Company Quick10K Filing
Quick10K
Pope Resources Partnership
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$69.52 4 $303
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
8-K 2019-02-22 Amend Bylaw, Exhibits
8-K 2018-11-07 Earnings, Exhibits
8-K 2018-10-18 Enter Agreement, Off-BS Arrangement, Regulation FD, Exhibits
8-K 2018-10-17 Other Events, Exhibits
8-K 2018-10-17 Other Events, Exhibits
8-K 2018-08-07 Earnings, Exhibits
8-K 2018-06-18 Other Events, Exhibits
8-K 2018-05-23 Regulation FD, Exhibits
8-K 2018-05-07 Earnings, Exhibits
8-K 2018-04-02 Other Events, Exhibits
8-K 2018-02-28 Earnings, Exhibits
8-K 2018-02-07 Other Events, Exhibits
8-K 2018-02-01 Other Events, Exhibits
8-K 2018-01-02 Other Events, Exhibits
WM Waste Management
WCN Waste Connections
SRCL Stericycle
CLH Clean Harbors
ADSW Advanced Disposal Services
CWST Casella Waste Systems
ESTR Estre
SMED Sharps Compliance
PESI Perma Fix Environmental Services
AWX Avalon Holdings
POPE 2018-09-30
Part I - Financial Information
Item 1. Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II - Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters To A Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
EX-31.1 ex-31110xqq32018.htm
EX-31.2 ex-31210xqq32018.htm
EX-32.1 ex-32110xqq32018.htm
EX-32.2 ex-32210xqq32018.htm

Pope Resources Partnership Earnings 2018-09-30

POPE 10Q Quarterly Report

Balance SheetIncome StatementCash Flow

10-Q 1 pope10-qq32018.htm 10-Q Document


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 September 30, 2018

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

Commission File Number 1-9035

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
 
Large Accelerated Filer o
Accelerated Filer x
Emerging growth company o
 
Non-accelerated Filer o
Smaller Reporting Company o
 
                                                                                                           
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    
Yes o          No x

Partnership units outstanding at October 31, 2018: 4,352,216





Pope Resources
Index to Form 10-Q Filing
For the Nine Months Ended September 30, 2018

Description
Page Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 





PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
Pope Resources, a Delaware Limited Partnership
September 30, 2018 and December 31, 2017
(in thousands)
 
2018
 
2017
ASSETS
 
 
 
Current assets
 
 
 
Partnership cash
$
1,791

 
$
1,788

ORM Timber Funds cash
4,575

 
1,636

Cash
6,366

 
3,424

Restricted cash
1,005

 
1,860

Total cash and restricted cash
7,371

 
5,284

Accounts receivable, net
5,654

 
6,427

Contract assets
4,947

 

Land held for sale
5,013

 
5,728

Prepaid expenses and other current assets
1,408

 
591

    Total current assets
24,393

 
18,030

Properties and equipment, at cost
 

 
 

Timber and roads
356,017

 
267,662

Timberland
69,115

 
55,056

Land held for development
20,809

 
19,311

Buildings and equipment, net of accumulated depreciation (2018 - $8,085; 2017 - $7,833)
5,497

 
5,306

    Total property and equipment, at cost
451,438

 
347,335

Other assets
8,862

 
15,308

Total assets
$
484,693

 
$
380,673

 
 
 
 
LIABILITIES, PARTNERS’ CAPITAL AND NONCONTROLLING INTERESTS
 

 
 

Current liabilities
 

 
 

Accounts payable
$
2,284

 
$
2,430

Accrued liabilities
4,111

 
4,451

Current portion of long-term debt - Partnership
127

 
123

Deferred revenue
277

 
197

Current portion of environmental remediation liability
2,134

 
2,160

Other current liabilities
1,165

 
401

    Total current liabilities
10,098

 
9,762

Long-term debt, net of unamortized debt issuance costs and current portion - Partnership
89,475

 
70,037

Long-term debt, net of unamortized debt issuance costs - Funds
57,307

 
57,291

Environmental remediation and other long-term liabilities
4,712

 
2,957

Partners’ capital and noncontrolling interests
 

 
 

General partners' capital (units issued and outstanding 2018 - 60; 2017 - 60)
1,026

 
1,028

Limited partners' capital (units issued and outstanding 2018 - 4,254; 2017 - 4,251)
62,503

 
63,519

Noncontrolling interests
259,572

 
176,079

    Total partners’ capital and noncontrolling interests
323,101

 
240,626

Total liabilities, partners’ capital and noncontrolling interests
$
484,693

 
$
380,673

See accompanying notes to condensed consolidated financial statements.

3



CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
Pope Resources, a Delaware Limited Partnership
Nine Months Ended September 30, 2018 and 2017
(in thousands, except per unit data)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Revenue
$
28,008

 
$
18,803

 
$
80,907

 
$
52,039

Cost of sales
(16,769
)
 
(11,388
)
 
(43,644
)
 
(31,568
)
Operating expenses
(5,137
)
 
(4,520
)
 
(14,471
)
 
(13,296
)
Environmental remediation expense

 

 
(2,900
)
 

General and administrative expenses
(1,930
)
 
(1,134
)
 
(4,954
)
 
(4,240
)
Gain on sale of timberland

 
44

 

 
12,547

Income from operations
4,172

 
1,805

 
14,938

 
15,482

 
 
 
 
 
 
 
 
Interest expense, net
(1,311
)
 
(1,179
)
 
(3,703
)
 
(3,306
)
 
 
 
 
 
 
 
 
Income before income taxes
2,861

 
626

 
11,235

 
12,176

Income tax expense
(117
)
 
(46
)
 
(243
)
 
(105
)
Net and comprehensive income
2,744

 
580

 
10,992

 
12,071

 
 
 
 
 
 
 
 
Net and comprehensive (income) loss attributable to noncontrolling interests - ORM Timber Funds
(110
)
 
1,078

 
(2,498
)
 
(6,885
)
Net and comprehensive loss attributable to noncontrolling interests - Real Estate
10

 

 
68

 

Net and comprehensive income attributable to unitholders    
$
2,644

 
$
1,658

 
$
8,562

 
$
5,186

 
 
 
 
 
 
 
 
Allocable to general partners
$
37

 
$
23

 
$
119

 
$
72

Allocable to limited partners
2,607

 
1,635

 
8,443

 
5,114

Net and comprehensive income attributable to unitholders
$
2,644

 
$
1,658

 
$
8,562

 
$
5,186

 
 
 
 
 
 
 
 
Basic and diluted earnings per unit attributable to unitholders
$
0.60

 
$
0.38

 
$
1.96

 
$
1.17

 
 
 
 
 
 
 
 
Basic and diluted weighted average units outstanding
4,316

 
4,324

 
4,319

 
4,325

 
 
 
 
 
 
 
 
Distributions per unit
$
0.80

 
$
0.70

 
$
2.20

 
$
2.10

See accompanying notes to condensed consolidated financial statements.

4



CONDENSED CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL AND NONCONTROLLING INTERESTS (Unaudited)
Pope Resources, a Delaware Limited Partnership
Nine Months Ended September 30, 2018
(in thousands, except unit amounts)

 
 
 
Attributable to Pope Resources
 
 
 
 
 
Units
 
General Partners
 
Limited Partners
 
Noncontrolling Interests
 
Total
December 31, 2017
4,311,065

 
$
1,028

 
$
63,519

 
$
176,079

 
$
240,626

Net income

 
119

 
8,443

 
2,430

 
10,992

Cash distributions

 
(133
)
 
(9,458
)
 
(11,217
)
 
(20,808
)
Capital call

 

 

 
92,280

 
92,280

Equity-based compensation
16,178

 
13

 
911

 

 
924

Units issued under distribution reinvestment plan
1,808

 

 
128

 

 
128

Unit repurchases
(13,422
)
 

 
(939
)
 

 
(939
)
Payroll taxes paid on unit net settlements
(1,466
)
 
(1
)
 
(101
)
 

 
(102
)
September 30, 2018
4,314,163

 
$
1,026

 
$
62,503

 
$
259,572

 
$
323,101


See accompanying notes to condensed consolidated financial statements.


5



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Pope Resources, a Delaware Limited Partnership
Nine Months Ended September 30, 2018 and 2017 (in thousands)
 
2018
 
2017
Net income
$
10,992

 
$
12,071

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

 
 

Depletion
21,104

 
12,737

Equity-based compensation
924

 
950

Depreciation and amortization
439

 
393

Deferred taxes and other
57

 
10

Cost of land sold
1,407

 
1,970

Gain on sale of timberland - Funds

 
(12,547
)
Gain on disposal of property and equipment
(9
)
 
(3
)
Cash flows from changes in operating accounts
 

 
 

Accounts receivable, net
772

 
354

Prepaid expenses, contract assets, and other assets
(5,656
)
 
5,673

Real estate project expenditures
(2,182
)
 
(6,496
)
Accounts payable and accrued liabilities
(489
)
 
(1,452
)
Deferred revenue
80

 
(164
)
Environmental remediation accruals
2,900

 

Environmental remediation payments
(1,145
)
 
(6,182
)
Other current and long-term liabilities
740

 
94

Net cash provided by operating activities
29,934

 
7,408

 
 
 
 
Cash flows from investing activities
 

 
 

Reforestation and roads
(2,534
)
 
(1,665
)
Capital expenditures
(571
)
 
(162
)
Proceeds from sale of property and equipment
10

 
30

Investment in unconsolidated real estate joint venture

 
(250
)
Acquisitions of timberland - Partnership
(6,355
)
 
(4,951
)
Acquisitions of timberland - Funds
(108,364
)
 

Proceeds from sale of timberland - Funds

 
26,590

Net cash provided by (used in) investing activities
(117,814
)
 
19,592

 
 
 
 
Cash flows from financing activities
 

 
 

Line of credit borrowings
27,300

 
23,000

Line of credit repayments
(7,800
)
 
(8,000
)
Repayment of long-term debt
(92
)
 
(5,088
)
Debt issuance costs

 
(104
)
Proceeds from unit issuances - distribution reinvestment plan
128

 
4

Unit repurchases
(939
)
 
(648
)
Payroll taxes paid on unit net settlements
(102
)
 
(94
)
Cash distributions to unitholders
(9,591
)
 
(9,168
)
Cash distributions - ORM Timber Funds, net of distributions to Partnership
(11,217
)
 
(26,359
)
Capital call - ORM Timber Funds, net of Partnership contribution
92,280

 
825

Net cash provided by (used in) financing activities
89,967

 
(25,632
)
 
 
 
 
Net increase in cash and restricted cash
2,087

 
1,368

Cash and restricted cash at beginning of period
5,284

 
2,937

Cash and restricted cash at end of period
$
7,371

 
$
4,305

See accompanying notes to condensed consolidated financial statements.

6



POPE RESOURCES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 2018

1.
The condensed consolidated balance sheets as of September 30, 2018, and December 31, 2017, and the related condensed consolidated statements of comprehensive income for the three- and nine-month periods, and partners’ capital and cash flows for the nine-month periods, ended September 30, 2018, and 2017, 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, 2017, is derived from the Partnership’s audited consolidated financial statements and notes thereto for the year ended December 31, 2017, 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, 2018.

2.
The financial statements in the Partnership’s 2017 annual report on Form 10-K include a summary of significant accounting policies of the Partnership and should be read in conjunction with this Quarterly Report on Form 10-Q.

In February 2016, the FASB established Topic 842, Leases, which requires lessees to recognize leases on the balance sheet and disclose certain information about leasing arrangements. The new standard establishes a right-of-use (ROU) model that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as financing or operating, with classification affecting the pattern and classification of expense recognition in the income statement. For lessors, leases will be classified as a sales-type, direct financing, or operating lease. A lease is classified as a sales-type lease if any one of five criteria are met, each of which indicate that the lease, in effect, transfers control of the underlying asset to the lessee. If none of those five criteria are met, but two additional criteria are both met, indicating that the lessor has transferred substantially all the risks and benefits of the underlying asset to the lessee and a third party, the lease is a direct financing lease. All leases that are not sales-type or direct financing leases are operating leases.

The new standard is effective for us on January 1, 2019. We expect to adopt the new standard on January 1, 2019 and use the effective date as our date of initial application. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods before January 1, 2019. The new standard provides a number of optional practical expedients in transition. We expect to elect all of the new standard’s available transition practical expedients.

Due to the Partnership’s limited leasing activity, we do not expect the effect of this standard to be material to the Partnership’s consolidated financial statements. As a lessee, we currently believe that the most significant effect relates to the recognition of new ROU assets and lease liabilities on our balance sheet for our leases, which consist principally of leases of office equipment and office space. We expect to elect the practical expedient to not separate lease and non-lease components for all leases. As a lessor, we currently believe that all of our leases, which consist of leases of real estate, will continue to be classified as operating leases under the new standard.

3.
Effective January 1, 2018, the Partnership adopted Topic 606, Revenue from Contracts with Customers. For revenue from the Partnership Timber and Funds Timber segments, which consists primarily of the sale of logs, there were no changes to the timing or amount of revenue recognized because contracts are legally enforceable, the transaction price is fixed, and performance is completed and control transfers at a point in time, typically when risk of loss and title passes to the customer. Similarly, no changes were identified to the timing or amount of revenue recognized from certain components of other revenue in these segments, including commercial thinning, royalties from gravel mines and quarries, and land use permits. For timber deed sales, the timing of revenue recognition was accelerated under the new standard to the effective date of the contract, whereas under the previous revenue recognition guidance the revenue was generally recognized when the timber was harvested by the customer. Under Topic 606, revenue recognized from timber deed sales in the third quarter of 2018 was $588,000 less than it would have been under the previous revenue recognition standards. For the nine months ended September 30, 2018, revenue recognized under Topic 606 was $6.9 million greater than it would have been under the previous revenue recognition accounting standards. For the Real Estate segment, this new standard may result in accelerating the recognition of revenue for performance obligations that are satisfied over time, which generally consist of construction and landscaping activity in common areas completed after transaction closing. The Partnership adopted this standard using the cumulative effect transition method applied to uncompleted contracts as of the date of adoption. The

7



Partnership, however, had no uncompleted contracts at the date of adoption. Accordingly, the adoption of this standard did not have a cumulative effect on the Partnership’s consolidated financial statements.

Revenue is measured based on the consideration specified in a contract with a customer. The Partnership recognizes revenue when it satisfies a performance obligation by transferring control over a product or service to a customer. Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction that are collected by the Partnership from a customer are excluded from revenue. Shipping costs associated with delivering products to customers are included in cost of sales.

Included in “Accounts receivable, net” are $4.4 million of receivables from contracts with customers as of September 30, 2018, and December 31, 2017. Significant changes in the contract asset balance during the period were as follows, and there were no contract liabilities as of September 30, 2018, and December 31, 2017:

Contract assets, January 1, 2018
$

Revenue recognized from the satisfaction of performance obligations
10,255

Revenue recognized from changes in estimates of variable consideration
249

Transferred to receivables from contract assets
(5,557
)
Contract assets, September 30, 2018
$
4,947


The contract assets in the table above represent rights to consideration for timber deeds transferred to the customer and are related to the Funds Timber segment. These contracts provide the customer the legal right to harvest timber on the Funds’ property. The value of a timber deed contract is determined based on the estimated timber volume by tree species multiplied by the contracted price. The contract consideration is considered variable because the timber volume is an estimate until the harvest is completed. The contract assets are transferred to receivables when the rights to consideration become due under the contract. Customers may harvest the timber at their discretion, within a time period and operational parameters stated in the contract.

The following is a description of principal activities, separated by reportable segments, from which the Partnership generates its revenue.

Partnership Timber and Funds Timber

Log sale revenue in these two segments is recognized when control is transferred, and title and risk of loss passes to the customer, which typically occurs when logs are delivered to the customer. Revenue in these two segments is earned primarily from the harvest and sale of logs from the Partnership’s and Funds’ timberland. Other revenue in these segments is generated from the sale of rights to harvest timber (timber deed sales), commercial thinning, ground leases for cellular communication towers, royalties from gravel mines and quarries, and land use permits. Timber deed sales are generally structured so that the customer pays a contracted price per volume, measured in thousands of board feet (MBF), and revenue is recognized when control is transferred to the customer, which generally occurs on the effective date of the contract. Commercial thinning consists of the selective cutting of timber stands that have not yet reached optimal harvest age. However, this timber does have some commercial value and revenue is based on the volume harvested. Royalty revenue from gravel mines and quarries is recognized monthly based on the quantity of material extracted.

The following table presents log sale and other revenue for the quarters and nine months ended September 30, 2018 and 2017:


8



(in thousands)
Quarter ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Partnership Timber
 
 
 
 
 
 
 
Log sale revenue
$
11,638

 
$
8,298

 
$
31,312

 
$
24,686

Other revenue
601

 
600

 
1,635

 
1,487

Total revenue
$
12,239

 
$
8,898

 
$
32,947

 
$
26,173

 
 
 
 
 
 
 
 
Funds Timber
 
 
 
 
 
 
 
Log sale revenue
$
11,353

 
$
5,682

 
$
29,356

 
$
19,912

Timber deed sale revenue
1,640

 
1,235

 
10,504

 
1,945

Other revenue
260

 
165

 
851

 
204

Total revenue
$
13,253

 
$
7,082

 
$
40,711

 
$
22,061


Timberland Investment Management (TIM)

Fee revenue generated by the TIM segment for managing the Funds includes fixed components related to invested capital and acres under management, and a variable component related to harvest volume from the Funds’ tree farms. These fees, which represent an expense in the Funds Timber segment, are eliminated in consolidation. The TIM segment occasionally earns revenue from providing timberland management-related consulting services to third-parties and recognizes such revenue as the related services are provided.

Real Estate

The Real Estate segment’s activities consist of investing in and later selling improved properties, holding properties for later development and sale, and managing commercial properties. Revenue is generated primarily from sales of land, sales of development rights known as conservation easements (CE’s), sales of unimproved land from the Partnership’s timberland portfolio, and residential and commercial rents. Revenue on real estate sales is recorded on the date the sale closes. When a real estate transaction is closed with obligations to complete infrastructure or other construction, the portion of the total contract allocated to the post-closing obligations may be recognized over time as that work is performed, provided the customer either simultaneously receives and consumes the benefits as we perform under the contract, our performance creates or enhances the asset controlled by the customer, or we do not create an asset with an alternative use to the customer and we have an enforceable right to payment for the performance completed. Progress towards the satisfaction of our performance obligations is generally measured based on costs incurred relative to the total cost expected to be incurred for the performance obligations.

The following table breaks down revenue for the Real Estate segment for the quarters and nine months ended September 30, 2018 and 2017:

 
Quarter ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Development rights (CE)
$

 
$

 
$
3,730

 
$

Residential land sales
1,975

 
2,487

 
2,126

 
2,942

Unimproved land

 

 
125

 

Total land sales
1,975

 
2,487

 
5,981

 
2,942

Rentals and other
541

 
336

 
1,268

 
863

Total revenue
$
2,516

 
$
2,823

 
$
7,249

 
$
3,805



9



4.
The Partnership has two general partners: Pope MGP, Inc. and Pope EGP, Inc. In total, these two entities own 60,000 limited partner units. The allocation of distributions, profits, and losses among the general and limited partners is pro rata across all units outstanding.

5.
ORM Timber Fund II, Inc. (Fund II), ORM Timber Fund III (REIT) Inc. (Fund III), and ORM Timber Fund IV LLC (Fund IV), collectively “the Funds”, were formed by Olympic Resource Management LLC (ORMLLC), a wholly owned subsidiary of the Partnership, for the purpose of raising capital to purchase timberlands. The objective of these Funds is to generate a return on investments through the acquisition, management, value enhancement, and sale of timberland properties. Each fund is organized to operate for a specific term from the end of its respective investment period; ten years for each of Fund II and Fund III, and fifteen years for Fund IV. Fund II and Fund III are scheduled to terminate in March 2021 and December 2025, respectively. Fund IV will terminate on the fifteenth anniversary of the end of its investment period, which will occur on the earlier of placement of all committed capital or December 31, 2019, subject to certain extension provisions.

Pope Resources and ORMLLC together own equity interests totaling 20% of Fund II, 5% of Fund III, and 15% of Fund IV. The Funds are considered variable interest entities because their organizational and governance structures are the functional equivalent of a limited partnership. As the managing member of the Funds, the Partnership is the primary beneficiary of each of the Funds as it has the authority to direct the activities that most significantly impact their economic performance, as well as the right to receive benefits and the obligation to absorb losses that could potentially be significant to the Funds. Accordingly, the Funds are consolidated into the Partnership’s financial statements. The obligations of each of the Funds are non-recourse to the Partnership.

In January 2018, Fund IV closed on the acquisitions of two tree farms, one in southwestern Oregon and one in south Puget Sound, Washington, for $33.6 million and $80.4 million, respectively. In 2017, Fund IV paid deposits totaling $5.7 million for these acquisitions. The Partnership’s share of the combined purchase price was $17.0 million. The combined purchase price was allocated $100.7 million to timber and roads, and $13.3 million to the underlying land. In October 2018, Fund IV closed on the acquisition of a tree farm in south Puget Sound, Washington for $32.2 million, of which the Partnership’s share was $4.8 million.

In January 2017, Fund II closed on the sale of one of its tree farms, located on the Oregon coast, for $26.5 million. The Partnership’s share of the pretax results from this tree farm was a gain of $2.5 million for the nine months ended September 30, 2017.

The assets and liabilities of the Funds as of September 30, 2018, and December 31, 2017, were as follows:
 
(in thousands)
September 30, 2018

December 31, 2017
Assets:
Cash
$
4,575

 
$
1,636

Other current assets
7,905

 
2,481

Total current assets
12,480

 
4,117

Properties and equipment, net of accumulated depreciation
332,068

 
235,046

Other long-term assets

 
5,683

Total assets
$
344,548

 
$
244,846

Liabilities and equity:
 

 
 

Current liabilities
$
3,635

 
$
2,862

Long-term debt, net of unamortized debt issuance costs
57,307

 
57,291

Funds’ equity
283,606

 
184,693

Total liabilities and equity
$
344,548

 
$
244,846



10



6.
Other assets consisted of the following at September 30, 2018 and December 31, 2017:

 
September 30, 2018
 
December 31, 2017
 
 
 
 
Deferred tax assets, net
$
412

 
$
465

Cash held by like-kind exchange intermediaries

 
598

Deposits for acquisitions of timberland

 
5,688

Investment in Real Estate joint venture entity
5,895

 
5,895

Advances to Real Estate joint venture entity
753

 
37

Note receivable
1,802

 
2,625

Total
$
8,862

 
$
15,308


7.
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.

Beginning with the first quarter of 2018, we measure segment performance based on Adjusted EBITDDA in addition to operating income. We define Adjusted EBITDDA as earnings, on an internal basis, before interest, taxes, depletion, depreciation, amortization, gain or loss on sales of timberland, and environmental remediation expense. The following tables reconcile internally reported operating income (loss) from operations to Adjusted EBITDDA.

In addition, we have changed our internal reporting and our segment reporting to segregate our former “Fee Timber” segment into two segments: “Partnership Timber” includes the operating results of the Partnership’s 100%-owned timberland, while “Funds Timber” includes the operating results of its three private equity timber funds. Our chief operating decision maker reviews internal financial reporting information at the Partnership Timber and Funds Timber level to allocate resources and evaluate the results of the business. Prior period segment disclosures have been revised to reflect our current segment structure.

11



Quarter ended September 30, (in thousands)
Partnership Timber
 
Funds Timber
 
Timberland Investment Management
 
Real Estate
 
Other
 
Consolidated
2018
 
 
 
 
 
 
 
 
 
 
 
Revenue - internal
$
12,373

 
$
13,253

 
$
1,212

 
$
2,636

 
$

 
$
29,474

Eliminations
(134
)
 

 
(1,212
)
 
(120
)
 

 
(1,466
)
Revenue - external
12,239

 
13,253

 

 
2,516

 

 
28,008

 
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
(4,976
)
 
(9,932
)
 

 
(1,861
)
 

 
(16,769
)
 
 
 
 
 
 
 
 
 
 
 
 
Operating, general and administrative expenses - internal
(1,729
)
 
(2,435
)
 
(1,206
)
 
(1,209
)
 
(1,954
)
 
(8,533
)
Eliminations
43

 
1,212

 
151

 
36

 
24

 
1,466

Operating, general and administrative expenses - external
(1,686
)
 
(1,223
)
 
(1,055
)
 
(1,173
)
 
(1,930
)
 
(7,067
)
Income (loss) from operations - internal
5,668

 
886

 
6

 
(434
)
 
(1,954
)
 
4,172

Eliminations
(91
)
 
1,212

 
(1,061
)
 
(84
)
 
24

 

 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - external
$
5,577

 
$
2,098

 
$
(1,055
)
 
$
(518
)
 
$
(1,930
)
 
$
4,172

 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - internal
$
5,668

 
$
886

 
$
6

 
$
(434
)
 
$
(1,954
)
 
$
4,172

Depletion, depreciation, and amortization
1,094

 
5,906

 
21

 
68

 
10

 
7,099

Adjusted EBITDDA
$
6,762

 
$
6,792

 
$
27

 
$
(366
)
 
$
(1,944
)
 
$
11,271

 
 
 
 
 
 
 
 
 
 
 
 
2017
 

 
 

 
 

 
 

 
 

 
 

Revenue - internal
$
8,981

 
$
7,082

 
$
829

 
$
2,920

 
$

 
$
19,812

Eliminations
(83
)
 

 
(829
)
 
(97
)
 

 
(1,009
)
Revenue - external
8,898

 
7,082

 

 
2,823

 

 
18,803

 
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
(3,552
)
 
(5,717
)
 

 
(2,119
)
 

 
(11,388
)
 
 
 
 
 
 
 
 
 
 
 
 
Operating, general and administrative expenses - internal
(1,576
)
 
(1,937
)
 
(780
)
 
(1,213
)
 
(1,157
)
 
(6,663
)
Eliminations
38

 
829

 
101

 
18

 
23

 
1,009

Operating, general and administrative expenses -external
(1,538
)
 
(1,108
)
 
(679
)
 
(1,195
)
 
(1,134
)
 
(5,654
)
Gain on sale of timberland

 
44

 

 

 

 
44

Income (loss) from operations - internal
3,853

 
(528
)
 
49

 
(412
)
 
(1,157
)
 
1,805

Eliminations
(45
)
 
829

 
(728
)
 
(79
)
 
23

 

 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - external
$
3,808

 
$
301

 
$
(679
)
 
$
(491
)
 
$
(1,134
)
 
$
1,805

 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - internal
$
3,853

 
$
(528
)
 
$
49

 
$
(412
)
 
$
(1,157
)
 
$
1,805

Depletion, depreciation, and amortization
912

 
3,374

 
8

 
69

 
13

 
4,376

(Gain) loss on sale of timberland

 
(44
)
 

 

 

 
(44
)
Adjusted EBITDDA
$
4,765

 
$
2,802

 
$
57

 
$
(343
)
 
$
(1,144
)
 
$
6,137


12




Nine Months Ended September 30, (in thousands)
Partnership Timber
 
Funds Timber
 
Timberland Investment Management
 
Real Estate
 
Other
 
Consolidated
2018
 
 
 
 
 
 
 
 
 
 
 
Revenue - internal
$
33,313

 
$
40,711

 
$
3,376

 
$
7,621

 
$

 
$
85,021

Eliminations
(366
)
 

 
(3,376
)
 
(372
)
 

 
(4,114
)
Revenue - external
32,947

 
40,711

 

 
7,249

 

 
80,907

 
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
(11,996
)
 
(28,754
)
 

 
(2,894
)
 

 
(43,644
)
 
 
 
 
 
 
 
 
 
 
 
 
Operating, general and administrative expenses - internal
(5,076
)
 
(6,766
)
 
(3,337
)
 
(3,327
)
 
(5,033
)
 
(23,539
)
Eliminations
135

 
3,376

 
419

 
105

 
79

 
4,114

Operating, general and administrative expenses - external
(4,941
)
 
(3,390
)
 
(2,918
)
 
(3,222
)
 
(4,954
)
 
(19,425
)
Environmental remediation

 

 

 
(2,900
)
 

 
(2,900
)
Income (loss) from operations - internal
16,241

 
5,191

 
39

 
(1,500
)
 
(5,033
)
 
14,938

Eliminations
(231
)
 
3,376

 
(2,957
)
 
(267
)
 
79

 

Income (loss) from operations - external
$
16,010

 
$
8,567

 
$
(2,918
)
 
$
(1,767
)
 
$
(4,954
)
 
$
14,938

 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - internal
$
16,241

 
$
5,191

 
$
39

 
$
(1,500
)
 
$
(5,033
)
 
$
14,938

Depletion, depreciation, and amortization
2,930

 
18,275

 
48

 
204

 
35

 
21,492

Environmental remediation

 

 

 
2,900

 

 
2,900

Adjusted EBITDDA
$
19,171

 
$
23,466

 
$
87

 
$
1,604

 
$
(4,998
)
 
$
39,330

 
 
 
 
 
 
 
 
 
 
 
 
2017
 

 
 

 
 

 
 

 
 

 
 

Revenue - internal
$
26,425

 
$
22,061

 
$
2,494

 
$
4,136

 
$

 
$
55,116

Eliminations
(252
)
 

 
(2,494
)
 
(331
)
 

 
(3,077
)
Revenue - external
26,173

 
22,061

 

 
3,805

 

 
52,039

 
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
(10,430
)
 
(18,000
)
 

 
(3,138
)
 

 
(31,568
)
 
 
 
 
 
 
 
 
 
 
 
 
Operating, general and administrative expenses - internal
(4,286
)
 
(5,372
)
 
(2,705
)
 
(3,929
)
 
(4,321
)
 
(20,613
)
Eliminations
135

 
2,494

 
309

 
58

 
81

 
3,077

Operating, general and administrative expenses - external
(4,151
)
 
(2,878
)
 
(2,396
)
 
(3,871
)
 
(4,240
)
 
(17,536
)
Gain on sale of timberland

 
12,547

 

 

 

 
12,547

 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - internal
11,709

 
11,236

 
(211
)
 
(2,931
)
 
(4,321
)
 
15,482

Eliminations
(117
)
 
2,494

 
(2,185
)
 
(273
)
 
81

 

Income (loss) from operations - external
$
11,592

 
$
13,730

 
$
(2,396
)
 
$
(3,204
)
 
$
(4,240
)
 
$
15,482

 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations - internal
$
11,709

 
$
11,236

 
$
(211
)
 
$
(2,931
)
 
$
(4,321
)
 
$
15,482

Depletion, depreciation, and amortization
2,877

 
9,931

 
24

 
211

 
40

 
13,083

Gain on sale of timberland

 
(12,547
)
 

 

 

 
(12,547
)
Adjusted EBITDDA
$
14,586

 
$
8,620

 
$
(187
)
 
$
(2,720
)
 
$
(4,281
)
 
$
16,018



13



8.
Basic and diluted earnings per unit are calculated by dividing net income attributable to unitholders, adjusted for non-forfeitable distributions paid out to unvested restricted unitholders and preferred shareholders of Fund II and Fund III, by the weighted average units outstanding during the period. There were no dilutive securities outstanding during the periods presented. The following table shows the calculation of basic and diluted earnings per unit:

 
Quarter Ended 
 September 30,
 
Nine Months Ended 
 September 30,
(in thousands, except per unit amounts)
2018
 
2017
 
2018
 
2017
Net and comprehensive income attributable to Pope Resources’ unitholders
$
2,644

 
$
1,658

 
$
8,562

 
$
5,186

Less:
 

 
 

 
 

 
 

Non-forfeitable distributions paid to unvested restricted unitholders
(27
)
 
(25
)
 
(55
)
 
(84
)
Preferred share dividends - ORM Timber Funds
(8
)
 
(8
)
 
(23
)
 
(23
)
Net and comprehensive income for calculation of earnings per unit
$
2,609

 
$
1,625

 
$
8,484

 
$
5,079

 
 
 
 
 
 
 
 
Basic and diluted weighted average units outstanding
4,316

 
4,324

 
4,319

 
4,325

 
 
 
 
 
 
 
 
Basic and diluted net earnings per unit
$
0.60

 
$
0.38

 
$
1.96

 
$
1.17


9.
In the first quarter of 2018, the Partnership issued 11,393 restricted units pursuant to the management incentive compensation program and 3,575 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 nine months ended September 30, 2018, 1,198 units were granted with no restrictions to certain board members who elected to receive their quarterly board compensation in the form of units rather than cash. Units granted to directors are included in the calculation of total equity compensation expense which is recognized over the vesting period, for restricted units, or immediately for unrestricted units. Grants to retirement-eligible individuals on the date of grant are expensed immediately. The Partnership recognized $202,000 and $166,000 of equity compensation expense in the third quarter of 2018 and 2017, respectively, related to these compensation programs and $924,000 and $950,000 for the nine months ended September 30, 2018 and 2017, respectively.

10.
Supplemental disclosure of cash flow information: interest paid, net of amounts capitalized, totaled $3.5 million and $3.2 million during the first nine months of 2018 and 2017, respectively. Income taxes paid totaled $660,000 and $65,000 for the first nine months of 2018 and 2017, respectively.

11.
During the first nine months of 2018, the Partnership closed on six acquisitions of timberland in western Washington totaling 1,342 acres for $7.2 million. The Partnership utilized $598,000 of funds held by like-kind exchange intermediaries to fund a portion of these acquisitions. The aggregate purchase price was allocated $869,000 to land and $6.3 million to timber and roads. Part of the consideration paid for one of these transactions involved the conveyance by the Partnership of 365 acres of non-strategic timberland to the seller, valued at $214,000, with the remainder paid in cash.

12.
The Partnership’s financial instruments include cash, accounts receivable, and a note receivable, included in other assets, for which the carrying amount of each represents fair value based on current market interest rates or their short-term nature.

Collectively, the Partnership’s and the Funds’ fixed-rate debt has a carrying value of $101.5 million as of September 30, 2018 and December 31, 2017. 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 $101.1 million and $104.6 million as of September 30, 2018 and December 31, 2017, respectively.

13.
The Partnership had an accrual for estimated environmental remediation costs of $6.7 million and $5.0 million as of September 30, 2018 and December 31, 2017, respectively. The environmental remediation liability represents management’s estimate of payments to be made to remediate and monitor certain areas in and around Port Gamble Bay, Washington.

In December 2013, a consent decree and Clean-up Action Plan (CAP) related to Port Gamble Bay were finalized with the Washington State Department of Ecology (DOE) and filed with Kitsap County Superior Court. In the third quarter of 2015, the Partnership selected a contractor to complete the remediation work. Remediation activity began in late September 2015

14



and the required in-water portion of the cleanup was completed in January 2017. This will be followed by cleanup activity on the millsite and by a monitoring period, which is estimated to be approximately 15 years. Management’s cost estimates for the remainder of the project are based on amounts included in construction contracts, bids from contractors, and estimates for project management and other professional fees.

In February 2018, the Partnership and DOE entered into an agreed order with respect to the millsite under which the Partnership will perform a remedial investigation and feasibility study and develop a CAP. As with the in-water portion of the project, the CAP will define the scope of the remediation activity for the millsite. Based on design work completed to date, we discovered during the second quarter of 2018 that we will need to remove a greater volume of sediment from the millsite than we previously anticipated. The discovery of a higher volume of material to excavate, related capping, and updated estimates of long-term monitoring costs, caused the Partnership to increase its accrual by $2.9 million in the second quarter of 2018. Because 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 design of the millsite is expected to be substantially complete by the end of 2018 and the cleanup activity is expected to commence 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. The Partnership has been in discussions with the Trustees regarding their claims and the alleged conditions in Port Gamble Bay, and has also been discussing restoration alternatives that might address the damages the Trustees allege. Discussions with the Trustees may result in an obligation for the Partnership to fund NRD restoration activities and past assessment costs that are greater than it has estimated, and it is reasonably possible that this component of the liability may increase beyond what has been accrued in the liability. Management expects to be in a position to update its estimate of the NRD liability, or range of liability, by the end of 2018.

The environmental liability at September 30, 2018 is comprised of $2.1 million that management expects to expend in the next 12 months and $4.6 million thereafter.

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, 2016
$
16,761

 
$
7,700

 
$
(11,691
)
 
$
12,770

Year ended December 31, 2017
12,770

 

 
(7,791
)
 
4,979

Quarter ended March 31, 2018
4,979

 

 
(219
)
 
4,760

Quarter ended June 30, 2018
4,760

 
2,900

 
(666
)
 
6,994

Quarter ended September 30, 2018
$
6,994

 
$

 
$
(260
)
 
$
6,734



15



14.
In October 2018, the Partnership amended its timberland mortgage credit facilities (Credit Agreement) with Northwest Farm Credit Services to increase its borrowing capacity. The expanded credit facilities consist of the following components:

$30.0 million revolving line of credit bearing interest, paid quarterly, at LIBOR plus a margin of 1.60%, and maturing in October 2023. At closing, $15.7 million was outstanding under this facility.
$40.0 million delayed-draw term facility with an ultimate maturity of October 2028, on which $4.0 million was drawn in October 2018 as a variable-rate segment. The Partnership may borrow at any time under this facility through October 2023, subject to certain conditions established in the Credit Agreement. Borrowings may bear interest, paid quarterly, at variable or fixed rates at the election of the Partnership. Variable-rate segments bear interest at LIBOR plus a margin of 1.60%. Fixed-rate segments bear interest at the lenders pricing index at the time of borrowing plus a margin of 1.60% for maturities up to five years, and 1.65% for maturities greater than five years. Variable-rate segments may be converted to fixed-rate segments at the election of the Partnership. Fixed-rate loan segments must be for a minimum of $5.0 million, and no more than five such fixed-rate loan segments may be outstanding at any time. Fixed-rate loan segment maturities may be from one through ten years at the election of the Partnership, not to exceed the ultimate maturity of October 2028.
$71.8 million fully funded, long-term facility that consists of:
$9.8 million bearing interest at 6.40%, paid monthly, maturing September 2019
$6.0 million bearing interest at LIBOR plus 1.60%, paid quarterly, maturing October 2024
$10.0 million bearing interest at 6.05%, paid quarterly, maturing July 2025
$11.0 million bearing interest at 3.89%, paid quarterly, maturing July 2026
$11.0 million bearing interest at 4.13%, paid quarterly, maturing July 2028
$8.0 million bearing interest at 5.34%, paid quarterly, maturing October 2034
$8.0 million bearing interest at 5.34%, paid quarterly, maturing October 2035
$8.0 million bearing interest at 5.42%, paid quarterly, maturing October 2036
Variable-rate loan segments may be converted to fixed-rate loan segments with maturities from 1 - 10, 12, 15 or 18 years, not to exceed the ultimate maturity dates above. Any such fixed-rate loan segment will bear interest, paid quarterly, at the lender’s pricing index at the time of conversion plus margins of 1.60% for maturities up to five years, and 1.65% for maturities greater than five years.
Accordion feature that the Partnership may exercise in the future, subject to lender approval, to increase borrowing capacity by up to $50.0 million under either the $40.0 million or $71.8 million facility. Any such increases must be in $15.0 million minimum increments with no more than three such increases.

The amended credit facilities eliminate the 3:1 interest coverage ratio covenant that had previously applied to the loans. Instead, the interest coverage ratio will be calculated quarterly, and the interest margins will be adjusted if the interest coverage ratio is below 3:1. The maximum interest margin is 2.20%, for variable-rate loan segments and prospective fixed-rate loan segments with maturities up to five years, and 2.25% for prospective fixed-rate loan segments with maturities greater than five years. The lender may reset the interest margin in October 2023, for the $40.0 million facility, and in October 2023, 2028, and 2033, for the $71.8 million facility.

The amended credit facilities retain the requirements that the Partnership 1) not exceed a maximum debt-to-capitalization ratio of 30%, with total capitalization calculated using fair market (rather than carrying) value of timberland, roads and timber, and 2) not exceed a maximum loan-to-appraised value of collateral of 50%. These amended facilities are collateralized by a portion of the Partnership’s timberland.

The Partnership intends to use borrowing capacity under these facilities to repay the $9.8 million fixed-rate loan segment that matures in September 2019. Accordingly, this loan segment is reflected in long-term debt at September 30, 2018.

16



ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report contains a number of projections and statements about our expected financial condition, operating results, and business plans and objectives. These statements reflect management’s estimates based upon our current expectations, in light of management’s knowledge of existing circumstances and expectations about future developments. Statements about expectations and future performance are “forward looking statements” within the meaning of applicable securities laws, which describe our goals, objectives and anticipated performance. These statements can be identified by words such as “anticipate,” “believe,” “expect,” “intend” and similar expressions. Some of these statements are inherently uncertain, and some or all of these statements may not come to pass. Accordingly, you should not interpret these statements as promises that we will perform at a given level or that we will take any or all of the actions we currently expect to take. Our future actions, as well as our actual performance, will vary from our current expectations, and under various circumstances these variations may be material and adverse. Some of the factors that may cause our actual operating results and financial condition to fall short of our expectations are set forth in the part of this report entitled “Risk Factors” in Part II, Item 1A below. From time to time we identify other risks and uncertainties in our other filings with the Securities and Exchange Commission. The forward-looking statements in this report reflect our estimates and expectations as of the date of the report, and unless required by law, we do not undertake to update these statements as our business operations and environment change.

This discussion should be read in conjunction with the condensed consolidated financial statements and related notes included with this report. 
 
EXECUTIVE OVERVIEW

Pope Resources, A Delaware Limited Partnership (“we” or the “Partnership”), is engaged in four primary businesses: Partnership Timber, Funds Timber, Timberland Investment Management, and Real Estate.

By far the most significant segments, in terms of owned assets and operations, are our two timber segments, which we refer to as Partnership Timber and Funds Timber. These segments include timberlands owned directly by the Partnership and three private equity funds (“Fund II”, “Fund III” and “Fund IV”, collectively, the “Funds”), respectively. We refer to the timberland owned by the Partnership as the Partnership’s tree farms, and our Partnership Timber segment reflects operations from those properties. We refer to timberland owned by the Funds as the Funds’ tree farms, and operations from those properties are reported in our Funds Timber segment. When referring collectively to the Partnership’s and Funds’ timberland, we refer to them as the Combined tree farms. Operations in each of these segments consist of growing timber and manufacturing logs for sale to domestic wood products manufacturers and log export brokers.

Our Timberland Investment Management segment is engaged in organizing and managing private equity timber funds using capital invested by third parties and the Partnership. The Funds are consolidated into our financial statements, but then income or loss attributable to equity owned by third parties is subtracted from consolidated results in our Condensed Consolidated Statements of Comprehensive Income under the caption “Net and comprehensive (income) loss attributable to non-controlling interests-ORM Timber Funds” to arrive at “Net and comprehensive income attributable to unitholders”.

Our current strategy for adding timberland acreage is centered primarily on our private equity timber fund business model. However, where it does not conflict with exclusivity provisions with the Funds, we acquire smaller timberland parcels from time to time to add on to the Partnership’s existing tree farms. In addition, during periods when the Funds’ committed capital is fully invested, we may look to acquire larger timberland properties for the Partnership. Our three active timber funds have assets under management totaling approximately $490 million as of September 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 placed all of its committed capital. Our co-investment affords us a share of the Funds’ operating cash flows while also allowing us to earn asset management and timberland management fees, as well as potential future incentive fees, based upon the overall success of each fund. We also believe that this strategy allows us to maintain more sophisticated expertise in timberland acquisition, valuation, and management on a more cost-effective basis than we could for the Partnership’s timberlands alone. We believe our co-investment strategy also enhances our credibility with existing and prospective Fund investors by demonstrating that we have both an operational and a financial commitment to the Funds’ success.

Our Real Estate segment’s activities primarily include securing permits and entitlements, and in some cases, installing infrastructure for raw land development and then realizing that land’s value by selling larger parcels to developers who, in turn,

17



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 previously owned by the Partnership), either on our own or by partnering with another developer in a joint venture. Since these projects often span multiple years, the Real Estate segment may incur losses for multiple years while a project is developed, and will not recognize operating income until that project is sold. In addition, within this segment, we sometimes negotiate and sell development rights in the form of conservation easements (CE’s) on Partnership Timber properties which preclude future development, but allow continued timber operations. The strategy for our Real Estate segment centers around how and when to “harvest” or sell a parcel of land to realize its optimal value. In doing so, we seek to balance the long-term risks and costs of carrying and developing a property against the potential for income and cash flows upon sale. Land held for development by our Real Estate segment represents property in western Washington that has been deemed suitable for residential and commercial building sites. Land 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 2018 volume will range between 57-59 MMBF for the Partnership, and 72-75 MMBF for the Funds, including timber deed sales. The 57-59 MMBF for the Partnership includes 5-7 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, total 2018 harvest volume, including timber deed sales, is expected to be 65-68 MMBF.

We expect to close on the sale of three industrial lots in Kitsap County and a smaller HBU sale in Mason County before the end of the year.

Timber - Overall
 
Operations. As of September 30, 2018, Timber results include operations on 120,000 acres of timberland owned by the Partnership (Partnership Timber) in western Washington, and 124,000 acres of timberland owned by the Funds (Funds Timber) in western Washington, northwestern Oregon, southwestern Oregon, and northern California. In October 2018, Fund IV acquired an additional 9,400 acres in south Puget Sound, Washington and signed an agreement to acquire 7,100 acres in south central Washington.

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.

Revenue in our timber segments is also derived from commercial thinning operations, ground leases for cellular communication towers, and royalties from gravel mines and quarries, all of which, 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 Q3 2018, log prices increased slightly from prices realized during Q2 2018, but were well above the prices realized during Q3 2017. For the Partnership, the overall realized log price increased 5% and 11% relative to Q2 2018 and Q3 2017, respectively. For the Funds, the overall realized log price increased 1% and 15% relative to Q2 2018 and Q3 2017, respectively. West Coast softwood lumber production during Q3 2018 was 6% below that of Q2 2018 and 3% above Q3 2017.

West Coast softwood log exports in Q3 2018 were 1% below exports during Q2 2018 and 11% below Q2 2017, driven primarily by a softening China market which appears to be due to an increase in trade tensions between the U.S. and China. On

18



September 18, 2018, China announced tariffs on $60 billion of U.S. goods, which became effective on September 24, 2018. These tariffs on softwood logs from the Pacific Northwest (PNW) region include 5% on Douglas-fir and western hemlock logs (most impactful to us), 10% for spruce logs, 25% for pine logs, and 10% for softwood lumber. The potential exists for China to increase the tariffs on Douglas-fir and western hemlock to 20% on January 1, 2019, if the U.S. implements tariff increases on Chinese imports, as intimated by the Trump administration. The threat of tariff increases by the U.S. has created uncertainty among Pacific Northwest log exporters, who have become hesitant to purchase logs given the possibility that they could accumulate log inventories and then be unable to sell them in China. This has caused a reduction in prices in the export market, and timberland owners have responded by selling increasing amounts of logs into the domestic market. The domestic market, however, was already well supplied with logs and lumber, as manufacturers built up log inventories ahead of an expected fire season that never materialized. As such, log and finished lumber inventories at domestic mills are high, leading to log price reductions, quotas, and in some cases temporary shutdowns.

On a year-to-date basis, the overall realized log price increased 20% in 2018 for the Partnership and 19% for the Funds relative to the same period of 2017. West Coast softwood lumber production during the first nine months of 2018 increased 6% relative to the same period a year ago, while West Coast softwood log exports decreased 10%.

Partnership Timber

Partnership Timber operating results for the quarters ended September 30, 2018, June 30, 2018, and September 30, 2017, and the nine months ended September 30, 2018, and September 30, 2017, were as follows:
 
 
 
 
 
 
 
Nine Months Ended
 
Q3 2018
 
Q2 2018
 
Q3 2017
 
Sep-18
 
Sep-17
Partnership
 
 
 
 
 
 
 
 
 
Overall log price per MBF
$
759

 
$
726

 
$
686

 
$
763

 
$
637

Total volume (in MMBF)
15.3

 
6.9

 
12.1

 
41.0

 
38.7

 
 
 
 
 
 
 
 
 
 
(in thousands)
 
 
 
 
 
 
 
 
 
Log sale revenue
$
11,638

 
$
5,039

 
$
8,298

 
$
31,312

 
$
24,686

Other revenue
601

 
531

 
600

 
1,635

 
1,487

Total revenue
12,239

 
5,570

 
8,898

 
32,947

 
26,173

Cost of sales
(4,976
)
 
(1,994
)
 
(3,552
)
 
(11,996
)
 
(10,430
)
Operating expenses
(1,686
)
 
(1,795
)
 
(1,538
)
 
(4,941
)
 
(4,151
)
Operating income
$
5,577

 
$
1,781

 
$
3,808

 
$
16,010

 
$
11,592


Operating Income
 
Comparing Q3 2018 to Q2 2018.  Operating income more than tripled, increasing by $3.8 million from Q2 2018, driven by a 122% increase in delivered log volume, coupled with a weighted average realized log price increase of 5%. The increase in delivered log volume during the third quarter reflects the decision to pull a significant amount of volume from Q2 2018 ahead into Q1 2018, when log prices were stronger. Cost of sales increased by 150% from the higher harvest volume, while operating expenses decreased by 6%.
 
Comparing Q3 2018 to Q3 2017.  Operating income increased $1.8 million, or 46%, from Q3 2017, driven by increases of 26% in delivered log volume and 11% in the average realized log price. The increase in delivered log volume led to a 40% increase in cost of sales from Q3 2017.

Comparing YTD 2018 to YTD 2017. Operating income increased $4.4 million, or 38%, for the first nine months of 2018 from the first nine months of 2017, reflecting a 6% increase in log volume and 20% increase in weighted average log price realizations.

Revenue
 
Comparing Q3 2018 to Q2 2018.  Log sale revenue in Q3 2018 increased $6.6 million, or 131%, from Q2 2018, due to a 122% increase in delivered log volume and a 5% increase in average realized log prices.


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Comparing Q3 2018 to Q3 2017.  Log sale revenue in Q3 2018 increased $3.3 million, or 40%, from Q3 2017, due to a 26% increase in harvest volume and an 11% increase in average realized log prices.

Comparing YTD 2018 to YTD 2017. Log sale revenue in the first nine months of 2018 increased by $6.6 million, or 27%, from the first nine months of 2017, due to a 6% increase in harvest volume and a 20% rise in average realized log prices.

 Log Prices

Partnership Timber log prices for the quarters ended September 30, 2018, June 30, 2018, and September 30, 2017, and nine months ended September 30, 2018, and 2017, were as follows:

Average price realizations (per MBF)
 
 
 
 
 
 
Nine Months Ended
 
Q3 2018
 
Q2 2018
 
Q3 2017
 
Sep-18
 
Sep-17
Partnership
 
 
 
 
 
 
 
 
 
Douglas-fir domestic
$
791

 
$
812

 
$
758

 
$
822

 
$
690

Douglas-fir export
887

 
843

 
795

 
891

 
722

Whitewood domestic
669

 
529

 
579

 
603

 
522

Whitewood export
684

 
714

 
743

 
729

 
713

Cedar
1,150

 
1,373

 
1,477

 
1,329

 
1,427

Hardwood
749

 
721

 
712

 
724

 
669

Pulpwood
374

 
351

 
311

 
369

 
301

Overall log price
759

 
726

 
686

 
763

 
637


Comparing Q3 2018 to Q2 2018. Overall realized log prices in Q3 2018 were 5% higher than Q2 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 Douglas-fir sawlog prices changed by -3% and 5% for domestic and export sorts, respectively. Realized whitewood sawlog prices changed by 26% and -4% for domestic and export sorts, respectively. The large increase in the average domestic whitewood price reflects the efforts of a domestic customer to divert volume to their mill and away from the export market during Q3 2018. Prices for Douglas-fir and whitewood species were above historic averages for Q3 2018.

Comparing Q3 2018 to Q3 2017. From Q3 2017 to Q3 2018, average realized log prices increased 11%. The favorable change was attributable to increased prices in all species and sorts, excluding whitewood export (-8%) and cedar (-22%). In light of decreased export demand, continued strength in the domestic markets resulted in price strength for both of our primary species with increases in Douglas-fir and whitewood domestic log prices of 4% and 16%, respectively.

Comparing YTD 2018 to YTD 2017. Average realized log prices increased by 20% during the first nine months of 2018, relative to the same period in 2017. Douglas-fir and whitewood realized log prices increased 20% and 5%, respectively. Price increases for other species groups include: hardwood (8%) and pulpwood (23%). Prices for cedar decreased by 7%.

Log Volume

The Partnership harvested the following log volumes by species for the quarters ended September 30, 2018, June 30, 2018, and September 30, 2017, and the nine months ended September 30, 2018, and 2017:


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Volume (in MMBF)
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
Q3 2018
 
Q2 2018
 
Q3 2017
 
Sep-18
 
Sep-17
Partnership
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Douglas-fir domestic
9.3

61
%
 
3.5

51
%
 
5.6

46
%
 
25.0

62
%
 
18.3

48
%
Douglas-fir export
2.7

18
%
 
0.8

12
%
 
1.7

14
%
 
5.3

14
%
 
6.7

17
%
Whitewood domestic
0.5

3
%
 
0.2

3
%
 
1.0

8
%
 
1.0

2
%
 
1.9

5
%
Whitewood export
0.2

1
%
 
0.3

4
%
 
1.8

15
%
 
1.0

2
%
 
2.7

7
%
Cedar
0.3

2
%
 
0.3

4
%
 
0.1

1
%
 
1.0

2
%
 
0.9

2
%
Hardwood
0.4

3
%
 
0.4

6
%
 
0.2

2
%
 
1.4

3
%
 
1.3

3
%
Pulpwood
1.9

12
%
 
1.4

20
%
 
1.7

14
%
 
6.3

15
%
 
6.9

18
%
Log sale volume
15.3

100
%
 
6.9

100
%
 
12.1

100
%
 
41.0

100
%
 
38.7

100
%
Timber deed sale volume

 
 

 
 

 
 

 
 

 
Total volume
15.3

 
 
6.9

 
 
12.1

 
 
41.0

 
 
38.7

 

Comparing Q3 2018 to Q2 2018. Harvest volume increased 8.4 MMBF, or 122%, in Q3 2018 from Q2 2018. The increase reflects our decision to pull a significant amount of volume from Q2 2018 ahead into Q1 2018, when log prices were stronger. The primary changes in product mix during the quarter were a 16% increase in the share of Douglas-fir and an 8% decrease in the share of pulpwood.

 Comparing Q3 2018 to Q3 2017. Harvest volume increased 3.2 MMBF, or 26%, in Q3 2018 from Q3 2017. The increase in total volume reflects our decision to increase harvest in response to strong log markets while the change in species mix between quarters reflects our harvest in the current quarter of a high-valued Douglas-fir stand in 2018.

Comparing YTD 2018 to YTD 2017. Relative to the first nine months of 2017, YTD 2018 harvest volume increased by 2.3 MMBF, or 6%. The differences in the total harvest volume reflects our decision to increase harvest in response to strong log markets and the relative species mix reflects our harvest of a high-quality Douglas-fir stand in 2018.

Cost of Sales
 
Cost of sales varies with harvest volume, and for the quarters ended September 30, 2018, June 30, 2018, and September 30, 2017, and the nine months ended September 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)
 
 
 
 
 
 
Nine Months Ended
 
Q3 2018
 
Q2 2018
 
Q3 2017
 
Sep-18
 
Sep-17
Partnership
 
 
 
 
 
 
 
 
 
Harvest, haul, and tax
$
3,915

 
$
1,513

 
$
2,675

 
$
9,156

 
$
7,623

Depletion
1,057

 
478

 
877

 
2,830

 
2,807

Other
4

 
3

 

 
10

 

Total cost of sales
$
4,976

 
$
1,994

 
$
3,552

 
$
11,996

 
$
10,430

 
 
 
 
 
 
 
 
 
 
Amounts per MBF *
 
 
 
 
 
 
 
 
 
Harvest, haul, and tax
$
256

 
$
219

 
$
221

 
$
223

 
$
197

Depletion
$
69

 
$
69

 
$
72

 
$
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 Q3 2018 to Q2 2018. Cost of sales increased $3.0 million, or 150%, in Q3 2018 from Q2 2018 due to a 122% increase in harvest volume. On a per-MBF basis, the harvest, haul and tax rate increased by 17% due to season effects of logging at higher elevations which involves a relatively greater amount of more expensive cable logging systems.

21



 
Comparing Q3 2018 to Q3 2017. Cost of sales increased $1.4 million, or 40%, in Q3 2018 from Q3 2017 due primarily to a 26% increase in harvest volume. On a per-MBF basis, the harvest, haul and tax rate increased by 16%, while the per-MBF depletion rate decreased by 5%. Harvest and haul costs are up in the current quarter due to logging in more expensive units in the current quarter.
Comparing YTD 2018 to YTD 2017. Year-to-date 2018 cost of sales increased $1.6 million, or 15%, relative to the same period in 2017 due to a 6% increase in delivered log volume and a 13% increase in the per-MBF harvest, haul and tax rate, which was partially offset by a 5% decrease in the per-MBF depletion rate.

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 September 30, 2018, June 30, 2018, and September 30, 2017, segment operating expenses were $1.7 million, $1.8 million, and $1.5 million, respectively. The $109,000 decrease in operating expenses in Q3 2018 from Q2 2018 is attributable to lower road maintenance expenses, which were partially offset by higher silviculture and management expenses. Operating expenses increased by $148,000 from Q3 2017 to Q3 2018 due to higher road maintenance and management expenses, which were partially offset by lower silviculture expenses.

Year-to-date 2018 operating expenses increased by $790,000 to $4.9 million from $4.1 million in 2017, due to higher road maintenance and management expenses, which were partially offset by lower silviculture expenses. Management expenses increased due to increases in professional services as related to increased harvesting activity.

Funds Timber

Funds Timber operating results for quarters ended September 30, 2018, June 30, 2018, and September 30, 2017, and nine months ended September 30, 2018, and 2017, were as follows:

 
 
 
 
 
 
 
Nine Months Ended
 
Q3 2018
 
Q2 2018
 
Q3 2017