ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report contains a number of projections and statements about our expected financial condition, operating results, and business plans and objectives. These statements reflect management’s estimates based upon our current expectations, in light of management’s knowledge of existing circumstances and expectations about future developments. Statements about expectations and future performance are “forward looking statements” within the meaning of applicable securities laws, which describe our goals, objectives and anticipated performance. These statements can be identified by words such as
“anticipate,” “believe,” “expect,” “intend” and similar expressions
.
Some of these statements are inherently uncertain, and some or all of these statements may not come to pass. Accordingly, you should not interpret these statements as promises that we will perform at a given level or that we will take any or all of the actions we currently expect to take. Our future actions, as well as our actual performance, will vary from our current expectations, and under various circumstances these variations may be material and adverse. Some of the factors that may cause our actual operating results and financial condition to fall short of our expectations are set forth in the part of this report entitled “Risk Factors” in Part II, Item 1A below. From time to time we identify other risks and uncertainties in our other filings with the Securities and Exchange Commission. The forward-looking statements in this report reflect our estimates and expectations as of the date of the report, and unless required by law, we do not undertake to update these statements as our business operations and environment change.
This discussion should be read in conjunction with the condensed consolidated financial statements and related notes included with this report.
EXECUTIVE OVERVIEW
Pope Resources, A Delaware Limited Partnership (“we” or the “Partnership”), is engaged in four primary businesses: Partnership Timber, Funds Timber, Timberland Investment Management, and Real Estate.
By far the most significant segments, in terms of owned assets and operations, are our two timber segments, which we refer to as Partnership Timber and Funds Timber. These segments include timberlands owned directly by the Partnership and three private equity funds (“Fund II”, “Fund III” and “Fund IV”, collectively, the “Funds”), respectively. We refer to the timberland owned by the Partnership as the Partnership’s tree farms, and our Partnership Timber segment reflects operations from those properties. We refer to timberland owned by the Funds as the Funds’ tree farms, and operations from those properties are reported in our Funds Timber segment. When referring collectively to the Partnership’s and Funds’ timberland, we refer to them as the Combined tree farms. Operations in each of these segments consist of growing timber and manufacturing logs for sale to domestic wood products manufacturers and log export brokers.
Our Timberland Investment Management segment is engaged in organizing and managing private equity timber funds using capital invested by third parties and the Partnership. The Funds are consolidated into our financial statements, but then income or loss attributable to equity owned by third parties is subtracted from consolidated results in our Condensed Consolidated Statements of Comprehensive Income under the caption “Net and comprehensive (income) loss attributable to non-controlling interests-ORM Timber Funds” to arrive at “Net and comprehensive income attributable to unitholders”.
Our current strategy for adding timberland acreage is centered primarily on our private equity timber fund business model. However, we acquire smaller timberland parcels from time to time to add on to the Partnership’s existing tree farms. In addition, during periods when the Funds’ committed capital is fully invested, we may look to acquire larger timberland properties for the Partnership. Our three active timber funds have assets under management totaling approximately $490 million as of
June 30, 2018
based on the most recent appraisals. Through our 20% co-investment in Fund II, our 5% co-investment in Fund III, and our 15% co-investment in Fund IV, we have deployed $43 million of Partnership capital. Fund IV, launched in December 2016, is still in its investment period and has not yet drawn or deployed all of its committed capital. Our co-investment affords us a share of the Funds’ operating cash flows while also allowing us to earn asset management and timberland management fees, as well as potential future incentive fees, based upon the overall success of each fund. We also believe that this strategy allows us to maintain more sophisticated expertise in timberland acquisition, valuation, and management on a more cost-effective basis than we could for the Partnership’s timberlands alone. We believe our co-investment strategy also enhances our credibility with existing and prospective Fund investors by demonstrating that we have both an operational and a financial commitment to the Funds’ success.
Our Real Estate segment’s activities primarily include securing permits and entitlements, and in some cases, installing infrastructure for raw land development and then realizing that land’s value by selling larger parcels to developers who, in turn, seek to take the land further up the value chain by either selling homes to retail buyers or lots to developers of commercial
property. More recently, we have acquired and developed other real estate properties (not owned by the Partnership), either on our own or by partnering with another developer in a joint venture. Since these projects often span multiple years, the Real Estate segment may incur losses for multiple years while a project is developed, and will not recognize operating income until that project is sold. In addition, within this segment, we sometimes negotiate and sell development rights in the form of conservation easements (CE’s) on Partnership Timber properties which preclude future development, but allow continued forestry operations. The strategy for our Real Estate segment centers around how and when to “harvest” or sell a parcel of land to realize its optimal value. In doing so, we seek to balance the long-term risks and costs of carrying and developing a property against the potential for income and cash flows upon sale. Land held for development by our Real Estate segment represents property in western Washington that has been deemed suitable for residential and commercial building sites. Land and timber held for sale includes those properties in the development portfolio that we expect to sell in the next 12 months.
Outlook
We expect our 2018 harvest volume will be approximately 67 million board feet (MMBF) for the Partnership, and approximately 82 MMBF for the Funds, including timber deed sales. The 67 MMBF for the Partnership includes 15 MMBF of volume from timber located on Real Estate properties and recent small-tract acquisitions that is not factored into our long-term, sustainable harvest plan of 52 MMBF. On a look-through basis, defined as the Partnership plus its portion of the Funds based on its ownership interest in each Fund, 2018 harvest volume is expected to be 77 MMBF including timber deed sales. We will continue to monitor log markets and adjust our harvest levels accordingly as the year progresses.
The Puget Sound housing market remains strong, and we anticipate closing on additional residential lots from our Harbor Hill project in the fourth quarter, as well as potential sales from other projects in Kitsap County.
Timber - Overall
Operations.
Timber results include operations on 120,000 acres of timberland owned by the Partnership in western Washington, and 124,000 acres of timberland owned by the Funds in western Washington, northwestern Oregon, southwestern Oregon, and northern California. Timber revenue is earned primarily from the harvest and sale of logs from these timberlands, and is driven primarily by the volume of timber harvested and the average log price realized on the sale of that timber. Our harvest volume typically represents delivered log sales to domestic mills and log export brokers. We also occasionally sell rights to harvest timber (timber deed sales) from the Combined tree farms. The metrics used to calculate volumes sold and average price realized during the reporting periods exclude timber deed sales, except where stated otherwise. Harvest volumes are generally expressed in million board feet (MMBF) increments while harvest revenue and related costs are generally expressed in terms of revenue or cost per thousand board feet (MBF).
Logs from the Combined tree farms serve a number of different domestic and export markets, with domestic mills historically representing our largest market destination. Export customers consist of log brokers who sell the logs primarily to Japan, China and, to a lesser degree, Korea. The ultimate decision of whether to sell our logs to the domestic or export market is based on the net proceeds we receive after taking into account both the delivered log prices and the cost to deliver logs to the customer. As such, our reported log price realizations will reflect our properties’ proximity to customers as well as the broader log market.
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 in the tables that follow. Commercial thinning consists of the selective cutting of timber stands not yet of optimal harvest age. The smaller diameter logs harvested in these operations do, however, have some commercial value, thus allowing us to earn revenue while at the same time improving the projected value at harvest of the remaining timber in the stand.
Log Prices.
During Q2 2018, log prices declined slightly from prices realized during Q1 2018, but were well above the prices realized during Q2 2017. On a Combined basis, Q2 2018 realized log prices versus Q1 2018 for Douglas-fir sawlogs were down 4% and for whitewood sawlogs were up 2%. Q2 2018 realized log prices versus Q2 2017 for Douglas-fir sawlogs were up 19% and for whitewood sawlogs were up 13%. West Coast softwood lumber production during Q2 2018 was slightly below that of Q1 2018 and in line with that of Q2 2017. West Coast softwood log exports in Q2 2018 were 18% above exports during Q1 2018 and 2% above Q2 2017.
Year-to-date 2018 realized log prices increased 23% from the same period of 2017. On a Combined basis, YTD 2018 realized log prices versus YTD 2017 for Douglas-fir sawlogs were up 26% and for whitewood sawlogs were up 19%. West Coast softwood lumber production during the first six months of 2018 increased 4% relative to the same period a year ago, while West Coast softwood log exports decreased 9%.
Partnership Timber
Partnership Timber operating results for the quarters ended
June 30, 2018
,
March 31, 2018
, and
June 30, 2017
, and the
six months ended
June 30, 2018
, and
June 30, 2017
, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
Q2 2018
|
|
Q1 2018
|
|
Q2 2017
|
|
Jun-18
|
|
Jun-17
|
Partnership
|
|
|
|
|
|
|
|
|
|
Overall log price per MBF
|
$
|
726
|
|
|
$
|
779
|
|
|
$
|
616
|
|
|
$
|
765
|
|
|
$
|
615
|
|
Total volume (in MMBF)
|
6.9
|
|
|
18.8
|
|
|
12.5
|
|
|
25.7
|
|
|
26.6
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
Log sale revenue
|
$
|
5,039
|
|
|
$
|
14,635
|
|
|
$
|
7,710
|
|
|
$
|
19,674
|
|
|
$
|
16,387
|
|
Other revenue
|
531
|
|
|
503
|
|
|
459
|
|
|
1,034
|
|
|
888
|
|
Total revenue
|
5,570
|
|
|
15,138
|
|
|
8,169
|
|
|
20,708
|
|
|
17,275
|
|
Cost of sales
|
(1,994
|
)
|
|
(5,026
|
)
|
|
(3,336
|
)
|
|
(7,020
|
)
|
|
(6,878
|
)
|
Operating expenses
|
(1,795
|
)
|
|
(1,460
|
)
|
|
(1,426
|
)
|
|
(3,255
|
)
|
|
(2,613
|
)
|
Operating income
|
$
|
1,781
|
|
|
$
|
8,652
|
|
|
$
|
3,407
|
|
|
$
|
10,433
|
|
|
$
|
7,784
|
|
Operating Income
Comparing
Q2 2018
to
Q1 2018
.
Operating income decreased $6.9 million, or 78%, from
Q1 2018
. An average realized log price decrease of 7%, coupled with a 63% decrease in delivered log volume, resulted in a 66% decrease in log sale revenue. The decrease in delivered log volume during the second quarter reflects the decision to pull a significant amount of volume ahead into Q1 2018, when log prices were stronger than Q2 2018. A 23% increase in operating expenses was more than offset by a 60% decrease in cost of sales from the lower harvest volume.
Comparing
Q2 2018
to
Q2 2017
.
Operating income decreased $1.6 million, or 48%, from
Q2 2017
, driven by a 45% decrease in delivered log volume, which was partially offset by an 18% rise in average realized log prices.
Comparing YTD
2018
to YTD
2017
. Operating income increased $2.6 million, or 34% for the first
six months
of
2018
from the first
six months
of
2017
.
Revenue
Comparing
Q2 2018
to
Q1 2018
. Log sale revenue in
Q2 2018
decreased $9.6 million, or 66%, from
Q1 2018
due to a 63% decrease in delivered log volume and a 7% decline in average realized log prices.
Comparing
Q2 2018
to
Q2 2017
. Log sale revenue in
Q2 2018
decreased $2.7 million, or 35%, from
Q2 2017
, due to a 45% decrease in harvest volume, which was partially offset by an 18% rise in average realized log prices. Other revenue increased by $72,000.
Comparing YTD
2018
to YTD
2017
.
Log sale revenue in the first
six months
of
2018
increased by $3.3 million, or 20%, from the first
six months
of
2017
.
Log Prices
Partnership Timber log prices for the quarters ended
June 30, 2018
,
March 31, 2018
, and
June 30, 2017
, and
six months ended
June 30, 2018
, and
2017
, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average price realizations (per MBF)
|
|
|
|
|
|
|
Six Months Ended
|
|
Q2 2018
|
|
Q1 2018
|
|
Q2 2017
|
|
Jun-18
|
|
Jun-17
|
Partnership
|
|
|
|
|
|
|
|
|
|
Douglas-fir domestic
|
$
|
812
|
|
|
$
|
850
|
|
|
$
|
674
|
|
|
$
|
841
|
|
|
$
|
660
|
|
Douglas-fir export
|
843
|
|
|
922
|
|
|
723
|
|
|
896
|
|
|
696
|
|
Whitewood domestic
|
529
|
|
|
549
|
|
|
474
|
|
|
542
|
|
|
462
|
|
Whitewood export
|
714
|
|
|
764
|
|
|
686
|
|
|
742
|
|
|
653
|
|
Cedar
|
1,373
|
|
|
1,458
|
|
|
1,513
|
|
|
1,422
|
|
|
1,423
|
|
Hardwood
|
721
|
|
|
708
|
|
|
687
|
|
|
713
|
|
|
661
|
|
Pulpwood
|
351
|
|
|
375
|
|
|
307
|
|
|
367
|
|
|
298
|
|
Overall log price
|
726
|
|
|
779
|
|
|
616
|
|
|
765
|
|
|
615
|
|
Comparing
Q2 2018
to
Q1 2018
. Overall realized log prices in Q2 2018 were 7% lower than Q1 2018. Our overall average realized log price is influenced heavily by price movements for our two most prevalent species, Douglas-fir and whitewood, and the relative harvest volume mix of those two species. Realized sawlog prices decreased by 5% in Q2 2018 versus Q1 2018 for Douglas-fir and by 6% for whitewood. Prices for both species are above historic averages and reflect the continued strong demand in both the domestic and export markets during the quarter.
Comparing
Q2 2018
to
Q2 2017
.
From Q2 2017 to Q2 2018, average realized log prices increased 18%. The favorable change was attributable to an increase in lumber production which when combined with a strong export market resulted in price strength for both of our primary species with increases in Douglas-fir and whitewood log prices of 19% and 10%, respectively. Relative to Q2 2017, prices for cedar were down 9%, while hardwood sawlogs and all pulpwood species showed increases of 5% and 14%, respectively.
Comparing YTD
2018
to YTD
2017
.
Average realized log prices increased by 24% for all our species groups during the first six months of 2018, relative to the same period in 2017. Douglas-fir and whitewood realized log prices increased 27% and 19%, respectively. Prices increased for other species groups include: pine (21%), cedar (3%), hardwood (8%) and pulpwood (23%).
Log Volume
The Partnership harvested the following log volumes by species for the quarters ended
June 30, 2018
,
March 31, 2018
, and
June 30, 2017
, and the
six months ended
June 30, 2018
, and
2017
, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Volume (in MMBF)
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
Q2 2018
|
|
Q1 2018
|
|
Q2 2017
|
|
Jun-18
|
|
Jun-17
|
Partnership
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Douglas-fir domestic
|
3.5
|
|
51
|
%
|
|
12.2
|
|
64
|
%
|
|
6.0
|
|
49
|
%
|
|
15.7
|
|
61
|
%
|
|
12.7
|
|
49
|
%
|
Douglas-fir export
|
0.8
|
|
12
|
%
|
|
1.8
|
|
10
|
%
|
|
1.9
|
|
15
|
%
|
|
2.6
|
|
10
|
|
|
4.9
|
|
18
|
|
Whitewood domestic
|
0.2
|
|
3
|
%
|
|
0.3
|
|
2
|
%
|
|
0.4
|
|
3
|
%
|
|
0.5
|
|
2
|
|
|
0.9
|
|
3
|
|
Whitewood export
|
0.3
|
|
4
|
%
|
|
0.5
|
|
3
|
%
|
|
0.4
|
|
3
|
%
|
|
0.8
|
|
3
|
|
|
0.9
|
|
3
|
|
Cedar
|
0.3
|
|
4
|
%
|
|
0.4
|
|
2
|
%
|
|
0.3
|
|
2
|
%
|
|
0.6
|
|
2
|
|
|
0.9
|
|
3
|
|
Hardwood
|
0.4
|
|
6
|
%
|
|
0.6
|
|
3
|
%
|
|
0.8
|
|
6
|
%
|
|
1.0
|
|
4
|
|
|
1.1
|
|
4
|
|
Pulpwood
|
1.4
|
|
20
|
%
|
|
3.0
|
|
16
|
%
|
|
2.7
|
|
22
|
%
|
|
4.5
|
|
18
|
|
|
5.2
|
|
20
|
|
Log sale volume
|
6.9
|
|
100
|
%
|
|
18.8
|
|
100
|
%
|
|
12.5
|
|
100
|
%
|
|
25.7
|
|
100
|
%
|
|
26.6
|
|
100
|
%
|
Timber deed sale volume
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Total volume
|
6.9
|
|
|
|
18.8
|
|
|
|
12.5
|
|
|
|
25.7
|
|
|
|
26.6
|
|
|
Comparing
Q2 2018
to
Q1 2018
. Harvest volume decreased 11.9 MMBF, or 63%, in
Q2 2018
from
Q1 2018
. The decrease reflects our decision to pull planned harvest volume from Q2 into Q1 when log prices were stronger. Product mix was relatively consistent between the two comparable quarters, with the exception of a 15% decrease in the relative share of
domestic Douglas-fir, which reflects the decision to pull volume forward into Q1 as that sort received a strong premium from domestic mills as they scrambled to increase production to meet demand from the domestic softwood lumber market.
Comparing
Q2 2018
to
Q2 2017
.
Harvest volume decreased 5.6 MMBF, or 45%, in
Q2 2018
from
Q2 2017
. While volume was pulled forward from Q2 2018 to Q1 2018, our planned harvest volume in 2017 followed a more consistent quarterly pattern. Product mix was relatively consistent between the two comparable quarters.
Comparing YTD
2018
to YTD
2017
.
Relative to the first six months of 2017, YTD
2018
harvest volume decreased by 0.9 MMBF, or 3%. Product mix was relatively consistent between the two periods, with the exception of an 8% decrease in the Douglas-fir export sort and a 13% increase in the Douglas-fir domestic sort, which is indicative of the strengthening domestic market relative to the export market.
Cost of Sales
Cost of sales varies with harvest volume, and for the quarters ended
June 30, 2018
,
March 31, 2018
, and
June 30, 2017
, and the
six months ended
June 30, 2018
, and
2017
, was as follows, with the first part of the table expressing these costs in total dollars and the second part of the table expressing those costs that are driven by volume on a per MBF basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
Six Months Ended
|
|
Q2 2018
|
|
Q1 2018
|
|
Q2 2017
|
|
Jun-18
|
|
Jun-17
|
Partnership
|
|
|
|
|
|
|
|
|
|
Harvest, haul, and tax
|
$
|
1,513
|
|
|
$
|
3,728
|
|
|
$
|
2,428
|
|
|
$
|
5,241
|
|
|
$
|
4,948
|
|
Depletion
|
478
|
|
|
1,295
|
|
|
908
|
|
|
1,773
|
|
|
1,930
|
|
Other
|
3
|
|
|
3
|
|
|
—
|
|
|
6
|
|
|
—
|
|
Total cost of sales
|
$
|
1,994
|
|
|
$
|
5,026
|
|
|
$
|
3,336
|
|
|
$
|
7,020
|
|
|
$
|
6,878
|
|
|
|
|
|
|
|
|
|
|
|
Amounts per MBF *
|
|
|
|
|
|
|
|
|
|
Harvest, haul, and tax
|
$
|
219
|
|
|
$
|
198
|
|
|
$
|
194
|
|
|
$
|
204
|
|
|
$
|
186
|
|
Depletion
|
$
|
69
|
|
|
$
|
69
|
|
|
$
|
73
|
|
|
$
|
69
|
|
|
$
|
73
|
|
|
|
*
|
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 2018
to
Q1 2018
.
Cost of sales decreased $3.0 million, or 60%, in Q2 2018 from Q1 2018 due to a 63% decrease in harvest volume. On a per-MBF basis, the harvest, haul and tax rate increased by 10% due to higher relative cost of the units harvested in the current quarter. Higher cost units are typically harvested as the winter weather wanes, allowing access to higher elevation and more expensive portions of our tree farms.
Comparing
Q2 2018
to
Q2 2017
.
Cost of sales decreased $1.3 million, or 40%, in Q2 2018 from Q2 2017 due to a 45% decrease in harvest volume. On a per-MBF basis, the harvest, haul and tax rate increased by 13%, while the per-MBF depletion rate decreased by 5%. Harvest and haul costs are up in the current quarter due to higher relative cost of the units harvested in the current quarter.
Comparing YTD
2018
to YTD
2017
.
Year-to-date 2018 cost of sales increased $142,000, or 2%, relative to the same period in 2017 due to a 10% increase in the per-MBF harvest, haul and tax rate, which was partially offset by a 5% decrease in the per-MBF depletion rate and a 3% decline in harvest volume.
Operating Expenses
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, 2018
,
March 31, 2018
, and
June 30, 2017
, segment operating expenses were $1.8 million, $1.5 million, and $1.4 million, respectively. The $335,000 increase in operating expenses in Q2 2018 from Q1 2018 is attributable to higher management, silviculture and road maintenance expenses. Operating expenses increased by $370,000 from Q2 2017 to Q2 2018 due to higher road maintenance and management expenses, which were partially offset by lower silviculture expenses.
Funds Timber
Funds Timber operating results for quarters ended
June 30, 2018
,
March 31, 2018
, and
June 30, 2017
, and
six months ended
June 30, 2018
, and
2017
, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
Q2 2018
|
|
Q1 2018
|
|
Q2 2017
|
|
Jun-18
|
|
Jun-17
|
Funds
|
|
|
|
|
|
|
|
|
|
Overall log price per MBF
|
$
|
707
|
|
|
$
|
698
|
|
|
$
|
617
|
|
|
$
|
718
|
|
|
$
|
594
|
|
Total volume (MMBF)
|
28.6
|
|
|
13.1
|
|
|
12.8
|
|
|
41.7
|
|
|
26.4
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
Log sale revenue
|
$
|
8,494
|
|
|
$
|
9,509
|
|
|
$
|
6,630
|
|
|
$
|
18,003
|
|
|
$
|
14,232
|
|
Other revenue
|
9,423
|
|
|
32
|
|
|
643
|
|
|
9,455
|
|
|
747
|
|
Total revenue
|
17,917
|
|
|
9,541
|
|
|
7,273
|
|
|
27,458
|
|
|
14,979
|
|
Cost of sales
|
(11,870
|
)
|
|
(6,952
|
)
|
|
(5,190
|
)
|
|
(18,822
|
)
|
|
(12,283
|
)
|
Operating expenses - internal
|
(2,525
|
)
|
|
(1,806
|
)
|
|
(1,662
|
)
|
|
(4,331
|
)
|
|
(3,435
|
)
|
Gain on sale of timberland
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
12,503
|
|
Operating income - internal
|
3,522
|
|
|
783
|
|
|
421
|
|
|
$
|
4,305
|
|
|
$
|
11,764
|
|
Eliminations
*
|
1,140
|
|
|
1,024
|
|
|
817
|
|
|
$
|
2,164
|
|
|
$
|
1,665
|
|
Operating income - external
|
$
|
4,662
|
|
|
$
|
1,807
|
|
|
$
|
1,238
|
|
|
$
|
6,469
|
|
|
$
|
13,429
|
|
* Represents management fees charged to the Funds and eliminated from operating expenses in consolidation. In the TIM segment, these fees are reflected as revenue, on an internal reporting basis, and eliminated in consolidation.
Operating Income
Comparing
Q2 2018
to
Q1 2018
.
Operating income increased $2.9 million from Q1 2018. Other revenue increased by $9.4 million, driven by timber deed sales of 16.6 MMBF that had no counterpart in Q1 2018. The higher total revenue was partially offset by 71% and 40% increases in cost of sales and operating expenses, respectively. An 8% decrease in delivered log volume was partially offset by a 1% increase in the average realized log price, resulting in a 11% decrease in log sale revenue.
Comparing
Q2 2018
to
Q2 2017
.
Operating income increased $3.4 million from Q2 2017, driven by a 15% increase in average delivered log price, a 1.3 MMBF increase in delivered log volume and a 14.5 MMBF increase in timber deed sale volume. The $8.8 million increase in other revenue reflects the 14.5 MMBF increase in timber deed sale volume, which included a 77% increase in prices associated with that volume. The higher total revenue in Q2 2018 was partially offset by $6.7 million and $863,000 increases in cost of sales and operating expenses, respectively.
Comparing YTD
2018
to YTD
2017
.
Year-to-date
operating income decreased $7.0 million from the first six months of 2017. Our YTD 2017 results reflect a $12.5 million gain on the January 2017 sale of a 6,500-acre tree farm on the Oregon coast by Fund II. Excluding this gain, operating income increased by $5.5 million, driven by a $8.7 million rise in other revenue related to higher timber deed sales and a 25% increase in average realized log prices. Offsetting these were a 53% increase in cost of sales and a 26% increase in operating expenses.
The table below reflects the Partnership’s share of the Funds’ results based on its 20%, 5%, and 15% ownership interest in Fund II, Fund III, and Fund IV, respectively. We present this as additional information to help readers understand the financial benefit we receive from investing in these private equity vehicles and the resulting economics of owning Pope Resources units. These results will fluctuate between periods based on the relative activity in each fund and the Partnership’s different ownership interest in each fund:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
Q2 2018
|
|
Q1 2018
|
|
Q2 2017
|
|
Jun-18
|
|
Jun-17
|
Partnership's share of Funds
|
|
|
|
|
|
|
|
|
|
Total volume (MMBF)
|
3.7
|
|
|
1.7
|
|
|
1.8
|
|
|
5.4
|
|
|
3.5
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
Log sale revenue
|
$
|
1,091
|
|
|
$
|
1,207
|
|
|
$
|
1,076
|
|
|
$
|
2,298
|
|
|
$
|
2,038
|
|
Other revenue
|
1,255
|
|
|
5
|
|
|
32
|
|
|
1,260
|
|
|
39
|
|
Total revenue
|
2,346
|
|
|
1,212
|
|
|
1,108
|
|
|
3,558
|
|
|
2,077
|
|
Cost of sales
|
(1,463
|
)
|
|
(781
|
)
|
|
(700
|
)
|
|
(2,245
|
)
|
|
(1,465
|
)
|
Operating expenses - internal
|
(325
|
)
|
|
(201
|
)
|
|
(198
|
)
|
|
(525
|
)
|
|
(415
|
)
|
Gain on sale of timberland
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
2,501
|
|
Operating income - internal
|
558
|
|
|
230
|
|
|
210
|
|
|
788
|
|
|
2,698
|
|
Eliminations *
|
129
|
|
|
113
|
|
|
84
|
|
|
241
|
|
|
169
|
|
Operating income - external
|
$
|
687
|
|
|
$
|
343
|
|
|
$
|
294
|
|
|
$
|
1,029
|
|
|
$
|
2,867
|
|
* Represents the Partnership’s share of management fees charged to the Funds and eliminated from operating expenses in consolidation. In the TIM segment, these fees are reflected as revenue, on an internal reporting basis, and eliminated in consolidation.
Revenue
Comparing
Q2 2018
to
Q1 2018
. Total revenue in Q2 2018 increased $8.4 million, or 88%, from Q1 2018 due to a $9.4 million increase in other revenue, which was partially offset by a $1.0 million decrease in log sale revenue. The increase in other revenue was driven by $8.9 million of timber deed sales, which had no counterpart in Q1 2018. The decrease in log sale revenue reflects a decrease in harvest volume of 1.1 MMBF, which was partially offset by a 1% increase in the average delivered log price.
Comparing
Q2 2018
to
Q2 2017
. Total revenue in Q2 2018 increased $10.6 million from Q2 2017 due to an $8.8 million increase in other revenue and a $1.9 million in log sale revenue. The increase in other revenue was primarily driven by a $8.3 million increase in timber deed sales. The increase in log sale revenue was due to 12% and 15% increases in delivered log volume and realized log prices, respectively.
Comparing YTD
2018
to YTD
2017
.
Total revenue for the first six months of 2018 increased $12.5 million, or 83%, relative to the same period of 2017. The increase in log sale revenue was driven by a 21% increase in average realized log prices and a 5% rise in delivered log volume. The increase in other revenue was primarily driven by a $8.2 million increase in timber deed sales.
Log Prices
Funds Timber log prices for quarters ended
June 30, 2018
,
March 31, 2018
, and
June 30, 2017
and the
six months ended
June 30, 2018
and
2017
, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average price realizations (per MBF)
|
|
|
|
|
|
|
Six Months Ended
|
|
Q2 2018
|
|
Q1 2018
|
|
Q2 2017
|
|
Jun-18
|
|
Jun-17
|
Funds
|
|
|
|
|
|
|
|
|
|
Douglas-fir domestic
|
$
|
815
|
|
|
$
|
797
|
|
|
$
|
674
|
|
|
$
|
822
|
|
|
$
|
660
|
|
Douglas-fir export
|
870
|
|
|
896
|
|
|
759
|
|
|
908
|
|
|
762
|
|
Whitewood domestic
|
662
|
|
|
622
|
|
|
585
|
|
|
664
|
|
|
553
|
|
Whitewood export
|
727
|
|
|
745
|
|
|
691
|
|
|
722
|
|
|
616
|
|
Pine
|
513
|
|
|
511
|
|
|
486
|
|
|
509
|
|
|
501
|
|
Cedar
|
1,276
|
|
|
1,161
|
|
|
1,012
|
|
|
1,326
|
|
|
1,189
|
|
Hardwood
|
778
|
|
|
758
|
|
|
660
|
|
|
753
|
|
|
651
|
|
Pulpwood
|
357
|
|
|
332
|
|
|
271
|
|
|
371
|
|
|
284
|
|
Overall log price
|
707
|
|
|
698
|
|
|
617
|
|
|
718
|
|
|
594
|
|
Timber deed sales
|
534
|
|
|
—
|
|
|
301
|
|
|
534
|
|
|
292
|
|
Comparing
Q2 2018
to
Q1 2018
. Overall realized log prices in Q2 2018 were 1% higher than Q1 2018. Price movements for our two most prevalent species, Douglas-fir and whitewood, were mixed depending on the market. Domestic prices increased 2% and 6% for Douglas-fir and whitewood, respectively, while export prices decreased 3% and 2%. Prices for both species are above historic averages and reflect the continued strong demand in both the domestic and export markets during the quarter. Meaningful increases were also realized for cedar (10%) and pulpwood (8%).
Comparing
Q2 2018
to
Q2 2017
. From Q2 2017 to Q2 2018, average realized log prices increased 15%. The favorable change was attributable to price strength for both of our primary species with volume-weighted (domestic and export) increases in Douglas-fir and whitewood realized log prices of 19% and 12%, respectively, due to strength in both the domestic and export markets. Relative to Q2 2017, price increases were also realized for pine (6%), cedar (26%), hardwood (18%), and pulpwood (32%).
Comparing YTD
2018
to YTD
2017
.
Realized log prices increased for all of our species groups during the first six months of 2018, relative to the same period in 2017. Douglas-fir and whitewood volume-weighted (domestic and export) increases realized log prices increased 24% and 18%, respectively. Price increases for other species groups include: pine (2%), cedar (12%), hardwood (16%) and pulpwood (31%).
Log Volume
The Funds harvested the following log volumes by species for the quarters ended
June 30, 2018
,
March 31, 2018
, and
June 30, 2017
, and
six months
ended
June 30, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Volume (in MMBF)
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
Q2 2018
|
|
Q1 2018
|
|
Q2 2017
|
|
Jun-18
|
|
Jun-17
|
Funds
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Douglas-fir domestic
|
3.4
|
|
27
|
%
|
|
3.8
|
|
29
|
%
|
|
3.7
|
|
34
|
%
|
|
7.3
|
|
29
|
%
|
|
8.8
|
|
37
|
%
|
Douglas-fir export
|
2.3
|
|
19
|
%
|
|
1.6
|
|
12
|
%
|
|
2.2
|
|
21
|
%
|
|
4.0
|
|
16
|
%
|
|
3.3
|
|
14
|
%
|
Whitewood domestic
|
2.1
|
|
18
|
%
|
|
4.9
|
|
37
|
%
|
|
1.9
|
|
18
|
%
|
|
7.0
|
|
28
|
%
|
|
5.0
|
|
21
|
%
|
Whitewood export
|
1.2
|
|
10
|
%
|
|
0.4
|
|
3
|
%
|
|
0.6
|
|
6
|
%
|
|
1.6
|
|
6
|
%
|
|
2.0
|
|
8
|
%
|
Pine
|
0.9
|
|
8
|
%
|
|
0.2
|
|
2
|
%
|
|
1.3
|
|
12
|
%
|
|
1.0
|
|
4
|
%
|
|
1.3
|
|
5
|
%
|
Cedar
|
0.1
|
|
1
|
%
|
|
0.3
|
|
2
|
%
|
|
—
|
|
—
|
%
|
|
0.4
|
|
2
|
%
|
|
0.2
|
|
1
|
%
|
Hardwood
|
0.3
|
|
3
|
%
|
|
0.2
|
|
2
|
%
|
|
—
|
|
—
|
%
|
|
0.5
|
|
2
|
%
|
|
0.2
|
|
1
|
%
|
Pulpwood
|
1.7
|
|
14
|
%
|
|
1.7
|
|
13
|
%
|
|
1.0
|
|
9
|
%
|
|
3.3
|
|
13
|
%
|
|
3.2
|
|
13
|
%
|
Log sale volume
|
12.0
|
|
100
|
%
|
|
13.1
|
|
100
|
%
|
|
10.7
|
|
100
|
%
|
|
25.1
|
|
100
|
%
|
|
24.0
|
|
100
|
%
|
Timber deed sale volume
|
16.6
|
|
|
|
—
|
|
|
|
2.1
|
|
|
|
16.6
|
|
|
|
2.4
|
|
|
Total volume
|
28.6
|
|
|
|
13.1
|
|
|
|
12.8
|
|
|
|
41.7
|
|
|
|
26.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Partnership’s share of funds
|
3.7
|
|
|
|
1.7
|
|
|
|
1.8
|
|
|
|
5.4
|
|
|
|
3.5
|
|
|
Comparing
Q2 2018
to
Q1 2018
. Harvest volume, including timber deed sales, increased 15.5 MMBF in Q2 2018 from Q1 2018. This increase was driven by the 16.6 MMBF sold as timber deeds in Q2 2018, which had no counterpart in Q1 2018. The relative volume sold to the export market increased by 14%, from 15% of Q1 2018 total volume to 29% of Q2 2018 total volume. The relative volume of whitewood sold into the domestic market decreased by 19%.
Comparing
Q2 2018
to
Q2 2017
. Harvest volume, including timber deed sales, increased by 15.8 MMBF in Q2 2018 from Q2 2017, with 14.5 MMBF and 1.3 MMBF increases in timber deed contracts and delivered log volume , respectively. The relative volume of Douglas-fir and pine decreased by 11% and 4% respectively, while the relative volume of whitewood and pulpwood increased by 4% and 5%, respectively.
Comparing YTD
2018
to YTD
2017
.
Harvest volume, including timber deed sales, increased by 15.3 MMBF, or 58%, in the first six months of 2018 relative to the same period in 2017. The increase was driven primarily by the sale of timber deed contracts for 14.0 MMBF on two properties that were acquired during Q1 2018. The relative volume mix for Douglas-fir decreased by 6%, while that of whitewood increased by 5%.
Cost of Sales
Cost of sales vary with harvest volume. Because the Funds’ tree farms were acquired much more recently than those of the Partnership, the depletion rates for the Funds’ tree farms are much higher than for the Partnership. For the quarters ended
June 30, 2018
,
March 31, 2018
, and
June 30, 2017
, and
six months
ended
June 30, 2018
and
2017
, cost of sales were as follows, with the first part of the table expressing these costs in total dollars and the second part of the table expressing those costs that are driven by volume on a per MBF basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
Six Months Ended
|
|
Q2 2018
|
|
Q1 2018
|
|
Q2 2017
|
|
Jun-18
|
|
Jun-17
|
Funds
|
|
|
|
|
|
|
|
|
|
Harvest, haul, and tax *
|
$
|
2,924
|
|
|
$
|
3,517
|
|
|
$
|
2,535
|
|
|
$
|
6,441
|
|
|
$
|
5,728
|
|
Depletion *
|
8,946
|
|
|
3,422
|
|
|
2,655
|
|
|
12,368
|
|
|
6,555
|
|
Other
|
—
|
|
|
13
|
|
|
—
|
|
|
13
|
|
|
—
|
|
Total cost of sales
|
$
|
11,870
|
|
|
$
|
6,952
|
|
|
$
|
5,190
|
|
|
$
|
18,822
|
|
|
$
|
12,283
|
|
|
|
|
|
|
|
|
|
|
|
Partnership’s share of Funds
|
$
|
1,465
|
|
|
$
|
782
|
|
|
$
|
700
|
|
|
$
|
2,247
|
|
|
$
|
1,465
|
|
|
|
|
|
|
|
|
|
|
|
Amounts per MBF
|
|
|
|
|
|
|
|
|
|
Harvest, haul, and tax
|
$
|
244
|
|
|
$
|
268
|
|
|
$
|
237
|
|
|
$
|
257
|
|
|
$
|
239
|
|
Depletion
|
$
|
313
|
|
|
$
|
261
|
|
|
$
|
207
|
|
|
$
|
297
|
|
|
$
|
248
|
|
* 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 2018
to
Q1 2018
.
Cost of sales increased $4.9 million, or 71%, in Q2 2018 from Q1 2018 due to a 118% increase in harvest volume, including timber deed sales. A 20% increase in the Funds’ average depletion rate, due to the mix of harvest volume from the Funds’ properties, was partially offset by a 9% decrease in the per-MBF harvest, haul, and tax rates, which was driven by less expensive harvest units and shorter hauls to customers in Q2 2018 compared to Q1 2018.
Comparing
Q2 2018
to
Q2 2017
.
Cost of sales increased $6.7 million, or 129%, in Q2 2018 from Q2 2017, as a result of a 123% increase in harvest volume, including timber deed sales.
Comparing YTD
2018
to YTD
2017
.
Cost of sales increased $6.5 million, or 53%, in the first six months of 2018 relative to the same period in 2017 due to a 15.3 MMBF, or 58%, increase in harvest volume, including timber deed sales.
Operating Expenses
Operating expenses include the cost of maintaining existing roads and building temporary roads for harvesting, silviculture costs, and other management expenses that include the asset and timberland management fees charged to the Funds. These fees, which are the source of revenue for our Timberland Investment Management segment (discussed below), are eliminated in consolidation, and amounted to $1.1 million, $1.0 million, $816,000 in Q2 2018, Q1 2018, and Q2 2017, respectively. After elimination of these fees, for the quarters ended June 30, 2018, March 31, 2018, and June 30, 2017, Fund operating expenses were $1.4 million, $782,000, and $845,000, respectively.
The $603,000 increase in operating expenses in Q2 2018 from Q1 2018 is attributable in part to operating expenses incurred on the Fund IV properties which were acquired during Q1 2018. Specific cost increases include $342,000 and $292,000 in road maintenance and silviculture expenses, respectively, that were partially offset by a $31,000 decrease in management expenses.
Operating expenses increased by $540,000 between Q2 2017 and Q2 2018, again due in part to operating expenses incurred on the Fund IV properties which were acquired during Q1 2018. Specific cost increases include $472,000 in road maintenance and $113,000 in management expenses, which were only partially offset by a $45,000 decrease in silviculture expenses.
Operating expenses increased by $397,000 during the first six months of 2018 relative to the same period in 2017, driven by the Fund IV acquisitions and include increases of $440,000 and $19,000 in road maintenance and silviculture expenses, respectively, that were only partially offset by a $62,000 decrease in management expenses.
Gain on Sale of Timberland
There were no timberland sales during the first half of 2018. The $12.5 million gain on sale of timberland in the first quarter of 2017 resulted from the sale of a 6,500-acre tree farm on the Oregon coast by Fund II for $26.5 million.
Timberland Investment Management
The Timberland Investment Management (TIM) segment manages timberland portfolios on behalf of three private equity timber funds that currently own a combined 124,000 acres of commercial timberland in western Washington, northwestern Oregon, southwestern Oregon, and northern California. Total assets under management are $490 million based on the most recent appraisals and the recent Fund IV timberland acquisition values.
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 $905,000 and $6.0 million during the
six months ended
June 30, 2018
and
2017
, respectively. The 2017 distributions included $5.5 million from Fund II’s sale of a 6,500-acre tree farm.
The Partnership earned asset, investment, and timberland management fees from the Funds of
$2.2 million
and
$1.7 million
for the
six months ended
June 30, 2018
and
2017
, respectively. These fees, which represent a portion of the operating expenses in our Funds Timber segment (discussed above) are eliminated as the Funds are consolidated in our financial statements, as shown in the table below.
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 TIM segment for the quarters ended
June 30, 2018
and
2017
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
|
(in thousands, except invested capital, volume and acre data)
|
|
Jun-18
|
|
Jun-17
|
Revenue internal
|
|
$
|
1,140
|
|
|
$
|
817
|
|
Intersegment eliminations
|
|
(1,140
|
)
|
|
(817
|
)
|
Revenue external
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
Operating income internal
|
|
$
|
85
|
|
|
$
|
(35
|
)
|
Intersegment eliminations
|
|
(1,001
|
)
|
|
(716
|
)
|
Operating loss external
|
|
$
|
(916
|
)
|
|
$
|
(751
|
)
|
|
|
|
|
|
Invested capital (in millions)
|
|
$
|
354
|
|
|
$
|
240
|
|
Acres owned by Funds
|
|
124,000
|
|
|
88,000
|
|
Harvest volume - Funds (MMBF), including timber deed sales
|
|
28.6
|
|
|
12.8
|
|
TIM generated management fee revenue of
$1.1 million
and
$817,000
from managing the Funds during
Q2 2018
and
Q2 2017
, respectively. The $320,000 increase in revenue resulted primarily from an increase in management fees associated with a rise in invested capital and acres owned following the acquisition of two properties by Fund IV in Q1 2018.
Operating expenses rose for the quarter ended
June 30, 2018
, versus the comparable period in
2017
, totaling
$916,000
and
$751,000
, respectively, due to costs associated with capital placement efforts associated with our fourth timber fund as well as additional personnel costs to manage our expanding timber fund portfolio.
Revenue and operating loss for the TIM segment for the
six months ended
June 30, 2018
and
2017
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
(in thousands, except invested capital, volume and acre data)
|
|
Jun-18
|
|
Jun-17
|
Revenue internal
|
|
$
|
2,164
|
|
|
$
|
1,665
|
|
Intersegment eliminations
|
|
(2,164
|
)
|
|
(1,665
|
)
|
Revenue external
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
Operating income (loss) internal
|
|
$
|
33
|
|
|
$
|
(260
|
)
|
Intersegment eliminations
|
|
(1,896
|
)
|
|
(1,457
|
)
|
Operating loss external
|
|
$
|
(1,863
|
)
|
|
$
|
(1,717
|
)
|
|
|
|
|
|
Invested capital (in millions)
|
|
$
|
354
|
|
|
$
|
240
|
|
Acres owned by Funds
|
|
124,000
|
|
|
88,000
|
|
Harvest volume - Funds (MMBF), including timber deed sales
|
|
41.7
|
|
|
26.4
|
|
TIM generated management fee revenue of
$2.2 million
and
$1.7 million
from managing the Funds for the
six months
ended
June 30, 2018
and
2017
, respectively. The acquisition of two tree farms by Fund IV in 1Q-2018 resulted in a $477,000 increase in revenue associated with management fees.
Operating expenses incurred by the TIM segment for the
six months
ended
June 30, 2018
and
2017
totaled
$1.9 million
and
$1.7 million
, respectively. The increase in operating expenses is attributable to costs associated with capital placement efforts associated with our fourth timber fund as well as additional personnel costs to manage our expanding timber fund portfolio.
Real Estate
The Partnership’s Real Estate segment produces its revenue primarily from the sale of land within its 2,100-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. In addition, we may acquire and develop other properties for sale, either on our own or by partnering with other experienced real estate developers. 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:
|
|
•
|
Residential and commercial 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 management expects to sell within the next 12 months, are classified on our balance sheet as a current asset under “Land and Timber Held for Sale”. The
$10.7 million
amount currently in Land and Timber Held for Sale reflects properties that are under contract and expected to close between now and the end of the second quarter of 2019, comprising residential and commercial parcels from our Harbor Hill project in Gig Harbor, Washington, and a residential parcel in Bremerton, Washington.
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 often 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 2018
to
Q2 2017
.
In
Q2 2018
, we closed on the sale of a conservation easement covering 7,800 acres of timberland for $3.7 million, as well as a residential lot and a parcel of undeveloped land for $176,000. In
Q2 2017
, we closed on the sale of a 10-acre rural residential lot for $170,000. Rental and other revenue increased from
$279,000
in
Q2 2017
to
$419,000
in
Q2 2018
due primarily to development and asset management fees related to our joint venture project on Bainbridge Island, Washington. We recorded environmental remediation expense of $2.9 million in the second quarter of 2018 based on updated estimates of costs for our project in Port Gamble, WA, as discussed in more detail below. Excluding the environmental remediation expense, Real Estate operating expenses were
$1.1 million
during
Q2 2018
and
$1.5 million
during
Q2 2017
. The decrease in operating expenses is due primarily to lower professional fees in connection with planning and development for properties, as well as reduced labor costs resulting from fewer personnel in the Real Estate segment in 2018 as the Harbor Hill project progresses towards completion. These factors resulted in an operating loss of
$315,000
for
Q2
2018
compared to
$1.5 million
for
Q2
2017
.
Comparing YTD
2018
to YTD
2017
. All of the development transactions in the first
six months
of
2018
and
2017
occurred in the second quarter of each year, as described above, however the first six months of 2017 also included $285,000 of revenue recognized under the percentage-of-completion method on parcels sold in Q4 2016 from our Harbor Hill development. As with the second quarter results, the year-to-date increase in rental and other income was due primarily development and asset management fees related to our joint venture project on Bainbridge Island, Washington. Excluding the $2.9 million Q2 2018 environmental remediation expense, Real Estate operating expenses decreased from
$2.7 million
to
$2.0 million
for the first
six months
of
2017
and
2018
, respectively, due primarily to lower professional fees in connection with planning and development for properties, as well as reduced labor costs resulting from fewer personnel in the Real Estate segment in 2018 as the Harbor Hill project progresses towards completion. These factors resulted in an operating loss of
$1.2 million
for the first
six months
of
2018
compared to an operating loss of
$2.7 million
for the corresponding period of
2017
.
Real Estate revenue and gross margin are summarized in the table below for the
six months ended
June 30, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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
|
Development rights (CE)
|
|
$
|
3,730
|
|
|
$
|
3,485
|
|
|
Acres:
|
|
7,800
|
|
|
478
|
|
|
447
|
|
Residential
|
|
151
|
|
|
104
|
|
|
Acres:
|
|
10
|
|
|
15,100
|
|
|
10,400
|
|
Unimproved land
|
|
125
|
|
|
67
|
|
|
Acres:
|
|
14
|
|
|
8,929
|
|
|
4,786
|
|
Total land
|
|
4,006
|
|
|
3,656
|
|
|
|
|
|
|
|
|
|
|
|
|
Rentals and other
|
|
727
|
|
|
44
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2018 total
|
|
$
|
4,733
|
|
|
$
|
3,700
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential land sales *
|
|
$
|
455
|
|
|
$
|
213
|
|
|
Acres:
|
|
10
|
|
|
45,500
|
|
|
21,300
|
|
Total land
|
|
455
|
|
|
213
|
|
|
|
|
|
|
|
|
|
|
|
|
Rentals and other
|
|
527
|
|
|
(250
|
)
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2017 total
|
|
$
|
982
|
|
|
$
|
(37
|
)
|
|
|
|
|
|
|
|
|
|
|
|
* Includes $285,000 of revenue recognized in the current period from lots sold in previous periods.
Environmental Remediation
As disclosed previously, we have a liability for environmental remediation at Port Gamble, Washington, due to contamination that we believe to have occurred in Port Gamble prior to our 1985 acquisition of the property from Pope & Talbot, Inc. (P&T), or between that acquisition and the time P&T ceased to operate the site. We have adjusted that liability from time to time based on evolving circumstances. The required remediation in Port Gamble Bay was completed in January 2017. We are working with DOE to formulate the design of the millsite cleanup, which we expect to result in a consent decree and cleanup action plan (CAP) specific to the millsite. We expect the design of the millsite cleanup to be substantially completed by approximately the end of 2018. Based on design work completed to date, it appears that we will need to remove a greater volume of sediment from the millsite than we previously anticipated. This higher volume of material to excavate, related capping, and updated estimates of long-term monitoring costs, led us to increase our accrual by
$2.9 million
in the second quarter of 2018. As the design of the millsite cleanup is not yet finalized, it is reasonably possible that the accrual for the millsite component of the liability may still increase. The bulk of the millsite cleanup activity is expected to occur in 2019.
Certain environmental laws allow state, federal, and tribal trustees (collectively, the Trustees) to bring suit against property owners to recover damages for injuries to natural resources. Like the liability that attaches to current property owners in the cleanup context, liability for natural resource damages (NRD) can attach to a property owner simply because an injury to natural resources resulted from releases of hazardous substances on that owner’s property, regardless of culpability for the release. In the case of Port Gamble, the Trustees are alleging that the Partnership has NRD liability because of releases that occurred on its property. We have been in discussions with the Trustees regarding their claims and the alleged conditions in Port Gamble Bay, and 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 restoration activities and past assessment costs that are greater than we have estimated, and it is reasonably possible that this component of the liability may increase. We expect to update our estimate of the NRD liability, or range of liability, during the next twelve months.
In addition to the millsite cleanup and NRD components of the project, costs may still change as a result of unforeseen conditions. For example, as we transition to the maintenance and monitoring phases of the project, conditions may arise that require corrective action, and monitoring protocols may change over time. The monitoring period is estimated to be approximately 15 years. In addition, extreme weather events could cause damage to sediment caps that would need to be repaired. These factors could result in additional costs.
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 when we can reasonably estimate the amount.
General and Administrative (G&A)
G&A expenses were flat at
$1.4 million
for the
second quarter
s of
2018
and
2017
. G&A expenses decreased to
$3.0 million
for the first
six months
of
2018
from
$3.1 million
for the first
six months
of
2017
. The decrease is primarily due to lower personnel costs, particularly incentive compensation.
Interest Expense, Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
(in thousands)
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Interest income - Partnership
|
$
|
34
|
|
|
$
|
1
|
|
|
$69
|
|
$3
|
Interest expense - Partnership
|
(782
|
)
|
|
(670
|
)
|
|
(1,458)
|
|
(1,229)
|
Interest expense - Funds
|
(581
|
)
|
|
(582
|
)
|
|
(1,157)
|
|
(1,151)
|
Capitalized interest - Partnership
|
81
|
|
|
134
|
|
|
154
|
|
250
|
Interest expense, net
|
$
|
(1,248
|
)
|
|
$
|
(1,117
|
)
|
|
$(2,392)
|
|
$(2,127)
|
The increase in interest income is due to interest on the note receivable from the sale in December 2017 of an 11-acre parcel from our Harbor Hill project to the City of Gig Harbor.
The Partnership’s and Fund III’s debt arrangements with Northwest Farm Credit Services (NWFCS) are included in the latter’s 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 $270,000 and $234,000 for
Q2
2018
and
Q2
2017
, respectively, and by $598,000 and $548,000 for the first
six
months
of
2018
and
2017
, respectively. The increases in both interest expense and patronage are due to higher average debt balances in 2018.
Capitalized interest decreased from 2017 to 2018 due to the reduction in basis from 2017 due to completed construction activity at Harbor Hill.
Income Tax
The Partnership and Funds recorded consolidated income tax expense of
$29,000
and
$3,000
for
Q2
2018
and
Q2
2017
, respectively, and
$127,000
and
$59,000
for the first
six months
of
2018
and
2017
, 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 and the Funds do 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
The line item “Net and comprehensive (income) loss attributable to noncontrolling interests - ORM Timber Funds” represents the combination of the portions of the net income or loss for the Funds which are attributable to third-party owners: 80% for Fund II, 95% for Fund III, and 85% for Fund IV.
The line item “Net and comprehensive (income) loss attributable to noncontrolling interests - Real Estate ” represents two-thirds of the net income or loss from a Real Estate entity, Ferncliff Investors, that is attributable to third party owners. Ferncliff Investors holds a 50% interest in an unconsolidated real estate joint venture entity.
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 our assessment, commercial credit arrangements with banks or other financial institutions. During periods of reduced operating cash flows, we have available to us lines of credit that can be accessed in order to provide for 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 and variable interest rate tranches and operating lines of credit with Northwest Farm Credit Services (NWFCS). The mortgage debt at
June 30, 2018
includes $51.8 million in term loans with NWFCS structured in five tranches that mature from 2019 through 2028, and is collateralized by portions of the Partnership’s timberland. Our commercial office building in Poulsbo, Washington is collateral for a $2.4 million loan from NWFCS that matures in 2023. We also have available a $31.0 million facility with NWFCS structured as a revolving credit facility through December 31, 2019, after which it converts to a term loan with multiple tranches that have an ultimate maturity in July 2027. At
June 30, 2018
, $16.0 million was outstanding under this facility at a variable rate based on the one-month LIBOR rate plus 1.85%. Our $20.0 million operating line of credit matures April 1, 2020, and we had $20.0 million drawn as of
June 30, 2018
. The line of credit carries a variable interest rate that is based on the one-month LIBOR rate plus 1.50%.
These debt agreements contain covenants that are measured either quarterly or annually, consisting of the following:
•
a minimum interest coverage ratio of 3:1;
|
|
•
|
a maximum debt-to-total-capitalization ratio of 30%, with total capitalization calculated using fair market (vs. carrying) value of timberland, roads and timber; and
|
|
|
•
|
a maximum debt-to-appraised value of collateral of 50%.
|
The Partnership is in compliance with these covenants as of
June 30, 2018
, and expects to remain in compliance for at least the next twelve months.
Mortgage debt within the Funds is collateralized by Fund properties only, with no recourse to the Partnership. 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 collateralized by a portion of Fund II’s timberland portfolio, with both tranches maturing 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. 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 a portion 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.
Fund II’s mortgage contains a requirement to maintain a loan-to-value ratio of less than 50%, with the denominator defined as fair market value. Fund III’s mortgage contains covenants, measured annually, that requires Fund III to maintain an interest coverage ratio of 1.5:1, maintain working capital of $500,000, and not exceed a debt-to-appraised value of collateral of 50%. Fund II and Fund III are in compliance with these covenants as of
June 30, 2018
, and we expect they will remain in compliance for at least the next twelve months.
The
$1.9 million
decrease in cash generated for the
six months ended
June 30, 2018
compared to
June 30, 2017
is explained in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
(in thousands)
|
2018
|
|
Change
|
|
2017
|
Cash provided by operating activities
|
$
|
18,329
|
|
|
$
|
12,709
|
|
|
$
|
5,620
|
|
|
|
|
|
|
|
Investing activities
|
|
|
|
|
|
Reforestation and roads
|
(1,861
|
)
|
|
(752
|
)
|
|
(1,109
|
)
|
Capital expenditures
|
(462
|
)
|
|
(370
|
)
|
|
(92
|
)
|
Proceeds from sale of property and equipment
|
4
|
|
|
(26
|
)
|
|
30
|
|
Investment in unconsolidated real estate joint venture
|
(250
|
)
|
|
(250
|
)
|
|
—
|
|
Acquisition of timberland - Partnership
|
(6,355
|
)
|
|
(1,404
|
)
|
|
(4,951
|
)
|
Acquisition of timberland - Funds
|
(108,364
|
)
|
|
(108,364
|
)
|
|
—
|
|
Proceeds from sale of timberland - Funds
|
—
|
|
|
(26,444
|
)
|
|
26,444
|
|
Cash provided by (used in) investing activities
|
(117,288
|
)
|
|
(137,610
|
)
|
|
20,322
|
|
Financing activities
|
|
|
|
|
|
|
|
|
Line of credit borrowings
|
24,300
|
|
|
5,793
|
|
|
18,507
|
|
Line of credit repayments
|
(4,500
|
)
|
|
3,500
|
|
|
(8,000
|
)
|
Repayment of long-term debt
|
(61
|
)
|
|
4,998
|
|
|
(5,059
|
)
|
Debt issuances costs
|
—
|
|
|
77
|
|
|
(77
|
)
|
Units issued under distribution reinvestment plan
|
120
|
|
|
120
|
|
|
—
|
|
Unit repurchases
|
(653
|
)
|
|
(596
|
)
|
|
(57
|
)
|
Payroll taxes paid upon unit net settlements
|
(102
|
)
|
|
(8
|
)
|
|
(94
|
)
|
Cash distributions to unitholders
|
(6,103
|
)
|
|
12
|
|
|
(6,115
|
)
|
Cash distributions to fund investors, net of distributions to Partnership
|
(6,323
|
)
|
|
17,614
|
|
|
(23,937
|
)
|
Capital call - ORM Timber Funds, net of Partnership contribution
|
92,280
|
|
|
91,455
|
|
|
825
|
|
Cash provided by (used in) financing activities
|
98,958
|
|
|
122,965
|
|
|
(24,007
|
)
|
Net increase (decrease) in cash and restricted cash
|
$
|
(1
|
)
|
|
$
|
(1,936
|
)
|
|
$
|
1,935
|
|
The increase in cash from operating activities of
$12.7 million
resulted primarily from a 27% increase in timber harvest volume, including timber deed sales, a 23% rise in average log price realizations, lower Real Estate project expenditures of $3.1 million, and a decrease in environmental remediation expenditures of $3.4 million.
Cash from investing activities during
2018
decreased by
$137.6 million
compared to
2017
due primarily to the acquisition of a two tree farms by the Fund IV in January 2018. In addition, Fund II sold one of its tree farms in January 2017.
Cash from financing activities increased in the current year by
$123.0 million
due primarily to capital calls for Fund IV’s two tree farm acquisitions, net borrowings under credit facilities, and the 2017 distribution of the net proceeds from the sale of one of Fund II’s tree farms to that fund’s investors which had no counterpart in 2018.
Seasonality
Timber - Partnership and Funds.
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 strong log prices, when we may accelerate harvest volume, or soft log prices, when we may defer harvest volume. In addition, our quarterly harvest patterns may be impacted by severe weather or fire conditions.
Timberland Investment 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 the Partnership in periods in which these transactions close, and relatively limited revenue and operating 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
2018
are projected to be approximately $10.4 million. The most significant expenditures relate to finishing residential lots for sale to merchant homebuilders in our Harbor Hill project, and reforestation and roads. 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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
|
|
June 30 YTD
|
|
Remainder of Year
|
|
Total
|
in millions
|
|
|
|
|
|
Harbor Hill project development
|
$
|
1.2
|
|
|
$
|
4.7
|
|
|
$
|
5.9
|
|
Reforestation and roads - Partnership
|
1.1
|
|
|
0.5
|
|
|
1.6
|
|
Reforestation and roads - Funds
|
0.8
|
|
|
0.9
|
|
|
1.7
|
|
Other
|
0.5
|
|
|
1.8
|
|
|
2.3
|
|
|
$
|
3.6
|
|
|
$
|
7.9
|
|
|
$
|
11.5
|
|
ACCOUNTING MATTERS
Critical Accounting Estimates
An accounting estimate is deemed to be critical if it requires us to make assumptions about matters that are highly uncertain at the time the accounting estimate is made, and also if different estimates that we reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the presentation of the Company’s financial condition, changes in financial condition, or results of operations. 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 cost allocation of purchased timberland, timber depletion, and environmental remediation liabilities.
For a further discussion of our critical accounting 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, 2017
. See also note 2 to the condensed consolidated financial statements.