POPE RESOURCES LTD PARTNERSHIP - FORM 10-Q - August 9, 2016

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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, 2016

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

Commission File Number 1-9035

POPE RESOURCES, A DELAWARE
LIMITED PARTNERSHIP
(Exact name of registrant as specified in its charter)
Delaware
91-1313292
(State or other jurisdiction of 
incorporation or organization) 
(IRS Employer
Identification Number)
 
19950 7th Avenue NE, Suite 200, Poulsbo, WA 98370
Telephone: (360) 697-6626
(Address of principal executive offices including zip code)
(Registrant’s telephone number including area code)

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

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

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

Partnership units outstanding at July 31, 2016: 4,349,477




Pope Resources
Index to Form 10-Q Filing
For the Six Months Ended June 30, 2016

Description
Page Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




P A R T  I – FINANCIAL INFORMATION
ITEM 1
FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
Pope Resources, a Delaware Limited Partnership
June 30, 2016 and December 31, 2015
(in thousands)
 
2016
 
2015
ASSETS
 
 
 
Current assets
 
 
 
Partnership cash
$
912

 
$
6,310

ORM Timber Funds cash
1,892

 
3,396

Cash
2,804

 
9,706

Accounts receivable, net
2,601

 
3,238

Land held for sale
6,624

 
3,642

Prepaid expenses and other
651

 
810

    Total current assets
12,680

 
17,396

Properties and equipment, at cost
 

 
 

  Timber and roads, net of accumulated depletion (2016 -  $107,600; 2015 - $103,378)
263,300

 
266,104

Timberland
53,950

 
53,879

Land held for development
26,860

 
25,653

Buildings and equipment, net of accumulated depreciation (2016 - $7,520; 2015 - $7,251)
5,847

 
6,024

    Total property and equipment, at cost
349,957

 
351,660

Other assets
 
 
 
Deposit for acquisition of timberland
1,581

 
—

Other assets
969

 
1,000

Total assets
$
365,187

 
$
370,056

 
 
 
 
LIABILITIES, PARTNERS' CAPITAL AND NONCONTROLLING INTERESTS
 

 
 

Current liabilities
 

 
 

Accounts payable
$
1,856

 
$
1,384

Accrued liabilities
3,393

 
3,442

Current portion of long-term debt
117

 
114

Deferred revenue
317

 
278

Current portion of environmental remediation liability
11,905

 
11,200

Other current liabilities
329

 
322

    Total current liabilities
17,917

 
16,740

Long-term debt, net of current portion
93,749

 
84,537

Environmental remediation and other long-term liabilities
809

 
5,713

Partners' capital and noncontrolling interests
 

 
 

General partners' capital (units issued and outstanding 2016 - 60; 2015 - 60)
922

 
1,009

Limited partners' capital (units issued and outstanding 2016 - 4,253; 2015 - 4,240)
57,381

 
63,539

Noncontrolling interests
194,409

 
198,518

    Total partners' capital and noncontrolling interests
252,712

 
263,066

Total liabilities, partners' capital and noncontrolling interests
$
365,187

 
$
370,056

See accompanying notes to condensed consolidated financial statements.

3


CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
Pope Resources, a Delaware Limited Partnership
For the Three and Six Months Ended June 30, 2016 and 2015
(in thousands, except per unit data)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Revenue
$
12,713

 
$
13,904

 
$
23,782

 
$
40,812

Cost of sales
(7,471
)
 
(8,815
)
 
(14,611
)
 
(23,312
)
Operating expenses
(4,041
)
 
(3,711
)
 
(7,414
)
 
(6,859
)
General and administrative expenses
(1,059
)
 
(1,198
)
 
(2,663
)
 
(2,388
)
Gain on sale of timberland
—

 
—

 
226

 
—

Income (loss) from operations
142

 
180

 
(680
)
 
8,253

 
 
 
 
 
 
 
 
Interest expense, net
(747
)
 
(777
)
 
(1,405
)
 
(1,522
)
 
 
 
 
 
 
 
 
Income (loss) before income taxes
(605
)
 
(597
)
 
(2,085
)
 
6,731

Income tax expense
—

 
(28
)
 
(50
)
 
(368
)
Net income (loss)
(605
)
 
(625
)
 
(2,135
)
 
6,363

 
 
 
 
 
 
 
 
Net and comprehensive loss attributable to noncontrolling interests - ORM Timber Funds
1,041

 
914

 
1,536

 
1,735

Net and comprehensive income (loss) attributable to unitholders    
$
436

 
$
289

 
$
(599
)
 
$
8,098

 
 
 
 
 
 
 
 
Allocable to general partners
$
6

 
$
4

 
$
(8
)
 
$
113

Allocable to limited partners
430

 
285

 
(591
)
 
7,985

Net and comprehensive income (loss) attributable to unitholders
$
436

 
$
289

 
$
(599
)
 
$
8,098

 
 
 
 
 
 
 
 
Basic and diluted earnings (loss) per unit attributable to unitholders
$
0.09

 
$
0.06

 
$
(0.15
)
 
$
1.87

 
 
 
 
 
 
 
 
Basic and diluted weighted average units outstanding
4,313

 
4,298

 
4,312

 
4,296

 
 
 
 
 
 
 
 
Distributions per unit
$
0.70

 
$
0.65

 
$
1.40

 
$
1.30

See accompanying notes to condensed consolidated financial statements.

4


CONDENSED CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (Unaudited)
Pope Resources, a Delaware Limited Partnership
Six Months Ended June 30, 2016
(in thousands)

 
Attributable to Pope Resources
 
 
 
 
 
General Partners
 
Limited Partners
 
Noncontrolling Interests
 
Total
December 31, 2015
$
1,009

 
$
63,539

 
$
198,518

 
$
263,066

Net loss
(8
)
 
(591
)
 
(1,536
)
 
(2,135
)
Cash distributions
(85
)
 
(6,003
)
 
(2,573
)
 
(8,661
)
Equity-based compensation
8

 
586

 
—

 
594

Indirect repurchase of units for minimum tax withholding
(2
)
 
(150
)
 
—

 
(152
)
June 30, 2016
$
922

 
$
57,381

 
$
194,409

 
$
252,712



5


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Pope Resources, a Delaware Limited Partnership
Six Months Ended June 30, 2016 and 2015
(in thousands)
 
2016
 
2015
Net income (loss)
$
(2,135
)
 
$
6,363

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
 

 
 

Depletion
4,193

 
4,948

Equity-based compensation
594

 
580

Excess tax benefit of equity-based compensation
—

 
(5
)
Depreciation and amortization
371

 
314

Deferred taxes
—

 
203

Cost of land sold
1,037

 
6,503

Gain on sale of timberland
(226
)
 
—

Gain on disposal of property and equipment
(24
)
 
—

Cash flows from changes in operating accounts
 

 
 

Accounts receivable, net
638

 
1,397

Prepaid expenses and other assets
188

 
(2,735
)
Real estate project expenditures
(5,225
)
 
(4,615
)
Accounts payable and accrued liabilities
447

 
(288
)
Deferred revenue
40

 
64

Environmental remediation
(4,175
)
 
(572
)
Other current and long-term liabilities
(20
)
 
35

Net cash provided by (used in) operating activities
(4,297
)
 
12,192

 
 
 
 
Cash flows from investing activities
 

 
 

Maturity of short-term investments
—

 
1,000

Reforestation and roads
(918
)
 
(1,098
)
Buildings and equipment
(140
)
 
(166
)
Deposit for acquisition of timberland - Partnership
(1,581
)
 
—

Acquisition of timberland - Partnership
(1,069
)
 
(2,876
)
Proceeds from sale of timberland - Funds
723

 
—

Net cash used in investing activities
(2,985
)
 
(3,140
)
 
 
 
 
Cash flows from financing activities
 

 
 

Borrowings on line of credit, net
9,250

 
—

Repayment of long-term debt
(57
)
 
(55
)
Payroll taxes paid on unit net settlements
(152
)
 
(107
)
Excess tax benefit of equity-based compensation
—

 
5

Cash distributions to unitholders
(6,088
)
 
(5,637
)
Cash distributions - ORM Timber Funds, net of distributions to Partnership
(2,573
)
 
(4,163
)
Net cash provided by (used in) financing activities
380

 
(9,957
)
 
 
 
 
Net decrease in cash
(6,902
)
 
(905
)
Cash at beginning of period
9,706

 
24,028

Cash at end of period
$
2,804

 
$
23,123

See accompanying notes to condensed consolidated financial statements.


6


POPE RESOURCES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2016

1.
The condensed consolidated balance sheets as of June 30, 2016 and December 31, 2015 and the related condensed consolidated statements of comprehensive income for the three- and six-month periods and cash flows for the six-month periods ended June 30, 2016 and 2015 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, 2015 is derived from the Partnership’s audited consolidated financial statements and notes thereto for the year ended December 31, 2015, 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, 2016.

2.
The financial statements in the Partnership’s 2015 annual report on Form 10-K include a summary of significant accounting policies of the Partnership and should be read in conjunction with this Quarterly Report on Form 10-Q.

On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective on January 1, 2018. The standard permits the use of either the retrospective or cumulative effect transition method. The Partnership is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. Management has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

In February 2016, the FASB issued ASU 2016-02, Leases, which requires substantially all leases to be reflected on the balance sheet as a liability and a right-of-use asset. The ASU will replace existing lease accounting guidance in U.S. GAAP when it becomes effective on January 1, 2019, though early application is permitted. The standard will be applied on a modified retrospective basis in which certain optional practical expedients may be applied. Due to the Partnership's limited leasing activity, management does not expect the effect of this standard to be material to its ongoing financial reporting.

The Partnership adopted ASU 2015-17, Balance Sheet Classification of Deferred Taxes, effective January 1, 2016. In accordance with this standard, all deferred tax assets and liabilities are classified as noncurrent on the Partnership's condensed consolidated balance sheets. Our adoption of this ASU did not have a material impact on our consolidated financial statements and related disclosures.

3.
The Partnership has two general partners: Pope MGP, Inc. and Pope EGP, Inc. In total, these two entities own 60,000 partnership units. The allocation of distributions, profits and losses among the general and limited partners is pro rata across all units outstanding.

4.
ORM Timber Fund I, LP (Fund I), ORM Timber Fund II, Inc. (Fund II), and ORM Timber Fund III (REIT) Inc. (Fund III), collectively “the Funds”, were formed by Olympic Resource Management LLC (ORMLLC), a wholly owned subsidiary of the Partnership, for the purpose of attracting capital to purchase timberlands. The objective of these Funds is to generate a return on investments through the acquisition, management, value enhancement and sale of timberland properties. Each Fund will operate for a term of ten years from the end of the respective investment period. Fund I sold all of its timberland holdings in 2014 and terminated in 2015. Fund II is scheduled to terminate in March 2021 and Fund III is scheduled to terminate in December 2025.

Pope Resources and ORMLLC together owned 20% of Fund I, currently own 20% of Fund II and 5% of Fund III. The Funds are considered variable interest entities because their organizational and governance structures are the functional equivalent of a limited partnership. As the general partner or 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 obligation to absorb losses that could potentially be significant to the Funds. Accordingly, the Funds are consolidated into the Partnership’s financial statements. Additionally, the obligations of each of the Funds do not have any recourse to the Partnership.


7


The Partnership’s condensed consolidated balance sheet included assets and liabilities of the Funds as of June 30, 2016 and December 31, 2015, which were as follows:
 
(in thousands)
June 30, 2016
 
December 31, 2015
Assets:
Cash
$
1,892

 
$
3,396

Other current assets
1,085

 
602

Total current assets
2,977

 
3,998

Properties and equipment, net of accumulated depletion and depreciation (2016 - $38,096; 2015 - $34,757)
268,456

 
271,850

Total assets
$
271,433

 
$
275,848

Liabilities and equity:
 

 
 

Current liabilities
$
1,760

 
$
1,723

Long-term debt
57,257

 
57,246

Total liabilities
59,017

 
58,969

Funds' equity
212,416

 
216,879

Total liabilities and equity
$
271,433

 
$
275,848


5.
In the presentation of the Partnership’s revenue and operating income (loss) by segment, all intersegment revenue and expense is eliminated to determine operating income (loss) reported externally. The following tables reconcile internally reported income (loss) from operations to externally reported income (loss) from operations by business segment, for the three and six months ended June 30, 2016 and 2015:

8


 
Fee Timber
 
 
Three Months Ended June 30, (in thousands)
Pope Resources
ORM Timber Funds
Total Fee Timber
 
Timberland Management
 
Real Estate
 
Other
 
Consolidated
2016
 
 
 
 
 
 
 
 
 
 
 
Revenue - internal
$
8,186

$
4,136

$
12,322

 
$
788

 
$
516

 
$
—

 
$
13,626

Eliminations
(52
)
—

(52
)
 
(788
)
 
(73
)
 
—

 
(913
)
Revenue - external
8,134

4,136

12,270

 
—

 
443

 
—

 
12,713

 
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
(3,789
)
(3,197
)
(6,986
)
 
—

 
(485
)
 
—

 
(7,471
)
 
 
 
 
 
 
 
 
 
 
 
 
Operating, general and administrative expenses - internal
(1,597
)
(1,544
)
(3,141
)
 
(665
)
 
(1,133
)
 
(1,074
)
 
(6,013
)
Eliminations
32

794

826

 
62

 
10

 
15

 
913

Operating, general and administrative expenses - external
(1,565
)
(750
)
(2,315
)
 
(603
)
 
(1,123
)
 
(1,059
)
 
(5,100
)
 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - internal
2,800

(605
)
2,195

 
123

 
(1,102
)
 
(1,074
)
 
142

Eliminations
(20
)
794

774

 
(726
)
 
(63
)
 
15

 
—

 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - external
$
2,780

$
189

$
2,969

 
$
(603
)
 
$
(1,165
)
 
$
(1,059
)
 
$
142

 
 
 
 
 
 
 
 
 
 
 
 
2015
 

 

 

 
 

 
 

 
 

 
 

Revenue - internal
$
4,835

$
4,501

$
9,336

 
$
767

 
$
4,665

 
$
—

 
$
14,768

Eliminations
(64
)
—

(64
)
 
(767
)
 
(33
)
 
—

 
(864
)
Revenue - external
4,771

4,501

9,272

 
—

 
4,632

 
—

 
13,904

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

 
(2,977
)
 
—

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

767

767

 
64

 
4

 
29

 
864

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

(443
)
885

 
(82
)
 
604

 
(1,227
)
 
180

Eliminations
(64
)
767

703

 
(703
)
 
(29
)
 
29

 
—

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

$
324

$
1,588

 
$
(785
)
 
$
575

 
$
(1,198
)
 
$
180


9


 
Fee Timber
 
 
Six Months Ended June 30, (in thousands)
Pope Resources
ORM Timber Funds
Total Fee Timber
 
Timberland Management
 
Real Estate
 
Other
 
Consolidated
2016
 
 
 
 
 
 
 
 
 
 
 
Revenue - internal
$
12,624

$
9,498

$
22,122

 
$
1,611

 
$
1,900

 
$
—

 
$
25,633

Eliminations
(100
)
—

(100
)
 
(1,603
)
 
(148
)
 
—

 
(1,851
)
Revenue - external
12,524

9,498

22,022

 
8

 
1,752

 
—

 
23,782

 
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
(5,397
)
(7,482
)
(12,879
)
 
—

 
(1,732
)
 
—

 
(14,611
)
 
 
 
 
 
 
 
 
 
 
 
 
Operating, general and administrative expenses - internal
(2,797
)
(2,787
)
(5,584
)
 
(1,406
)
 
(2,241
)
 
(2,697
)
 
(11,928
)
Eliminations
59

1,609

1,668

 
129

 
20

 
34

 
1,851

Operating, general and administrative expenses - external
(2,738
)
(1,178
)
(3,916
)
 
(1,277
)
 
(2,221
)
 
(2,663
)
 
(10,077
)
Gain on sale of timberland
—

226

226

 
—

 
—

 
—

 
226

 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - internal
4,430

(545
)
3,885

 
205

 
(2,073
)
 
(2,697
)
 
(680
)
Eliminations
(41
)
1,609

1,568

 
(1,474
)
 
(128
)
 
34

 
—

Income (loss) from operations - external
$
4,389

$
1,064

$
5,453

 
$
(1,269
)
 
$
(2,201
)
 
$
(2,663
)
 
$
(680
)
 
 
 
 
 
 
 
 
 
 
 
 
2015
 

 

 

 
 

 
 

 
 

 
 

Revenue - internal
$
13,707

$
11,657

$
25,364

 
$
1,601

 
$
15,661

 
$
—

 
$
42,626

Eliminations
(146
)
—

(146
)
 
(1,601
)
 
(67
)
 
—

 
(1,814
)
Revenue - external
13,561

11,657

25,218

 
—

 
15,594

 
—

 
40,812

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

 
(7,872
)
 
—

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

1,601

1,601

 
146

 
9

 
58

 
1,814

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

(505
)
4,993

 
(59
)
 
5,765

 
(2,446
)
 
8,253

Eliminations
(146
)
1,601

1,455

 
(1,455
)
 
(58
)
 
58

 
—

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

$
1,096

$
6,448

 
$
(1,514
)
 
$
5,707

 
$
(2,388
)
 
$
8,253



10


6.
Basic and diluted earnings per unit are calculated by dividing net income (loss) attributable to unitholders, adjusted for non-forfeitable distributions paid out to unvested restricted unitholders and preferred shareholders of Fund II and Fund III, by the weighted average units outstanding during the period.  There were no dilutive securities outstanding during the periods presented. The following table shows the calculation of basic and diluted income (loss) per unit:

 
Quarter Ended 
 June 30,
 
Six Months Ended 
 June 30,
(in thousands, except per unit amounts)
2016
 
2015
 
2016
 
2015
Net income (loss) attributable to Pope Resources' unitholders
$
436

 
$
289

 
$
(599
)
 
$
8,098

Less:
 

 
 

 
 

 
 

Net income attributable to unvested restricted unitholders
(25
)
 
(25
)
 
(50
)
 
(37
)
Preferred share dividends - ORM Timber Funds
(8
)
 
(8
)
 
(16
)
 
(16
)
Net income (loss) for calculation of earnings (loss) per unit
$
403

 
$
256

 
$
(665
)
 
$
8,045

 
 
 
 
 
 
 
 
Basic and diluted weighted average units outstanding
4,313

 
4,298

 
4,312

 
4,296

 
 
 
 
 
 
 
 
Basic and diluted earnings (loss) per unit
$
0.09

 
$
0.06

 
$
(0.15
)
 
$
1.87


7.
In the first quarter of 2016, the Partnership granted 10,400 restricted units pursuant to the management incentive compensation program and 3,880 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, 2016, 924 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. We recognized $178,000 and $242,000 of equity compensation expense in the second quarter of 2016 and 2015, respectively, and $594,000 and $580,000 for the six months ended June 30, 2016 and 2015, respectively, related to these compensation programs.

8.
Supplemental disclosure of cash flow information: interest paid, net of amounts capitalized, totaled $1.2 million and $1.4 million for the first six months of 2016 and 2015, respectively. Income taxes paid totaled $146,000 and $205,000 during the first six months of 2016 and 2015, respectively.

9.
The Partnership’s financial instruments include cash and cash equivalents and accounts receivable, for which the carrying amount of each represents fair value based on current market interest rates or their short-term nature. Carrying amounts of contracts receivable, although long-term, also approximate fair value based on current market rates.

The Partnership’s and the Funds’ fixed-rate debt collectively have a carrying value of $84.8 million and $84.9 million as of June 30, 2016 and December 31, 2015, respectively.   The estimated fair value of this debt, based on current interest rates for similar instruments (Level 2 inputs in the Fair Value Hierarchy), is approximately $93.5 million and $89.8 million, as of June 30, 2016 and December 31, 2015, respectively.

10.
The Partnership had an accrual for estimated environmental remediation costs of $12.6 million and $16.8 million as of June 30, 2016 and December 31, 2015, respectively. The environmental remediation liability represents management’s estimate of payments to be made to monitor and remediate certain areas in and around Port Gamble Bay, Washington.

In December of 2013, a consent decree and Clean-up Action Plan (CAP) related to Port Gamble were finalized with the Washington State Department of Ecology (DOE) and filed with Kitsap County Superior Court. In the third quarter of 2015, the Partnership selected a contractor to complete the remediation work. Remediation activity began in late September of 2015 and will continue through 2017, followed by a period of monitoring activity. Management's cost estimates for the project are based on amounts included in the construction contract and estimates for project management and other professional fees.

The environmental liability at June 30, 2016 is comprised of $11.9 million that management expects to expend in the next 12 months and $0.7 million thereafter.


11


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, 2014
13,241

 
10,000

 
1,590

 
21,651

Year ended December 31, 2015
21,651

 
—

 
4,890

 
16,761

Quarter ended March 31, 2016
16,761

 
—

 
3,222

 
13,539

Quarter ended June 30, 2016
$
13,539

 
$
—

 
$
952

 
$
12,587


11.
In July 2016, the Partnership closed on the acquisition of a 7,324-acre tree farm in western Washington for $31.9 million. It consists of 6,746 owned acres and a timber deed on 578 acres that expires in 2051. The acquisition was financed with a new $32.0 million credit facility issued under the existing master loan agreement with Northwest Farm Credit Services (NWFCS) and is comprised of three segments, all of which require quarterly interest-only payments with principal due at maturity. The two fixed rate loan segments are for $11.0 million each, one of which matures in July 2026 and the other of which matures in July 2028. These segments bear interest at 3.89% and 4.13%, respectively. The third segment is for $10.0 million, matures in July 2023 and bears interest at a variable rate based on the one-month LIBOR plus a margin of 2.20%. As with the Partnership's other debt arrangements with NWFCS, this loan will be included in the lender's annual patronage program, which rebates a portion of the interest paid in the prior year back to the borrower. The loan is not collateralized by the timberland acquired in this transaction, but rather by the same portions of the Partnership's timberland that are already pledged as collateral for the Partnership's existing credit facility with NWFCS.

In July 2016, the Partnership closed on sale of 144 acres of undeveloped land in Kitsap County, Washington for $1.1 million.

In August 2016, the Partnership entered into a $21.0 million loan agreement issued under the existing master loan agreement with NWFCS. Advances under the loan require quarterly interest-only payments with principal due at maturity in July 2027. Advances under the loan agreement can bear interest at a variable rate based on the one-month LIBOR plus a margin of 1.85% (base rate loan segment) or at fixed rates based on the lender's rate pricing index, for terms of one through eleven years, plus a margin of 1.95% (fixed rate loan segment). In addition, base rate loan segments can be converted to fixed rate loan segments, though no more than four fixed rate loan segments may be outstanding at any time. The Partnership will draw $11.0 million as a base rate loan segment in August 2016 and will use the proceeds to pay down its operating line of credit so that its full capacity is available to fund either Real Estate lot development, environmental remediation expenditures, or other liquidity needs. The remaining $10.0 million under the loan agreement will be available for borrowing through March 31, 2017. As with the Partnership's other debt arrangements with NWFCS, this loan will be included in the lender's annual patronage program, which rebates a portion the interest paid in the prior year back to the borrower. The loan is collateralized by the same portions of the Partnership's timberland that are already pledged as collateral for the Partnerships existing credit facility with NWFCS.

12


ITEM 2.

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

This report contains a number of projections and statements about our expected financial condition, operating results, and business plans and objectives. These statements reflect management’s estimates based upon our current 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. 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 three primary businesses. The first, and by far most significant segment in terms of owned assets and operations, is the Fee Timber segment. This segment includes timberlands owned directly by the Partnership and operations of two private equity funds ("Fund II" and "Fund III", collectively, the “Funds”). When we refer to the timberland owned by the Partnership, we describe it as the Partnership’s tree farms. We refer to timberland owned by the Funds as the Funds’ tree farms. When referring collectively to the Partnership’s and Funds’ timberland we will refer to them as the Combined tree farms. Operations in this segment consist of growing timber to be harvested as logs for sale to domestic manufacturers and export brokers. The second most significant business segment in terms of total assets owned is the development and sale of real estate. Real Estate activities primarily take the form of securing permits, entitlements, and, in some cases, installing infrastructure for raw land development and then realizing that land’s value by selling larger parcels to buyers who will take the land further up the value chain by either selling homes to retail buyers or lots to developers of commercial property. Since these land projects span multiple years, the Real Estate segment may incur losses for multiple years while a project is developed, and will not recognize operating income until that project is sold. In addition, within this segment we sometimes negotiate and sell development rights in the form of conservation easements (CE’s) on Fee Timber properties which preclude future development, but allow continued forestry operations. Our third business segment, which we refer to as Timberland Management, is engaged in organizing and managing private equity timber funds using capital invested by third parties and the Partnership.

Our current strategy for adding timberland acreage is centered primarily on our private equity timber fund business model. However, we will 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 as we did in July 2016 with the acquisition of a 7,324-acre tree farm as discussed below under Recent Developments. We have closed and invested capital from three timber funds, with assets under management totaling approximately $364 million as of June 30, 2016 based on the most recent appraisals. Through our 20% co-investment in Fund II and our 5% co-investment in Fund III, we have deployed $26 million of Partnership 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.

The Funds are consolidated into our financial statements, but then income or loss attributable to equity owned by third parties is eliminated from consolidated results in our Condensed Consolidated Statements of Comprehensive Income (Loss)

13


under the caption “Net and comprehensive loss attributable to non-controlling interests-ORM Timber Funds” to arrive at net and comprehensive income (loss) attributable to unitholders of the Partnership.

The strategy for our Real Estate segment centers around how and when to “harvest” a parcel of land and optimize value realization by selling the property, balancing the long-term risks and costs of carrying and developing a property against the potential for income and 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 represents those properties in the development portfolio that we expect to sell in the next year.
 
Second quarter highlights

•
Harvest volume was 20.9 million board feet (MMBF) in Q2 2016 compared to 15.1 MMBF in Q2 2015, a 38% increase. Harvest volume for the first six months of 2016 was 36.6 MMBF compared to 39.6 MMBF for 2015, an 8% decrease. These harvest volume figures do not include timber deed sales of 0.6 MMBF in Q1 2015 sold by Fund III. The harvest volume and log price realization metrics cited below also exclude these timber deed sales.
•
Average realized log price per thousand board feet (MBF) was $563 in Q2 2016 compared to $562 per MBF in Q2 2015. For the first six months of 2016, the average realized log price was $575 per MBF compared to $591 per MBF for 2015, a 3% decrease.
•
As a percentage of total harvest, volume sold to export markets in Q2 2016 increased only slightly to 15% from 14% in Q2 2015, while the mix of volume sold to domestic markets was 66% in Q2 2016 compared to 68% in Q2 2015. For the first six months of 2016, the relative percentages of volume sold to export and domestic markets were 17% and 63%, respectively, compared to 17% and 61%, respectively, in 2015. Hardwood, cedar and pulpwood log sales make up the balance of harvest volume.
•
The percentage of total harvest comprised of Douglas-fir sawlogs dropped to 45% in Q2 2016 from 52% in Q2 2015, with an increase in the whitewood sawlog component to 26% in Q2 2016 from 20% in Q2 2015. For the first six months of 2016, Douglas-fir sawlogs increased to 50% of total harvest volume from 48% in 2015.
•The Partnership acquired 287 acres of timberland during Q2 2016 for $1.1 million.

Outlook

Depending on log markets, we expect our total 2016 harvest volume to be between 88 and 93 MMBF, including volume from the 7,324-acre tree farm acquired in July 2016. For our Real Estate segment, markets remain strong and in the second half of 2016 we anticipate significant residential lot sales from our Harbor Hill project as well as some potential sales of undeveloped land.


RECENT DEVELOPMENTS

As mentioned above, on July 22, 2016, we closed on the acquisition of a 7,324-acre tree farm in western Washington for $31.9 million. The property consists of 6,746 owned acres and a timber deed on 578 acres that expires in 2051. The acquisition was financed with a new $32.0 million loan from Northwest Farm Credit Services (NWFCS) and consists of multiple balloon maturities: $10 million in 2023, $11.0 million in 2026, and $11.0 million in 2028.

In August 2016, we entered into a new $21.0 million loan agreement with NWFCS. Advances under the loan are due at maturity in 2027. We plan to borrow $11.0 million in August 2016 to pay down our operating line of credit so that its full capacity is available to fund either Real Estate lot development, Port Gamble environmental remediation expenditures, or other liquidity needs. The remaining $10.0 million under this loan agreement will be available for borrowing through March 31, 2017.

See also footnote 11 to the condensed consolidated financial statements for information about these transactions and terms of the loan agreements.

The following table and chart present our capitalization and debt maturities, respectively, on a pro-forma basis as of September 30, 2016.

14


September 30, 2016 Pro Forma Capitalization
(Partnership only)
 
 
 
 
 
 
 
 
 
 
 
 
amounts in thousands, debt balances exclude debt issuance costs
 
 
 
 
Sources
 
Uses
 
 
Maturity
Net Interest Rate (1)
 
Balance 6/30/2016
 Timberland Acquisition Mortgage
Other Mortgage (2)
 
Timberland Acquisition
Debt Repayment
Other uses (3)
Pro Forma Balance 9/30/2016
Interest-only, fixed-rate mortgage
2017
3.85
%
 

$5,000

 
 
 
 
 
 

$5,000

Interest-only, fixed-rate mortgage
2019
5.40
%
 
9,800

 
 
 
 
 
 
9,800

Revolving line of credit (4)
2020
1.22
%
 
9,250

 
 
 
 

($9,250
)
 
—

Amortizing, fixed-rate mortgage
2023
2.80
%
 
2,636

 
 
 
 
(29
)
 
2,607

Interest-only, fixed-rate mortgage
2025
5.05
%
 
10,000

 
 
 
 
 
 
10,000

Interest-only, variable-rate mortgage (5)
2023
1.89
%
 
 

$10,000

 
 
 
 
 
10,000

Interest-only, fixed-rate mortgage
2026
3.08
%
 
 
11,000

 
 
 
 
 
11,000

Interest-only, variable-rate mortgage (6)
2027
1.54
%
 
 
 

$11,000

 
 
 
 
11,000

Interest-only, fixed-rate mortgage
2028
3.32
%
 
 
11,000

 
 
 
 
 
11,000

Total debt
 
 
 

$36,686

 
 
 
 
 
 
$
70,836

Less: Cash
 
 
 
912


$32,000


$11,000

 

($31,901
)

($9,279
)

($2,732
)
—

Net debt
 
 
 

$35,774

 
 
 
 
 
 

$70,836

Equity market cap (7)
 
 
 

$282,639

 
 
 
 
 
 

$282,639

Net debt / enterprise value (8)
 
 
 
11.2
%
 
 
 
 
 
 
20
%
Weighted average interest rate, net of patronage
 
3.9
%
 
 
 
 
 
 
3.3
%
 
 
 
 
 
 
 
 
 
 
 
 
(1) Interest rate net of patronage of 100 bps on debt held at 6/30/16 and 81 bps on new debt
(2) Additional $10.0 million available, must be drawn by 3/31/2017
(3) Including, but not limited to, acquisition closing costs, environmental remediation expenditures and Harbor Hill development costs
(4) Maximum borrowing limit of $20.0 million
(5) Rate is based on LIBOR of 0.50% plus spread of 1.39% (net of patronage)
(6) Rate is based on LIBOR of 0.50% plus spread of 1.04% (net of patronage)
(7) Based on unit price of $65 and outstanding units of 4,348,298
(8) Enterprise value equals equity market cap plus net debt


15



Taking into account the aforementioned borrowings, our interest coverage, (defined as EBITDDA attributable to unitholders divided by interest expense attributable to unitholders, including capitalized interest) is consistent with our timber-REIT peers and maintains a balance sheet that enables us to take advantage of the harvest optionality characteristic that is so important for the timberland asset class. The following table presents the calculation of our interest coverage ratio on a pro-forma basis utilizing 2015 results and interest expense under these new loans.

Amounts in thousands, except interest coverage ratio
 
Net income attributable to unitholders
$
10,943

Interest expense
2,970

Less: interest expense attributable to noncontrolling interests
(2,111
)
Income taxes
207

Less: income tax expense attributable to noncontrolling interests
(292
)
Depreciation and amortization expense
736

Less: depreciation and amortization expense attributable to noncontrolling interests
(20
)
Depletion expense
9,900

Less: depletion expense attributable to noncontrolling interests
(7,076
)
EBITDDA attributable to unitholders
$
15,257

 
 
Interest expense attributable to unitholders, including capitalized interest
1,743

Interest expense related to new $32 and $11 million borrowings
1,062

Pro-forma 2015 interest expense attributable to unitholders, including capitalized interest
$
2,805

Pro-forma interest coverage ratio
5.4



16


RESULTS OF OPERATIONS

The following table reconciles and compares key revenue and cost elements that impacted our net income (loss) attributable to unitholders for the respective quarters and six months ended June 30, 2016 and 2015.  The explanatory text that follows the table describes in detail certain of these changes by business segment.
(in thousands)
Quarter Ended 
 June 30,
 
Six Months Ended 
 June 30,
Net income (loss) attributable to Pope Resources' unitholders:
 
 
 
2016 period
$
436

 
$
(599
)
2015 period
289

 
8,098

Variance
$
147

 
$
(8,697
)
Detail of variance:
 

 
 

Fee Timber
 

 
 

Log volumes (A)
$
3,260

 
$
(1,773
)
Log price realizations (B)
21

 
(586
)
Gain on sale of timberland
—

 
226

Production costs
(942
)
 
1,886

Depletion
(206
)
 
675

Other Fee Timber
(752
)
 
(1,423
)
Timberland Management
182

 
245

Real Estate
 

 
 

Land sales
(1,590
)
 
(3,314
)
Conservation easement sales
—

 
(4,311
)
Other Real Estate
(150
)
 
(283
)
General and administrative costs
139

 
(275
)
Net interest expense
30

 
117

Income taxes
28

 
318

Noncontrolling interests
127

 
(199
)
Total variances
$
147

 
$
(8,697
)
(A)
Volume variance calculated by extending change in sales volume by the average log sales price for the comparison period.
(B)
Price variance calculated by extending the change in average realized price by current period sales volume.


17


Fee Timber
 
Fee Timber results include operations on 111,000 acres of timberland owned by the Partnership and 94,000 acres of timberland owned by the Funds. Fee Timber revenue is earned primarily from the harvest and sale of logs from these timberlands which are located in western Washington, northwestern Oregon, and northern California. This revenue source is driven primarily by the volume of timber harvested and the average log price realized on the sale of that timber. Our harvest volume is based typically on manufactured log sales to domestic mills and log export brokers. We also occasionally sell rights to harvest timber (timber deed sale) from the Combined tree farms. The metrics used to calculate volumes sold and average price realized during the reporting periods exclude the timber deed sales, except where stated otherwise. Harvest volumes are generally expressed in million board feet (MMBF) increments while harvest revenue and related costs are generally expressed in terms of revenue or cost per thousand board feet (MBF).

Fee Timber revenue is also derived from commercial thinning operations, ground leases for cellular communication towers, and royalties from gravel mines and quarries, all of which, along with timber deed sales, are included in other revenue below. Commercial thinning consists of the selective cutting of timber stands not yet of optimal harvest age.  However, they do have some commercial value, thus allowing us to earn revenue while at the same time improving the projected value at harvest of the remaining timber in the stand.

Revenue and operating income for the Fee Timber segment for the quarters ended June 30, 2016, March 31, 2016, and June 30, 2015 were as follows:
 
(in millions)
Quarter ended
 
Log Sale
Revenue
 
Other
Revenue
 
Total Fee
Timber
Revenue
 
Gain on Sale of
Timberland
 
Operating
Income
 
Harvest
Volume
(MMBF)
 
Timber Deed Sale Volume (MMBF)
Partnership
 
$
7.7

 
$
0.5

 
$
8.2

 
$
—

 
$
2.8

 
13.7

 
—

Funds
 
4.1

 
—

 
4.1

 
—

 
0.2

 
7.2

 
—

Total June 2016
 
$
11.8

 
$
0.5

 
$
12.3

 
$
—

 
$
3.0

 
20.9

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Partnership
 
$
4

 
$
0.4

 
$
4.4

 
$
—

 
$
1.6

 
6.3

 
—

Funds
 
5.2

 
0.2

 
5.4

 
0.2

 
0.9

 
9.3

 
—

Total March 2016
 
$
9.2

 
$
0.6

 
$
9.8

 
$
0.2

 
$
2.5

 
15.6

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Partnership
 
$
4.1

 
$
0.7

 
$
4.8

 
$
—

 
$
1.3

 
7.2

 
—

Funds
 
4.3

 
0.2

 
4.5

 
—

 
0.3

 
7.9

 
—

Total June 2015
 
$
8.4

 
$
0.9

 
$
9.3

 
$
—

 
$
1.6

 
15.1

 
—

 
Operating Income
 
Comparing Q2 2016 to Q1 2016.  Operating income increased $485,000, or 20%, from $2.5 million in Q1 2016 to $3.0 million in Q2 2016. This increase is due primarily to a 34% increase in harvest volume offset partially by a 5% decrease in average realized log prices, a 19% increase in cost of sales due to the higher harvest volume and a $713,000 increase in operating expenses. In addition, Q1 2016 included a $226,000 gain on the sales of two small Fund properties that had no counterpart in Q2 2016.
 
Comparing Q2 2016 to Q2 2015.  Operating income increased $1.4 million, or 88%, from $1.6 million in Q2 2015 to $3.0 million in Q2 2016. This increase is due primarily to a 38% increase in harvest volume, offset partially by a 20% increase in cost of sales due to the higher harvest volume, and a $468,000 increase in operating expenses.
 
Revenue
 
Comparing Q2 2016 to Q1 2016.  Log sale revenue in Q2 2016 increased $2.6 million, or 28%, from Q1 2016 due to a 34% increase in harvest volume, offset partially by a 5% decrease in average realized log prices. Poor weather conditions

18


during Q1 2016 and expectations of better prices later in the year caused harvest volumes in that quarter to be lower than usual, creating a low base against which to compare Q2 2016 harvest volume.

Comparing Q2 2016 to Q2 2015.  Log sale revenue in Q2 2016 increased $3.4 million, or 40%, from Q2 2015, primarily as a result of a 38% increase in harvest volume. The increase in harvest volume in the current year is related to differences in weather patterns during the first quarter of each comparable year that created intra-quarter harvest timing differences. In 2015, temperatures were unseasonably warm, allowing for increased access to timberland throughout our region. As a result, our harvest volume was relatively higher in the first quarter of 2015 and then lower in the second quarter. By contrast, weather conditions were comparatively poor in early 2016, reflected by lower harvest volume in the first quarter and higher harvest volume in the second quarter. The decrease in other revenue is attributable primarily to $391,000 of commercial thinning activity in Q2 2015 that had no counterpart in Q2 2016.
 
Revenue and operating income for the Fee Timber segment for the six months ended June 30, 2016 and 2015 were as follows:
 
(in millions) Six Months Ended
 
Log Sale Revenue
 
Other Revenue
 
Total Fee Timber Revenue
 
Gain on Sale of Timberland
 
Operating Income
 
Harvest Volume (MMBF)
 
Timber Deed Sale Volume (MMBF)
Partnership
 
$
11.6

 
$
0.9

 
$
12.5

 
$
—

 
$
4.4

 
20.0

 
—

Funds
 
9.5

 
0.2

 
9.7

 
0.2

 
1.1

 
16.6

 
—

Total June 2016
 
$
21.1

 
$
1.1

 
$
22.2

 
$
0.2

 
$
5.5

 
36.6

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Partnership
 
$
12.4

 
$
1.2

 
$
13.6

 
$
—

 
$
5.4

 
19.7

 
—

Funds
 
11.0

 
0.6

 
11.6

 
—

 
1.1

 
19.9

 
0.6

Total June 2015
 
$
23.4

 
$
1.8

 
$
25.2

 
$
—

 
$
6.5

 
39.6

 
0.6

 
Operating Income
 
Comparing YTD 2016 to YTD 2015.  Operating income decreased by $1.0 million, or 15%, from $6.5 million in the first six months of 2015 to $5.5 million in the first six months of 2016, primarily as a result of an 8% decrease in harvest volume and a 3% decrease in average realized log prices. Also contributing to the decline in operating income was a $585,000 increase in operating expenses and $792,000 reduction in other revenue due to commercial thinning operations and timber deed sales in 2015 that had no counterparts in 2016. These decreases in operating income were offset partially by a 17% reduction in cost of sales related to the decline in harvest volume and a $226,000 gain on the sale of two small Fund properties during 2016 that had no counterpart in 2015.
 
Revenue
 
Comparing YTD 2016 to YTD 2015.  Log sale revenue in the first half of 2016 decreased $2.3 million, or 10%, from the first half of 2015. The reduction in revenue was the result of an 8% decrease in harvest volume and a 3% decrease in average realized log prices. Since the expiration of the Softwood Lumber Agreement (SLA) last October, Canadian lumber has been sold duty-free into the U.S. market, and will continue to do so at least until October of this year. This, combined with a strong U.S. Dollar, has contributed to a 36% increase in British Columbia exports of softwood lumber to the U.S. compared to 2015. This influx of Canadian lumber has kept lumber prices, and in turn, log prices in check when compared to last year. The $792,000 decrease in other revenue is due to commercial thinning operations and timber deed sales on the Combined tree farms in 2015 that had no counterparts in 2016.

Log Volume

We harvested the following log volumes by species from the Combined tree farms, exclusive of timber deed sales, for the quarters ended June 30, 2016, March 31, 2016, and June 30, 2015:
 

19


Volume (in MMBF)
Quarter Ended
 
 
Jun-16
% Total
 
Mar-16
% Total

 
Jun-15
% Total
Sawlogs
Douglas-fir
9.4

45
%
 
8.6

55
%
 
7.8

52
%
 
Whitewood
5.4

26
%
 
2.7

17
%
 
3.0

20
%
 
Pine
1.2

6
%
 
—

—
%
 
1.1

7
%
 
Cedar
1.0

5
%
 
0.9

6
%
 
0.5

3
%
 
Hardwood
0.7

3
%
 
0.6

4
%
 
0.4

3
%
Pulpwood
All Species
3.2

15
%
 
2.8

18
%
 
2.3

15
%
Total
 
20.9

100
%
 
15.6

100
%
 
15.1

100
%
 
Comparing Q2 2016 to Q1 2016. Harvest volume increased 5.3 MMBF, or 34%, in Q2 2016 from Q1 2016. The increase stems from unusually low harvest volumes during Q1 2016 when poor weather conditions limited access to our higher-elevation timberlands, combined with the expectation that log prices would improve later in the year as the U.S. housing market continues to recover. Our species mix shifted from Douglas-fir in Q1 2016 towards whitewood and pine in Q2 2016. This is a function of weather patterns and tree farm mix. The better weather conditions in Q2 2016 allowed for access to higher-elevation timberlands, where whitewoods are more prevalent. The pine volume comes almost exclusively from Fund III’s McCloud tree farm in northern California, where we conducted no operations during Q1 2016.
 
 Comparing Q2 2016 to Q2 2015. Harvest volume increased 5.8 MMBF, or 38%, in Q2 2016 from Q2 2015. The increase is due to different weather patterns this year relative to last year. In 2016, poor weather constrained our harvest in the first quarter which we recovered by increasing our harvest in the second quarter when the weather improved. By contrast, in 2015 the weather was unusually warm in the first quarter, allowing us to harvest more volume than is typical for that time of year, which resulted in comparatively low volume in the second quarter. Our species mix shifted from Douglas-fir in Q2 2015 towards whitewood in Q2 2016 due to improved whitewood log markets and less favorable Douglas-fir log markets relative to the prior year.
 
We harvested the following log volumes by species from the Combined tree farms, exclusive of timber deed sales, for the six months ended June 30, 2016 and 2015:

Volume (in MMBF)
Six Months Ended
 
 
Jun-16
% Total
 
Jun-15
% Total
Sawlogs:
Douglas-fir
18.2

50
%
 
19.1

48
%
 
Whitewood
8.0

22
%
 
9.0

23
%
 
Pine
1.2

3
%
 
1.1

3
%
 
Cedar
1.9

5
%
 
1.8

4
%
 
Hardwood
1.3

4
%
 
1.9

5
%
Pulpwood:
All Species
6.0

16
%
 
6.7

17
%
Total
 
36.6

100
%
 
39.6

100
%
 
Comparing YTD 2016 to YTD 2015. Harvest volume decreased 3.0 MMBF, or 8%, in the first six months of 2016 compared to the first six months of 2015. The decrease in harvest volume is attributable to weaker domestic and export markets in 2016 as compared to 2015 and deferring harvest until the latter half of 2016 in expectation of better log markets. Species mix was relatively stable between 2015 and 2016.
 
Log Prices
 
Logs from the Combined tree farms serve a number of different domestic and export markets, with domestic mills historically representing our largest market destination. Export customers consist of log brokers who sell the logs primarily to Japan, China and, to a lesser degree, Korea.


20


We realized the following log prices by species for the quarters ended June 30, 2016, March 31, 2016, and June 30, 2015:
 
 
 
Quarter Ended
 
 
Jun-16
 
Mar-16
 
Jun-15
Average price realizations (per MBF):
 
 
Sawlogs:
Douglas-fir
$
596

 
$
620

 
$
608

 
Whitewood
550

 
490

 
541

 
Pine
500

 
—

 
552

 
Cedar
1,271

 
1,514

 
1,120

 
Hardwood
521

 
539

 
532

Pulpwood:
All Species
290

 
312

 
322

Overall
 
563

 
591

 
562


The following table compares the dollar and percentage change in log prices from each of Q1 2016 and Q2 2015 to Q2 2016:
   
 
 
Change to Q2 2016 from Quarter Ended
 
 
Mar-16
 
Jun-15
 
 
$/MBF
 
%
 
$/MBF
 
%
Sawlogs:
Douglas-fir
$
(24
)
 
(4
%)
 
$
(12
)
 
(2
%)
 
Whitewood
60

 
12
%
 
9

 
2
%
 
Pine
500

 
NA

 
(52
)
 
(9
%)
 
Cedar
(243
)
 
(16
%)
 
151

 
13
%
 
Hardwood
(18
)
 
(3
%)
 
(11
)
 
(2
%)
Pulpwood:
All Species
(22
)
 
(7
%)
 
(32
)
 
(10
%)
Overall
 
(28
)
 
(5
%)
 
1

 
—
%
 
Overall realized log prices in Q2 2016 were 5% lower than Q1 2016 and essentially flat compared to Q2 2015. Our overall average is influenced heavily by price movements for our two most prevalent species on the Combined tree farms, Douglas-fir and whitewood, and the relative mix of harvest volume between those two species. From Q1 2016 to Q2 2016, log prices for these two species decreased 4% and increased 12%, respectively. Douglas-fir was weighed down by weakness in the Japanese market that was offset partially by solid demand from China which also served to support domestic pricing. Whitewood prices benefitted from solid demand from China, as well as from a local mill that was short on log supply. Cedar experienced a 16% price decrease due to the closure of a cedar mill in the Hood Canal market area as well as 20% of Q2 2016 cedar volume consisting of lower-valued incense cedar produced on Fund III’s McCloud tree farm, while in Q1 2016 all cedar volume was higher-value western red cedar produced primarily on the Partnership's tree farms.

From Q2 2015 to Q2 2016, the negligible increase in average realized log prices was attributable to offsetting price movements amongst the various species, and a shift in mix from Douglas-fir in Q2 2015 towards whitewood in Q2 2016. Douglas-fir prices decreased 2% while whitewood prices increased 2%. Prices for pine, produced almost exclusively on Fund III’s McCloud tree farm, were down 9% due to an excess of pine lumber at mills in the northern California market. The 13% increase in cedar prices is due to 45% of Q2 2015 cedar volume coming from lower-valued incense cedar produced on Fund III’s McCloud tree farm, while in Q2 2016 incense cedar made up only 20% of total cedar volume.
 

21


The following table compares realized log prices by species for the first six months of 2016 and 2015, as well as the dollar and percentage change in log prices between the two periods:
 
 
 
Six Months Ended
 
 
Jun-16
 
 
 
 
 
Jun-15
 
 
 

 
∆ from Jun-16 to Jun-15
 
 

 
 
 
 
$/MBF
 
%
 
 
Sawlogs:
Douglas-fir
$
608

 
$
(21
)
 
(3
%)
 
$
629

 
Whitewood
530

 
(20
)
 
(4
%)
 
550

 
Pine
500

 
(51
)
 
(9
%)
 
551

 
Cedar
1,384

 
(14
)
 
(1
%)
 
1,398

 
Hardwood
529

 
(94
)
 
(15
%)
 
623

Pulpwood:
All species
300

 
(26
)
 
(8
%)
 
326

Overall
 
575

 
(16
)
 
(3
%)
 
591

 
Overall realized log prices decreased 3% in the first six months of 2016 versus the corresponding period of 2015. The overall average is influenced heavily by Douglas-fir and whitewood prices, which were down 3% and 4%, respectively, but all other species and pulpwood experienced a decline in price as well. Douglas-fir was down on reduced pricing in the domestic market, while whitewood declined on lower pricing in the export market. Hardwood prices declined 15% due to the influence in early 2015 of a significant portion of higher-value red alder peeler logs that had no counterpart in 2016.

Customers

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

The table below categorizes logs sold by customer type for the quarters ended June 30, 2016, March 31, 2016, and June 30, 2015:

 
Q2 2016
 
Q1 2016
 
Q2 2015
 
Volume
 
 

 
Volume
 
 
 
Volume
 
 
Destination
MMBF
%
 
Price
 
MMBF
%
 
Price
 
MMBF
%
 
Price
Export brokers
3.2

15
%
 
$
607

 
2.8

18
%
 
$
669

 
2.1

14
%
 
$
604

Domestic mills
13.8

66
%
 
618

 
9.4

60
%
 
653

 
10.3

68
%
 
608

Hardwood
0.7

4
%
 
521

 
0.6

4
%
 
539

 
0.4

3
%
 
532

Pulpwood
3.2

15
%
 
290

 
2.8

18
%
 
312

 
2.3

15
%
 
322

Total
20.9

100
%
 
563

 
15.6

100
%
 
591

 
15.1

100
%
 
562

 
Comparing Q2 2016 to Q1 2016. Volume sold to the export market decreased to 15% of Q2 2016 harvest volume compared to 18% of Q1 2016 volume, while volume sold to the domestic market increased to 66% of Q2 2016 harvest volume compared to 60% of Q1 2016 harvest volume. This shift in customer mix reflects the harvest of 4.6 MMBF during Q2 2016 on Fund III’s McCloud tree farm, which sells all its volume into the domestic market. There was no harvest at McCloud during Q1 2016 as the winter snow prevented access to timber stands.

Comparing Q2 2016 to Q2 2015. The relative amounts of volume sold to our various customer types changed little during Q2 2016 compared to Q2 2015.


22


The table below categorizes logs sold by customer type for the six-month periods ended June 30, 2016 and 2015:

 
Six Months Ended
 
June 2016
 
June 2015
 
Volume
 
 
Volume
 
Destination
MMBF
%
Price
 
MMBF
%
Price
Export brokers
6.1

17
%
$
636

 
6.8

17
%
$
646

Domestic mills
23.2

63
%
632

 
24.2

61
%
647

Hardwood
1.3

4
%
529

 
1.9

5
%
623

Pulpwood
6.0

16
%
300

 
6.7

17
%
326

Subtotal
36.6

100
%
575

 
39.6

100
%
591

Timber deed sale
—

 

—

 
0.6

 
389

Total
36.6

 

 

 
40.2

 
 

 
Comparing YTD 2016 to YTD 2015. The relative amounts of volume sold to our various customer types changed little during the first six months of 2016 as compared to the corresponding period in 2015. Timber deed sales volume of 0.6 MMBF during the first six months of 2015 came from Fund III’s Willapa tree farm.

Cost of Sales
 
Fee Timber cost of sales, which consists predominantly of harvest, haul and depletion costs, vary with harvest volume. Commercial thinning costs are the primary component of other cost of sales in the tables below.
 
Fee Timber cost of sales for the quarters ended June 30, 2016, March 31, 2016, and June 30, 2015, was as follows, with the first table expressing these costs in total dollars and the second table expressing those costs that are driven by volume on a per MBF basis:
 
(in thousands) Quarter Ended
 
Harvest, Haul and Tax
 
Depletion
 
Other
 
Total Fee Timber Cost of Sales
 
Harvest Volume (MMBF)
 
Timber Deed Sale Volume (MMBF)
Partnership
 
$
3,188

 
$
586

 
$
15

 
$
3,789

 
13.7

 
—

Funds
 
1,921

 
1,277

 
—

 
3,198

 
7.2

 
—

Total June 2016
 
$
5,109

 
$
1,863

 
$
15

 
$
6,987

 
20.9

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
Partnership
 
$
1,323

 
$
271

 
$
14

 
$
1,608

 
6.3

 
—

Funds
 
2,226

 
2,059

 
—

 
4,285

 
9.3

 
—

Total March 2016
 
$
3,549

 
$
2,330

 
$
14

 
$
5,893

 
15.6

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
Partnership
 
$
1,669

 
$
348

 
$
284

 
$
2,301

 
7.2

 
—

Funds
 
2,189

 
1,309

 
39

 
3,537

 
7.9

 
—

Total June 2015
 
$
3,858

 
$
1,657

 
$
323

 
$
5,838

 
15.1

 
—

 

23


(Amounts per MBF) Quarter Ended
 
Harvest, Haul and Tax *
 
Depletion *
Partnership
 
$
233

 
$
43

Funds
 
267

 
177

Total June 2016
 
$
244

 
$
89

 
 
 
 
 
Partnership
 
$
210

 
$
43

Funds
 
239

 
221

Total March 2016
 
$
228

 
$
149

 
 
 
 
 
Partnership
 
$
232

 
$
48

Funds
 
277

 
166

Total June 2015
 
$
255

 
$
110

 
*
Timber deed sale volumes are excluded in the per MBF computation for harvest, haul and tax costs but included in the per MBF computation for depletion.
 
Comparing Q2 2016 to Q1 2016. Cost of sales increased $1.1 million, or 19%, in Q2 2016 from Q1 2016. The increase was attributable primarily to a 34% rise in harvest volume that was offset partially by a 40% decrease in the depletion rate. The decline in the depletion rate is a function the balance between harvest volume from the Funds' tree farms (which have a higher cost basis and thus a higher depletion rate) and the Partnership's tree farms (which have a relatively lower cost basis and thus a lower depletion rate). For the relevant periods, 66% of Q2 2016 harvest volume came from the Partnership tree farms, compared to only 40% during Q1 2016. The Funds’ tree farms have higher cost bases and depletion rates because they were purchased more recently at higher timberland valuations.
 
Comparing Q2 2016 to Q2 2015. Cost of sales increased $1.1 million, or 20%, in Q2 2016 from Q2 2015. The increase was attributable primarily to a 38% increase in harvest volume that was offset partially by a 19% decrease in the depletion rate. The decline in the depletion rate is a function of 66% of Q2 2016 harvest volume coming from the Partnership, compared to only 48% during Q2 2015. The Funds’ tree farms have higher depletion rates because they were purchased more recently at higher timberland valuations. The decrease in other cost of sales is attributable to commercial thinning activity during Q2 2015 that had no counterpart in Q2 2016.

Fee Timber cost of sales for the six months ended June 30, 2016 and 2015 was as follows, with the first table expressing these costs in total dollars and the second table expressing those costs that are driven by volume on a per MBF basis:
 
(in thousands) Six Months Ended
 
Harvest, Haul and Tax
 
Depletion
 
Other
 
Total Fee Timber Cost of Sales
 
Harvest Volume (MMBF)
 
Timber Deed Sale Volume (MMBF)
Partnership
 
$
4,511

 
$
857

 
$
29

 
$
5,397

 
20.0

 
—

Funds
 
4,147

 
3,336

 
—

 
7,483

 
16.6

 
—

Total June 2016
 
$
8,658

 
$
4,193

 
$
29

 
$
12,880

 
36.6

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
Partnership
 
$
4,577

 
$
930

 
$
401

 
$
5,908

 
19.7

 
—

Funds
 
5,325

 
3,938

 
269

 
9,532

 
19.9

 
0.6

Total June 2015
 
$
9,902

 
$
4,868

 
$
670

 
$
15,440

 
39.6

 
0.6

 

24


(Amounts per MBF) Six Months Ended
 
Harvest, Haul and Tax *
 
Depletion *
Partnership
 
$
226

 
$
43

Funds
 
250

 
201

Total June 2016
 
$
237

 
$
115

 
 
 
 
 
Partnership
 
$
232

 
$
47

Funds
 
268

 
192

Total June 2015
 
$
250

 
$
121

 
*
Timber deed sale volumes are excluded in the per MBF computation for harvest, haul and tax costs but included in the per MBF computation for depletion.
 
Comparing YTD 2016 to YTD 2015. Cost of sales decreased $2.6 million, or 17%, in the first six months of 2016 compared to the corresponding period in 2015 due to an 8% decrease in harvest volume and a 5% decline in both the per MBF depletion and harvest, haul, and tax rates. The decline in the depletion rate is a function of 55% of 2016 harvest volume coming from the Partnership, compared to 49% during 2015. The Funds’ tree farms have higher depletion rates because they were purchased more recently at higher timberland valuations. The decrease in other cost of sales is attributable to commercial thinning activity during 2015 that had no counterpart in 2016.
 
Operating Expenses
 
Fee Timber operating expenses include the cost of maintaining existing roads and building temporary roads for harvesting, silviculture costs, and other management expenses. For the quarters ended June 30, 2016, March 31, 2016, and June 30, 2015, operating expenses were $2.3 million, $1.6 million, and $1.8 million, respectively. The increase in operating expenses in Q2 2016 compared to both Q1 2016 and Q2 2015 was attributable to the increase in harvest volume and higher silviculture, road maintenance and pre-commercial thinning expenses.

Fee Timber operating expenses for the six months ended June 30, 2016 and 2015 were $3.9 million and $3.3 million, respectively.  The increase is attributable primarily to higher silviculture and road expenses on the Combined tree farms related to a rise in costs from pre-commercial thinning and maintaining existing roads.

Gain on Sale of Timberland

The gain on sale of timberland in 2016 occurred in the first quarter from sales of two parcels of timberland from the Funds totaling 210 acres.

Timberland Management
 
The Timberland Management segment develops timberland investment portfolios on behalf of the Funds. Our private equity timber funds own a combined 94,000 acres of commercial timberland in western Washington, northwestern Oregon, and northern California with total assets under management of $364 million based on the most recent appraisals.

 Fund Distributions and Fees Paid to the Partnership

Fund distributions are paid from available Fund cash, generated primarily from the harvest and sale of timber after paying all Fund expenses, management fees, and recurring capital costs. The Partnership received combined distributions from the Funds of $211,000 and $862,000, in the six months ended June 30, 2016, and 2015, respectively. The 2015 distributions included $622,000 from Fund I, which dissolved later in that year.
The Partnership earned asset, investment, and timberland management fees from the Funds of $1.6 million for the six months ended June 30, 2016 and 2015.

25


Revenue and Operating Loss

The fees earned from managing the Funds include a fixed component related to invested capital and acres owned, and a variable component related to harvest volume from the Funds’ tree farms.
 
Revenue and operating loss for the Timberland Management segment for the quarters ended June 30, 2016 and 2015 were as follows:
  
(in thousands, except invested
 
Quarter Ended
capital, volume and acre data)
 
Jun-16
 
Jun-15
Revenue internal
 
$
788

 
$
767

Intersegment eliminations
 
(788
)
 
(767
)
Revenue external
 
$
—

 
$
—

 
 
 
 
 
Operating income internal
 
$
123

 
$
(82
)
Intersegment eliminations
 
(726
)
 
(703
)
Operating loss external
 
$
(603
)
 
$
(785
)
 
 
 
 
 
Invested capital (in millions)
 
$
258

 
$
253

Acres owned by Funds
 
94,000

 
80,000

Harvest volume - Funds (MMBF), including timber deed sales
 
7.2

 
7.9

 
Comparing Q2 2016 to Q2 2015. Timberland Management generated management fee revenue of $788,000 and $767,000 from managing the Funds for the second quarters of 2016 and 2015, respectively. While the increase in revenue was only $21,000, there were a number of larger offsetting factors that produced the result. The increase in invested capital from Fund III’s $50.5 million acquisition of the Mashel tree farm in Q4 2015 was offset by a downward correction to the calculation of invested capital in Q4 2015 used to determine the asset management and investment management fees, resulting in lower fees on an ongoing basis. In addition, Fund III’s sale from the Willapa tree farm to Weyerhaeuser in Q3 2015 and two small timberland sales from Willapa and Fund II’s Riffe Lake tree farm in Q1 2016 served to reduce invested capital and, in turn, the management fees charged to the Funds. The Mashel tree farm acquisition added 15,000 acres to Fund III, while the timberland sales removed 1,000 acres. Notwithstanding the increase in acres owned in Q2 2016 versus Q2 2015, harvest volume by the Funds declined from Q2 2015 as we elected to defer volume in expectation of better prices later in the year as the U.S. housing market continues its recovery.

Operating expenses incurred for the quarters ended June 30, 2016, and 2015 totaled $603,000 and $785,000, respectively. The decrease in operating expenses is attributable to a decline in costs incurred placing capital for Fund III. The drawdown period for Fund III ended in December 2015.

Revenue and operating loss for the Timberland Management segment for the six months ended June 30, 2016 and 2015 were as follows:
 

26


(in thousands, except invested
 
Six Months Ended
capital, volume and acre data)
 
Jun-16
 
Jun-15
Revenue internal
 
$
1,611

 
$
1,601

Intersegment eliminations
 
(1,603
)
 
(1,601
)
Revenue external
 
$
8

 
$
—

 
 
 
 
 
Operating income internal
 
$
205

 
$
(59
)
Intersegment eliminations
 
(1,474
)
 
(1,455
)
Operating loss external
 
$
(1,269
)
 
$
(1,514
)
 
 
 
 
 
Invested capital (in millions)
 
$
258

 
$
253

Acres owned by Funds
 
94,000

 
80,000

Harvest volume - Funds (MMBF), including timber deed sales
 
16.6

 
20.5

 
Comparing YTD 2016 to YTD 2015. Timberland Management generated management fee revenue of $1.6 million from managing the Funds for the six months ended June 30, 2016 and 2015. As with the quarterly results, there were a number of larger offsetting factors that resulted management fees remaining flat from 2015 to 2016.
 
Operating expenses incurred by the Timberland Management segment for the six months ended June 30, 2016 and 2015 totaled $1.3 million and $1.5 million, respectively. The decrease in operating expenses is attributable to a decline in costs incurred placing capital for Fund III.
 
Real Estate
 
The Partnership’s Real Estate segment produces its revenue primarily from the sale of land within its 2,400-acre portfolio.  Additional sources of revenue include sales of development rights and tracts of land from the Partnership’s timberland portfolio, together with residential and commercial property rents earned from our Port Gamble and Poulsbo properties. Real Estate holdings are located in the Washington counties of Pierce, Kitsap, and Jefferson with sales of land for this segment typically falling into one of three general types:

•
Commercial, business park, and residential plat land sales represent land sold after development rights have been obtained and are generally sold with prescribed infrastructure improvements.

•
Rural residential lot sales that generally require some capital improvements such as zoning, road building, or utility access improvements prior to completing the sale.

•
The sale of unimproved land, which generally consists of larger acreage sales rather than single lot sales, is normally completed with very little capital investment prior to sale.

In addition to outright sales of fee simple interests in land, we also enter into conservation easement (CE) sales that allow us to retain the right to harvest and manage timberland, but bar any future subdivision of or real estate development on, the property.
 
“Land Held for Development” on our Condensed Consolidated Balance Sheets represents the Partnership’s cost basis in land that has been identified as having greater value as development property than timberland. Our Real Estate segment personnel work with local officials to obtain entitlements for further development of these parcels

Those properties that are for sale, under contract, and for which the Partnership has an expectation they will sell within the next 12 months, are classified on our balance sheet as a current asset under “Land Held for Sale”. The $6.6 million amount currently in Land Held for Sale reflects properties that are under contract and expected to close between now and the end of the second quarter of 2017, comprising 138 single-family residential lots from the Harbor Hill project, two separate single-family lot sales as well as a 144-acre sale of undeveloped land.
 

27


Project costs that are associated directly with the development and construction of a real estate project are capitalized and then included in cost of sales when the property is sold, along with our original basis in the underlying land and the closing costs associated with the sale transaction.
 
Results from Real Estate operations vary significantly from period-to-period as we make multi-year investments in entitlements and infrastructure prior to selling entitled or developed land.

Comparing Q2 2016 to Q2 2015. There were no land sales in the second quarter of 2016, though we recognized the remaining $157,000 of revenue on a percentage-of-completion basis on parcels sold in previous quarters. In Q2 2015, we closed on the sale of 33 residential lots from our Harbor Hill development for $3.3 million and a 175-acre conservation land sale for $920,000. Real Estate operating expenses remained flat at $1.1 million for the second quarters of 2016 and 2015.  These factors resulted in operating loss of $1.2 million for the second quarter of 2016 compared to operating income of $575,000 in the second quarter of 2015.
 
Comparing YTD 2016 to YTD 2015. In the first six months of 2016, we closed on the sale of 9 single-family residential lots from our Harbor Hill development and recognized the remaining revenue on a percentage-of-completion basis on parcels sold in previous periods for a combined total of $1.2 million.  In the first six months of 2015, we closed on the sale of 75 residential lots from Harbor Hill for $9.0 million and on conservation land and easement sales covering 3,861 acres for $6.0 million. Rental and other activities in our Real Estate segment have decreased in 2016 due to the loss of a tenant at our corporate headquarters building and commercial tenants at Port Gamble due to the environmental remediation project. Real Estate operating expenses increased from $2.0 million to $2.2 million for the first six months of 2015 and 2016, respectively, due primarily to legal and other professional fees in connection with planning and development for a number of properties. These factors resulted in an operating loss of $2.2 million for the first six months of 2016 compared to operating income of $5.7 million for the first six months of 2015.

Real Estate revenue, gross margin and operating income are summarized in the table below for the six months ended June 30, 2016 and 2015:

(in thousands, except units sold and per unit amounts)
 
 
 
 
 
 
 
 
For the six months ended:
 
 
 
 
 
 
 
 
 
 
 
 
Description
 
Revenue
 
Gross Margin
 
Units Sold
 
Revenue per unit
 
Gross Margin per unit
Residential
 
1,220

 
154

 
Lots:
 
9

 
135,556

 
17,111

Total land
 
1,220

 
154

 
 
 
 

 
 

 
 

Rentals and other
 
532

 
(134
)
 
 
 
 

 
 

 
 

June 30, 2016 total
 
$
1,752

 
$
20

 
 
 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Conservation land sale
 
$
1,644

 
$
912

 
Acres:
 
469

 
3,505

 
1,945

Development rights (CE)
 
4,311

 
4,311

 
Acres:
 
3,392

 
1,271

 
1,271

Residential
 
8,994

 
2,416

 
Lots:
 
75

 
119,920

 
32,213

Total land
 
14,949

 
7,639

 
 
 
 

 
 

 
 

Rentals and other
 
645

 
83

 
 
 
 

 
 

 
 

June 30, 2015 total
 
$
15,594

 
$
7,722

 
 
 
 

 
 

 
 

 
Environmental Remediation

As disclosed previously, we have a liability for environmental remediation at Port Gamble, Washington, due to contamination that occurred in Port Gamble Bay prior to our 1985 acquisition of the property from Pope & Talbot, Inc. We have adjusted that liability from time to time based on evolving circumstances. The first construction season was completed in January 2016. The second and final construction season began in late June 2016 and will continue into the first half of 2017, followed by a period of monitoring activity.
Project costs may still vary due to a number of factors, including but not limited to:

28


Handling of dredged material: Our liability estimate is based on the assumption that we will be able to reuse the majority of dredged material on the millsite. However, we have not yet obtained approval from the relevant regulatory agencies to use the millsite as a permanent location for these materials. We may be required to relocate some or all of the dredged material to land that we own a short distance from the town of Port Gamble or to a commercial landfill. Either of these scenarios would result in an increase in costs. It is possible that the final determination of whether to reuse the material at the millsite or transfer it to an alternative location may not occur until after we complete the construction phase of the project. As a result, if it becomes necessary to relocate the dredged material, we may incur additional expenses during the post-construction monitoring phase of the project.
Costs based on unit pricing: The majority of the components of the remediation work are based on a price per unit and the number of units is an estimate. For example, we are not certain of the number of pilings or volume of wood waste that will ultimately need to be removed from Port Gamble Bay. The cost for this work is priced on a per piling or cubic yard basis, so to the extent the actual number of pilings or volume of wood waste to be removed changes from our estimates, the overall cost may change.
Unforeseen conditions: Site conditions may be different than what was contemplated during the project design and this could result in changes to the scope of work to be completed. For example, the Washington State Department of Ecology has required us to increase the depth of the dredging in certain areas where the depth of wood waste is greater than expected originally.
Natural Resource Damages (NRD): 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 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. The Trustees are alleging that Pope Resources has NRD liability because of releases that occurred on its property. We have been in discussions with the Trustees regarding their claims, and the alleged conditions in Port Gamble Bay. We have also been discussing restoration alternatives that might address the damages the Trustees allege. Resolution of these NRD claims will likely occur after the construction phase of the project is completed. Discussions with the Trustees may result in an obligation for us to fund NRD restoration activities and past assessment costs that are not included currently in our liability. The outcome of this matter is too uncertain for us to determine the likelihood or potential amount of any such obligation at this time.
Should any future circumstances result in a change to the estimated cost of the project, we will record an appropriate adjustment to the liability in the period it becomes known and we can reasonably estimate the amount.


General and Administrative (G&A)
 
G&A expenses decreased to $1.1 million in the second quarter of 2016 from $1.2 in the second quarter of 2015. G&A expenses increased to $2.7 million for the first six months of 2016 from $2.4 million for the first six months of 2015. The decrease in G&A expenses for the second quarter of 2016 compared to the second quarter of 2015 was due primarily to lower professional fees in 2016. The increase in G&A expenses on a year-to-date basis was due primarily to personnel costs for being fully staffed in 2016 relative to 2015 and higher incentive compensation expense in 2016.
 
Interest Expense, Net
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Interest income
$
3

 
$
7

 
$
6

 
$
14

Interest expense
(933
)
 
(988
)
 
(1,744
)
 
(1,969
)
Capitalized interest expense
183

 
204

 
333

 
433

Interest expense, net
$
(747
)
 
$
(777
)
 
$
(1,405
)
 
$
(1,522
)

The Partnership’s and Fund III’s debt arrangements with Northwest Farm Credit Services (NWFCS) are included in its patronage program, which rebates a portion of interest paid in the prior year back to the borrower. This NWFCS patronage program is a feature common to most of this lender’s loan agreements. The patronage program reduced interest expense by

29


$143,000 and $120,000 for the second quarters of 2016 and 2015, respectively, and by $394,000 and $238,000 for the first six months of 2016 and 2015, respectively. The decrease in interest expense on a quarterly and year-to-date basis is due to the higher patronage rebate in 2016 relative to 2015 as well as lower average debt balances in 2016 due to the July 2015 repayment of a $5.0 million debt tranche, net of borrowings under our operating line of credit. In addition, the interest rate on borrowings under the line of credit is lower than the interest rate on the debt tranche that was repaid in 2015.
Capitalized interest decreased from 2015 to 2016 on both a quarterly and year-to-date basis as sales activity at Harbor Hill outpaced construction, resulting in a lower average basis in 2016 compared to 2015.

Income Tax
 
The Partnership recorded income tax expense of $0 and $28,000 for the quarters ended June 30, 2016 and 2015, respectively, and $50,000 and $368,000 for the first six months of 2016 and 2015, respectively.
 
Pope Resources is a limited partnership and is therefore not subject to federal income tax. Taxable income/loss is instead reported to unitholders each year on a Form K-1 for inclusion in each unitholder’s income tax return. However, Pope Resources does have corporate subsidiaries that are subject to income tax, giving rise to the line item for such tax in the Condensed Consolidated Statement of Comprehensive Income.


Noncontrolling interests-ORM Timber Funds
 
The line item “Net and comprehensive loss attributable to noncontrolling interests-ORM Timber Funds” represents the combination of the 80% portion of the net income or loss for Fund II which is attributable to third-party owners plus 95% of the net income or loss of Fund III that is similarly attributable to third-party owners.

Off-Balance Sheet Arrangements
 
We do not have any material off-balance sheet arrangements.

Liquidity and Capital Resources

We ordinarily finance our business activities using operating cash flows and, where appropriate in management’s assessment, commercial credit arrangements with banks or other financial institutions. During periods of reduced operating cash flows, such as the first half of 2016, we have available a line of credit that can be accessed in order to provide for any liquidity needs. We expect that funds generated internally from operations and externally through financing will provide the required resources for the Partnership’s operations and capital expenditures for at least the next twelve months.

The Partnership’s debt consists of mortgage debt with fixed interest rates and an operating line of credit with Northwest Farm Credit Services (NWFCS). The mortgage debt at June 30, 2016 includes $24.8 million in term loans with NWFCS structured in three tranches which mature from 2017 through 2025. In addition, our commercial office building in Poulsbo, Washington is collateral for a $2.6 million loan from NWFCS that matures in 2023. Our $20.0 million operating line of credit matures April 1, 2020 and we had $9.3 million drawn as of June 30, 2016. The line of credit carries a variable interest rate that is based on the one-month LIBOR rate plus 1.5%.
 
These debt agreements contain covenants that are measured quarterly. Among the covenants measured is a requirement that the Partnership maintain an interest coverage ratio of 3:1 and not exceed a maximum debt-to-total-capitalization ratio of 30%, with total capitalization calculated using fair market (vs. carrying) value of timberland, roads and timber. The Partnership is in compliance with these covenants as of June 30, 2016 and expects to remain in compliance for at least the next twelve months.
 
Mortgage debt within our private equity timber funds are collateralized by Fund properties only. Fund II has a timberland mortgage comprised of two fixed rate tranches totaling $25.0 million with MetLife Insurance Company. The tranches are non-amortizing and both mature in September 2020. The loans allow for, but do not require, annual principal payments of up to 10% of outstanding principal without incurring a make-whole premium. This mortgage is collateralized by a portion of Fund II’s timberland portfolio. Fund III has a timberland mortgage comprised of two fixed rate tranches totaling $32.4 million with NWFCS. The mortgage is non-amortizing and collateralized by all of Fund III’s timberland, with an $18.0 million tranche maturing in December 2023 and a $14.4 million tranche maturing in October 2024.
 

30


The $6.0 million decrease in cash generated for the six months ended June 30, 2016 compared to June 30, 2015 is explained in the following table:
 
 
Six Months Ended June 30,
(in thousands)
2016
 
Change
 
2015
Cash provided by (used in) operating activities
$
(4,297
)
 
$
(16,489
)
 
$
12,192

 
 
 
 
 
 
Investing activities
 
 
 
 
 
Maturity of short-term investments
—

 
(1,000
)
 
1,000

Reforestation and roads
(918
)
 
180

 
(1,098
)
Buildings and equipment
(140
)
 
26

 
(166
)
Deposit for acquisition of timberland - Partnership
(1,581
)
 
(1,581
)
 
—

Proceeds from sale of timberland - Funds
723

 
723

 
—

Acquisition of timberland - Partnership
(1,069
)
 
1,807

 
(2,876
)
Cash used in investing activities
(2,985
)
 
155

 
(3,140
)
Financing activities
 

 
 

 
 

Borrowings on line of credit, net
9,250

 
9,250

 
—

Repayment of long-term debt
(57
)
 
(2
)
 
(55
)
Payroll taxes paid upon unit net settlements
(152
)
 
(45
)
 
(107
)
Excess tax benefit of equity-based compensation
—

 
(5
)
 
5

Cash distributions to unitholders
(6,088
)
 
(451
)
 
(5,637
)
  Cash distributions to fund investors, net of distributions to Partnership
(2,573
)
 
1,590

 
(4,163
)
Cash provided by (used in) financing activities
380

 
10,337

 
(9,957
)
Net increase (decrease) in cash and cash equivalents
$
(6,902
)
 
$
(5,997
)
 
$
(905
)
 
The decrease in cash provided by (used in) operating activities of $16.5 million resulted primarily from fewer Real Estate sales in 2016, a $3.6 million increase in environmental remediation expenditures, an 8% decrease in timber harvest volume, and a 3% decrease in log prices.
 
Cash used in investing activities during 2016 decreased by $0.2 million compared to 2015 due primarily to proceeds from the sale of two small timberland parcels by the Funds in 2016 that had no counterpart in 2015, along with lower expenditures for timberland acquisitions and for reforestation and roads.
 
Cash provided by financing activities increased in the current year by $10.3 million due primarily to borrowings on our operating line of credit and a decrease in distributions to investors in our private equity timber funds, offset partially by an increase in distributions to Pope Resources' unitholders.
 
Seasonality
 
Fee Timber.  The elevation and terrain characteristics of our timberlands are such that we can conduct harvest operations virtually year-round on a significant portion of our tree farms.  Generally, we concentrate our harvests from these areas in those months when weather limits operations on other properties, thus taking advantage of reduced competition for log supply to our customers and improving prices realized. As such, on a combined basis the pattern of quarterly volumes harvested is flatter than would be the case if looking at one tree farm in isolation. However, this pattern may not hold true during periods of comparatively soft log prices, when we may defer harvest volume to capture greater value when log prices strengthen.
 
Timberland Management. Management revenue generated by this segment consists of asset and timberland management fees. These fees, which relate primarily to our activities on behalf of the Funds and are eliminated in consolidation, vary based upon the amount of invested capital, the number of acres owned by the Funds, and the volume of timber harvested from properties owned by the Funds and are not expected to be significantly seasonal.
 
Real Estate. While Real Estate results are not expected to be seasonal, the nature of the activities in this segment will likely result in periodic large transactions that will have significant positive impacts on both revenue and operating income of

31


the Partnership in periods in which these transactions close, and relatively limited revenue and income in other periods. While the variability of these results is not primarily a function of seasonal weather patterns, we do expect to see some seasonal fluctuations in this segment because of the general effects of weather on Pacific Northwest development activities.

Capital Expenditures and Commitments
 
Capital expenditures, excluding timberland acquisitions, for the full year 2016 are projected to be approximately $20.2 million. The most significant expenditures relate to finishing residential lots for sale to merchant homebuilders in our Harbor Hill project later this year and the installation of a new wastewater treatment plant for the town of Port Gamble. The following table presents our capital expenditures by major category on a year-to-date basis and what we expect for the remainder of the year:
in millions
YTD
 
Remainder of Year
 
Total
 
 
 
 
 
 
Harbor Hill project development
$
4.8

 
$
8.6

 
$
13.4

Port Gamble wastewater treatment plant
—

 
3.6

 
3.6

Reforestation and roads
0.9

 
1.1

 
2.0

Other
0.6

 
0.6

 
1.2

 
$
6.3

 
$
13.9

 
$
20.2


ACCOUNTING MATTERS
 
Critical Accounting Policies and Estimates
 
An accounting policy is deemed to be “critical” if it is important to a company’s results of operations and financial condition, and requires significant judgment and estimates on the part of management in its application. The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect certain amounts reported in the financial statements and related disclosures. Actual results could differ from these estimates and assumptions. Management believes its most critical accounting policies and estimates relate to the calculation of timber depletion as well as modeling performed to determine liabilities for matters such as environmental remediation, and potential asset impairments.
 
For a further discussion of our critical accounting policies and estimates see Accounting Matters in the Management Discussion and Analysis section of our Annual Report on Form 10-K for the year ended December 31, 2015. See also note 2 to the condensed consolidated financial statements.
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Interest Rate Risk
 
The consolidated fixed-rate debt outstanding had a fair value of approximately $93.5 million and $89.8 million at June 30, 2016 and December 31, 2015, respectively, based on the prevailing interest rates for similar financial instruments. A change in interest rate on fixed-rate debt will affect the fair value of debt, whereas a change in the interest rate on variable-rate debt will affect interest expense and cash flows payable by the Partnership. A hypothetical 1% change in prevailing interest rates would change the fair value of fixed-rate long-term debt obligations by $3.0 million. We are not subject to material foreign currency risk, derivative risk, or similar uncertainties.
 
ITEM 4. CONTROLS AND PROCEDURES
 
The Partnership’s management maintains a system of internal controls, which management views as adequate to promote the timely identification and reporting of material, relevant information. Those controls include (1) requiring executive management and all managers in accounting roles to sign and adhere to a Code of Conduct and (2) implementation of a confidential hotline for employees to contact the Audit Committee directly with financial reporting concerns. Additionally, the Partnership’s senior management team meets regularly to discuss significant transactions and events affecting the Partnership’s operations. The Partnership’s executive officers lead these meetings and consider whether topics discussed represent information that should be disclosed under generally accepted accounting principles and the rules of the SEC. The Board of

32


Directors of the Partnership’s general partner includes an Audit Committee. The Audit Committee reviews the earnings release and all reports on Form 10-Q and 10-K prior to their filing. The Audit Committee is responsible for hiring the Partnership’s external auditors and meets with those auditors at least eight times each year, including regularly scheduled executive sessions outside the presence of management.

Our executive officers are responsible for establishing and maintaining disclosure controls and procedures. They have designed such controls to ensure that others make all material information known to them within the organization. Management regularly evaluates ways to improve internal controls.

As of the end of the period covered by this quarterly report on Form 10-Q our executive officers completed an evaluation of the disclosure controls and procedures and have determined them to be effective. There have been no changes to internal control over financial reporting that materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.


33


PART II- OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
From time to time, the Partnership may be subject to legal proceedings and claims that may have a material adverse impact on its business. Management is not aware of any current legal proceedings or claims that are expected to have, individually or in the aggregate, a material adverse impact on its business, prospects, financial condition or results of operations.
 
ITEM 1A. RISK FACTORS
 
Risks Related to Our Industry and Our Markets

We are sensitive to demand and price issues relating to our sales of logs in both domestic and foreign markets. We generate Fee Timber revenue primarily by selling softwood logs to domestic mills and to third-party intermediaries who resell them to the export market. The domestic market for logs in our operating area depends heavily on U.S. housing starts. Recently, the U.S. housing market has started to improve but, to the extent the recovery in the housing market should stall, such a turn of events could have a negative impact on our operating results. Demand from export markets for Pacific Northwest logs are affected significantly by fluctuations in United States, Japanese and, increasingly, Chinese and Korean economies, the foreign currency exchange rate between these Asian currencies and the U.S. dollar, as well as by ocean transportation costs. Further, the prices we realize for our logs depend in part upon competition, and the recent expiration of the Softwood Lumber Agreement between the United States and Canada in October 2015 may have the effect of increasing the supply of logs from Canada. While this has not had a noticeable impact to date, it remains too early to assess whether the longer-term implications of the expiry of this agreement may have an adverse impact on the prices we realize on the sales of our logs.

Our Fee Timber and Timberland Management segments are highly dependent upon sales of commodity products. Our revenues from our forestry businesses, which comprise our Fee Timber and our Timberland Management segments, are widely available from producers in other regions of the United States and in a number of other countries. We are therefore subject to risks associated with the production of commonly available products, such that an increase in supply from abroad as a result of overproduction by competitors in other nations or as a result of changes in currency exchange rates, may reduce the demand for our products in some or all of the markets in which we do business. Similarly, from time to time in the past we have seen, and in the future we may experience, an increase in supply or a reduction in demand as a result of international tensions or competition that are beyond our control and that may not be predictable.

We are subject to statutory and regulatory restrictions that currently limit, and may increasingly limit, our ability to generate income. Our ability to grow and harvest timber can be impacted significantly by legislation, regulations or court rulings that restrict or stop forest practices. For example, events that focus media attention upon natural disasters and damage to timberlands have at various times brought increasing public attention to forestry practices. Similarly, certain activist groups in Oregon have proposed a ballot initiative that, if approved and sustained in the courts, would eliminate clearcutting, which is the predominant harvest practice across our geographic region. These initiatives, alone or in combination, may limit the portion of our timberlands that is eligible for harvest, may make it more expensive or less efficient to harvest all or certain portions of our timberlands, or may restrict other aspects of our operations. Additional regulations, whether or not adopted in response to such events, may make it more difficult or expensive for us to harvest timber and may reduce the amount of harvestable timber on our properties. These and other restrictions on logging, planting, road building, fertilizing, managing competing vegetation, and other activities can significantly increase the cost or reduce available inventory thereby reducing income. Any such additional restrictions would likely have a similar effect on our Timberland Management operations. We cannot offer assurances that we will not be alleged to have failed to comply with these regulations, or we may face a reduction in revenues or an increase in costs as a result of complying with newly adopted statutes, regulations and court or administrative decisions. These claims may take the form of individual or class action litigation, regulatory or enforcement proceedings, or both. Any such claims could result in substantial defense costs and divert management’s attention from the ongoing operation of our business, and if any such claims were successful, may result in substantial damage awards, fines or civil penalties.

Environmental and other activist groups may have an adverse impact on the value of our assets or on our ability to generate revenues from our timberlands. In recent years we have seen an increase in activities by environmental groups, Native American tribes, and other activists in the legislative, administrative and judicial processes that govern all aspects of our operations. For example, on more than one occasion the Washington Department of Ecology applied more stringent regulatory standards to our existing environmental remediation operations at Port Gamble, Washington, after soliciting or receiving input from tribal representatives. These revisions substantially increased the cost and the time associated with our previously-existing remediation plans. Similarly, citizens’ and environmental groups have significant influence in the

34


entitlement and zoning processes that affect our Real Estate operations. These activities are not likely to diminish in the foreseeable future, and in some instances may have a material impact upon the revenues we can generate from our properties or upon the costs of generating those revenues.

Our businesses are highly dependent upon domestic and international macroeconomic factors. Both our timberland operations and our real estate operations are highly influenced by housing markets. Our Fee Timber and Timberland Management segments depend upon housing and construction markets in the United States and in other Pacific Rim countries. Our Real Estate segment depends upon a highly localized demand in the Puget Sound region of Western Washington. Factors that affect these markets will have a disproportionate impact on our business, and may be difficult or impossible to predict or estimate accurately.

We face increasing competition from engineered and recycled products. Our Fee Timber and Timberland Management segments derive substantially all their revenues from the market for softwood logs and wood products derived from them. Recent years have witnessed the emergence of plastic, fiberglass, wood composite and recycled products, as well as metal products in certain industries, that may have the effect of reducing demand for our products. As these products evolve, and as other competitive products may be developed, we may face a decline in log price realizations that would have an adverse impact on our revenues, our earnings and the value of our assets.

As a property owner and seller, we face environmental risks associated with events that occur or that may be alleged to have occurred on our properties. Various federal and state environmental laws in the states in which we operate place liability for environmental contamination on the current and former owners of real estate on which contamination is discovered. These laws are often a source of “strict liability,” meaning that an owner or operator need not necessarily have caused, or even been aware of, the release of hazardous substances. Such a circumstance applies to our operations at Port Gamble and Port Ludlow, Washington, for example, where contamination occurred prior to the formation of the Partnership. If hazardous substances are discovered or are alleged to have been released on property that we currently own or operate, that we have owned or operated in the past, or that we acquire or operate in the future, we may be subject to liability for the cost of remediating these properties without regard for our conduct or our knowledge of the events that led to the contamination or alleged contamination. These events would likely increase our expenses and might, in some cases, make it more difficult or impossible for us to continue operating our timberlands or to sell parcels of real estate for a price we would deem reasonable, or at all.

Risks Relating to Our Operations

Our operations are geographically concentrated, and we may face greater impacts from localized events than would more geographically diverse timber companies. Because our operations are conducted exclusively west of the Cascade Mountains of the Pacific Northwest, between northern California and the Canadian border, regionalized events and conditions may have a more pronounced impact upon our operations than they might upon a more geographically diverse timber company. For example, disease and insect infestations tend to be local or regional in scope, and because our Fee Timber and Timberland Management businesses are geographically concentrated, events of this nature may affect our operations more significantly than they might a similarly situated company whose operations are more widely dispersed. Similarly, because the vast majority of our Real Estate operations are limited to the Puget Sound region of Western Washington, regional impacts such as growth patterns, weather patterns and natural disasters, as well as socio-political events such as environmental and land use initiatives, may disproportionately affect that segment more significantly than a company whose operations are less concentrated.

Consolidation of sawmills in our geographic operating area may reduce competition among our customers, which could adversely affect our log prices. In the past we have experienced, and may continue to experience, consolidation of sawmills and other wood products manufacturing facilities in the Pacific Northwest. For example, Simpson Timber Co. announced in 2015 the sale of four of their mills in the Pacific Northwest region to two separate buyers. Two of those mills will be shut down permanently while another will be closed until a new, more modern, mill is built in its place. The replacement mill is expected to open in late 2016 or early 2017. In addition, Interfor announced recently their intention to sell a lumber mill in Tacoma, Washington that it closed in May 2015. Because a portion of our cost of sales in our Fee Timber segment, which encompasses the Combined tree farms, consists of transportation costs for delivery of logs to domestic sawmills, it becomes increasingly expensive to transport logs over longer distances for sales in domestic markets. As a result, a reduction in the number of sawmills, or in the number of sawmill operators, may reduce competition for our logs, increase transportation costs, or both. These consolidations thus may have a material adverse impact upon our Fee Timber revenue or income and, as that segment has traditionally represented our largest business unit, upon our results of operation and financial condition as a whole. Any such material adverse impact on timber revenue and income as a result of regional mill consolidations will also indirectly

35


affect our Timberland Management segment in the context of raising capital for investment in Pacific Northwest-based timber funds.

Our real estate holdings are highly illiquid, and changes in economic and regulatory factors may affect the value of our properties or the timing of the proceeds, if any, that we expect to receive on the sale of such properties. The value of our real estate investments, and our income from Real Estate operations, is sensitive to changes in the economic and regulatory environment, as well as various land-use regulations and development risks, including the ability to obtain the necessary permits and land entitlements that would allow us to maximize the revenue from our real estate investments. Our real estate investments are long-term in nature, which raises the risk that unforeseen changes in the economy or laws surrounding development activities may have an adverse effect on our investments. These investments often are highly illiquid and thus may not generate cash flow if and when needed to support our other operations. Further, we occasionally announce contracts relating to the sale of our real estate holdings, but those agreements may contain contingencies and conditions that may delay or prevent the consummation of transactions even after we have agreed to sale terms.

Our timber investment fund business depends upon establishing and maintaining a strong reputation among investors, and on our ability to maintain strong relationships with existing and prospective investors in our Funds. Our ability to expand our operations using our private equity timber fund strategy depends to a significant degree upon our ability to maintain and develop our expertise in managing timberlands in a manner that generates investment returns for prospective Fund investors. Events or conditions that adversely impact this capacity, including events that damage our reputation or our relationship with Fund investors, may make it more difficult to grow our operations using this strategy, and in some instances may result in actual or alleged liability to our investors. Any such events may cause a reduction in our revenues or may cause us to realize less than the optimum potential of our assets.

We have an environmental remediation liability associated with our Port Gamble property, and that liability may increase. We currently own certain real estate at Port Gamble on the Kitsap Peninsula in western Washington. Sediments adjacent to the property were alleged to have been impacted by operations occurring prior to our acquisition of the property, which occurred at the time of our spinoff from Pope & Talbot, Inc. in 1985. However, as current owner of Port Gamble, we have environmental liability for these properties under Washington State’s Model Toxics Control Act (MTCA). In December 2013, we reached an agreement with the Washington State Department of Ecology (“DOE”) in the form of a consent decree (“CD”) and clean-up action plan (“CAP”) that provides for the cleanup of Port Gamble Bay. Together, these documents outline the terms under which the Partnership will conduct environmental remediation as well as the specific clean-up activities to be performed. The CD and CAP were filed with the Kitsap County Superior Court in December 2013.  On June 8, 2015, Kitsap County Superior Court ruled on summary judgment that Washington’s Department of Natural Resources (DNR) did not qualify as an owner or operator of the site and therefore did not have liability under the MTCA. DNR had been identified by DOE as a "potentially liable person" under the MTCA. The effect of the court’s ruling is to absolve DNR of any responsibility to contribute to the cost of cleanup at Port Gamble. We have appealed the Superior Court’s ruling, and believe we have a strong case for overturning the lower court’s decision, however, there can be no assurance that we will prevail in this matter or that we can reach an acceptable settlement with DNR. The recorded liability reflects the estimated cost of the entire project, without any contribution by DNR. Additionally, 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 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. The Trustees are alleging that Pope Resources has NRD liability because of releases that occurred on its property. We have been in discussions with the Trustees regarding their claims, and the alleged conditions in Port Gamble Bay. We have also been discussing restoration alternatives that might address the damages the Trustees allege. Discussions with the Trustees may result in an obligation for us to fund NRD assessment and restoration activities that are not included currently in our liability. The outcome of this matter is too uncertain for us to determine the likelihood or potential amount of any such obligation at this time.

Management continues to monitor the Port Gamble cleanup processes closely. The $12.6 million remediation accrual as of June 30, 2016 represents our current estimate of the remaining cleanup cost and most likely outcome to various contingencies. These estimates are predicated upon a variety of factors, including the actual amount of the ultimate cleanup costs. The liability is based upon a number of estimates and judgments that are subject to change as the project progresses. There may be additional litigation costs if we successfully overturn the Superior Court's ruling but cannot reach a settlement with DNR, and the outcome of any such litigation is uncertain. The filing of the CD limits our legal exposure for matters covered by the decree, but does not eliminate it entirely. DOE reserves the right to reopen the CD if new information regarding factors previously unknown to the agency requres further remedial action. While unlikely, a reopening of the CD may result in adverse financial impacts and may have the effect of distracting management and other key personnel from the day to day

36


operation of our business. These factors, alone or in combination with other challenges, may have a material adverse effect upon our assets, income and operations.

We compete with a number of larger competitors that may be better able than we to absorb price fluctuations, may be able to expend greater resources on production, may have greater access to capital, and may operate more efficiently than we can. We compete against much larger companies in each of our business segments. We compete with these companies for management and line personnel, as well as for purchases of relatively scarce capital assets such as land and standing timber and for sales of our products. These larger competitors may have access to larger amounts of capital and significantly greater economies of scale, and they may be better able to absorb the risks inherent in our line of business. Moreover, the timber industry has experienced consolidation in recent years and, as that consolidation occurs, our relative market share decreases and the relative financial capacity of our competitors increases. While management believes the Partnership is at a competitive advantage over some of these companies because of our lack of vertical integration into forest products manufacturing, our advantageous tax structure, and management’s attempts to diversify our asset base, we cannot assure readers that competition will not have a material and adverse effect on our results of operations or our financial condition.

We and our customers are dependent upon active credit markets to fund operations. We sell logs from our Fee Timber segment to mills and log brokers that in most circumstances rely upon an active credit market to fund their operations. Our Real Estate sales are also often dependent upon credit markets in order to fund acquisitions. To the extent borrowing restrictions impinge on customers’ access to debt, we expect those customers to respond by reducing their expenditures, and those reductions may have the effect of directly reducing our revenues and of indirectly reducing the demand for our products. Any such outcomes could materially and adversely impact our results of operations, cash flows, and financial condition.

We may incur losses as a result of natural disasters that may occur, or that may be alleged to have occurred, on our properties. Forests are subject to a number of natural hazards, including damage by fire, severe windstorms, insects and disease, flooding and landslides. Changes in global climate conditions may intensify these natural hazards. Severe weather conditions and other natural disasters can also reduce the productivity of timberlands and disrupt the harvesting and delivery of forest products. While damage from natural causes is typically localized and would normally affect only a small portion of our timberlands at any one time, these hazards are unpredictable and losses might not be so limited. Consistent with the practices of other large timber companies, we do not maintain insurance against loss of standing timber on our timberlands due to natural disasters. However, as a result of the extreme fire conditions in the Pacific Northwest in 2015, we have acquired fire insurance on a portion of our timberland portfolio.

We rely on contract loggers and truckers who are in short supply and seeking consistent work at increasing rates.  We rely on contract loggers and truckers for the production and transportation, respectively, of our products to customers.  During the economic downturn of 2008 and 2009 most industrial forestry firms deferred harvest, which resulted in a shortfall in demand for the contract logging and trucking work force.  Many private logging and trucking companies did not survive the protracted economic downturn.  As the economy has improved and companies return to harvesting, a shortage of logging contractors and truckers has developed.  The remaining contractors who survived did so by reducing their workforce or, in the case of log truckers, converting their trucks to configurations suitable for highway freight hauling.  This decline in the pool of available contractors has resulted in a steady increase in harvest and haul costs and market forces that are emphasizing continuity of work when soliciting contractor bids for a job.  The commitment to more continuous work could preclude our ability to time markets, affecting total returns.

Risks Relating to Ownership of Our Securities

We are controlled by our managing general partner. As a master limited partnership, substantially all of our day-to-day affairs are controlled by our managing general partner, Pope MGP, Inc. The board of directors of Pope MGP, Inc. serves as our board of directors, and by virtue of a stockholder agreement, each of the two individual shareholders of Pope MGP, Inc. have the ability to designate one of our directors and jointly appoint two others, with the fifth board position taken by our chief executive officer, who serves as a director by virtue of his executive position. Unitholders may remove the managing general partner only in limited circumstances, including, among other things, a vote by the holders of a two-thirds majority of the “qualified units,” which means the units that have been owned by their respective holders for at least five years prior to such vote. By virtue of the terms of our agreement of limited partnership, as amended, or “partnership agreement”, our managing general partner directly, and the general partner shareholders indirectly, have the ability to do the following: prevent or impede transactions that would result in a change of control of the Partnership; to prevent or, upon the approval of limited partners holding a majority of the units, to cause, the sale of the assets of the Partnership; and to cause the Partnership to take or refrain from taking certain other actions that one might otherwise perceive to be in the Partnership’s best interest. Under our

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partnership agreement, we are required to pay to Pope MGP, Inc. an annual management fee of $150,000, and to reimburse Pope MGP, Inc. for certain expenses incurred in managing our business.

We have a limited market capitalization and a relatively low historic trading volume, as a result of which the trading prices of our units may be more volatile than would an investment in a more liquid security. Our relatively small public float and our limited trading volume may, in certain instances, make trading in our units more volatile, as a result of which our price may deviate more significantly, and opportunities to buy or sell our units may be more limited, than investors might experience with a more liquid market. This circumstance may be magnified during times of significant or prolonged selling pressure on our securities.

We benefit from certain tax treatment accorded to master limited partnerships, and if that status changes the holders of our units may realize less advantageous tax consequences. The Partnership is a Master Limited Partnership and is therefore not generally subject to U.S. federal income taxes. If a change in tax law (or interpretation of current tax law) caused the Partnership to become subject to income taxes, operating results would be adversely affected. We also have a handful of taxable subsidiaries. The estimation of income tax expense and preparation of income tax returns requires complex calculations and judgments. We believe the estimates and calculations used in this process are proper and reasonable and more likely than not would be sustained under examination by federal or state tax authorities, however if a federal or state taxing authority disagreed with the positions we have taken, a material change in provision for income taxes, net income, or cash flows could result.

 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
(a) - (e) None

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

On May 11, 2016 the Partnership repurchased five units at $68.23 per unit from a single third-party unitholder. 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
None
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
None
 
ITEM 5. OTHER INFORMATION
 
(a)
There have been no material changes in the procedures for shareholders of the Partnership’s general partner to nominate directors to the board.

ITEM 6. Exhibits
 
Exhibits.

31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a).
 
 
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a).
 
 
32.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350 (furnished with this report in accordance with SEC Rel. No. 33-8238).
 
 
32.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350 (furnished with this report in accordance with SEC Rel. No. 33-8238).


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101.INS
XBRL Instance Document
 
 
101.SCH
XBRL Taxonomy Extension Schema Document
 
 
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document

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SIGNATURES
 
Pursuant to the requirement 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, on August 9, 2016.
 
 
POPE RESOURCES,
 
A Delaware Limited Partnership
 
 
 
 
By:
POPE MGP, Inc.
 
 
Managing General Partner
 
 
 
 
 
 
 
 
By:  /s/ Thomas M. Ringo
 
 
Thomas M. Ringo
 
 
President and Chief Executive Officer
 
 
(Principal Executive Officer)
 
 
 
 
 
 
 
 
By:  /s/ John D. Lamb
 
 
John D. Lamb
 
 
Vice President and Chief Financial Officer
 
 
(Principal Financial Officer)
 
 
 
 
 
 
 
 
By: /s/  Sean M. Tallarico
 
 
Sean M. Tallarico
 
 
Controller
 
 
(Principal Accounting Officer)


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POPE RESOURCES LTD PARTNERSHIP Reports

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