 100% to the General Partners.  Accordingly, the General Partner interest was allocated the entire net income that was reported in the three and six month periods ended

 

8

 

June 30, 2004.  In accordance with the Partnership Agreement, 100% of income and losses will continue to be allocated to the General Partners unless and until the cumulative additional losses they have been allocated are fully recovered.

 

Note 8: Unit-Based Compensation

 

The Partnership accounts for unit options using the intrinsic value method as prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.”   Pursuant to SFAS No. 148 “Accounting for Stock-Based Compensation - Transition and Disclosure,” which the Partnership adopted in December 2002, the Partnership has computed, for pro forma disclosure purposes, the impact on net loss and net loss per unit as if it had accounted for its unit-based compensation plans in accordance with the fair value method prescribed by SFAS No. 123 “Accounting for Stock-Based Compensation” as follows (in thousands, except per unit amounts):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Net income (loss), as reported		$	10,910		$	(20,903	)	$	16,235		$	(37,418	)
Deduct - total unit-based employee compensation expense determined under the fair value based method for all awards		(1		)	(8		)	(3		)	(16		)
Net income (loss), pro forma		$	10,909		$	(20,911	)	$	16,232		$	(37,434	)
Basic and diluted net income (loss) per unit:
As reported		$	—		$	(0.68	)	$	—		$	(1.21	)
Pro forma		$	—		$	(0.68	)	$	—		$	(1.21	)

 

No unit options have been granted since 2001.

 

Note 9: Segment Reporting

 

The Partnership classifies its business into three segments: 1) Timberlands, consisting of the operation of tree farms and the harvest and sale of logs to the Partnership’s manufacturing facilities and to third parties, and the sale of timber and timberlands to third parties; 2) Manufacturing, consisting of the manufacture of logs into dimension lumber and the sale of such lumber as well as residual chips and other by-products; and 3) Alliance Lumber, consisting of the distribution and supply of building materials through the Partnership’s professional contractor service yards.  The Corporate and Other category includes general corporate overhead and expenses not allocated to the segments, miscellaneous operations not significant enough to be classified as a separate segment and other items not specifically allocated to the operating segments.

 

The Partnership does not show assets by segment, as historic costs are not used by management to allocate resources or assess performance.

 

9

 

The following summarizes the Partnership’s segment information (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
Revenues		2004			2003			2004			2003
Timberlands:
Trade		$	6,161		$	4,252		$	11,690		$	11,169
Intersegment		3,254			6,257			12,144			15,801
		9,415			10,509			23,834			26,970
Manufacturing:
Trade		32,790			16,611			58,911			38,587
Intersegment		2,036			899			2,888			2,072
		34,826			17,510			61,799			40,659
Alliance Lumber:
Trade		65,185			37,481			113,805			72,261
Intersegment		—			—			—			—
		65,185			37,481			113,805			72,261
Corporate and Other:
Trade		2,700			1,835			4,977			4,274
Intersegment		—			16			—			76
		2,700			1,851			4,977			4,350
Total:
Total revenues		112,126			67,351			204,415			144,240
Less intersegment		(5,290		)	(7,172		)	(15,032		)	(17,949		)
Revenues		$	106,836		$	60,179		$	189,383		$	126,291

 

		Three Months Ended June 30,						Six Months Ended June 30,
Operating income (loss)		2004			2003			2004			2003
Timberlands		$	609		$	226		$	1,214		$	1,005
Manufacturing		11,277			(605		)	18,239			(1,182		)
Alliance Lumber		4,064			2,086			6,431			4,455
Corporate and Other		(1,432		)	(4,330		)	(3,715		)	(6,167		)
Operating income (loss)		14,518			(2,623		)	22,169			(1,889		)
Interest expense		(180		)	(12,068		)	(448		)	(24,020		)
Reorganization expenses		(1,884		)	(5,078		)	(4,007		)	(5,078		)
Other		(463		)	(615		)	(877		)	(909		)
Net income (loss) from continuing operations		$	11,991		$	(20,384	)	$	16,837		$	(31,896	)

 

Note 10:  Discontinued Operations

 

Trading and Distribution Segment

 

In April and May 2003, in two separate transactions, the Partnership sold the inventory and fixed assets related to its Trading and Distribution Segment and discontinued the segment’s operations.  The purchasers of these assets assumed the operating leases, accounts payable and accrued expenses related to these businesses.  The Partnership received cash proceeds of $4.5 million from these asset sales, all of which was immediately applied to outstanding principal on the revolving credit facility. The results of operations of the Trading and Distribution Segment are reflected as discontinued operations on the accompanying consolidated statements of operations for all 2003 periods presented in accordance with Statement of Financial Accounting Standards No. 144 (“SFAS No. 144”) “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

During March 2003, deterioration of the Partnership’s trade credit availability began to adversely affect operating margins in the Trading and Distribution Segment.  Pursuant to the provisions of SFAS No. 142 “Goodwill and Other Intangible Assets,” the Partnership evaluated the goodwill balance of this segment for impairment following the change in circumstances during the first quarter of 2003, utilizing a fair value analysis of the business in the current market environment.  Based on the results of this evaluation, the Partnership determined that its goodwill was impaired and recorded a non-cash impairment charge of $5.5 million in the three months ended March 31, 2003.  This $5.5 million charge is included in discontinued operations.

 

10

 

Summarized financial information for these operations is as follows (in thousands):

 

		Three Months Ended June 30, 2003			Six Months Ended June 30, 2003
External revenues		$	6,333		$	34,140
Operating loss		(482		)	(5,826		)

 

Las Vegas Operations of Alliance Lumber Segment

 

In April 2004, the Partnership closed the sale of its Alliance Lumber Segment operations in Las Vegas, Nevada, resulting in a recognized loss of $1.2 million in the second quarter of 2004.  Results of operations for the Las Vegas operations are reported as discontinued operations for all periods presented in accordance with SFAS No. 144.  Summarized financial information for these operations is as follows (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
External revenues		$	—		$	13,231		$	18,756		$	26,271
Operating income (loss)		117			(41		)	596			300
Gain (loss) on disposal		(1,198		)	4			(1,198		)	4

 

Sale of the net assets of the Las Vegas operations produced cash proceeds of $12.3 million, all of which was immediately paid to CIT to reduce outstanding borrowings under the DIP Revolver.

 

Note 11: Subsequent Events

 

Reno, Nevada Operations of Alliance Lumber Segment

 

On July 13, 2004, the Bankruptcy Court approved a motion filed by the Partnership to sell its Alliance Lumber Segment operations in Reno, Nevada.  This transaction closed in July 2004 and generated $14.2 million of cash, $1.4 million of which was immediately paid to CIT to eliminate outstanding borrowings under the DIP Revolver. No gain or loss was recognized on the transaction.  This disposition reduced the borrowing base and availability on the Partnership’s DIP Revolver (see below).  For income tax purposes, sale of these operations is expected to trigger a deferred taxable gain from the original acquisition transaction, resulting in an income tax liability of approximately $0.5 million, which will be recognized in the third quarter of 2004.  This tax liability is a liability of the wholly-owned C-Corporation subsidiary which made the original acquisition, and would not be allocated to unit holders.

 

Phoenix, Arizona Operations of Alliance Lumber Segment

 

On July 13, 2004, the Bankruptcy Court approved a motion filed by the Partnership to sell its Alliance Lumber Segment operations in Phoenix, Arizona.  This transaction closed in August 2004 and generated $39.4 million of cash. A gain of approximately $1.0 million was recognized on the transaction.  This disposition, along with the earlier Las Vegas and Reno, Nevada dispositions, reduced the DIP Revolver limit from $40.0 million to $20.0 million and also reduced the related borrowing base and availability (see below). For income tax purposes, sale of these operations is expected to trigger a deferred taxable gain from the original acquisition transaction, resulting in an income tax liability of approximately $1.3 million, which will be recognized in the third quarter of 2004.  This tax liability is a liability of the wholly-owned C-Corporation subsidiary which made the original acquisition, and would not be allocated to unit holders.

 

DIP Revolver Availability

 

The DIP Revolver agreement provides that the total borrowing limit is reduced from $40.0 million to $20.0 million following the disposition of the Alliance Lumber Segment, which was completed in August 2004. In addition, borrowings under the DIP Revolver are limited to a borrowing base.  The borrowing base is a function of the levels of related collateral, and has been reduced by the dispositions described above.  As of August 3, 2004, there was zero outstanding and approximately $13.1 million available on the DIP Revolver.

 

11

 

Manufacturing Segment

 

In July 2004, the Partnership signed an Asset Purchase Agreement to sell its Manufacturing Segment operations, subject to higher and better bids and objections under the jurisdiction of the Bankruptcy Court.  On July 13, 2004, the Partnership filed a motion with the Bankruptcy Court for the disposition of these assets. A hearing was held on July 26, 2004, and a motion for the bidding procedures regarding these operations was approved by the Bankruptcy Court.  Any competing bids from interested parties are due at the Bankruptcy Court by August 10, 2004.  A hearing is scheduled for August 18, 2004 with the Bankruptcy Court to conduct an auction, if necessary, after which a motion is expected to be filed for the sale of these operations.  A hearing has been scheduled with the Bankruptcy Court to hear the sale motion on August 19, 2004.  If approved by the Bankruptcy Court, the disposition is expected to close in August or September 2004, resulting in estimated cash proceeds of approximately $57.2 million.  This disposition will further reduce the borrowing base and availability on the Partnership’s DIP Revolver.

 

Item 2.                       Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Chapter 11 Bankruptcy Reorganization

 

During the second quarter of 2003, we were unable to meet the financial covenants and scheduled interest payments pursuant to our bank loan and senior note agreements. In addition, we were unable to successfully negotiate a recapitalization with our bank lenders and senior note holders.  Accordingly, on June 29, 2003, we filed voluntary petitions for relief under Chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Arizona in Phoenix, Arizona (the “Bankruptcy Court”) for the Partnership and all but one of our subsidiaries, Klamath Northern Railway, Co.  We currently manage our properties and operate our businesses as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code.

 

We have experienced net losses in thirteen of the last fifteen fiscal quarters, and would have reported a net loss in the first and second quarters of 2004 if $12.7 million and $12.9 million, respectively, of contractual interest expense had been recognized.  The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern, and in accordance with SOP 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code.”  As a result of our Chapter 11 filing, there is no assurance that the carrying amounts of our assets will be realized or that the liabilities will be settled for the amounts recorded. Until a plan of reorganization is confirmed by the Bankruptcy Court, we are not able to determine the ultimate disposition of our assets and liabilities.

 

During the first two quarters of 2004, the following occurred under the jurisdiction of the Bankruptcy Court:

 

•                  Negotiations on a consensual plan of re-organization with representatives of the senior note holders and acquisition facility banks continued.

•                  A marketing process was conducted regarding the Partnership’s Manufacturing Segment and Alliance Lumber Segment assets.

•                  In April 2004, the Partnership closed the sale of its Alliance Lumber Segment operations in Las Vegas, Nevada.

•                  In June, 2004, the Partnership filed motions with the Bankruptcy Court to dispose of the Partnership’s remaining Alliance Lumber Segment operations in Reno, Nevada and in Phoenix, Arizona.

 

See further discussion below for events in the bankruptcy process which occurred subsequent to June 30, 2004.

 

The creditors on the acquisition facility and senior notes assert that their debt is collateralized by our timberlands and certain real property and equipment associated with our Manufacturing Segment. The remaining liabilities subject to compromise are generally unsecured. The Chapter 11 filing constitutes a default or event of default under a number of our debt, lease and other contractual relationships. While we are under bankruptcy protection, any scheduled interest or principal payments are deferred and creditors are generally prohibited from pursuing collection of their pre-petition claims by the automatic stay provisions of the Bankruptcy Code. In

 

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accordance with SOP 90-7, we stopped accruing interest on our term debt effective June 30, 2003, because it is not probable it will be paid during the bankruptcy proceedings or be an allowed claim. An additional $12.9 million and $25.6 million, respectively, of interest expense would have been recognized in the three and six month periods ended June 30, 2004, if not for the Chapter 11 bankruptcy petition.

 

On November 10, 2003, a hearing was held in the Bankruptcy Court on a motion from us, which was opposed by the creditors, to extend the period of exclusivity in which only we could present a plan of reorganization to the Bankruptcy Court.  At the hearing, the Bankruptcy Court denied our motion, thereby ending the period within which we had the exclusive right to propose a reorganization plan.  We are negotiating with the major creditor constituents in our Chapter 11 proceedings, and have begun a process by which our assets and operations will likely be sold or otherwise divested in order to satisfy creditor claims. We anticipate that we will file a consensual Chapter 11 plan, jointly with these creditor constituents, that will likely further this divestiture process. It appears highly unlikely that the claims of the holders of our acquisition facility bank debt and senior notes will be satisfied in full. Accordingly, the Chapter 11 plan that is currently under negotiation contemplates the extinguishment of our partnership units with no recovery to holders of units, and any plan that is ultimately confirmed by the Bankruptcy Court will likely extinguish the equity units. Further, it is likely that any plan that is ultimately confirmed will, in conjunction with any pre-confirmation asset dispositions, result in the disposition of substantially all of our operations and associated assets.

 

Subsequent Events

 

Reno, Nevada Operations of Alliance Lumber Segment

 

On July 13, 2004, the Bankruptcy Court approved a motion filed by us to sell our Alliance Lumber Segment operations in Reno, Nevada.  This transaction closed in July 2004 and generated $14.2 million of cash, $1.4 million of which was immediately paid to CIT to eliminate outstanding borrowings under the DIP Revolver. No gain or loss was recognized on the transaction.  This disposition reduced the borrowing base and availability on our DIP Revolver (see Liquidity and Capital Resources).  For income tax purposes, sale of these operations is expected to trigger a deferred taxable gain from the original acquisition transaction, resulting in an income tax liability of approximately $0.5 million, which will be recognized in the third quarter of 2004.  This tax liability is a liability of the wholly-owned C-Corporation subsidiary which made the original acquisition, and would not be allocated to unit holders.

 

Phoenix, Arizona Operations of Alliance Lumber Segment

 

On July 13, 2004, the Bankruptcy Court approved a motion filed by us to sell our Alliance Lumber Segment operations in Phoenix, Arizona.  This transaction closed in August 2004 and generated $39.4 million of cash. A gain of approximately $1.0 million was recognized on the transaction.  This disposition reduced the DIP Revolver limit from $40.0 million to $20.0 million and also reduced the related borrowing base and availability (see Liquidity and Capital Resources). For income tax purposes, sale of these operations is expected to trigger a deferred taxable gain from the original acquisition transaction, resulting in an income tax liability of approximately $1.3 million, which will be recognized in the third quarter of 2004.  This tax liability is a liability of the wholly-owned C-Corporation subsidiary which made the original acquisition, and would not be allocated to unit holders.

 

Manufacturing Segment

 

In July 2004, we signed an Asset Purchase Agreement to sell our Manufacturing Segment operations, subject to higher and better bids and objections under the jurisdiction of the Bankruptcy Court.  On July 13, 2004, we filed a motion with the Bankruptcy Court for the disposition of these assets. A hearing was held on July 26, 2004, and a motion for the bidding procedures regarding these operations was approved by the Bankruptcy Court.  Any competing bids from interested parties are due at the Bankruptcy Court by August 10, 2004.  A hearing is scheduled for August 18, 2004 with the Bankruptcy Court to conduct an auction, if necessary, after which a motion is expected to be filed for the sale of these operations.  A hearing has been scheduled with the Bankruptcy Court to hear the sale motion on August 19, 2004.  If approved by the Bankruptcy Court, the disposition is expected to close in August or September 2004, resulting in estimated cash proceeds of

 

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approximately $57.2 million.  This disposition will further reduce the borrowing base and availability on our DIP Revolver (see Liquidity and Capital Resources).

 

Industry Overview

 

The forest products and building materials industries are characterized by highly volatile commodity pricing.  Product pricing for logs, dimension lumber and other building materials is a function of species, grade, size and availability. Prices are heavily influenced by short-term supply and demand factors. Prices tend to follow broad seasonal and cyclical patterns. Demand is influenced by activity levels in the housing and construction industries, as well as general economic conditions and foreign currency exchange rates. In recent years, over capacity of lumber manufacturing facilities has led to an abundance of supply. Supply has been further increased by imported products from Canada and other countries. In addition, competition from non-wood based products and composite materials has also influenced prices for dimension lumber. Although demand has been strong over the last three years, excess supply has contributed to low prices for lumber, which, in turn, has depressed prices for logs and timberlands.  Beginning in the second half of 2003, prices for lumber and paneling increased sharply, and have remained relatively strong through the second quarter of 2004.  Prices for logs have remained relatively low, but have increased modestly in late 2003 and the first half of 2004.  A major trade dispute with Canada over the importation of lumber and paneling has continued to cast uncertainty over the markets for these products.  Weather and forest fire activity, as well as environmental issues concerning the harvesting of timber, are also contributing factors to supply and the volatility of prices in our industry.

 

Forward-Looking Statements

 

Information contained in Item 2 and other sections of this report includes “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our expectations, forecasts, hopes, beliefs, predictions, intentions or strategies regarding the future that are not purely historical, but are based on assumptions that in the future may prove not to be accurate. These assumptions include harvest volumes, species mix, prices for logs and lumber, demand for housing and levels and amounts received for stumpage and property sales. Our business and prospects are subject to a number of risks, including the volatility of timber and lumber prices, factors limiting harvesting of timber including contractual obligations, governmental restrictions, weather and access limitations – as well as the substantial capital resources required to fund our operations and the uncertainty regarding the outcome of our chapter 11 reorganization process.  Accordingly, actual results may differ materially from the expectations expressed in this report.

 

Additional factors that could affect future performance include our ability to successfully reorganize under bankruptcy protection, environmental risks, operating risks normally associated with the timber industry, competition, government regulations and policies, and economic changes in the regions where our products or substitute products are sold, including Southeast Asia and Japan. Other risk factors include fluctuations in the value of the U.S. dollar against foreign currencies, and our ability to implement our business strategy. These and other risks are described in our registration statements and reports filed from time to time on forms 10-K, 8-K and 10-Q, which are available from us or the United States Securities and Exchange Commission.

 

Liquidity and Capital Resources

 

As discussed above, on June 29, 2003, we filed for Chapter 11 bankruptcy protection.  Pursuant to the bankruptcy proceedings, we have listed certain pre-petition liabilities which existed prior to the June 29, 2003 bankruptcy filing as liabilities subject to compromise.  Disposition and settlement of such liabilities is under the jurisdiction of the Bankruptcy Court. Certain accounts payable and accrued expenses classified as liabilities subject to compromise have been satisfied through the disposition of our Alliance Lumber operations in Las Vegas, Nevada in April 2004, and additional portions of these liabilities have been further satisfied through the dispositions recorded in July and August of 2004.

 

14

 

The following table summarizes the pre-petition liabilities that are included as liabilities subject to compromise (in thousands):

 

		March 31, 2004			December 31, 2003
Acquisition facility principal		$	112,372		$	112,372
Senior notes principal		400,658			400,658
Adequate protection payments(1)		(6,000		)	(3,000		)
Accrued interest		21,039			21,039
Deferred enhanced interest		4,927			4,927
Make whole fees and interest		6,360			6,360
Accounts payable		1,163			1,419
Other accrued expenses		3,724			3,428
Total		$	544,243		$	547,203

 

(1)          In October 2003, we agreed to pay $0.5 million per month, retroactive to July 2003, to the acquisition facility banks and senior note holders as adequate protection payments related to their asserted collateral.  Such payments are to be applied to reduce, on a dollar-for-dollar basis, the aggregate allowed secured claims of the senior note holders and the acquisition facility banks. The method for allocating the adequate protection payments will be determined by the Bankruptcy Court and, therefore, we are not able to apply these payments to specific debt components at this time.

 

On July 17, 2003 the Bankruptcy Court entered a final financing order approving a $40 million debtor-in-possession credit facility (“DIP Revolver”) with CIT Group/Business Credit (“CIT”).  The $40 million limit is subject to a borrowing base and is collateralized by accounts receivable, inventory and substantially all personal property. The DIP Revolver bears interest at either (a) the Chase Bank Prime Rate plus 0.5% or (b) LIBOR plus 3%, at our option.  Any LIBOR loans are made for fixed one, two or three month terms.  The DIP Revolver terminates on January 1, 2005 or upon the effective date of a Bankruptcy Court approved plan of reorganization and contains certain covenants and restrictions.  As of June 30, 2004, there was $14.1 million outstanding at an interest rate of 4.5% and approximately $25.9 million remained available on the DIP Revolver.   However, subsequent to June 30, 2004, borrowings and availability under the DIP Revolver have been reduced by the disposition of assets and operations discussed above.  As of June 30, 2004, we were in compliance with all of the covenants of the DIP Revolver.

 

The DIP Revolver agreement provides that the total borrowing limit is reduced from $40.0 million to $20.0 million following the disposition of the Alliance Lumber Segment, which was completed in August 2004. In addition, borrowings under the DIP Revolver are limited to a borrowing base.  The borrowing base is a function of the levels of related collateral, and has been reduced by the dispositions described above.  As of August 3, 2004, there was zero outstanding and approximately $13.1 million available on the DIP Revolver.

 

Working capital increased to $79.4 million at June 30, 2004 compared to $59.4 million at December 31, 2003, primarily due to increases in accounts receivable, inventory and deposits on timber cutting contracts and a decrease in the amount outstanding on our DIP Revolver.  The increases in accounts receivable and inventory are primarily due to higher product prices during the quarter ended June 30, 2004 compared with the quarter ended December 31, 2003, partially off-set by the disposition of our Las Vegas, Nevada operations.  The increase in timber cutting contracts reflects deposits we have made on several agency timber sales for fire salvage logging in Oregon.

 

Net cash provided by operating activities of $2.3 million resulted from net income of $16.2 million and depletion, depreciation and amortization of $9.9 million, partially off-set by changes in working capital components.

 

Additions to timberlands of $2.6 million in the first six months of 2004 resulted from normal costs for road building and maintenance, pre-commercial thinning and reforestation activities.

 

15

 

The decrease in the balance outstanding under our DIP Revolver reflects proceeds from the sale of our Las Vegas, Nevada operations, partially off-set by increased borrowing for inventories.  Sale of the net assets of our Las Vegas operations produced cash proceeds of $12.3 million, all of which was immediately paid to CIT to reduce outstanding borrowings under the DIP Revolver.

 

We indefinitely suspended our cash distributions beginning in the fourth quarter of 2000. Furthermore, we are prohibited from making cash distributions to unitholders during our Chapter 11 reorganization process. Since it is unlikely that our unitholders will receive anything as a result of our Chapter 11 bankruptcy proceedings, it is unlikely that we will make any future cash distributions on our units.

 

See further discussion above regarding changes in Liquidity and Capital Resources which occurred subsequent to June 30, 2004.

 

Results of Continuing Operations

 

During the second quarter of 2003, we sold our Trading and Distribution Segment, which is reflected as discontinued operations on our consolidated statements of operations for the three and six month periods ended June 30, 2003.  In addition, in March 2004, the Bankruptcy Court approved the sale of, and in April 2004, we sold, the assets related to our Las Vegas, Nevada Alliance Lumber Segment operations. The results of the Las Vegas operations are reflected as discontinued operations in all periods presented.  Please see additional discussion regarding discontinued operations below.

 

		Three Months Ended June 30,
		2004					2003
(Dollars in thousands)		Dollars			% of revenue(1)		Dollars			% of revenue(1)
Revenue		$	106,836		100.0	%	$	60,179		100.0	%
Operating costs:
Cost of products sold		87,009			81.4		55,313			91.9
Loss on disposal of assets		—			—		1,269			2.1
Selling, general and administrative expenses		5,309			5.0		6,220			10.3
Operating income (loss)		14,518			13.6		(2,623		)	(4.4	)
Interest expense		180			0.2		12,068			20.1
Amortization of debt issuance costs		752			0.7		640			1.1
Other income, net		(289		)	(0.3	)	(25		)	—
Income (loss) from operations before reorganization items		13,875			13.0		(15,306		)	(25.4	)
Reorganization items		(1,884		)	(1.8	)	(5,078		)	8.4
Income (loss) before discontinued operations		11,991			11.2		(20,384		)	(33.9	)
Loss from discontinued operations		(1,081		)	(1.0	)	(519		)	(0.9	)
Net income (loss)		$	10,910		10.2	%	$	(20,903	)	(34.7	)%

 

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		Six Months Ended June 30,
		2004					2003
(Dollars in thousands)		Dollars			% of revenue(1)		Dollars			% of revenue(1)
Revenue		$	189,383		100.0	%	$	126,291		100.0	%
Operating costs:
Cost of products sold		156,519			82.6		115,819			91.7
(Gain) loss on disposal of assets		(18		)	—		794			0.6
Selling, general and administrative expenses		10,713			5.6		11,567			9.2
Operating income (loss)		22,169			11.7		(1,889		)	(1.5	)
Interest expense		448			0.2		24,020			19.0
Amortization of debt issuance costs		1,220			0.6		1,063			0.8
Other income, net		(343		)	(0.2	)	(154		)	(0.1	)
Income (loss) from operations before reorganization items		20,844			11.0		(26,818		)	(21.2	)
Reorganization items		(4,007		)	(2.1	)	(5,078		)	(4.0	)
Income (loss) before discontinued operations		16,837			8.9		(31,896		)	(25.3	)
Loss from discontinued operations		(602		)	(0.3	)	(5,522		)	4.4
Net income (loss)		$	16,235		8.6	%	$	(37,418	)	(29.6	)%

 

(1)  Percentages may not add due to rounding.

 

Revenue

 

Revenue increased $46.7 million, or 77.5%, to $106.8 million in the second quarter of 2004 compared to $60.2 million in the second quarter of 2003 and increased $63.1 million, or 50.0% to $189.4 million in the six months ended June 30, 2004 compared to $126.3 million in the comparable period of 2003.  These increases are primarily due to increased revenues from our Manufacturing and Alliance Lumber Segments, both of which benefited from higher prices for their products in 2004 as discussed more fully below.

 

Cost of Products Sold

 

Cost of products sold increased $31.7 million, or 57.3%, to $87.0 million in the second quarter of 2004 compared to $55.3 million in the second quarter of 2003 and increased $40.7 million, or 35.1%, to $156.5 million in the six months ended June 30, 2004 compared to $115.8 million in the comparable period of 2003.  These increases were due to increased sales volume.   The decreases in cost of products sold as a percentage of revenue in the three and six months ended June 30, 2004 compared to the same periods of 2003 were primarily due to higher lumber prices in our Manufacturing Segment, as discussed more fully below.

 

(Gain) Loss on Disposal of Assets

 

The $0.8 million loss on disposal of assets in the six months ended June 30, 2003 includes a $0.5 million gain in the first quarter of 2003 from the sale of an aircraft, offset by a $1.3 million loss on disposal of an aircraft in the second quarter of 2003.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses decreased $0.9 million, or 14.6%, to $5.3 million in the second quarter of 2004 compared to $6.2 million in the second quarter of 2003 and decreased $0.9 million, or 7.4%, to $10.7 million in the six months ended June 30, 2004 compared to $11.6 million in the comparable period of 2003.  Reductions in personnel costs from reduced headcount and reduced retirement plan costs were partially off-set by increased costs for insurance and bad debts expense.

 

Interest Expense

 

In accordance with SOP 90-7, interest expense in the three and six month periods ended June 30, 2004 does not include contractual interest totaling $12.9 million and $25.6 million, respectively, on the Senior Notes and Acquisition Facility since it is not probable it will be paid subsequent to our June 29, 2003 Chapter 11 bankruptcy filing.  Please read “Chapter 11 Bankruptcy Reorganization” above also.

 

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Reorganization Items

 

Reorganization items consist primarily of professional fees and other charges incurred related to our Chapter 11 reorganization and recapitalization efforts. We anticipate continuing to incur significant professional fees and court costs in future quarters related to our reorganization efforts under Chapter 11.

 

Income Taxes

 

In the past, we have not paid significant income taxes and have not included a provision for income taxes in our financial statements. As a partnership, taxation on our results of operations is generally the responsibility of the unitholders.  However, we own, directly and indirectly, four corporations that constitute a consolidated group of corporations for federal income tax purposes. This consolidated group of corporations is expected to incur an income tax liability in 2004, following the 2004 dispositions of our Alliance Lumber Segment operations.  We estimate an income tax liability of approximately $1.8 million will be incurred in the third quarter of 2004 from the disposition of our Reno and Phoenix operations.  We may incur material income tax liabilities in the future from any further disposition of additional assets.  Any such income tax incurred by these taxable entities would generally not be allocated to unitholders.

 

Allocation of Income (Losses)

 

Our partnership agreement provides that profit and losses are generally allocated 1.01% to the General Partner interest and 98.99% to the Limited Partner interest.  In addition, the partnership agreement specifies that net losses are not allocated to limited partners to the extent doing so would result in (or increase) a deficit balance in their capital accounts. At that point, net losses are allocated 100% to the General Partners.  In the third quarter of 2003, the Limited Partners’ capital accounts were reduced to zero, and subsequent income and losses have been allocated 100% to the General Partners. Accordingly, the General Partner interest was allocated our entire $10.9 million and $16.2 million of net income in the three and six month periods ended June 30, 2004.  In accordance with the Partnership Agreement, 100% of income and losses will continue to be allocated to the General Partners unless and until the cumulative additional losses they have been allocated are fully recovered.

 

Discontinued Operations

 

Trading and Distribution Segment

 

In April and May 2003, in two separate transactions, we sold the inventory and fixed assets related to our Trading and Distribution Segment and discontinued the segment’s operations.  The purchasers of these assets assumed the operating leases, accounts payable and accrued expenses related to these businesses.  We received cash proceeds of $4.5 million from these asset sales, all of which was immediately applied to outstanding principal on the revolving credit facility.  The results of operations of the Trading and Distribution Segment are reflected as discontinued operations on the accompanying consolidated statements of operations for all 2003 periods presented in accordance with Statement of Financial Accounting Standards No. 144 (“SFAS No. 144”) “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

During March 2003, deterioration of our trade credit availability began to adversely affect operating margins in the Trading and Distribution Segment.  Pursuant to the provisions of SFAS No. 142 “Goodwill and Other Intangible Assets,” we evaluated the goodwill balance of this segment for impairment following the change in circumstances during the first quarter of 2003, utilizing a fair value analysis of the business in the current market environment. Based on the results of this evaluation, we determined that our goodwill was impaired and recorded a non-cash impairment charge of $5.5 million in the three months ended March 31, 2003.  This $5.5 million charge is included in discontinued operations.

 

Summarized financial information for these operations is as follows (in thousands):

 

		Three Months Ended June 30, 2003			Six Months Ended June 30, 2003
External revenues		$	6,333		$	34,140
Operating loss		(482		)	(5,826		)

 

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Las Vegas Operations of Alliance Lumber Segment

 

In April 2004, we closed the sale of our Alliance Lumber Segment operations in Las Vegas, Nevada, resulting in a recognized loss of $1.2 million in the second quarter of 2004.  Results of operations for the Las Vegas operations are reported as discontinued operations for all periods presented in accordance with SFAS No. 144.  Summarized financial information for these operations is as follows (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
External revenues		$	—		$	13,231		$	18,756		$	26,271
Operating income (loss)		117			(41		)	596			300
Gain (loss) on disposal		(1,198		)	4			(1,198		)	4

 

Sale of the net assets of the Las Vegas operations produced cash proceeds of $12.3 million, all of which was immediately paid to CIT to reduce outstanding borrowings under the DIP Revolver.

 

Results of Operations by Segment

 

External revenue by segment and as a percentage of total revenue was as follows (dollars in thousands):

 

		Three Months Ended June 30,										Six Months Ended June 30,
		2004					2003					2004					2003
Timberlands		$	6,161		5.8	%	$	4,252		7.1	%	$	11,690		6.2	%	$	11,169		8.8	%
Manufacturing		32,790			30.7	%	16,611			27.6	%	58,911			31.1	%	38,587			30.6	%
Alliance Lumber		65,185			61.0	%	37,481			62.3	%	113,805			60.1	%	72,261			57.2	%
Corporate and Other		2,700			2.5	%	1,835			3.0	%	4,977			2.6	%	4,274			3.4	%
		$	106,836				$	60,179				$	189,383				$	126,291

 

Operating income (loss) by segment was as follows (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Timberlands		$	609		$	226		$	1,214		$	1,005
Manufacturing		11,277			(605		)	18,239			(1,182		)
Alliance Lumber		4,064			2,086			6,431			4,455
Corporate and Other		(1,432		)	(4,330		)	(3,715		)	(6,167		)
		$	14,518		$	(2,623	)	$	22,169		$	(1,889	)

 

Timberlands

 

The $1.9 million, or 44.9%, increase in external Timberlands Segment sales in the second quarter of 2004 compared to the second quarter of 2003 reflects a 52.6% increase in domestic log shipments, a 45.8% decrease in export log shipments and a 14.1% increase in weighted average domestic sales realizations.  These factors are discussed more fully below.

 

The $0.5 million, or 4.7%, increase in external Timberlands Segment sales in the six month period ended June 30, 2004 compared to the same period of 2003 reflects a 15.6% increase in domestic log shipments, a 62.0% decrease in export log shipments and an 8.7% increase in weighted average domestic sales realizations.  These factors are discussed more fully below.

 

Internal sales of logs to our Manufacturing Segment decreased to $3.3 million and $12.1 million, respectively, in the three and six month periods ended June 30, 2004 compared to $6.3 million and $15.8 million, respectively, in the comparable periods of 2003. These decreases primarily reflect a 50.2% and a 25.2% reduction, respectively, in volume, due to reduced harvest levels in 2004 at all of our tree farms.  Our Manufacturing Segment has increased its purchases of externally sourced logs during 2004 in order to mitigate the reduced fee harvest from our tree farms.  These decreases were partially offset by a 4.4% and a 2.7% increase, respectively,

 

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in average internal sales realizations reflecting higher market log prices in the first six months of 2004 compared to the first six months of 2003.

 

The $0.4 million and $0.2 million increases, respectively, in Timberlands operating income in the three and six month periods ended June 30, 2004 compared to the same periods of 2003 were primarily a result of the volume and price changes discussed above as well as reduced depletion expense rates (see Note 6) partially off-set by slightly higher overhead expenses.

 

Domestic Log Sales

 

Average external domestic prices received for logs sold from the various tree farms were as follows (dollars per thousand board feet (“MBF”)):

 

		Three Months Ended June 30,								Six Months Ended June 30,
Tree Farm		2004			2003			% Change		2004			2003			% Change
Oregon		$	373		$	627		(40.5	)%	$	373		$	627		(40.5	)%
Hamilton		$	469		$	436		7.6	%	$	456		$	425		7.3	%
Olympic		$	446		$	376		18.6	%	$	403		$	376		7.2	%
Weighted average		$	462		$	405		14.1	%	$	436		$	401		8.7	%

 

The increases at the Hamilton and Olympic tree farms in 2004 over the comparable 2003 periods are due to higher market prices for logs and changes in species and grade mix.

 

The domestic external volume from each of our tree farms was as follows (in MBF):

 

		Three Months Ended June 30,						Six Months Ended June 30,
Tree Farm		2004		2003		% Change		2004		2003		% Change
Oregon		57		227		(74.9	)%	58		227		(74.4	)%
Hamilton		8,208		2,755		197.9	%	14,548		9,215		57.9	%
Olympic		3,588		4,783		(25.0	)%	8,895		10,890		(18.3	)%
Total		11,853		7,765		52.6	%	23,501		20,332		15.6	%

 

The increase in volume from the Hamilton Tree Farm is due to increased fee harvest following the temporary curtailment of logging activity in the second quarter of 2003.  The decrease in volume from the Olympic Tree Farm reflects reduced fee harvest levels in 2004.

 

During the second quarter of 2003, a small volume of large diameter ponderosa pine logs were sold from our Oregon Tree Farm to an external customer.  During the first half of 2004, a small volume of pulp, post and pole logs were sold to external customers from our Oregon Tree Farm.  The majority of volume from the Oregon Tree Farm was utilized by our Gilchrist mill.

 

Export Log Sales

 

Revenue from export logs accounted for approximately 0.1% of total revenues in the three months and six months ended June 30, 2004.  Revenue from export logs accounted for 0.2% and 0.6% of total revenues, respectively, in the three months and six months ended June 30, 2003.  The decrease in export sales revenue is due to reduced sales volume from reduced availability of export grade logs in the areas of our Washington tree farms which are currently being harvested.  In addition, higher domestic log prices and soft export demand for such logs have currently mitigated much of the advantage from exporting them.

 

Manufacturing

 

The $16.2 million, or 97.4%, increase in external revenue from our sawmills in the second quarter of 2004 compared to the second quarter of 2003 reflects a 53.0% increase in average external lumber sales realizations and a 32.1% increase in external lumber sales volumes.  These factors are discussed more fully below.

 

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The $20.3 million, or 52.7%, increase in external revenue from our sawmills in the six month period ended June 30, 2004 compared to the six month period ended June 30, 2003 reflects a 42.4% increase in average external lumber sales realizations and a 9.9% increase in external lumber sales volumes.  These factors are discussed more fully below.

 

Internal shipments increased 31.7% and decreased 14.3%, respectively, to 4.6 MMBF and 7.0 MMBF, respectively, in the three and six month periods ended June 30, 2004 compared to 3.5 MMBF and 8.1 MMBF, respectively, in the comparable periods of 2003.  These changes in internal shipments from our Manufacturing Segment are primarily due to the disposition of our Trading and Distribution Segment in the second quarter of 2003. Excluding the impact from sales to our discontinued Trading and Distribution Segment, internal shipments increased in 2004 compared to 2003, reflecting the reduced production levels in the second quarter of 2003 resulting from our temporary curtailment of production.

 

The improvement in operating results of our Manufacturing Segment in the three and six month periods ended June 30, 2004 compared to the same periods of 2003 is primarily a result of the increased realizations and volume described above.  The increased volume in the 2004 periods is largely a result of the temporary market-related curtailment of operations we implemented in the second quarter of 2003.  In addition, we have improved production efficiencies at our sawmills during 2004.

 

Average external prices received for lumber sales by region were as follows (dollars per MBF):

 

		Three Months Ended June 30,								Six Months Ended June 30,
Sawmill		2004			2003			% Change		2004			2003			% Change
Oregon		$	400		$	268		49.3	%	$	372		$	269		38.3	%
Washington		$	409		$	259		57.9	%	$	380		$	259		46.7	%
Weighted average		$	404		$	264		53.0	%	$	376		$	264		42.4	%

 

The improvements in the average realizations are due to improved market prices resulting from strong demand from the domestic housing market, as well as changes in product mix.

 

External lumber sales volumes by region were as follows (in MBF):

 

		Three Months Ended June 30,						Six Months Ended June 30,
Sawmill		2004		2003		% Change		2004		2003		% Change
Oregon		38,193		30,179		26.6	%	76,769		72,352		6.1	%
Washington		37,979		27,495		38.1	%	69,679		60,876		14.5	%
Total Volume		76,172		57,674		32.1	%	146,448		133,228		9.9	%

 

The increases in volume in both regions are primarily caused by the temporary market-related production curtailment we implemented during the second quarter of 2003.

 

Following is information regarding our chip sales:

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Chip sales revenue (in thousands of dollars)		$	1,984		$	1,365		$	3,857		$	3,116
Chip sales as a percentage of revenue		1.9		%	2.3		%	2.0		%	2.5		%
Chip prices (per bone-dry unit (“BDU”))		$	67		$	64		$	66		$	61
Chip volume (in BDUs)		29,463			21,232			58,124			51,036

 

The increases in the price per BDU are due to improved market prices for chips.  The increases in volume are due to the increases in production volume at our saw mills, as chips are a by-product of saw mill operations.

 

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Alliance Lumber Segment

 

Our Alliance Lumber Segment includes professional contractor service yards in Arizona and Nevada and involves the sale of lumber and building materials. Our Las Vegas, Nevada operations were sold in April 2004 and are reflected as discontinued operations for all periods presented.  In addition, we sold our Reno, Nevada operations and our Phoenix, Arizona operations in the third quarter of 2004.  Following these dispositions, the Alliance Lumber Segment has been discontinued in the third quarter of 2004.

 

Revenue from our Alliance Lumber Segment increased $27.7 million, or 73.9%, in the second quarter of 2004 compared to the second quarter of 2003, and increased $41.5 million, or 57.5%, in the six months ended June 30, 2004 compared to the six months ended June 30, 2003.  These increases reflect a 15.7% and an 11.7% increase, respectively, in unit volume, measured in total board feet, as well as higher market prices for lumber and paneling, reflecting the strong housing market in the southwestern region of the United States.

 

Operating income from our Alliance Lumber Segment increased $2.0 million, or 94.8%, in the second quarter of 2004 compared to the second quarter of 2003, and increased $2.0 million, or 44.4%, in the six months ended June 30, 2004 compared to the six months ended June 30, 2003.  The improved operating income is primarily a result of the increased volume described above.

 

Corporate and Other

 

The operating loss from our Corporate and Other category decreased to $1.4 million and $3.7 million, respectively, in the three and six month periods ended June 30, 2004, compared to $4.3 million and $6.2 million, respectively, in the comparable periods of 2003.  The improved results reflect lower personnel costs from reduced headcount and retirement plan expenses, offset in part by increased costs for insurance and bad debt expense.

 

Critical Accounting Policies

 

We reaffirm the critical accounting policies and estimates described in our 2003 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on April 22, 2004.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

Our $40 million debtor-in-possession financing agreement (“DIP Revolver”) has a variable rate of interest.  At June 30, 2004, we had $14.1 million outstanding under the DIP Revolver at an interest rate of 4.5%.  A hypothetical 10 percent increase in interest rates to 4.95% would not have a material effect on our cash flows or results of operations.

 

The fair market value of long-term fixed interest rate debt is subject to interest rate risk.  Generally, the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise.  The interest rate changes affect the fair market value but do not impact earnings or cash flows.  Our acquisition facility has a variable rate of interest.  Our senior notes and acquisition facility, included in liabilities subject to compromise at June 30, 2004, are not publicly traded and similar instruments are not available for comparison.  We are therefore unable to estimate the fair value of the senior notes or acquisition facility.

 

Item 4.  Controls and Procedures

 

Disclosure Controls and Procedures

 

Our management has evaluated, under the supervision and with the participation of our President and Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based on that evaluation, our President and Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that information required to be disclosed in our Exchange Act reports is

 

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(1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Internal Control Over Financial Reporting

 

There has been no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 5.  Other Information

 

Disposition of Reno, Nevada Operations of Alliance Lumber Segment

 

On July 21, 2004, we sold our Alliance Lumber Segment operations in Reno, Nevada to Reno Lumber, Inc. for $14.2 million in cash. Reno Lumber, Inc. is partially owned by our former manager of these operations.  The sales price was determined by arms length negotiations.  The buyer purchased the inventory, accounts receivable, property, plant and equipment, and certain prepaid assets, and assumed the accounts payable and certain accrued expenses related to these operations.  This transaction was approved by the Bankruptcy Court in a hearing on July 13, 2004.

 

Phoenix, Arizona Operations of Alliance Lumber Segment

 

On August 2, 2004, we sold our Alliance Lumber Segment operations in Phoenix, Arizona to ALC Acquisition LLC for $39.4 million in cash. ALC Acquisition LLC is owned by the original founder of Alliance Lumber in Phoenix, Arizona and our former manager of these operations.  The sales price was determined by arms length negotiations.  The buyer purchased the inventory, accounts receivable, property, plant and equipment, and certain prepaid assets, and assumed the accounts payable and certain accrued expenses related to these operations.  This transaction was approved by the Bankruptcy Court in a hearing on July 13, 2004.

 

Item 6.  Exhibits and Reports on Form 8-K

 

(a) Exhibits

 

The exhibits filed as part of this report are listed below and this list is intended to serve as the exhibit index:

 

3.1                     Form of Second Amended and Restated Agreement of Limited Partnership of Crown Pacific Partners, L.P. (filed as Exhibit A to Part I of Registrant’s Registration Statement on Form S-1 No. 83-85066).

3.2                     Form of Agreement of Limited Partnership of Crown Pacific Limited Partnership (filed as Exhibit 3.2 to the Registrant’s Statement on Form S-1 No. 83-85066).

3.3                     First Amendment to Second Amended and Restated Agreement of Limited Partnership of Crown Pacific Limited Partnership (filed as Exhibit 3.1 to the Registrant’s Form 10-Q for the quarter ended March 31, 1997).

3.4                     Second Amendment to Amended and Restated Agreement of Limited Partnership of Crown Pacific Limited Partnership (filed as Exhibit 3.4 to the Registrant’s Form 10-K for the year ended December 31, 1997).

3.5                     Third Amendment to Amended and Restated Agreement of Limited Partnership of Crown Pacific Limited Partnership (filed as Exhibit 3.5 to the Registrant’s Form 10-K for the year ended December 31, 1999).

31.1               Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2               Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1               Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2               Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b) Reports on Form 8-K:

 

We did not file any reports on Form 8-K during the quarter ended June 30, 2004.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date:   August 9, 2004	CROWN PACIFIC PARTNERS, L.P.
	By:		Crown Pacific Management Limited Partnership, as General Partner
	By:	/s/ Steven E. Dietrich
	Steven E. Dietrich
	Senior Vice President, Chief Financial Officer and Treasurer
	(Duly Authorized Officer and Principal Financial and Accounting Officer)

 

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