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 March 31, 2005
OR
( ) TRANSACTION 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 (IRS Employer
incorporation or organization) Identification Number)
19245 10th Avenue NE, 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_____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the Securities and Exchange Act of 1934).
Yes____ No X
Partnership units outstanding at April 29, 2005: 4,586,096
---------
Pope Resources
Index to Form 10-Q Filing
For the Quarter Ended March 31, 2005
Description Page Number
- --------------------------------------------------------------------------------
Part I. Financial Information
Item 1 Financial Statements (unaudited)
Condensed Consolidated Balance Sheets 4
Condensed Consolidated Statements of Operations 5
Condensed Consolidated Statements of Cash Flows 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and 11
Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Risk 29
Item 4. Controls and Procedures 30
Part II. Other Information 30
Item 1. Legal Proceedings 30
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 30
Item 3. Defaults Upon Senior Securities 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 30
Item 6. Exhibits 31
Signatures 32
P A R T I - FINANCIAL INFORMATION
ITEM 1
FINANCIAL STATEMENTS
3
CONSOLIDATED BALANCE SHEETS (Unaudited)
Pope Resources
March 31, 2005 and December 31, 2004
(Thousands)
2005 2004
- ---------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 4,472 $ 757
Accounts receivable 2,849 1,120
Land held for sale 32 152
Current portion of contracts receivable 787 606
Prepaid expenses and other 134 195
--------- ----------
Total current assets 8,274 2,830
--------- ----------
Properties and equipment at cost:
Land held for development 9,291 9,074
Land and land improvements 13,958 13,958
Roads and timber (net of accumulated
depletion of $30,261 and $26,418) 61,023 64,485
Buildings and equipment (net of accumulated
depreciation of $6,178 and $6,034) 3,355 3,166
--------- ----------
87,627 90,683
--------- ----------
Other assets:
Contracts receivable, net of current portion 167 158
Other 945 1,197
--------- ----------
1,112 1,355
--------- ----------
Total assets $ 97,013 $ 94,868
========= ==========
Liabilities and Partners' Capital
Current liabilities:
Accounts payable $ 909 $ 597
Accrued liabilities 1,048 1,492
Environmental remediation 148 468
Current portion of long-term debt 1,602 1,602
Minority interest 105 30
Operating line of credit - 758
Deferred profit 1,070 918
Other current liabilities 64 70
--------- ----------
Total current liabilities 4,946 5,935
Long-term debt, net of current portion 32,504 34,164
Other long term liabilities 211 236
Partners' capital 59,352 54,533
--------- ----------
Total liabilities and partners' capital $ 97,013 $ 94,868
========= ==========
See accompanying notes to condensed consolidated financial statements.
4
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
For the Three Months Ended March 31, 2005 and 2004
(Thousands, except per unit data)
2005 2004
--------------- ----------------
Revenues $ 16,656 $ 11,732
Cost of sales (7,804) (4,488)
Operating expenses (2,333) (1,758)
General and administrative expenses (848) (738)
--------------- ----------------
Income from operations 5,671 4,748
--------------- ----------------
Other income (expense):
Interest expense (736) (774)
Interest income 19 24
--------------- ----------------
(717) (750)
Income before income taxes and minority interest 4,954 3,998
Income tax expense (247) -
--------------- ----------------
Income before minority interest 4,707 3,998
Minority interest (101) -
--------------- ----------------
Net income $ 4,606 $ 3,998
=============== ================
Allocable to general partners $ 61 $ 53
Allocable to limited partners 4,545 3,945
--------------- ----------------
$ 4,606 $ 3,998
=============== ================
Earnings per unit:
Basic $ 1.01 $ 0.88
=============== ================
Diluted $ 0.97 $ 0.87
=============== ================
Weighted average units outstanding:
Basic 4,561 4,518
=============== ================
Diluted 4,730 4,575
=============== ================
See accompanying notes to condensed consolidated financial statements.
5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Pope Resources
Three Months Ended March 31, 2005 and 2004
(Thousands) 2005 2004
----------- ----------
Net income $4,606 $3,998
Add back non-cash charges:
Deferred profit 152 108
Depletion 3,843 1,471
Depreciation and amortization 152 168
Cost of land sold 134 -
Change in working capital accounts:
Accounts receivable (1,729) (2,320)
Contracts receivable (190) 845
Other current assets 61 354
Accounts payable 312 67
Accrued liabilities (444) (444)
Environmental remediation (320) (9)
Deferred taxes 247 -
Minority interest 101 -
Other (32) (13)
----------- ----------
Net cash flows provided by operating activities 6,893 4,225
Cash flows used in investing
activities:
Capital expenditures (947) (813)
Timberland acquisition - (8,518)
----------- ----------
Net cash used in investing
activities (947) (9,331)
----------- ----------
Cash flows used in financing
activities:
Minority interest distribution (26) (59)
Repayment of long-term debt (1,660) (1,541)
Repayment of line of credit (758) -
Option exercise 901 19
Unitholder distribution (688) (316)
----------- ----------
Net cash used in financing
activities (2,231) (1,897)
----------- ----------
Net increase (decrease) in cash and cash equivalents 3,715 (7,003)
Cash and cash equivalents at beginning of period 757 10,361
----------- ----------
Cash and cash equivalents at end of the three-month
period $4,472 $3,358
=========== ==========
See accompanying notes to condensed consolidated financial statements.
6
POPE RESOURCES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 2005
1. The condensed consolidated financial statements as of March 31, 2005 and
December 31, 2004 and for the three-months (quarter) ended March 31, 2005
and March 31, 2004 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 "SEC"). The financial
information for the quarters ended March 31, 2005 and 2004 is unaudited,
but, in the opinion of management, reflects 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,
2004, is derived from the Partnership's audited consolidated financial
statements and notes thereto for the year ended December 31, 2004, and
should be read in conjunction with such financial statements. The results
of operations for the quarter ended March 31, 2005 are not necessarily
indicative of the results of operations that may be achieved for the entire
fiscal year ending December 31, 2005.
2. The financial statements in the Partnership's 2004 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.
3. Basic net earnings per unit are based on the weighted average number of
units outstanding during the period. Diluted net earnings per unit are
based on the weighted average number of units and dilutive unit options
outstanding at the end of the period.
Quarter Ended
March 31,
2005 2004
-------------- ------------------
Weighted average units outstanding (in
thousands):
Basic 4,561 4,518
Dilutive effect of unit options 169 57
-------------- ------------------
Diluted 4,730 4,575
============== ==================
Options to purchase 317,773 units at prices ranging from $9.30 to $37.73
were outstanding during the quarter ended March 31, 2005. Options to
purchase 148 units at an exercise price of $37.73 were not included in the
computation of diluted earnings per unit because the option exercise prices
were greater than the average market prices of units during the period.
Options to purchase 379,100 units at prices ranging from $9.30 to $27.88
per unit were outstanding during the quarter ended March 31, 2004. Options
to purchase 178,464 units at prices ranging from $17.40 to $27.88 were not
included in the computation of diluted earnings per unit because the option
exercise prices were greater than the average market prices of units during
the period.
The Partnership accounts for unit-based compensation in accordance with APB
Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly,
compensation cost for unit options is measured as the excess, if any, of
7
the fair value of the Partnership's units at the date of grant over the
amount an employee must pay to acquire the unit.
Unit options granted have an exercise price not less than the fair value of
the Partnership's unit price on the date of the grant. Had compensation
expense for unit option grants been recognized based on the fair value at
the grant date consistent with the Black-Scholes method described in SFAS
No. 123, Accounting for Stock-Based Compensation, the Partnership's net
income would have been adjusted to the pro forma amounts indicated below:
(In thousands, except per unit amounts) 2005 2004
---- ----
Net income as reported $4,606 $3,998
Add back employee unit based
compensation expense recognized - -
Subtract proforma compensation
expense under SFAS 123 (35) (50)
---- ----
Pro forma net income
under SFAS No. 123 $4,571 $3,948
====== ======
As reported:
Basic $1.01 $0.88
Diluted $0.97 $0.87
Proforma earnings per unit:
Basic $1.00 $0.87
Diluted $0.97 $0.86
The fair value of options was calculated using the Black-Scholes
option-pricing model, with the following assumptions during the first
quarter of 2005 and 2004:
2005 2004
--------------- ---------------
Expected life 5 years 5 years
Risk free interest rate 4.22% - 4.36% 3.97% - 4.75%
Dividend yield 1.2% - 1.5% 1.2% - 1.8%
Volatility 20.0% - 26.2% 20.7% - 25.4%
Weighted average value $8.00 $4.46
8
4. Supplemental disclosure of cash flow information: Interest paid amounted to
approximately $743,000 and $765,000 for the quarters ended March 31, 2005
and 2004, respectively. Income taxes paid amounted to approximately zero
and $5,000 for the quarters ended March 31, 2005 and 2004, respectively.
5. Revenue and operating income by segment for the quarters ended March 31,
2005 and 2004, respectively, are as follows:
9
Quarter Ended Fee Timberland
March 31, (Thousands) Timber Management & Real Estate Other Consolidated
Consulting
- -----------------------------------------------------------------------------------------------------------------------------
2005
Revenue $ 13,663 $ 1,615 $ 1,388 $ - $ 16,666
Eliminations - (1) (9) - (10)
------------ --------------- --------------- ----------- ------------------
Revenue 13,663 1,614 1,379 - 16,656
Cost of sales (7,533) - (271) - (7,804)
Operating expenses (1,097) (772) (474) (848) (3,191)
Eliminations 9 - 1 - 10
------------ --------------- --------------- ----------- ------------------
Operating expenses (1,088) (772) (473) (848) (3,181)
Income (loss) from operations 5,033 843 643 (848) 5,671
Eliminations 9 (1) (8) - -
------------ --------------- --------------- ----------- ------------------
Income (loss) from operations $ 5,042 $ 842 $ 635 $ (848) $ 5,671
============ =============== =============== =========== ==================
2004
Revenue $ 11,424 $ 235 $ 204 $ - $ 11,863
Eliminations (13) (109) (9) - (131)
------------ --------------- --------------- ----------- ------------------
Revenue 11,411 126 195 - 11,732
Cost of sales (4,482) - (6) - (4,488)
Operating expenses (890) (568) (431) (738) (2,627)
Eliminations 92 38 1 - 131
------------ --------------- --------------- ----------- ------------------
Operating expenses (798) (530) (430) (738) (2,496)
Income (loss) from operations 6,052 (333) (233) (738) 4,748
Eliminations 79 (71) (8) - -
------------ --------------- --------------- ----------- ------------------
Income (loss) from operations $ 6,131 $ (404) $ (241) $ (738) $ 4,748
============ =============== =============== =========== ==================
10
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 our management's estimates based on our current goals, in
light of management's expectations about future developments. Statements about
expectations and future performance are "forward looking statements" within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
Because these statements describe our goals, objectives and anticipated
performance, they 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
"Risks and Uncertainties" below and other factors discussed in our annual report
on Form 10-K for the fiscal year ended December 31, 2004. Other issues that may
have an adverse and material impact on our business, operating results and
financial condition include environmental and land use regulations that limit
our ability to harvest timber and develop property and economic conditions that
affect consumer demand for our products and the prices we receive for them, and
those other risks and uncertainties discussed in our other filings with the
Securities and Exchange Commission. The forward looking statements in this
report are accurate as of the date of the report, and we cannot undertake to
update these statements as our business operations and environment change.
This discussion should be read in conjunction with the Partnership's
condensed consolidated financial statements and related notes included with this
report.
EXECUTIVE OVERVIEW
Pope Resources, A Delaware Limited Partnership ("we" or the "Partnership"),
was organized in October 1985 as a result of a spin-off by Pope & Talbot, Inc.
("P&T"). The Partnership is engaged in three primary businesses. The first, and
by far most significant, segment in terms of owned assets and operations is the
Fee Timber segment. Operations in this segment consist of growing timber to be
harvested as logs for sale to export and domestic manufacturers. The second most
significant business in terms of total assets owned is the development and sale
of real estate. Real Estate activities primarily take the form of securing
permits and entitlements for unimproved land and then realizing that land's
value by selling large parcels to buyers who will take the land further up the
value chain, either to home buyers or commercial property operators or lessors.
Since these land projects span multiple years, the Real Estate segment may incur
losses for multiple years until a major project is sold, which then results in
operating income. Our third business is providing timberland-related services to
third parties. These services may take the form of large-scale timberland
management, forestry consulting, or acquisition or disposition services.
Management's major opportunity and challenge is to profitably grow our
revenue base. We have added over 44,000 acres over the last three years to our
timberland portfolio. Our real estate challenges center around how and when to
"harvest" a parcel of land and capture the optimum value increment through sale.
Regarding our third-party timberland services, we began serving Cascade
Timberlands in January 2005, which represents a 522,000-acre timberland
11
management contract and are diligently seeking to secure additional income
opportunities for this segment.
12
RESULTS OF OPERATIONS
The following table reconciles and compares key revenue and cost elements that
determined net income realized for each of the three-month periods ended March
31, 2005 to March 31, 2004, respectively. In addition to the table's detailed
numeric analysis, the explanatory text that follows the table describes many of
these changes by business segment.
QUARTER TO QUARTER COMPARISONS
(Amounts in $000's except
per unit data)
Q1 2005 vs. Q1 2004
Total Per Basic Unit
----------------- ------------------
Net income:
1st Quarter 2005 $4,606 $1.01
1st Quarter 2004 3,998 0.88
----------------- ------------------
Variance $608 $0.13
================= ==================
Detail of earnings variance:
Fee Timber:
Log price realizations (A) $920 $0.21
Log volumes (B) 741 0.17
Timberland sale income (6) -
Depletion (2,372) (0.53)
Other Fee Timber (372) (0.09)
Timberland Management &
Consulting:
Management fee changes 1,187 0.26
Other Timberland Mgmnt &
Consulting 59 0.01
Real Estate
Land sales 903 0.20
Other (27) (0.01)
General and adminisitrative
costs (110) (0.02)
Interest expense 38 0.01
Other (taxes, minority int.,
interest inc.) (353) (0.08)
----------------- ------------------
$608 $0.13
================= ==================
(A) Price variance allocated based on changes in price using current period
volume.
(B) Volume variance allocated based on change in sales volume and the average
log sales price for the current period less variance in log production
costs.
Fee Timber
- ----------
Fee Timber revenue is earned primarily from the harvest and sale of logs
from the Partnership's 115,000 acres of fee timberland located in western
Washington and, to a lesser extent, from the sale of gravel and cellular
communication tower leases. Revenue from the sales of timberland tracts will
also appear periodically in results for this segment. Our Fee Timber revenue is
driven primarily by the volume of timber harvested, which we ordinarily express
in terms of millions of board feet, or "MMBF", and by the average prices
realized on log sales, which we express in dollars per thousand board feet, or
"MBF".
When discussing our Fee Timber operations, current results are compared to
both the last completed quarter and the comparable quarter from the prior year.
Both of these comparisons are made to help the reader gain an understanding of
the trends in market price and harvest volumes that affect Fee Timber results of
13
operations. Revenue and operating income for the Fee Timber segment for the
quarters ended March 31, 2005, December 31, 2004 and March 31, 2004 are as
follows:
- ------------------------------------------------------------------------------------------------------------------
Mineral, Cell
Quarter Ended: Log Sales Tower & Other Revenue Total Fee Timber Operating Income
- ------------------------------------------------------------------------------------------------------------------
March 31, 2005 $ 13.3 million $ 0.4 million $ 13.7 million $ 5.0 million
December 31, 2004 5.0 million 0.6 million 5.6 million 1.6 million
March 31, 2004 11.0 million 0.4 million 11.4 million 6.1 million
- ------------------------------------------------------------------------------------------------------------------
Fluctuations in total Fee Timber revenue and operating income between Quarter 1
2005 and Quarter 4 2004 and Quarter 1 2005 and Quarter 1 2004 are as follows:
- --------------------------------------------------------------------------------------------------------
Quarterly changes Total Fee Timber Revenue Operating Income
- --------------------------------------------------------------------------------------------------------
Q-1 2005 and Q-4 2004 $ 8.1 million $ 3.4 million
Q-1 2005 and Q-1 2004 2.3 million (1.1) million
The increase in revenue and operating income for the current quarter from
the fourth quarter of 2004 is due to an increase in harvest volume and an
increase in price realized. Log volume harvested for the quarter ended March 31,
2005 increased 153% from the quarter ended December 31, 2004 while average price
realized increased 7%. The comparatively low harvest volume in the fourth
quarter of 2004 was due to front-loading 2004's annual harvest in the first
three quarters of that year. The increase in average price realized in the first
quarter of 2005 relative to the fourth quarter of 2004 is due to a slight
improvement in mix (a lower percentage of harvest attributable to pulp) combined
with an improvement in domestic prices in the early part of 2005.
Following two timberland acquisitions which closed during 2004, first
quarter log harvest volume increased 13% from 2004 to 2005. In addition, average
log prices were also up $40 per MBF, representing a 7% increase over 2004's
first quarter log prices. These higher volumes and stronger prices explain the
increase in revenue for the first quarter of 2005 versus the comparable period
in 2004. The $1.1 million decrease in operating income in the first quarter of
2005 compared to the prior year is attributable to an increase in current
quarter depletion expense that more than offset the current quarter's
comparatively higher harvest volumes and realized log prices. The additional log
harvest volume coming from a fourth quarter 2004 acquisition carried with it
$2.7 million of depletion expense due to the use of a separate depletion pool
for volume harvested from this acquisition. The separate depletion pool was
created because the timber inventory from this acquisition was almost completely
merchantable. The decline in operating income is attributable to this increase
in depletion expense. Cash flow resulting from the incremental harvest from this
acquired timberland will serve to offset a large portion of the purchase price.
The Partnership harvested the following log volumes from its fee
timberlands for the quarters ended March 31, 2005, December 31, 2004, and March
31, 2004:
14
Quarter Ended
31-March-05 31-Dec-04 31-March-04
------------------ ----------------- ----------------
Log sale volumes (MBF):
Export 3,510 1,153 5,624
Domestic 15,065 5,414 11,690
Pulp 2,937 1,422 2,633
Hardwoods 1,488 1,111 405
------------------ ----------------- ----------------
Total 23,000 9,100 20,352
================== ================= ================
Through March 31, 2005, we have harvested 29% of our planned annual harvest
(versus 35% for the comparable period in the prior year). Inasmuch as the
aforementioned late-2004 timberland acquisition represented primarily a purchase
of merchantable timber, our annual harvest in 2005 is projected to increase to a
projected level of 79 MMBF from 2004's annual level of 60 MMBF. Harvest volume
was front-loaded in 2004 to take advantage of strong log markets while we expect
to spread the annual harvest in 2005 somewhat more evenly between the quarters,
albeit still weighted toward the first three quarters of 2005. The proportion of
overall log volume sold to the export market was 15% in the first quarter of
2005 versus 13% for the fourth quarter of 2004 and 28% for the first quarter of
2004. The large decrease in volume sold to the export market in the first
quarter of 2005 versus the first quarter of 2004 is due to a harvest mix in the
prior year that included units with particularly strong components of export
logs.
We realized the following log prices from our fee timberlands for the
quarters ended March 31, 2005, December 31, 2004, and March 31, 2004:
Quarter Ended
Average price realizations (per MBF): 31-March-05 31-Dec-04 31-March-04
Export $ 661 $ 676 $ 659
Domestic 616 590 554
Pulp 273 209 221
Hardwoods 627 617 558
Overall 580 544 540
We sell our logs to domestic mills and to log brokers that resell our logs
to Japanese customers and, when export conditions allow, to the Korean and
Chinese log markets. Prices paid by these log brokers are dependent upon the
export market for logs but are generally purchased for a premium to prices paid
by domestic customers. In the current quarter, export prices have remained
relatively consistent with both the fourth and first quarters of 2004.
Domestic log prices for the quarter ended March 31, 2005 were 4% and 11%
higher than the fourth and first quarters in 2004, respectively. This
improvement in domestic log prices is attributed to warm weather conditions
experienced in the Pacific Northwest in the first part of 2005 combined with the
strong housing market in the U.S. These warm, dry weather conditions have raised
concerns about operational curtailments due to fire risks for Pacific Northwest
log production during the spring and summer months when timber production is
generally the highest. Log yards at regional mills are building inventory as a
hedge against such possible curtailments.
15
The average price realized per MBF on pulp logs was $273, $209, and $221,
for the quarters ended March 31, 2005, December 31, 2004 and March 31, 2004,
respectively. Pulp prices have increased in the first quarter of 2005 relative
to both the fourth quarter of 2004 and the prior year's comparable period due to
the threat of summertime operational restrictions on timber harvests causing
mill operators to be concerned about raw material shortages. The average price
realized per MBF on hardwood logs was $627, $617, and $558, for the quarters
ended March 31, 2005, December 31, 2004 and March 31, 2004, respectively. The
increase in price realized for hardwood is due to an increase in the quality of
the hardwood logs harvested in the first quarter of 2005. The units harvested in
the first quarter of 2005 included several areas with a large component of high
quality alder stands resulting in an increase in price realized.
Cost of Sales
Cost of sales for the Fee Timber segment consists of harvest costs and
depletion expense. Harvest costs represent the direct cost incurred to
manufacture trees into logs and deliver those logs to their point of sale.
Depletion expense represents the cost of acquiring or growing the timber
harvested and is calculated using a depletion rate developed from an
accumulation of the cost of the timber and capitalized road cost, divided by the
estimated volume of merchantable timber available for harvest. The depletion
rate is then applied to the volume harvested to calculate depletion expense. Fee
Timber cost of sales for the quarters ended March 31, 2005, December 31, 2004,
and March 31, 2004, respectively, were:
- --------------------------------------------------------------------------------------------------------
Harvest and
Quarter Ended: Haul Costs Depletion Expense Total
- --------------------------------------------------------------------------------------------------------
March 31, 2005 $ 3.7 million $ 3.8 million $ 7.5 million
December 31, 2004 1.5 million 1.4 million 2.9 million
March 31, 2004 3.0 million 1.5 million 4.5 million
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
Harvest and Haul Depletion Expense per
Quarter Ended: Costs per MBF MBF Total
- --------------------------------------------------------------------------------------------------------
March 31, 2005 $ 161 $ 167 $ 328
December 31, 2004 169 150 319
March 31, 2004 148 72 220
- --------------------------------------------------------------------------------------------------------
Harvest and haul costs, depletion expense, and total cost of sales have
increased in the first quarter of 2005 relative to both the fourth and first
quarters of 2004 due to the increase in harvest volume. Harvest costs vary based
upon the physical site characteristics of acres harvested during the year. For
example, sites that are not readily accessible, or are located on a steep
hillside, are more expensive to harvest. Furthermore, haul costs vary based upon
the distance between the harvest area and the mill customer's location. For the
quarter ended March 31, 2005, harvest and haul costs per MBF have decreased
relative to the fourth quarter of 2004 due to a higher proportion of total
harvest from those harvest units coming from units that are lower in elevation
and less expensive to harvest. Average harvest and haul costs are expected to
increase for the remainder of the year as those harvest units that are at higher
elevations and therefore more costly to operate will represent a larger
proportion of total volume. We expect this to increase harvest and haul cost on
a per MBF basis for the next two quarters.
16
Harvest and haul costs per MBF in the current quarter have increased
relative to the first quarter of 2004 due to a combination of higher fuel costs
which result in an increase in the cost of harvesting and hauling timber and an
increase in proportional harvest from higher elevation harvest units. We expect
average harvest and haul costs to remain at relatively high levels as long as
fuel costs remain at current levels .
A depletion rate is applied to all volume harvested. We are using two
separate depletion rates in 2005, one for volume harvested from those
timberlands we acquired in the fourth quarter of 2004 (the "Quilcene
Timberlands") and one for volume harvested from all other owned fee timberlands.
The increase in depletion expense for the first quarter quarter of 2005 stemmed
from harvest activity on the Quilcene Timberlands for which a separate depletion
pool was created. The separate depletion pool was created because the timber
inventory from this acquisition was almost completely merchantable. We expect to
harvest a total of approximately 79 MMBF in 2005, of which 21 MMBF is expected
to come from this separate depletion pool. The depletion cost resulting from log
harvests on this acquired timberland will approximate the net stumpage value
(delivered log price less harvesting and transportation cost) realized on the
sale of this particular timber. As such, the incremental harvest from this
acquired property will result in a negligible net income impact while
nonetheless generating operating cash flow and EBITDDA.
Depletion expense for the first quarter of 2005 and 2004 was calculated as
follows:
Quarter Quarter Mar-04
ended ended
Pooled Separate March-05 Pooled Separate December-04 Pooled
--------------------------------- ----------------------------- -----------
Volume harvested (MBF) 15,681 7,319 23,000 6,771 2,329 9,100 20,351
Rate/MBF $72 $370 $167 $72 $377 $150 $72
--------------------------------- ----------------------------- -----------
Depletion expense $1,135,000 $2,708,000 $3,843,000 $486,000 $879,000 $1,365,000 $1,471,000
================================= ============================= ===========
Operating Expenses
Fee Timber operating expenses for the quarters ended March 31, 2005,
December 31, 2004, and March 31, 2004 were $1.1 million, $1.1 million, and
$798,000, respectively. Operating expenses are consistent between the current
quarter and quarter ended December 31, 2004 and have increased 36% from the
comparable period in prior year. The increase from the quarter ended March 31,
2004 is primarily due to an increase in road maintenance costs. Road maintenance
costs have increased in the first quarter of 2005 due to the cost of building
temporary roads resulting from the increase in harvest volume combined with the
cost of complying with Washington state road regulations. Road maintenance costs
are expected to increase for the next several years due, in part, to new
Washington state regulations surrounding road maintenance and abandonment
Timberland Management & Consulting
- ----------------------------------
Revenue and operating income (loss) for the Timberland Management &
Consulting segment for the quarters ended March 31, 2005 and 2004 were as
follows:
- --------------------------------------------------------------------------------
Quarter Ended: Revenue Operating income (loss)
- --------------------------------------------------------------------------------
March 31, 2005 $ 1.6 million $ 0.8 million
March 31, 2004 0.1 million (0.4) million
- --------------------------------------------------------------------------------
17
Revenue for the quarter ended March 31, 2005 was $1.5 million higher than
the comparable period in 2004. Operating income for the first quarter of 2005
was $842,000 versus a $404,000 loss for the comparable period in the prior year.
The increase in revenue and operating income is primarily due to timberland
management and consulting services provided to Cascade Timberlands LLC. Cascade
Timberlands LLC is a new Timberland Management and Consulting client that owns
522,000 acres of timberland located in Washington and Oregon. Olympic Resource
Management LLC began providing timberland management and other timberland
consulting services on these properties in January 2005.
Management is currently working on the launch of a private equity timber
fund. Olympic Resource Management LLC is expected to act as general partner for
the fund and Pope Resources plans to invest 10% of the equity capital. The fund
target size is $50 million. We expect to close the fund to new investors in the
first half of 2005, and begin actively searching for timber properties soon
thereafter. The Timberland Management & Consulting segment is expected to earn
fees from managing the fund.
Operating Expenses
Timberland Management & Consulting operating expenses for the quarters
ended March 31, 2005 and 2004 were $772,000 and $530,000, respectively. The
increase in operating expenses in the first quarter of 2005 is primarily
attributable to the opening of two new office locations in Sedro-Woolley,
Washington and Bend, Oregon and additional staffing to provide services under
the timberland management agreement with Cascade Timberlands LLC.
Real Estate
- -----------
The Partnership's Real Estate segment consists primarily of residential and
commercial property rents and revenue from the sale of land that is expected to
be used for something other than growing and harvesting timber. The
Partnership's real estate holdings are located in Pierce, Kitsap, and Jefferson
Counties in Washington State.
Revenue and operating income (loss) for the Real Estate segment for the
quarters ended March 31, 2005 and 2004 are as follows:
- --------------------------------------------------------------------------------
Quarter Ended: Revenue Operating income (loss)
- --------------------------------------------------------------------------------
March 31, 2005 $ 1.4 million $ 0.6 million
March 31, 2004 0.2 million (0.2) million
- --------------------------------------------------------------------------------
First quarter revenue consists of $1.2 million in rural residential lot
sales and $0.2 million of rent earned on residential and commercial leases at
Port Gamble, Washington while prior year revenue consists primarily of rent
earned at Port Gamble. Operating income in 2005 includes $904,000 generated
through lot sales, netted against expenses incurred while management pursues
zoning and development entitlements to maximize value from the Partnership's
3,000-acre portfolio of land investments. Operating loss in the prior year
includes expenses incurred while pursuing zoning and development entitlements.
The Port Gamble townsite operated at break-even results for both the current and
prior quarters. The current status of zoning and development pursuits is
described below.
At our development property in Gig Harbor, Washington Costco Wholesale
Corporation, Northwest Capital Investors (NCI), and a subsidiary of the
Partnership, Olympic Property Group (OPG) submitted detailed applications with
the City of Gig Harbor for a 25-acre retail shopping center on OPG's Harbor Hill
18
project. The applications submitted to the City are for site plan review and a
binding site plan for a proposed Costco store and over five acres of additional
multi-tenant retail space. Our first closing on this property is expected in
early 2006 to Costco Wholesale Corporation covering up to 17 acres of the
320-acre site.
The Partnership's rural residential lot program produces lots from 5 to 80
acres in size, based on underlying zoning densities. Typically for this type of
program the entitlement effort is more modest in scale, usually involving simple
lot segregations and boundary line adjustments. Development includes minor road
building, surveying, and the extension of utilities. The Partnership expects to
list approximately 500 acres for sale under this program during the remainder of
2005.
The 263-acre planned development in the City of Bremerton includes 60 acres
of industrial and 203 acres of residential uses. The purchase and sale agreement
with the Kitsap County Consolidated Housing Authority entered to purchase 203
acres that are zoned for residential use has expired. We are currently marketing
the property to other interested developers.
Cost of Sales
Real Estate cost of sales for the quarters ended March 31, 2005 and 2004,
respectively, were $271,000 and $6,000. The 2005 amount consists of costs
associated with the aforementioned rural residential lot sales. Cost of sales
during the remainder of 2005 will include costs associated with any additional
rural residential lot sales that are closed during the remainder of 2005.
Operating Expenses
Real Estate operating expenses were consistent for the quarters ended March
31, 2005 and 2004 at $473,000 and $430,000, respectively. The increase in
operating expenses in our Real Estate segment is due to an increase in personnel
related costs in this segment as activities surrounding our development
properties have increased over the last year due to increased market activity
for developable land. This trend is expected to continue for the remainder of
2005.
Environmental Remediation
The Partnership has accrued liabilities for environmental cleanup of
$155,000 and $474,000 as of March 31, 2005 and December 31, 2004, respectively.
The environmental liability at March 31, 2005 includes $148,000 that the
Partnership expects to expend in the next 12 months and $7,000 thereafter. The
accrual represents estimated environmental remediation costs in and around the
townsite of Port Gamble, Washington. Current activities at the site include
monitoring to determine if prior clean up activities were effective and
discussions with the Washington State Department of Ecology to obtain their
agreement that the site is clean and to confirm that no further remediation
activities are required.
Activity in the Environmental Remediation liability is detailed as follows:
19
Balances at the
Beginning of the Additions to Expenditures Balances at the
Period Accrual for Remediation End of the Period
---------------------------------------------------------- ------------------
Year Ended December 31, 2000 $120,000 $ 1,956,000 $ 206,000 $ 1,870,000
Year Ended December 31, 2001 1,870,000 461,000 1,409,000
-
Year Ended December 31, 2002 1,409,000 730,000 1,510,000 629,000
Year Ended December 31, 2003 629,000 - 337,000 292,000
Year Ended December 31, 2004 292,000 466,000 284,000 474,000
Quarter ended March 31, 2005 474,000 319,000 155,000
General and Administrative (G&A)
- --------------------------------
General and administrative expenses for the quarters ended March 31, 2005
and 2004 were $848,000 and $738,000, respectively. The $110,000 increase in
general and administrative expenses is due to a combination of increased audit
and salary costs. We expect to end 2005 with an increase in audit, professional
services, and personnel costs as we begin to implement the new requirements of
the internal control audit and reporting requirements mandated by the Sarbanes
Oxley Act of 2002 that will be required if we meet the definition of an
accelerated filer as of June 30, 2005. Based upon our current unit price we
expect to fall within the definition of an accelerated filer in 2005.
Interest Income and Expense
- ---------------------------
Interest income for the quarter ended March 31, 2005 declined to $19,000
from $24,000 for the quarter ended March 31, 2004. The decline in interest
income is due to the payoffs of notes receivable that occurred between the first
quarter of last year and this year's first quarter. Interest expense for the
quarters ended March 31, 2005 and 2004 was $736,000 and $774,000, respectively.
Our debt consists primarily of mortgage debt with a fixed interest rate. The
decrease in interest expense is the result of our annual principal payments made
at the end of the first quarter on that debt.
Income Tax
- ----------
Pope Resources is a limited partnership and is, therefore, not subject to
corporate income tax. Taxable income/loss is reported to unitholders each year
on a Form K-1 for inclusion in each unitholder's tax return. Pope Resources does
have corporate subsidiaries that are subject to income tax.
For the quarter ended March 31, 2005 the Partnership recorded $247,000 of
income tax expense based upon income generated in the Partnership's taxable
subsidiaries, as compared to no tax expense or benefit for the comparable period
in the prior year. The increase in tax expense is due to improved results in our
Timberland Management & Consulting segment.
Minority Interest
- -----------------
Minority interest represents Pope MGP's share of income earned from the
Investor Portfolio Management Business (IPMB). The amendment to the Limited
Partnership Agreement authorizing the Partnership to pursue the IPMB further
specifies that income from the IPMB will be split using a sliding scale
allocation method beginning at 80% to the Partnership's wholly-owned subsidiary,
ORM, Inc., and 20% to Pope MGP, Inc., the managing general partner of the
Partnership. The sliding scale allocation method evenly divides IPMB income
between ORM, Inc. and Pope MGP, Inc. once such income reaches $7,000,000 in a
given fiscal year.
20
Current activities of the IPMB are contained in the Timberland Management &
Consulting segment which includes timberland consulting, management, and
expenses associate with the launch of a private equity fund. Minority interest
allocation of income increased from none for the first quarter of 2004 to
$101,000 in the first quarter of 2005 due to improved Timberland Management &
Consulting results related to the Cascade Timberlands LLC management agreement.
21
Supplemental Segment Information
- --------------------------------
The following table provides comparative operating information for the
Partnership's segments:
SEGMENT INFORMATION
(all amounts in $000's)
Three months ended
31-Mar-05 31-Mar-04 31-Dec-04
----------------- ----------------- ----------------
Revenues:
Fee Timber $13,663 $11,411 $5,576
Timberland Management & Consulting
(TM&C) 1,614 126 602
Real Estate 1,379 195 1,799
----------------- ----------------- ----------------
Total 16,656 11,732 7,977
Net income to EBITDDA reconciliation:
Net income $4,606 $3,998 $820
Added back:
Interest, net 717 750 728
Depletion 3,843 1,471 1,353
Depreciation and amortization 152 168 152
Income tax expense 247 - -
----------------- ----------------- ----------------
EBITDDA* $9,565 $6,387 $3,053
EBITDDA by segment*:
Fee Timber 8,911 7,633 2,960
TM&C 863 (382) (10)
Real Estate 671 (218) 904
General & administrative (includes
minority interest) (880) (646) (801)
----------------- ----------------- ----------------
Total 9,565 6,387 3,053
Depreciation, depletion and amortization:
Fee Timber 3,869 1,502 1,395
TM&C 21 22 22
Real Estate 36 23 19
General & administrative 69 92 69
----------------- ----------------- ----------------
Total 3,995 1,639 1,505
Operating income
(loss):
Fee Timber 5,042 6,131 1,565
TM&C 842 (404) (32)
Real Estate 635 (241) 885
General & administrative (848) (738) (870)
----------------- ----------------- ----------------
Total $5,671 $4,748 $1,548
================= ================= ================
* EBITDDA= Earnings before interest, income tax, depletion, depreciation, and
amortization. The Company considers earnings (net income or loss) before
interest expense, income taxes, depreciation, depletion and amortization
(EBITDDA) to be a relevant and meaningful indicator of liquidity and
earnings performance commonly used by investors, financial analysts and
others in evaluating companies in its industry and, as such, has provided
this information in addition to the generally accepted accounting
principle-based presentation of net income or loss.
22
Analysis of Operating Income
- ----------------------------
The following table sets forth expenses as a percentage of revenue for the
quarters ended March 31, 2005 and 2004:
Quarter ended March 31,
---------------------------------
2005 2004
----------------- ---------------
Revenue 100% 100%
Cost of sales 47 38
Operating expenses 14 15
General and administrative expenses 5 6
----------------- ---------------
Operating income 34% 41%
================= ===============
Cost of sales includes the cost of purchasing and producing tangible goods
for sale. In addition to depletion associated with timber production levels,
cost of sales for the Partnership will fluctuate due to the mix of revenue
between the sale of tangible goods and revenue generated from providing
services. Cost of sales as a percentage of revenue increased 9 percentage points
to 47% for the quarter ended March 31, 2005 from 38% in the comparable period in
2004. The increase in cost of sales as a percentage of revenue is attributable
to the increase in depletion expense resulting from the mix of timber harvests
off lands with varying per unit depletion rates.
Operating expenses consist of salary and other costs directly attributable
to revenue-generating activity. As a percentage of revenue, operating expenses
decreased for the quarter ended March 31, 2005 by 1 percentage point to 14% from
15% for the comparable period in 2004. The decrease in operating expenses as a
percentage of revenue is primarily due to the increase in revenue generated from
the Fee Timber and Real Estate segments. There is not a strong correlation
between revenue and operating expenses in these two segments so that, as a
result, the operating expense ratio decreases when revenue from these segments
increases. General and administrative expenses as a percentage of revenue for
the quarter ended March 31, 2005 decreased by 1 percentage point to 5% from the
comparable period in 2004's 6%. On a raw dollar basis, general and
administrative expenses increased $110,000 from last year's first quarter
compared to this year's first quarter, but declined as a percent of revenue
because revenue increased at a much greater rate proportionately between
periods.
23
Liquidity and Capital Resources
- -------------------------------
We ordinarily finance our operations using funds from operations and, where
appropriate in management's assessment, bank lines of credit. Funds generated
from operations and externally through financing are expected to provide the
required resources for the Partnership's future capital expenditures. The
Partnership's debt-to-total capitalization ratio was 36% at March 31, 2005
versus 40% as of December 31, 2004. Management considers its capital resources
to be adequate for its current plans and does not have specific plans that would
trigger a significant change in its debt-to-total capitalization ratio over the
next 12 months. We have a $10.0 million line of credit available with a zero
balance borrowed as of March 31, 2005.
We are currently working on locating investors for ORM Timber Fund I, LP
(the "Fund"). The fund's invested capital is expected to total approximately $50
million. Once the Fund is fully subscribed and suitable timber properties are
identified and brought under contract for purchase by the Fund, we expect to
invest the 10% of equity capital that is expected to total approximately $5
million.
Over the remaining nine months of 2005, management's plan is to harvest
approximately 56 MMBF of timber for a total fiscal 2005 harvest of 79 MMBF.
Since harvest plans are based on demand and pricing, actual harvesting may vary
subject to management's ongoing review.
In the first quarter of 2005, cash generated by operations totaled $6.9
million and overall cash and cash equivalents increased by $3.7 million. Cash
generated by operations increased $2.7 million from the comparable period last
year due to an increase in volume harvested and development land sales. Cash
used in investing activities totaled $947,000, which was comprised of $357,000
for reforestation, fertilization and roads; $227,000 for capitalizable costs
associated with our development properties; and $363,000 of other miscellaneous
capital additions. Cash used in financing activities totaled $2.2 million. This
total represents $1.7 million of long term debt payments; $758,000 of payments
on our operating line of credit; $688,000 of distributions to unitholders; and a
minority interest payment of $26,000, all netted against $901,000 of cash
received upon the exercise of unit options.
In the first quarter of 2004, cash generated by operations totaled $4.2
million and overall cash and cash equivalents decreased $7.0 million. Cash used
in investing activities totaled $9.3 million, which was comprised of $8.5
million for a timberland acquisition; $312,000 for reforestation and road
building; $285,000 of capitalizable costs on the development property at Gig
Harbor; and $216,000 of other miscellaneous capital additions. Cash used in
financing activities totaled $1.9 million consisting of $1.5 million of debt
payments; $316,000 of distributions to unitholders; and a minority interest
payment of $59,000 - all netted against $19,000 cash received from the exercise
of unit options.
Seasonality
- -----------
Fee Timber. The Partnership owns 115,000 acres of timberland in Washington
State. Our timber acreage is concentrated in two non-contiguous tree farms: the
71,000 acre Hood Canal tree farm located in Kitsap, Jefferson, Mason Counties on
the eastern side of Washington's Olympic Peninsula, and the 44,000 acre Columbia
tree farm located in Cowlitz, Clark, Lewis, Skamania, and Pierce counties on the
western side of Washington's Cascade mountain range.
The Hood Canal tree farm is concentrated at low elevations, which permits
us to harvest trees year-round. Generally, we concentrate our harvests from this
tree farm in the winter and spring when supply, and thus competition, is
typically lower and, accordingly, when we can expect to receive higher prices.
With the acquisition of the Columbia tree farm in 2001 management expected a
decrease in the seasonality of Fee Timber operations as the Columbia tree farm
24
is at higher elevations where harvest activities are generally possible only in
the late spring and summer months. In practice, over the last two years our
harvest has tended to be more front loaded as log prices have been relatively
strong in the first half of the year leading management to front load the
harvest plan. In future quarters, management expects quarterly harvest volume to
be affected by both local market conditions for logs and weather conditions.
Timberland Management & Consulting. Timberland Management & Consulting
operations are not 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 large
transactions that may have large positive or negative impacts on revenue and
operating income of the Partnership. Moreover, we expect to continue to see some
seasonal fluctuations in this segment because of the effects of weather on
Pacific Northwest development generally.
Capital Expenditures and Commitments
- ------------------------------------
Total capital expenditures in 2005 (excluding the $5.0 million planned
investment in the timber fund) are currently expected to be approximately $12.7
million, of which $947,000 has been expended through March 31, 2005. The $12.7
million expected year-end amount of capital expenditures includes $7.0 million
of expenditures related to the Real Estate project at Gig Harbor and $2.4
million related to a Real Estate project at the City of Bremerton. The actual
pace of the Gig Harbor expenditures will depend on how quickly we are able get
approval from the City of Gig Harbor on our planned infrastructure improvements
at the site. Similarly, the planned capital expenditures at the Bremerton site
are dependent upon receiving a signed purchase and sale agreement on this
property. The Partnership expects that the source of capital for these
expenditures will be a combination of funds generated internally through
operations and external financing.
Risks and Uncertainties
- -----------------------
Our business is subject to a number of risks and uncertainties, any one or
more of which could impact our operating results and financial condition
materially and adversely. Some of these risks are discussed in greater detail
below, arranged according to business segment. In addition, we face a number of
risks that affect our business generally. We compete against much larger
companies in each of its business segments. These larger competitors may have
access to larger amounts of capital and significantly greater economies of
scale. Land ownership carries with it the risk of incurring liabilities due to
accidents that take place on the land and previously undiscovered environmental
contamination. The Partnership endeavors to maintain adequate accruals to
reflect the cost of remediating known environmental contamination and other
liabilities resulting from land ownership, however these estimates may prove to
be inadequate as additional information is discovered. A more thorough
discussion of the risks and uncertainties that may affect our business is
contained in the Annual Report on Form 10-K for the fiscal year ended December
31, 2004, and in our various other filings with the Securities and Exchange
Commission. Readers should review these risks in deciding whether to invest in
Partnership units, and should recognize that those factors are not an exhaustive
list of risks that could cause us to deviate from management's expectations.
Readers also are cautioned that, in reviewing these risk factors, the factors
contained in this report and in our other SEC filings are effective as of the
date the filing was made, and we cannot undertake to update those disclosures.
25
Fee Timber
Fee Timber revenue are generated primarily through the sale of softwood
logs to both domestic mills and third-party intermediaries that resell to the
export market. The markets for these products are significantly affected by
fluctuations in U.S. and Japanese economies, as well as by the foreign currency
exchange rate between the Japanese yen and the U.S. dollar. Despite the strong
prices experienced in the current quarter, over the last few years the
Partnership has seen the price of logs erode in the Japanese market as competing
logs and lumber from regions outside of the U.S. and engineered wood products
have gradually gained market acceptance.
The domestic market for logs in the Puget Sound region has been impacted by
imported lumber from Canada and decreased demand for lumber as engineered wood
products have gained market acceptance in the U.S. These factors have had the
effect of concentrating mill ownership with larger mill operators and decreasing
the number of mills operating in the Puget Sound region. If this trend
continues, decreases in local demand for logs may decrease our profitability.
Our ability to grow and harvest timber can be significantly impacted by
legislation, regulations or court rulings that restrict or stop forest
practices. Restrictions on logging, planting, road building, fertilizing,
managing competing vegetation and other activities can significantly increase
the cost or reduce available inventory thereby reducing income.
Timberland Management & Consulting
The Timberland Management & Consulting segment is currently operating with
one major timberland management client. Management is working to expand our
customer base through market outreach efforts and marketing a private equity
fund that would be managed by the Timberland Management & Consulting segment.
26
Representative of those efforts is our renewed focus on the Investor
Portfolio Management Business ("IPMB"), which is a component of our Timberland
Management & Consulting segment. However, unlike many other components of our
business, which relate solely or primarily to real estate and timber operations,
this line of business carries risks relating to the offer and sale of
securities, and to the management of investment operations, including potential
liability to investors if we are determined to have made material misstatements
or omissions to those investors, potential accusations that we have breached
fiduciary duties to other limited partners, and similar types of investor
action. Moreover, litigation of shareholder-related matters can be expensive and
time consuming, and if brought, would likely distract management from their
focus on ordinary operating activities.
Real Estate
The value of our real estate investments is subject to changes in the
economic and regulatory environment, as well as various land use regulations and
development risks, including the ability to obtain the necessary permits and
zoning variances that would allow us to maximize our revenue from our real
estate investments. Our real estate investments are long-term in nature, which
raises the risk that unforeseen changes in the economy or laws surrounding
development activities may have an adverse affect on our investments. Moreover,
these investments often are highly illiquid and thus may not generate cash flow
if and when needed to support our other operations.
ACCOUNTING MATTERS
Accounting Standards Not Yet Implemented
In December 2004, the FASB released its revised standard, SFAS No. 123R
(SFAS 123R), Share-Based Payment. SFAS 123R requires that a public entity
measure the cost of equity based service awards based on the grant-date fair
value of the award. That cost will be recognized over the period during which an
employee is required to provide service in exchange for the award or the vesting
period. A public entity will initially measure the cost of liability based
service awards based on its current fair value and the fair value of that award
will be remeasured subsequently at each reporting date through the settlement
date. Changes in fair value during the requisite service period will be
recognized as compensation cost over that period. Adoption of SFAS 123R is
required for fiscal years beginning after June 15, 2005. The Company is
evaluating SFAS 123R and believes it will likely result in recognition of
additional non-cash stock-based compensation expense and accordingly would
decrease net income in amounts, which likely will be considered material. There
will be no effect on cash, working capital or total stockholders' equity.
The Partnership is currently negotiating with several potential investors
in ORM Timber Find I, LP (the Fund). The Fund has a target invested capital
amount of $50 million. Upon funding this $50 million target, the Fund will seek
to invest the raised capital in timberland investments. The Partnership will
invest 10% of the equity capital in the Fund so that, for example, if the target
of $50 million is reached Pope Resources will have contributed $5 million of
that equity total. The Fund is presently expected to be consolidated into the
Partnership's financial statements since an indirect subsidiary of the
Partnership (Olympic Resource Management LLC) will act as manager and general
partner of the Fund. However, Emerging Issues Task Force Issue No. 04-5,
"Investors' Accounting for an Investment in a Limited Partnership when the
Investors is the Sole General Partner and the Limited Partners have Certain
Rights" when finally concluded and issued, could require that the Partnership
not consolidate, but rather account for the Fund using the equity method of
accounting. Use of either the consolidation or equity method of accounting are
expected to result in comparable net income and Partners' capital in the
consolidated financial statements of the Partnership.
27
Critical Accounting Policies and Estimates
- ------------------------------------------
Management believes its most critical accounting policies and estimates
relate to management's calculation of timber depletion and liabilities for
matters such as environmental remediation, and potential asset impairments. In
relation to liabilities, potential impairments and other estimated charges, it
is management's policy to conduct ongoing reviews of significant accounting
policies and assumptions used in the preparation of the financial results of the
Partnership. The assumptions used are tested against available and relevant
information and reviewed with subject-matter experts for consistency and
reliability. During the preparation of financial results, tests are conducted to
ascertain that the net book carrying values of assets are not in excess of fair
values. These tests use current market information, if available, or other
generally accepted valuation methods, such as future cash flows. When the use of
estimates is necessary, an exact answer is unlikely, and therefore, the
reporting within a range of likely outcomes is used in the preparation of the
financial statements. Tests are also applied in order to be reasonably assured
that liabilities are properly reflected on the records of the Partnership and
that the notes to the financial statements are prepared in a fashion that
informs readers of possible outcomes and risks associated with the conduct of
business.
Depletion-Cost Pools: Depletion represents the cost of timber harvested and
is charged to operations by applying a depletion rate to volume harvested during
the period. The depletion rate is calculated in January each year by dividing
the Partnership's cost of merchantable timber by the volume of merchantable
timber. Merchantable timber is defined as timber that is equal to or greater
than 40 years of age.
To calculate the depletion rate the Partnership combines all properties
with similar characteristics and uses one depletion rate for all volume
harvested from that timberland asset pool. Each timberland acquisition is
evaluated for consistency with the already established timberland portfolio
using the following five characteristics:
1. Management-Will the acquisition be managed as part of the existing
cost pool?
2. Location-Is the tree farm in the same geography as the existing
timberland cost pool?
3. Products-Will the products harvested from the acquisition be
substantially similar to those harvested from the existing cost pool?
4. Customers/Markets-Will the harvest from the acquisition be sold to the
same customers/markets as logs harvested from the existing cost pool?
5. Stocking-Are the acres in the acquisition of a similar age class
distribution to the existing cost pool? (If the premerchantable
timberland acres in the acquisition are less than 50% of total acres,
stocking on the acquisition will be deemed sufficiently different and
strongly indicate that a separate pool is appropriate.)
In October 2004 we acquired 1,339 acres of timberland that are
substantially all merchantable timber. We have created a separate pool for this
acquisition with a depletion rate of $370 per MBF that is applied to timber
harvested from these recently acquired acres.
Depletion-Estimated Volume: Inventory volumes take into account the
applicable state and federal regulatory limits on timber harvests as applied to
the Partnership's properties, including the Forests and Fish law that
supplements Washington State's forest practice regulations to provide for
expanded riparian management zones, wildlife leave trees, and other harvest
restrictions. Timber inventory volume is accounted for by the Partnership's
standing timber inventory system, which utilizes annual statistical sampling of
28
the timber (cruising) with annual adjustments made for estimated growth and the
depletion of areas harvested.
The standing inventory system is subject to two processes each year to
monitor accuracy. The first is the annual cruise process and the second is a
comparison of (a) volume actually extracted by harvest to (b) inventory for the
corresponding stands of harvested timber in the standing inventory system at the
time of the harvest. A "cruise" represents a physical measurement of timber on a
specific set of acres. The cruise process is completed when the physical
measurement totals are compared to the inventory in the standing inventory
system. Only productive acres with timber that is at least 20 years old are
selected to cruise. The Partnership cruised 20% of its productive acres with 20
year old or greater timber in both 2003 and 2004 and plans to cruise 20% in 2005
and 10% thereafter. Specific acres are first selected for cruising with a bias
towards those acres that have gone the longest without a cruise and, second,
with a bias towards those acres that have been growing the longest. As the
cruise is being performed, only those trees with a breast height diameter
(approximately 4.5 feet from the ground) of at least 6 inches are measured for
inclusion in the inventory.
Environmental remediation: The environmental remediation liability
represents estimated payments to be made to remedy and monitor certain areas in
and around the townsite of Port Gamble. Port Gamble is a historic town that was
owned and operated by P&T, a related party, until 1985 when the townsite and
other assets were spun off to the Partnership. P&T continued to operate the
townsite until 1996 and leased the mill site at Port Gamble through January
2002, at which point P&T signed an agreement with the Partnership dividing the
responsibility for environmental remediation of Port Gamble between the two
parties.
The environmental remediation liability on the Partnership's books is based
upon an estimate of the Partnership's portion of the clean-up costs under this
agreement with P&T. While the majority of the Partnership's portion of the clean
up efforts is complete, there remains the possibility that the remaining
remediation or monitoring activities may exceed estimates, resulting in an
additional environmental remediation charge. Management will continue to monitor
the remaining liability against estimates to complete to determine if an
adjustment to the environmental remediation liability is necessary to accurately
represent management's estimate of remaining cost to complete the project.
Deferred tax assets: The Partnership has a United States subsidiary
corporation that has $759,000 of deferred tax assets as of March 31, 2005. The
majority of this balance represents net operating loss carryforwards resulting
from the liquidation of our subsidiary in Canada. Management evaluates the
likelihood of earning taxable income to absorb net operating loss carryforwards
each reporting period to determine if deferred tax assets will more likely than
not be utilized.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
- ------------------
As of March 31, 2005, the Partnership had $34.1 million of fixed rate debt
outstanding with a fair value of approximately $42 million based on the current
interest rates for similar financial instruments. A change in the interest rate
on fixed rate debt will affect the fair value of the debt, whereas a change in
the interest rate on variable rate debt will affect interest expense and cash
flows. A hypothetical 1% change in prevailing interest rates would change the
fair value of the Partnership's fixed-rate long-term debt obligations by $1.7
million.
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ITEM 4. CONTROLS AND PROCEDURES
The Partnership's management maintains an adequate system of internal
controls to promote the timely identification and reporting of material,
relevant information. Those controls include (1) requiring executive management
and all managers in accounting roles to sign and adhere to a Code of Conduct and
(2) implementation of a confidential hotline for employees to contact the Audit
Committee directly with financial reporting concerns. Additionally, the
Partnership's senior management team meets regularly to discuss significant
transactions and events affecting the Partnership's operations. The
Partnership's President & CEO and V.P. & CFO ("Executive Officers") lead these
meetings and consider whether topics discussed represent information that should
be disclosed under generally accepted accounting principles and the rules of the
SEC. The Board of Directors of the Partnership's general partner includes an
Audit Committee. The Audit Committee reviews the earnings release and all
reports on Form 10-Q and 10-K prior to their filing. The Audit Committee is
responsible for hiring the Partnership's external auditors and meets with those
auditors at least four times each year.
Our Executive Officers are responsible for establishing and maintaining
disclosure controls and procedures. They have designed such controls to ensure
that others make all material information known to them within the organization.
Management regularly evaluates ways to improve internal controls.
As of the end of the period covered by the quarterly report on Form 10-Q
our Executive Officers completed an evaluation of the disclosure controls and
procedures and have determined them to be functioning properly and effectively.
They did not discover any significant deficiencies or material weaknesses within
the controls and procedures that required modification.
PART II
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ITEM 1. LEGAL PROCEEDINGS
From time to time, the Partnership may be subject to legal proceedings and
claims that may have a material adverse impact on its business. Management is
not aware of any current legal proceedings or claims that will have,
individually or in the aggregate, a material adverse impact on its business,
prospects, financial condition or results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) - (e) None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
(a) None
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(b) There have been no material changes in the procedures for shareholders
of the Partnership's general partner to nominate directors to the
board.
ITEM 6. Exhibits
Exhibits.
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a).
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a).
32.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(b) and 18 U.S.C. Section 1350 (furnished with this report
in accordance with SEC Rel. No. 33-8238.
32.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(b) and 18 U.S.C. Section 1350 (furnished with this report
in accordance with SEC Rel. No. 33-8238.
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SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on May 11, 2005.
POPE RESOURCES,
A Delaware Limited Partnership
By: POPE MGP, Inc.
Managing General Partner
By: /s/ David L. Nunes
------------------------------
David L. Nunes
President and Chief Executive
Officer
(Principal Executive Officer)
By: /s/ Thomas M. Ringo
------------------------------
Thomas M. Ringo
Vice President and CFO
(Principal Accounting and
Financial Officer)
32