UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended June 30, 2012
OR
For the transition period from to
Commission File No.: 0-26823
ALLIANCE RESOURCE PARTNERS, L.P.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
1717 South Boulder Avenue, Suite 400, Tulsa, Oklahoma 74119
(Address of principal executive offices and zip code)
(918) 295-7600
(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. x Yes ¨ No
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). x Yes ¨ No
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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
As of August 8, 2012, 36,874,949 common units are outstanding.
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
ITEM 1.
ITEM 2.
ITEM 3.
ITEM 4.
PART II
OTHER INFORMATION
ITEM 1A.
ITEM 5.
ITEM 6.
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ALLIANCE RESOURCE PARTNERS, L.P. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except unit data)
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents
Trade receivables
Other receivables
Due from affiliates
Inventories
Advance royalties
Prepaid expenses and other assets
Total current assets
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment, at cost
Less accumulated depreciation, depletion and amortization
Total property, plant and equipment, net
OTHER ASSETS:
Equity investments in affiliates
Other long-term assets
Total other assets
TOTAL ASSETS
LIABILITIES AND PARTNERS’ CAPITAL
CURRENT LIABILITIES:
Accounts payable
Due to affiliates
Accrued taxes other than income taxes
Accrued payroll and related expenses
Accrued interest
Workers’ compensation and pneumoconiosis benefits
Current capital lease obligations
Other current liabilities
Current maturities, long-term debt
Total current liabilities
LONG-TERM LIABILITIES:
Long-term debt, excluding current maturities
Pneumoconiosis benefits
Accrued pension benefit
Workers’ compensation
Asset retirement obligations
Long-term capital lease obligations
Other liabilities
Total long-term liabilities
Total liabilities
COMMITMENTS AND CONTINGENCIES
PARTNERS’ CAPITAL:
Limited Partners - Common Unitholders 36,874,949 and 36,775,741 units outstanding, respectively
General Partners’ deficit
Accumulated other comprehensive loss
Total Partners’ Capital
TOTAL LIABILITIES AND PARTNERS’ CAPITAL
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except unit and per unit data)
SALES AND OPERATING REVENUES:
Coal sales
Transportation revenues
Other sales and operating revenues
Total revenues
EXPENSES:
Operating expenses (excluding depreciation, depletion and amortization)
Transportation expenses
Outside coal purchases
General and administrative
Depreciation, depletion and amortization
Total operating expenses
INCOME FROM OPERATIONS
Interest expense (net of interest capitalized for the three and six months ended June 30, 2012 and 2011 of $1,778, $167, $4,732 and $312, respectively)
Interest income
Equity in loss of affiliates, net
Other income
INCOME BEFORE INCOME TAXES
INCOME TAX EXPENSE (BENEFIT)
NET INCOME
GENERAL PARTNERS’ INTEREST IN NET INCOME
LIMITED PARTNERS’ INTEREST IN NET INCOME
BASIC AND DILUTED NET INCOME PER LIMITED PARTNER UNIT (Note 8)
DISTRIBUTIONS PAID PER LIMITED PARTNER UNIT
WEIGHTED AVERAGE NUMBER OF UNITS OUTSTANDING - BASIC AND DILUTED
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CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
OTHER COMPREHENSIVE INCOME:
Defined benefit pension plan
Amortization of actuarial loss
Total defined benefit pension plan adjustments
Amortization of actuarial loss (gain)
Total pneumoconiosis benefits adjustments
OTHER COMPREHENSIVE INCOME
TOTAL COMPREHENSIVE INCOME
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES
CASH FLOWS FROM INVESTING ACTIVITIES:
Property, plant and equipment:
Capital expenditures
Changes in accounts payable and accrued liabilities
Proceeds from sale of property, plant and equipment
Purchase of equity investments in affiliate
Payment for acquisition of business
Payments to affiliate for development of coal reserves
Advances/loans to affiliate
Payments from affiliate
Other
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under term loan
Borrowings under revolving credit facility
Payment on term loan
Payments on capital lease obligations
Payment of debt issuance costs
Net settlement of employee withholding taxes on vesting of Long-Term Incentive Plan
Cash contributions by General Partners
Distributions paid to Partners
Net cash used in financing activities
NET CHANGE IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
CASH AND CASH EQUIVALENTS AT END OF PERIOD
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest
Cash paid for income taxes
NON-CASH INVESTING AND FINANCING ACTIVITY:
Accounts payable for purchase of property, plant and equipment
Market value of common units issued under Long-Term Incentive and Directors Deferred Compensation Plans before minimum statutory tax withholding requirements
Assets acquired by capital lease
Acquisition of business:
Fair value of assets assumed
Cash paid
Fair value of liabilities assumed
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND PRESENTATION
Significant Relationships Referenced in Notes to Condensed Consolidated Financial Statements
References to “we,” “us,” “our” or “ARLP Partnership” mean the business and operations of Alliance Resource Partners, L.P., the parent company, as well as its consolidated subsidiaries.
References to “ARLP” mean Alliance Resource Partners, L.P., individually as the parent company, and not on a consolidated basis.
References to “MGP” mean Alliance Resource Management GP, LLC, the managing general partner of Alliance Resource Partners, L.P, also referred to as our managing general partner.
References to “SGP” mean Alliance Resource GP, LLC, the special general partner of Alliance Resource Partners, L.P., also referred to as our special general partner.
References to “Intermediate Partnership” mean Alliance Resource Operating Partners, L.P., the intermediate partnership of Alliance Resource Partners, L.P., also referred to as our intermediate partnership.
References to “Alliance Coal” mean Alliance Coal, LLC, the holding company for the operations of Alliance Resource Operating Partners, L.P., also referred to as our operating subsidiary.
References to “AHGP” mean Alliance Holdings GP, L.P., individually as the parent company, and not on a consolidated basis.
References to “AGP” mean Alliance GP, LLC, the general partner of Alliance Holdings GP, L.P.
Organization
ARLP is a Delaware limited partnership listed on the NASDAQ Global Select Market under the ticker symbol “ARLP.” ARLP was formed in May 1999 to acquire, upon completion of ARLP’s initial public offering on August 19, 1999, certain coal production and marketing assets of Alliance Resource Holdings, Inc., a Delaware corporation (“ARH”), consisting of substantially all of ARH’s operating subsidiaries, but excluding ARH. ARH is owned by Joseph W. Craft III, the President and Chief Executive Officer and a Director of our managing general partner, and Kathleen S. Craft. SGP, a Delaware limited liability company, is owned by ARH and holds a 0.01% general partner interest in each of ARLP and the Intermediate Partnership. We lease certain assets, including coal reserves and certain surface facilities, owned by SGP.
We are managed by our managing general partner, MGP, a Delaware limited liability company, which holds a 0.99% and a 1.0001% managing general partner interest in ARLP and the Intermediate Partnership, respectively, and a 0.001% managing member interest in Alliance Coal. AHGP is a Delaware limited partnership that was formed to become the owner and controlling member of MGP. AHGP completed its initial public offering on May 15, 2006. AHGP owns directly and indirectly 100% of the members’ interest of MGP, the incentive distribution rights (“IDR”) in ARLP and 15,544,169 common units of ARLP.
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Basis of Presentation
The accompanying condensed consolidated financial statements include the accounts and operations of the ARLP Partnership and present our financial position as of June 30, 2012 and December 31, 2011, the results of our operations and comprehensive income for the three and six months ended June 30, 2012 and 2011 and the cash flows for the six months ended June 30, 2012 and 2011. All of our intercompany transactions and accounts have been eliminated.
These condensed consolidated financial statements and notes are unaudited. However, in the opinion of management, these financial statements reflect all adjustments (which include only normal recurring adjustments) necessary for a fair presentation of the results for the periods presented. Results for interim periods are not necessarily indicative of results for a full year.
These condensed consolidated financial statements and notes are prepared pursuant to the rules and regulations of the Securities and Exchange Commission for interim reporting and should be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2011.
Use of Estimates
The preparation of the ARLP Partnership’s condensed consolidated financial statements in conformity with generally accepted accounting principles (“GAAP”) of the United States (“U.S.”) requires management to make estimates and assumptions that affect the reported amounts and disclosures in our condensed consolidated financial statements. Actual results could differ from those estimates.
2. NEW ACCOUNTING STANDARDS
New Accounting Standards Issued and Adopted
In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). ASU 2011-04 amends Accounting Standards Codification (“ASC”) 820, Fair Value Measurement, to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements. ASU 2011-04 was effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU 2011-04 did not have a material impact on our condensed consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 removes the presentation options in ASC 220, Comprehensive Income, and requires entities to report components of comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. Under the two statement approach, the first statement would include components of net income, and the second statement would include components of other comprehensive income (“OCI”). ASU 2011-05 does not change the items that must be reported in OCI. ASU 2011-05 was effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and its provisions had to be applied retrospectively for all periods presented in the financial statements. In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 (“ASU 2011-12”), which indefinitely deferred a provision of ASU 2011-05 that required entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which OCI is presented. The adoption of ASU 2011-05 did not have a material impact on our condensed consolidated financial statements.
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3. CONTINGENCIES
Various lawsuits, claims and regulatory proceedings incidental to our business are pending against the ARLP Partnership. We record an accrual for a potential loss related to these matters when, in management’s opinion, such loss is probable and reasonably estimable. Based on known facts and circumstances, we believe the ultimate outcome of these outstanding lawsuits, claims and regulatory proceedings will not have a material adverse effect on our financial condition, results of operations or liquidity. However, if the results of these matters were different from management’s current opinion and in amounts greater than our accruals, then they could have a material adverse effect.
4. ACQUISITION OF BUSINESS
On April 2, 2012, we acquired substantially all of Green River Collieries, LLC’s (“Green River”) assets related to its coal mining business and operations located in Webster and Hopkins Counties, Kentucky. The transaction includes the Onton No. 9 mining complex (“Onton mine”), which includes a dock, tugboat, and a lease for the preparation plant, and an estimated 40.0 million tons of coal reserves in the West Kentucky No. 9 coal seam. The Green River acquisition is consistent with our general business strategy and complements our current coal mining operations.
The following table summarizes the consideration paid to Green River and the recognized amount of assets acquired and liabilities assumed at the acquisition date (in thousands):
Consideration paid
Recognized amounts of net tangible and intangible assets acquired and liabilities assumed:
Property, plant and equipment, including mineral rights and leased facilities
Noncompete agreement
Customer contracts, net
Permits
Capital lease obligation
Asset retirement obligation
Net tangible and intangible assets acquired
We are awaiting receipt of the final valuation report from the independent appraisal of the fair values of the assets acquired and liabilities assumed from Green River. As a result the purchase price allocation of the assets and capital lease obligation acquired is preliminary pending completion of the final analysis of all assets acquired and liabilities assumed.
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Intangible assets and liabilities related to coal supply agreements will be amortized over the average term of the contracts. Mine permits will be amortized over the estimated useful life of the Onton mine and the noncompete agreement will be amortized over the term of the agreement.
The following unaudited pro forma information for the ARLP Partnership has been prepared for illustrative purposes and assumes that the business combination occurred on January 1, 2011. The unaudited pro forma results have been prepared based upon Green River’s historical results with respect to the business we acquired and estimates of the effects of the transactions that we believe are reasonable and supportable. The results are not necessarily reflective of the consolidated results of operations had the acquisition actually occurred on January 1, 2011, nor are they indicative of future operating results.
As reported
Pro forma
Net income
The revenues and net income related to the acquired business are reflected in our condensed consolidated statements of income beginning April 2, 2012 and totaled $25.2 million and $1.8 million, respectively, which are included in the total revenues and net income above for the six months ended June 30, 2012.
The pro forma net income includes adjustments to depreciation, depletion and amortization to reflect the new basis in property, plant and equipment and intangible assets acquired, elimination of income tax expense, and the elimination of interest expense of Green River as its debt was paid off in conjunction with the acquisition. Acquisition costs related to the business acquired of $0.6 million were reclassified to the beginning of 2011, as the acquisition was assumed to have been completed January 1, 2011 for the pro forma presentation.
Synergies from the acquisition are not reflected in the pro forma results.
5. FAIR VALUE MEASUREMENTS
We apply the provisions of FASB ASC 820, Fair Value Measurement, which, among other things, defines fair value, requires disclosures about assets and liabilities carried at fair value and establishes a hierarchal disclosure framework based upon the quality of inputs used to measure fair value.
Valuation techniques are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our own market assumptions. These two types of inputs create the following fair value hierarchy:
Level 1 – Quoted prices for identical instruments in active markets.
Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 – Instruments whose significant value drivers are unobservable.
The carrying amounts for cash equivalents, accounts receivable and accounts payable approximate fair value because of the short maturity of those instruments. At June 30, 2012 and December 31, 2011, the estimated fair value of our long-term debt, including current maturities, was approximately $759.4 million and $746.5 million, respectively, based on interest rates that we believe are currently available to us for issuance of debt with similar terms and remaining maturities (Note 6). The fair value of debt, which is based upon interest rates for similar instruments in active markets, is classified as a Level 2 measurement under the fair value hierarchy.
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6. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
Revolving Credit facility
Senior notes
Series A senior notes
Series B senior notes
Term loan
Less current maturities
Total long-term debt
On May 23, 2012, our Intermediate Partnership entered into a credit agreement (the “Credit Agreement”) with various financial institutions for a revolving credit facility (the “Revolving Credit Facility”) of $700 million and a term loan (the “Term Loan”) in the aggregate principal amount of $250 million (collectively, the Revolving Credit Facility and Term Loan are referred to as the “Credit Facility”). The Credit Facility replaces the $142.5 million revolving credit facility that would have matured September 25, 2012. Borrowings under the Credit Agreement bear interest at a Base Rate or Eurodollar Rate, at our election, plus an applicable margin which fluctuates depending upon the ratio of Consolidated Debt to Consolidated Cash Flow (as defined in the Credit Agreement). We have elected the Eurodollar Rate which, with applicable margin, was 1.9% on borrowings outstanding as of June 30, 2012. The Credit Facility matures May 23, 2017, at which time all amounts outstanding under the Revolving Credit Facility and the Term Loan are required to be repaid. Interest is payable quarterly, with principal of the Term Loan due as follows: commencing with the quarter ending June 30, 2014 and for each quarter thereafter ending on March 31, 2016, an amount per quarter equal to 2.50% of the aggregate amount of the Term Loan advances outstanding, 20% of the aggregate amount of the Term Loan advances outstanding per quarter beginning June 30, 2016 through December 31, 2016 with the remaining balance of the Term Loan advances being due May 23, 2017. We have the option to prepay the Term Loan at any time in whole or in part subject to terms and conditions described in the Credit Agreement. Upon a “change of control” (as defined in the Credit Agreement), the unpaid principal amount of the Credit Facility, all interest thereon and all other amounts payable under the Credit Agreement will become due and payable.
Also on May 23, 2012, our Intermediate Partnership terminated early its $300 million term loan agreement dated December 29, 2010. As of May 23, 2012, the aggregate unpaid principal amount of $300 million, including all accrued but unpaid interest, were repaid, using the proceeds of the Term Loan and borrowings under the Revolving Credit Facility. Our Intermediate Partnership did not incur any early termination penalties in connection with the prepayment of the term loan.
We incurred debt issuance costs of approximately $4.3 million in 2012 associated with the Credit Agreement, which have been deferred and are being amortized as a component of interest expense over the duration of the Credit Agreement. We expensed $1.1 million of previously deferred debt issuance costs associated with the terminated $300 million term loan.
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Our Intermediate Partnership has $54.0 million in senior notes (“Senior Notes”), $205.0 million in Series A and $145.0 million in Series B senior notes (collectively, the “2008 Senior Notes”) and the Credit Facility described above (collectively, the “ARLP Debt Arrangements”), which are guaranteed by all of the material direct and indirect subsidiaries of our Intermediate Partnership. The ARLP Debt Arrangements contain various covenants affecting our Intermediate Partnership and its subsidiaries restricting, among other things, the amount of distributions by our Intermediate Partnership, the incurrence of additional indebtedness and liens, the sale of assets, the making of investments, the entry into mergers and consolidations and the entry into transactions with affiliates, in each case subject to various exceptions. The ARLP Debt Arrangements also require the Intermediate Partnership to remain in control of a certain amount of mineable coal reserves relative to its annual production. In addition, the ARLP Debt Arrangements require our Intermediate Partnership to maintain the following: (a) debt to cash flow ratio of not more than 3.0 to 1.0 and (b) cash flow to interest expense ratio of not less than 3.0 to 1.0, in each case, during the four most recently ended fiscal quarters. The debt to cash flow ratio and cash flow to interest expense ratio were 1.24 to 1.0 and 16.2 to 1.0, respectively, for the trailing twelve months ended June 30, 2012. We were in compliance with the covenants of the ARLP Debt Arrangements as of June 30, 2012.
At June 30, 2012, we had borrowings of $55.0 million and $29.9 million of letters of credit outstanding with $615.1 million available for borrowing under the Revolving Credit Facility. We utilize the Revolving Credit Facility, as appropriate, to meet working capital requirements, anticipated capital expenditures and investments in affiliates, scheduled debt payments or distribution payments. We incur an annual commitment fee of 0.25% on the undrawn portion of the Revolving Credit Facility.
7. WHITE OAK TRANSACTIONS
On September 22, 2011 (the “Transaction Date”), we entered into a series of transactions with White Oak Resources LLC (“White Oak”) and related entities to support development of a longwall mining operation currently under construction. The transactions feature several components, including an equity investment in White Oak (represented by “Series A Units” containing certain distribution and liquidation preferences), the acquisition and leaseback of certain reserves and surface rights, a coal handling and services agreement and a backstop equipment financing facility. Our initial investment at the Transaction Date, using existing cash on hand, was $69.5 million and we committed to additionally fund approximately $330.5 million to $455.5 million over the next three to four years, of which $188.7 million was funded from the Transaction Date through June 30, 2012. We expect to fund these additional commitments using existing cash balances, future cash flows from operations, borrowings under revolving credit facilities and cash provided from the issuance of debt or equity. The following information discusses each component of these transactions in further detail.
Hamilton County, Illinois Reserve Acquisition
Our subsidiary, Alliance WOR Properties, LLC (“WOR Properties”) acquired from White Oak the rights to approximately 204.9 million tons of proven and probable high-sulfur coal reserves, of which 105.2 million tons are currently being developed for future mining by White Oak and certain surface properties and rights in Hamilton County, Illinois (the “Reserve Acquisition”), which is adjacent to White County, Illinois, where our White County Coal, LLC Pattiki mine is located. The asset purchase price of $33.8 million cash paid at closing was allocated to owned and leased coal rights. WOR Properties also provided $17.0 million to White Oak for the development of the acquired reserves between the Transaction Date and December 31, 2011. During the six months ended June 30, 2012, WOR Properties provided $34.6 million to White Oak for development of the acquired coal reserves and fulfilled its initial commitment for further development funding. WOR Properties has a remaining commitment of $54.6 million for additional coal reserve acquisitions.
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Equity Investment – Series A Units
Concurrent with the Reserve Acquisition, our subsidiary, Alliance WOR Processing, LLC (“WOR Processing”) made an equity investment of $35.7 million in White Oak to purchase Series A Units representing ownership in White Oak. WOR Processing also purchased $7.0 million of additional Series A Units between the Transaction Date and December 31, 2011. During the six months ended June 30, 2012, WOR Processing purchased $30.6 million of additional Series A Units.
WOR Processing’s ownership and member’s voting interest in White Oak at June 30, 2012 was 10.9% based upon currently outstanding voting units. The remainder of the equity ownership in White Oak, represented by Series B Units, is held by other investors and members of White Oak management.
We continually review all rights provided to WOR Processing and us by various agreements and continue to conclude all such rights are protective or participating in nature and do not provide WOR Processing or us the ability to unilaterally direct any of the primary activities of White Oak that most significantly impact its economic performance. As such, we recognize WOR Processing’s interest in White Oak as an equity investment in affiliate in our consolidated balance sheets. As of June 30, 2012, WOR Processing had invested $73.3 million in Series A Units of White Oak equity, which represents our current maximum exposure to loss as a result of our equity investment in White Oak. White Oak has made no distributions to WOR Processing or us.
We record WOR Processing’s equity in earnings or losses of affiliates under the hypothetical liquidation at book value method of accounting due to the preferences WOR Processing receives on distributions. For the three and six months ended June 30, 2012, we were allocated losses of $4.6 million and $8.6 million, respectively.
Services Agreement
Simultaneous with the closing of the Reserve Acquisition, WOR Processing entered into a Coal Handling and Preparation Agreement (“Services Agreement”) with White Oak pursuant to which WOR Processing committed to construct and operate a coal preparation plant and related facilities and a rail loop and loadout facility to service the White Oak longwall Mine No. 1. The expected cost to construct the facilities contemplated by the Services Agreement is approximately $99.5 million and will be expended by WOR Processing over the next three years. As of June 30, 2012, we have incurred $30.0 million of costs related to the facilities noted above, which is included in the property, plant and equipment, at cost line item in our condensed consolidated balance sheets. In addition, the Intermediate Partnership agreed to loan $10.5 million to White Oak for the construction of various assets on the surface property, including but not limited to, a bathhouse, office and warehouse (“Construction Loan”). The Construction Loan has a term of 20 years, with repayment scheduled to begin in 2015. White Oak has not used any amounts available under the Construction Loan as of June 30, 2012.
Equipment Financing Commitment
Also on the Transaction Date, the Intermediate Partnership committed to provide $100.0 million of fully collateralized equipment financing with a five-year term to White Oak for the purchase of coal mining equipment should other third-party funding sources not be available. During the second quarter of 2012, White Oak obtained third-party financing for the purchase of coal mining equipment, and on June 18, 2012, repaid the Intermediate Partnership the outstanding amount of $2.2 million for previous advances and interest due. White Oak also terminated early the equipment financing agreement with the Intermediate Partnership, and as part of the termination, paid the Intermediate Partnership a $2.0 million cancellation fee on June 18, 2012.
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8. NET INCOME PER LIMITED PARTNER UNIT
We apply the provisions of FASB ASC 260, Earnings Per Share (“FASB ASC 260”), which require the two-class method in calculating basic and diluted earnings per unit (“EPU”). Net income is allocated to the general partners and limited partners in accordance with their respective partnership percentages, after giving effect to any special income or expense allocations, including incentive distributions to our managing general partner, the holder of the IDR pursuant to our partnership agreement, which are declared and paid following the end of each quarter. Under the quarterly IDR provisions of our partnership agreement, our managing general partner is entitled to receive 15% of the amount we distribute in excess of $0.275 per unit, 25% of the amount we distribute in excess of $0.3125 per unit, and 50% of the amount we distribute in excess of $0.375 per unit. Our partnership agreement contractually limits our distributions to available cash; therefore, undistributed earnings of the ARLP Partnership are not allocated to the IDR holder. In addition, our outstanding awards under our Long-Term Incentive Plan (“LTIP”) and phantom units in notional accounts under our Supplemental Executive Retirement Plan (“SERP”) and the MGP Amended and Restated Deferred Compensation Plan for Directors (“Deferred Compensation Plan”) include rights to nonforfeitable distributions or distribution equivalents and are therefore considered participating securities. As such, we allocate undistributed and distributed earnings to these outstanding awards in our calculation of EPU.
The following is a reconciliation of net income used for calculating basic earnings per unit and the weighted average units used in computing EPU for the three and six months ended June 30, 2012 and 2011, respectively, (in thousands, except per unit data):
Adjustments:
General partner’s priority distributions
General partners’ 2% equity ownership
Limited partners’ interest in net income
Less:
Distributions to participating securities
Undistributed earnings attributable to participating securities
Net income available to limited partners
Weighted average limited partner units outstanding – basic and diluted
Basic and diluted net income per limited partner unit (1)
9. WORKERS’ COMPENSATION AND PNEUMOCONIOSIS
The changes in the workers’ compensation liability (including current and long-term liability balances) for each of the periods presented were as follows (in thousands):
Beginning balance
Accruals increase
Payments
Interest accretion
Valuation loss
Ending balance
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Certain of our mine operating entities are liable under state statutes and the Federal Coal Mine Health and Safety Act of 1969, as amended, to pay pneumoconiosis, or black lung, benefits to eligible employees and former employees and their dependents. Components of the net periodic benefit cost for each of the periods presented are as follows (in thousands):
Service cost
Interest cost
Amortization of net loss (gain)
Net periodic benefit cost
10. COMPENSATION PLANS
Long-Term Incentive Plan
We have the LTIP for certain employees and officers of our managing general partner and its affiliates who perform services for us. The LTIP awards are grants of non-vested “phantom” or notional units, which upon satisfaction of vesting requirements, entitle the LTIP participant to receive ARLP common units. Annual grant levels and vesting provisions for designated participants are recommended by our President and Chief Executive Officer, subject to review and approval of the compensation committee of the MGP board of directors (the “Compensation Committee”). On January 25, 2012, the Compensation Committee determined that the vesting requirements for the 2009 grants of 9,125 restricted units (net of 500 forfeitures) and the grants issued during the three months ended December 31, 2008 of 135,305 restricted units (net of 5,840 forfeitures) had been satisfied as of January 1, 2012. As a result of this vesting, on February 14, 2012, we issued 93,938 unrestricted common units to the LTIP participants. The remaining units were settled in cash to satisfy the individual tax withholding obligations for the LTIP participants. On February 6, 2012 and April 26, 2012, the Compensation Committee authorized additional grants of up to 106,779 and 8,500 restricted units, respectively, of which 107,114 were granted during the six months ended June 30, 2012 and will vest on January 1, 2015, subject to satisfaction of certain financial tests. The fair value of these 2012 grants is equal to the intrinsic value at the date of grant, which was $77.71 per unit. LTIP expense was $1.6 million and $1.4 million for the three months ended June 30, 2012 and 2011, respectively, and $3.1 million and $2.5 million for the six months ended June 30, 2012 and 2011, respectively. After consideration of the January 1, 2012 vesting and subsequent issuance of 93,938 common units, approximately 2.2 million units remain available for issuance under the LTIP in the future, assuming all grants issued in 2010, 2011 and 2012 currently outstanding are settled with common units and no future forfeitures occur.
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As of June 30, 2012, there was $11.2 million in total unrecognized compensation expense related to the non-vested LTIP grants that are expected to vest. That expense is expected to be recognized over a weighted-average period of 1.4 years. As of June 30, 2012, the intrinsic value of the non-vested LTIP grants was $19.3 million. As of June 30, 2012, the total obligation associated with the LTIP was $8.8 million and is included in the partners’ capital-limited partners line item in our condensed consolidated balance sheets.
As provided under the distribution equivalent rights provisions of the LTIP, all non-vested grants include contingent rights to receive quarterly cash distributions in an amount equal to the cash distributions we make to unitholders during the vesting period.
SERP and Directors Deferred Compensation Plan
We utilize the SERP to provide deferred compensation benefits for certain officers and key employees. All allocations made to participants under the SERP are made in the form of “phantom” ARLP units.
Our directors participate in the Deferred Compensation Plan. Pursuant to the Deferred Compensation Plan, for amounts deferred either automatically or at the election of the director, a notional account is established and credited with notional common units of ARLP, described in the plan as “phantom” units.
For both the SERP and Deferred Compensation Plan, when quarterly cash distributions are made with respect to ARLP common units, an amount equal to such quarterly distribution is credited to each participant’s notional account as additional phantom units. All grants of phantom units under the SERP and Deferred Compensation Plan vest immediately.
Amounts that were payable under either the SERP or Deferred Compensation Plan on or prior to January 1, 2011, were paid in either cash or common units of ARLP. Effective for amounts that become payable after January 1, 2011, both the Deferred Compensation Plan and the SERP require that vested benefits be paid to participants only in common units of ARLP, and therefore the phantom units have qualified for equity award accounting treatment since that date. As a result, we reclassified a total of
$9.2 million of obligations for the SERP and the Deferred Compensation Plan from due to affiliates and other long-term liabilities to partners’ capital in our condensed consolidated balance sheets as required under FASB ASC 718, Compensation-Stock Compensation, on January 1, 2011. For the six months ended June 30, 2012 and 2011, SERP and Deferred Compensation Plan participant notional account balances were credited with a total of 4,548 and 5,898 phantom units, respectively, and the fair value of these phantom units was $64.66 and $71.96, respectively, on a weighted-average basis. Total SERP and Deferred Compensation Plan expense was approximately $0.2 million for the three months ended June 30, 2012 and 2011 and $0.4 million for the six months ended June 30, 2012 and 2011.
As of June 30, 2012, there were 153,253 total phantom units outstanding under the SERP and Deferred Compensation Plan and the total intrinsic value of the SERP and Deferred Compensation Plan phantom units was $8.6 million. As of June 30, 2012, the total obligation associated with the SERP and Deferred Compensation Plan was $10.2 million and is included in the partners’ capital-limited partners line item in our condensed consolidated balance sheets.
11. COMPONENTS OF PENSION PLAN NET PERIODIC BENEFIT COSTS
Eligible employees at certain of our mining operations participate in a defined benefit plan (the “Pension Plan”) that we sponsor. The benefit formula for the Pension Plan is a fixed dollar unit based on years of service. Components of the net periodic benefit cost for each of the periods presented are as follows (in thousands):
Expected return on plan assets
Amortization of net loss
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We previously disclosed in our financial statements for the year ended December 31, 2011 that we expected to contribute
$5.4 million to the Pension Plan in 2012. During the six months ended June 30, 2012, we made contribution payments of $3.0 million for the 2011 plan year and $1.0 million for the 2012 plan year. On July 13, 2012, we made a payment of $1.0 million for the 2012 plan year.
On July 6, 2012, new federal legislation entitled Moving Ahead for Progress in the 21st Century Act was passed, which includes a provision aimed at stabilizing the interest rates used to calculate pension plan liabilities for pension funding purposes. We are currently evaluating the impact of this legislation; however, we anticipate that as a result of this new legislation, we will not make any further contributions beyond the $5.0 million noted above for the 2012 plan year.
12. SEGMENT INFORMATION
We operate in the eastern U.S. as a producer and marketer of coal to major utilities and industrial users. We aggregate multiple operating segments into five reportable segments: the Illinois Basin, Central Appalachia, Northern Appalachia, White Oak and Other and Corporate. The first three reportable segments correspond to the three major coal producing regions in the eastern U.S. Similar economic characteristics for our operating segments within each of these three reportable segments include coal quality, coal seam height, mining and transportation methods and regulatory issues. The White Oak reportable segment includes our activities associated with the White Oak longwall Mine No. 1 development project more fully described below.
The Illinois Basin reportable segment is comprised of multiple operating segments, including Webster County Coal, LLC’s Dotiki mining complex, Gibson County Coal, LLC’s mining complex, which includes the Gibson North mine and Gibson South project, Hopkins County Coal, LLC’s Elk Creek mining complex, White County Coal, LLC’s Pattiki mining complex, Warrior Coal, LLC’s mining complex, River View Coal, LLC’s mining complex, Sebree Mining, LLC (“Sebree”), which includes the Onton mine and Sebree property, and certain properties of Alliance Resource Properties, LLC (“Alliance Resource Properties”), ARP Sebree, LLC and ARP Sebree South, LLC. The development of the Gibson South mine is currently underway and we are in the process of permitting the Sebree property for future mine development. For information regarding the acquisition of the Onton mine, which was added to the Illinois Basin segment in April 2012, please see Note 4.
The Central Appalachian reportable segment is comprised of two operating segments, the Pontiki Coal, LLC and MC Mining, LLC mining complexes.
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The Northern Appalachian reportable segment is comprised of multiple operating segments, including Mettiki Coal, LLC’s mining complex, Mettiki Coal (WV), LLC’s Mountain View mining complex, two small third-party mining operations (one of which ceased operations in July 2011), the Tunnel Ridge, LLC (“Tunnel Ridge”) mine and the Penn Ridge Coal, LLC (“Penn Ridge”) property. In May 2012, longwall production began at the Tunnel Ridge mine. We are in the process of permitting the Penn Ridge property for future mine development.
The White Oak reportable segment is comprised of two operating segments, WOR Properties and WOR Processing. WOR Processing includes both the surface operations at White Oak currently under construction and the equity investment in White Oak. WOR Properties owns coal reserves acquired from White Oak and is committed to acquiring additional reserves from White Oak. WOR Properties has also completed initial funding commitments to White Oak for development of these reserves. The White Oak reportable segment also includes a loan to White Oak for current financial activities related to the acquisition of mining equipment (which was paid off and terminated in June 2012) and will include future financing activities for another loan to construct certain surface facilities (Note 7).
Other and Corporate includes marketing and administrative expenses, Alliance Service, Inc. and its subsidiary, Matrix Design Group, LLC (“Matrix Design”), Alliance Design Group, LLC (“Alliance Design”) (collectively, Matrix Design and Alliance Design are referred to as the “Matrix Group”), the Mt. Vernon Transfer Terminal, LLC (“Mt. Vernon”) dock activities, coal brokerage activity, our equity investment in Mid-America Carbonates, LLC and certain activities of Alliance Resource Properties.
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Reportable segment results as of and for the three and six months ended June 30, 2012 and 2011 are presented below.
Reportable segment results for the three months ended June 30, 2012 were as follows:
Total revenues (2)
Segment Adjusted EBITDA Expense (3)
Segment Adjusted EBITDA (4)(5)
Capital expenditures (7)
Reportable segment results for the three months ended June 30, 2011 were as follows:
Reportable segment results as of and for the six months ended June 30, 2012 were as follows:
Total assets (6)
Reportable segment results as of and for the six months ended June 30, 2011 were as follows:
The following is a reconciliation of consolidated Segment Adjusted EBITDA Expense to operating expenses (excluding depreciation, depletion and amortization) (in thousands):
Segment Adjusted EBITDA Expense
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Consolidated Segment Adjusted EBITDA
Interest expense, net
Income tax benefit (expense)
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13. SUBSEQUENT EVENTS
On July 27, 2012, we declared a quarterly distribution for the quarter ended June 30, 2012, of $1.0625 per unit, on all common units outstanding, totaling approximately $65.8 million (which includes our managing general partner’s incentive distributions), payable on August 14, 2012 to all unitholders of record as of August 7, 2012.
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Significant relationships referenced in this management’s discussion and analysis of financial condition and results of operations include the following:
References to “MGP” mean Alliance Resource Management GP, LLC, the managing general partner of Alliance Resource Partners, L.P., also referred to as our managing general partner.
Summary
We are a diversified producer and marketer of coal primarily to major United States (“U.S.”) utilities and industrial users. We began mining operations in 1971 and, since then, have grown through acquisitions and internal development to become the third largest coal producer in the eastern U.S. We operate eleven underground mining complexes in Illinois, Indiana, Kentucky, Maryland and West Virginia including the new Tunnel Ridge, LLC (“Tunnel Ridge”) longwall mine in West Virginia and the recently acquired Onton No. 9 mining complex (“Onton mine”) in west Kentucky acquired on April 2, 2012. We are constructing a new mine in southern Indiana and operate a coal loading terminal on the Ohio River at Mt. Vernon, Indiana. Also, we have an equity investment in White Oak Resources LLC (“White Oak”), we purchase and fund the development of reserves and are constructing surface facilities at White Oak’s new mining complex in southern Illinois. As is customary in the coal industry, we have entered into long-term coal supply agreements with many of our customers.
We have five reportable segments: Illinois Basin, Central Appalachia, Northern Appalachia White Oak and Other and Corporate. The first three reportable segments correspond to the three major coal producing regions in the eastern U.S. Factors similarly affecting financial performance of our operating segments within each of these three reportable segments include coal quality, coal seam height, mining and transportation methods and regulatory issues. The White Oak segment includes our activities associated with the White Oak longwall Mine No. 1 development project in southern Illinois more fully described below.
Illinois Basin reportable segment is comprised of multiple operating segments, including Webster County Coal, LLC’s Dotiki mining complex (“Dotiki”), Gibson County Coal, LLC’s mining complex, which includes the Gibson North mine and Gibson South project, Hopkins County Coal, LLC’s Elk Creek mining complex, White County Coal, LLC’s Pattiki mining complex (“Pattiki”), Warrior Coal, LLC’s mining complex (“Warrior”), River View Coal, LLC’s mining complex (“River View”), Sebree Mining, LLC (“Sebree”), which includes the
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Onton mine and Sebree property, and certain properties of Alliance Resource Properties, LLC (“Alliance Resource Properties”), ARP Sebree, LLC and ARP Sebree South, LLC. The development of the Gibson South mine is currently underway and we are in the process of permitting the Sebree property for future mine development. For information regarding the acquisition of the Onton mine which was added to the Illinois Basin segment in April 2012, please read “Item 1. Financial Statements (Unaudited) – Note 4. Acquisition of Business” of this Quarterly Report on Form 10-Q.
Central Appalachian reportable segment is comprised of two operating segments, the Pontiki Coal, LLC (“Pontiki”) and MC Mining, LLC (“MC Mining”) mining complexes.
Northern Appalachian reportable segment is comprised of multiple operating segments, including Mettiki Coal, LLC’s mining complex (“Mettiki”), Mettiki Coal (WV), LLC’s Mountain View mining complex, two small third-party mining operations (one of which ceased operations in July 2011), the Tunnel Ridge mine and the Penn Ridge Coal, LLC (“Penn Ridge”) property. In May 2012, longwall production began at the Tunnel Ridge mine. We are in the process of permitting the Penn Ridge property for future mine development.
White Oak reportable segment is comprised of two operating segments, Alliance WOR Properties, LLC (“WOR Properties”) and Alliance WOR Processing, LLC (“WOR Processing”). WOR Processing includes both the surface operations at White Oak currently under construction and the equity investment in White Oak. WOR Properties owns reserves acquired from White Oak and is committed to acquiring additional reserves from White Oak. WOR Properties has also completed initial funding commitments to White Oak for development of these reserves. The White Oak reportable segment also includes a loan to White Oak for current financial activities related to the acquisition of mining equipment (which was paid off and terminated in June 2012) and will include future financing activities for another loan to construct certain surface facilities. For more information on White Oak, please read “Item 1. Financial Statements (Unaudited) – Note 7. White Oak Transactions” of this Quarterly Report on Form 10-Q.
Other and Corporate reportable segment includes marketing and administrative expenses, Alliance Service, Inc. (“ASI”) and its subsidiary, Matrix Design Group, LLC (“Matrix Design”), Alliance Design Group, LLC (collectively, Matrix Design and Alliance Design Group, LLC are referred to as the “Matrix Group”), the Mt. Vernon Transfer Terminal, LLC (“Mt. Vernon”) dock activities, coal brokerage activity, our equity investment in Mid-America Carbonates, LLC (“MAC”), and certain activities of Alliance Resource Properties.
Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011
We reported net income of $95.5 million for the three months ended June 30, 2012 (“2012 Quarter”) compared to $98.2 million for the three months ended June 30, 2011 (“2011 Quarter”). This decrease of $2.7 million was principally due to higher operating expenses, depreciation, depletion and amortization, outside coal purchases and the anticipated pass through of losses related to the White Oak development project. These decreases to net income were substantially offset by record revenues driven by record tons sold and pricing. Higher operating expenses resulted from increased sales and production volumes, which particularly impacted materials and supplies expenses, labor-related expenses, maintenance costs, and sales related expenses. Higher operating expenses were also impacted by lower clean recoveries from our Illinois Basin run-of-mine production and the impact of regulatory actions on production and margins from our Central Appalachian mines. Anticipated increases in depreciation, depletion and amortization were attributable to the start-up of longwall production at the Tunnel Ridge mine, the addition of the Onton mine and capital expenditures related to infrastructure improvements at various other mines. Higher outside coal purchases resulted from increased coal brokerage volumes as
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well as Mettiki’s higher cost per ton of coal purchased. Record revenues reflect record tons sold and pricing resulting in an average coal sales price of $59.17 per ton sold for the 2012 Quarter as compared to $56.08 per ton sold for the 2011 Quarter. Record tons sold of 8.7 million tons and higher tons produced of 8.2 million tons in the 2012 Quarter compared to 7.9 million tons sold and 7.5 million tons produced in the 2011 Quarter primarily reflect increased production at our Tunnel Ridge mine, which initiated longwall production in May 2012, and the addition of the Onton mine in the 2012 Quarter.
Tons sold
Tons produced
Operating expenses and outside coal purchases
Coal sales. Coal sales for the 2012 Quarter increased 15.8% to $512.5 million from $442.5 million for the 2011 Quarter. The increase of $70.0 million in coal sales reflected the benefit of record tons sold (contributing $43.2 million in additional coal sales) and record average coal sales prices (contributing $26.8 million in additional coal sales). Average coal sales prices increased $3.09 per ton sold to $59.17 per ton in the 2012 Quarter compared to $56.08 per ton in the 2011 Quarter, primarily as a result of improved contract pricing, particularly in Illinois Basin and Northern Appalachia.
Operating expenses and outside coal purchases. Operating expenses and outside coal purchases increased 21.0% to $350.8 million for the 2012 Quarter from $290.0 million for the 2011 Quarter, primarily due to record coal sales and higher production volumes. On a per ton basis, operating expenses and outside coal purchases increased 10.2% to $40.50 per ton sold reflecting in part the impact of lower clean coal recoveries from our Illinois Basing run-of-mine production and lower production from our Central Appalachian mines due to regulatory actions and reduced workdays for miner vacations, as well as the impact of adverse conditions at our Mountain View mine. Operating expenses were impacted by various other factors, the most significant of which are also discussed below:
Labor and benefit expenses per ton produced, excluding workers’ compensation, increased 11.1% to $13.24 per ton in the 2012 Quarter from $11.92 per ton in the 2011 Quarter. This increase of $1.32 per ton represents pay rate increases and higher benefit expenses, particularly increased health care costs and retirement expenses, and the impact of increased headcount as we continue to hire and train additional employees for our new Tunnel Ridge mine as well as production decreases discussed above;
Materials and supplies expenses per ton produced increased 5.9% to $12.86 per ton in the 2012 Quarter from $12.14 per ton in the 2011 Quarter. The increase of $0.72 per ton produced resulted from an increase in cost for certain products and services, primarily outside services and contract labor used in the mining process (increase of $0.56 per ton) and roof support (increase of $0.15 per ton), as well as production decreases discussed above;
Maintenance expenses per ton produced increased 9.6% to $4.47 per ton in the 2012 Quarter from $4.08 per ton in the 2011 Quarter. The increase of $0.39 per ton produced was primarily due to increased maintenance costs as a result of the start-up of longwall production at the Tunnel Ridge mine and the addition of the Onton mine in the 2012 Quarter as well as cost increases in various other categories;
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Contract mining expenses decreased $1.9 million for the 2012 Quarter compared to the 2011 Quarter. The decrease primarily reflects the permanent closure of one third-party mining operation at the Mettiki mine complex in the Northern Appalachian region in July 2011;
Production taxes and royalties expenses (which were incurred as a percentage of coal sales prices and volumes) increased $0.43 per produced ton sold in the 2012 Quarter compared to the 2011 Quarter, primarily as a result of higher average coal sales prices; and
Outside coal purchases increased to $16.2 million for the 2012 Quarter compared to $5.8 million in the 2011 Quarter. The increase of $10.4 million was primarily attributable to increased coal brokerage volumes as well as Mettiki’s higher cost per ton of coal purchased.
General and administrative. General and administrative expenses for the 2012 Quarter increased to $16.1 million compared to $13.0 million in the 2011 Quarter. The increase of $3.1 million was primarily due to increases in salary and wage related expenses, incentive compensation expense and other professional services.
Other sales and operating revenues. Other sales and operating revenues are principally comprised of Mt. Vernon transloading revenues, Matrix Design revenues and other outside services and administrative services revenue from affiliates. Other sales and operating revenues increased to $11.9 million for the 2012 Quarter from $6.8 million for the 2011 Quarter. The increase of $5.1 million was primarily attributable to amounts received from a customer for the partial buyout of a certain Northern Appalachian coal contract.
Depreciation, depletion and amortization. Depreciation, depletion and amortization expense increased to $52.1 million for the 2012 Quarter from $39.1 million for the 2011 Quarter. The increase of $13.0 million was attributable to additional depreciation expense related to the start-up of longwall production at the Tunnel Ridge mine, the addition of the Onton mine and capital expenditures related to infrastructure improvements at various other mines.
Interest expense. Interest expense, net of capitalized interest, decreased to $8.3 million for the 2012 Quarter from $9.2 million for the 2011 Quarter. The decrease of $0.9 million was principally attributable to increased capitalized interest, as well as reduced interest expense resulting from our August 2011 principal repayment of $18.0 million on our original senior notes issued in 1999. Interest expense was also impacted by the early termination of our $300 million term loan, which was replaced with a $250.0 million term loan in the 2012 Quarter. These decreases were partially offset by increased interest expense on borrowings of $55.0 million outstanding under the revolving credit facility during the 2012 Quarter, as well as $1.1 million of deferred debt issuance costs related to the early termination of the $300 million term loan, each of which are discussed in more detail below under “–Debt Obligations.”
Equity in loss of affiliates, net. Equity in loss of affiliates, net includes our equity investments in MAC and White Oak. For the 2012 Quarter, equity in loss of affiliates was $4.4 million, which was primarily attributable to losses of $4.6 million allocated to us due to our equity investment in White Oak.
Transportation revenues and expenses. Transportation revenues and expenses were $5.4 million and $8.7 million for the 2012 and 2011 Quarters, respectively. The decrease of $3.3 million was primarily attributable to reduced tonnage for which we arrange transportation at certain mines as well as a decrease in average transportation rates in the 2012 Quarter. The cost of transportation services are passed through to our customers. Consequently, we do not realize any gain or loss on transportation revenues.
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Other income. Other income increased to $2.4 million for the 2012 Quarter from $0.4 million for the 2011 Quarter. The increase of $2.0 million was primarily due to a cancellation fee paid to the Intermediate Partnership by White Oak related to the termination of the equipment financing agreement. For information regarding the termination of the equipment financing agreement, please read “Item 1. Financial Statements (Unaudited) – Note 7. White Oak Transactions” of this Quarterly Report on Form 10-Q.
Income tax expense (benefit). The income tax benefit for the 2012 Quarter was $0.3 million compared to income tax expense of $0.3 million for the 2011 Quarter. Income taxes are primarily due to the operations of Matrix Design. The income tax benefit for the 2012 Quarter was due to a net operating loss carry forward related to Matrix Design from prior years as well as a research and development tax credit earned by Matrix Design.
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Segment Adjusted EBITDA. Our 2012 Quarter Segment Adjusted EBITDA increased $11.9 million, or 7.5%, to $171.6 million from the 2011 Quarter Segment Adjusted EBITDA of $159.7 million. Segment Adjusted EBITDA, tons sold, coal sales, other sales and operating revenues and Segment Adjusted EBITDA Expense by segment are (in thousands):
Segment Adjusted EBITDA
Illinois Basin
Central Appalachia
Northern Appalachia
White Oak
Other and Corporate
Elimination
Total Segment Adjusted EBITDA (2)
Total tons sold
Total coal sales
Total other sales and operating revenues
Total Segment Adjusted EBITDA Expense (3)
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the financial performance of our assets without regard to financing methods, capital structure or historical cost basis;
the ability of our assets to generate cash sufficient to pay interest costs and support our indebtedness;
our operating performance and return on investment compared to those of other companies in the coal energy sector, without regard to financing or capital structures; and
the viability of acquisitions and capital expenditure projects and the overall rates of return on alternative investment opportunities.
Segment Adjusted EBITDA is also used as a supplemental financial measure by our management for reasons similar to those stated in the previous explanation of EBITDA. In addition, the exclusion of corporate general and administrative expenses from Segment Adjusted EBITDA allows management to focus solely on the evaluation of segment operating profitability as it relates to our revenues and operating expenses, which are primarily controlled by our segments.
The following is a reconciliation of consolidated Segment Adjusted EBITDA to net income, the most comparable GAAP financial measure (in thousands):
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The following is a reconciliation of consolidated Segment Adjusted EBITDA Expense to operating expense, the most comparable GAAP financial measure (in thousands):
Operating expense (excluding depreciation, depletion and amortization)
Illinois Basin – Segment Adjusted EBITDA increased 14.9% to $142.7 million in the 2012 Quarter from $124.2 million in the 2011 Quarter. The increase of $18.5 million was primarily attributable to increased tons sold, which increased 10.3% to 7.0 million tons in the 2012 Quarter, as well as improved contract pricing resulting in a higher average coal sales price of $53.22 per ton sold during the 2012 Quarter compared to $50.10 per ton sold for the 2011 Quarter. Coal sales increased 17.1% to $371.3 million in the 2012 Quarter compared to $317.0 million in the 2011 Quarter. The increase of $54.3 million reflects the increase in the average coal sales price discussed above and increased tons produced and sold from expansion of production capacity at our Warrior mine and the addition of the Onton mine, partially offset by difficult mining conditions affecting production at certain mine operations. Total Segment Adjusted EBITDA Expense for the 2012 Quarter increased 18.6% to $229.0 million from $193.0 million in the 2011 Quarter and increased $2.31 per ton sold to $32.81 from $30.50 per ton sold, primarily as a result of certain cost increases described above under consolidated operating expenses, as well as lower coal recoveries at our River View mine, difficult mining conditions at the Dotiki mine related to its transition into a new coal seam and the addition of higher cost production from the Onton mine acquired on April 2, 2012.
Central Appalachia – Segment Adjusted EBITDA decreased 47.7% to $9.2 million for the 2012 Quarter compared to $17.6 million in the 2011 Quarter. The decrease of $8.4 million was primarily attributable to lower sales volumes as a result of the continued impact of losing a production unit at the Pontiki mine during the 2011 fourth quarter and the loss of a production unit at the MC Mining mine during the 2012 Quarter, each due to regulatory action. Segment Adjusted EBITDA Expense per ton sold during the 2012 Quarter increased to $62.10 compared to $55.85 per ton sold in the 2011 Quarter, an increase of $6.25 per ton sold reflecting certain cost increases described above under consolidated operating expenses, continued stringent regulatory compliance requirements and lower production volumes described above, partially offset by improved coal recoveries. Although Segment Adjusted EBITDA Expense per ton sold increased in the 2012 Quarter, Segment Adjusted EBITDA Expense for the 2012 Quarter decreased 22.6% to $30.6 million from $39.5 million in the 2011 Quarter primarily as a result of lower coal sales discussed above.
Northern Appalachia – Segment Adjusted EBITDA increased 35.9% to $21.2 million for the 2012 Quarter as compared to $15.6 million in the 2011 Quarter. This increase of $5.6 million was primarily attributable to increased other sales and operating revenues due to amounts received from a customer for the partial buy-out of a certain coal contract in the 2012 Quarter, as well as increased tons sold, which increased 28.1% to 1.1 million tons in the 2012 Quarter and a higher average coal sales price of $85.35 per ton sold for the 2012 Quarter compared to $79.92 per ton sold for the 2011 Quarter. Coal sales prices benefited from higher Mettiki export sales prices and increased prices on Tunnel Ridge shipments. Total Segment Adjusted EBITDA Expense for the 2012 Quarter increased 48.2% to $76.5 million from $51.6 million in the 2011 Quarter and increased $9.80 per ton sold to $71.92 from $62.12
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per ton sold, primarily as a result of higher cost per ton of purchased coal, the higher cost of initial longwall production at our new Tunnel Ridge mine and the impact of difficult mining conditions at the Mountain View mine, as well as the other cost increases described above under consolidated operating expenses.
White Oak – Segment Adjusted EBITDA was $(2.8) million in the 2012 Quarter primarily attributable to losses allocated to us due to our equity interest in White Oak.
Other and Corporate – Segment Adjusted EBITDA decreased $1.0 million in the 2012 Quarter from the 2011 Quarter. This decrease was primarily attributable to increased component expenses and research costs associated with service revenue and safety equipment sales by our Matrix Group, partially offset by higher coal brokerage sales. Other sales and operating revenues increased 15.3% to $10.4 million in the 2012 Quarter compared to $9.0 million for the 2011 Quarter. The increase of $1.4 million was primarily attributable to the increased sales of mine safety equipment by the Matrix Group to our other mining subsidiaries (which are eliminated upon consolidation). Segment Adjusted EBITDA Expense increased to $19.9 million for the 2012 Quarter, primarily due to increased outside coal purchases and the above mentioned increase in component expenses by the Matrix Group.
Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011
We reported net income of $178.4 million for the six months ended June 30, 2012 (“2012 Period”) compared to $193.6 million for the six months ended June 30, 2011 (“2011 Period”). This decrease of $15.2 million was principally due to higher operating expenses, outside coal purchases, depreciation, depletion and amortization and the anticipated pass through of losses related to the White Oak development project. These decreases to net income were substantially offset by record revenues driven by higher tons sold and pricing. Higher operating expenses resulted from increased sales and production volumes, which particularly impacted materials and supplies expenses, labor-related expenses, maintenance costs, and sales related expenses. Higher operating expenses were also impacted by lower clean recoveries from our Illinois Basin run-of-mine production and the impact of regulatory actions on production and margins from our Central Appalachian mines. Higher outside coal purchases resulted from increased coal brokerage activity as well as Mettiki’s higher cost per ton of coal purchases. Anticipated increases in depreciation, depletion and amortization were attributable to the start-up of longwall production at the Tunnel Ridge mine, the addition of the Onton mine and capital expenditures related to infrastructure improvements at various other operations. Increased revenues reflect improved pricing resulting in an average coal sales price of $57.19 per ton sold for the 2012 Period, as compared to $55.11 per ton sold in the 2011 Period. We had tons sold of 16.5 million tons and tons produced of 16.7 million tons in the 2012 Period compared to 15.4 million tons sold and 15.8 million tons produced in the 2011 Period. This increase in produced tons primarily reflects increased production at our Tunnel Ridge mine, which initiated longwall production in May 2012, increased production from the ramp-up of a ninth unit at our River View mine in the second half of 2011 and the acquisition of the Onton mine on April 2, 2012.
Coal sales. Coal sales for the 2012 Period increased 10.8% to $942.1 million from $850.2 million for the 2011 Period. The increase of $91.9 million in coal sales reflected the benefit of increased
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tons sold (contributing $57.6 million in additional coal sales) and higher coal sales prices (contributing $34.3 million in additional coal sales). Average coal sales prices increased $2.08 per ton sold to $57.19 per ton in the 2012 Period as compared to $55.11 per ton sold in the 2011 Period, primarily as a result of improved contract pricing across all regions and improved export sales prices from our Mettiki complex in the Northern Appalachian region.
Operating expenses and outside coal purchases. Operating expenses and outside coal purchases increased 16.1% to $638.5 million for the 2012 Period from $549.9 million for the 2011 Period, primarily due to increased coal sales and record production volumes. On a per ton basis, operating expenses and outside coal purchases increased 8.8% to $38.76 per ton sold reflecting in part the impact of lower clean recoveries from our Illinois Basin run-of-mine production and lower production from our Central Appalachian mines due to regulatory actions. Operating expenses were impacted by various other factors, the most significant of which are also discussed below:
Labor and benefit expenses per ton produced, excluding workers’ compensation, increased 12.9% to $12.77 per ton in the 2011 Period from $11.31 per ton in the 2011 Period. This increase of $1.46 per ton represents pay rate increases and higher benefit expenses, particularly increased health care cost and retirement expenses and the impact of increased headcount as we continue to hire and train additional employees for our new Tunnel Ridge mine as well as production decreases discussed above;
Material and supplies expenses per ton produced increased 7.4% to $12.61 per ton in the 2012 Period from $11.74 per ton in the 2011 Period. The increase of $0.87 per ton produced resulted from an increase in cost for certain products and services, primarily outside services and contract labor used in the mining process (increase of $0.56 per ton), roof support (increase of $0.23 per ton) and certain ventilation related materials and supplies (increase of $0.10 per ton) as well as production increases discussed above;
Maintenance expenses per ton produced increased 8.1% to $4.38 per ton in the 2012 Period from $4.05 per ton in the 2011 Period. The increase of $0.33 per ton produced was primarily due to increased maintenance costs at our new Tunnel Ridge mine, increased longwall maintenance costs at both Northern Appalachian mines and increased maintenance costs at our new Onton mine, as well as cost increases in various other categories;
Mine administration expenses increased $1.8 million for the 2012 Period compared to the 2011 Period, primarily due to increased regulatory costs, insurance costs and components expense associated with safety equipment sales by the Matrix Group;
Contract mining expenses decreased $3.1 million for the 2012 Period compared to the 2011 Period. The decrease primarily reflects the permanent closure of one third-party mining operation at our Mettiki mine complex in the Northern Appalachian region in July 2011;
Production taxes and royalties expenses (which were incurred as a percentage of coal sales prices and volumes) increased $0.30 per produced ton sold in the 2012 Period compared to the 2011 Period, primarily as a result of increased average coal sales prices across all regions; and
Outside coal purchases increased to $30.3 million for the 2012 Period compared to $9.6 million in the 2011 Period. The increase of $20.7 million was primarily attributable to increased coal brokerage activity as well as Mettiki’s higher cost per ton of coal purchased.
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General and administrative. General and administrative expenses for the 2012 Period increased to $30.3 million compared to $25.4 million in the 2011 Period. The increase of $4.9 million was primarily due to increases in salary and wage related expenses, incentive compensation expense and other professional services.
Other sales and operating revenues. Other sales and operating revenues are principally comprised of Mt. Vernon transloading revenues, Matrix Design and other outside services and administrative services revenue from affiliates. Other sales and operating revenues increased to $19.3 million for the 2012 Period from $13.0 million for the 2011 Period. The increase of $6.3 million was primarily attributable to amounts received from a customer for the partial buy-out of a certain Northern Appalachian coal contract and increased Matrix Design product sales.
Depreciation, depletion and amortization. Depreciation, depletion and amortization expense increased to $95.1 million for the 2012 Period from $77.0 million for the 2011 Period. The increase of $18.1 million was attributable to the start-up of longwall production at the Tunnel Ridge mine, the addition of the Onton mine and capital expenditures related to infrastructure improvements at various other operations.
Interest expense. Interest expense, net of capitalized interest, decreased to $14.2 million for the 2012 Period from $18.5 million for the 2011 Period. The decrease of $4.3 million was principally attributable to increased capitalized interest, as well as reduced interest expense resulting from our August 2011 principal repayment of $18.0 million on our original senior notes issued in 1999. Interest expense was also impacted by the early termination of our $300 million term loan, which was replaced with a $250.0 million term loan in the 2012 Period. These decreases were partially offset by increased interest expense on borrowings of $55.0 million outstanding under the revolving credit facility during the 2012 Period, as well as $1.1 million of deferred debt issuance costs related to the early termination of the $300 million term loan, each of which is discussed in more detail below under “–Debt Obligations.”
Equity in loss of affiliates, net. Equity in loss of affiliates, net includes our equity investments in MAC and White Oak. For the 2012 Period, equity in loss of affiliates was $8.2 million, which was primarily attributable to losses of $8.6 million allocated to us due to our equity investment in White Oak.
Transportation revenues and expenses. Transportation revenues and expenses were $12.0 million and $18.0 million for the 2012 and 2011 Periods, respectively. The decrease of $6.0 million was primarily attributable to reduced tonnage for which we arranged transportation at certain mines, as well as a decrease in average transportation rates in the 2012 Period. The cost of transportation services are passed through to our customers. Consequently, we do not realize any gain or loss on transportation revenues.
Other income. Other income increased to $2.6 million in the 2012 Period from $1.0 million in the 2011 Period. The increase of $1.6 million was primarily due to the cancellation fee paid to the Intermediate Partnership by White Oak related to the termination of the equipment financing agreement. For more information on White Oak, please read “Item 1. Financial Statements (Unaudited) – Note 7. White Oak Transactions” of this Quarterly Report on Form 10-Q.
Income tax expense (benefit). The income tax benefit for the 2012 Period was $0.6 million compared to income tax expense of $0.1 million for the 2011 Period. Income taxes are primarily due to the operations of Matrix Design. The income tax benefit for the 2012 Period was due to a net operating loss carryforward related to Matrix Design from prior years, as well as a research and development tax credit earned by Matrix Design.
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Segment Adjusted EBITDA. Our 2012 Period Segment Adjusted EBITDA increased $3.0 million, or 1.0%, to $317.3 million from the 2011 Period Segment Adjusted EBITDA of $314.3 million. Segment Adjusted EBITDA, tons sold, coal sales, other sales and operating revenues and Segment Adjusted EBITDA Expense by segment are (in thousands):
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Segment Adjusted EBITDA is also used as a supplemental financial measure by our management for reasons similar to those stated in the previous explanation of EBITDA. In addition, the exclusion of corporate general and administrative expenses from Segment Adjusted EBITDA allows management to focus solely on the evaluation of segment operating profitability as it relates to our revenues and operating expenses which are primarily controlled by our segments.
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Illinois Basin – Segment Adjusted EBITDA increased 9.7% to $279.6 million in the 2012 Period from $254.9 million in the 2011 Period. The increase of $24.7 million was primarily attributable to increased tons sold, which increased 7.9% to 13.5 million tons in the 2012 Period, as well as improved contract pricing resulting in a higher average coal sales price of $52.58 per ton sold during the 2012 Period compared to $50.16 per ton sold for the 2011 Period. Coal sales increased 13.1% to $709.3 million in the 2012 Period compared to $627.1 million in the 2011 Period. The increase of $82.2 million primarily reflects the increase in average coal sales price discussed above and increased tons produced and sold from expansion of production capacity at our River View mine and the addition of the Onton mine, partially offset by difficult mining conditions affecting production at certain mine operations. Total Segment Adjusted EBITDA Expense for the 2012 Period increased 15.3% to $430.5 million from $373.3 million in the 2011 Period and increased $2.05 per ton sold to $31.91 from $29.86 per ton sold, primarily as a result of certain cost increases described above under consolidated operating expenses, as well as lower coal production and recoveries at our Dotiki mine reflecting the transition to a new coal seam and the addition of higher cost production from the Onton mine acquired on April 2, 2012.
Central Appalachia – Segment Adjusted EBITDA decreased 37.7% to $19.4 million for the 2012 Period, compared to $31.1 million for the 2011 Period. The decrease of $11.7 million was primarily attributable to lower sales volumes as a result of difficult mining conditions our MC Mining mine experienced during the 2012 Period and the continued impact of losing a production unit at the Pontiki mine due to regulator action during the 2011 fourth quarter, partially offset by higher coal sales price per ton, which increased to $80.60 per ton in the 2012 Period from $79.89 per ton sold in the 2011 Period. Total Segment Adjusted EBITDA Expense per ton sold during the 2012 Period increased to $61.26 compared to $56.08 in the 2011 Period, an increase of $5.18 per ton sold reflecting certain cost increases described above under consolidated operating expenses, including continuing stringent regulatory compliance requirements, as well as lower production volumes described above partially offset by improved coal recoveries. Although Segment Adjusted EBITDA Expense per ton sold increased in the 2012 Period, Segment Adjusted EBITDA Expense for the 2012 Period decreased 16.0% to $61.4 million from $73.1 million in the 2011 Period primarily as a result of lower coal sales volumes discussed above.
Northern Appalachia – Segment Adjusted EBITDA decreased 17.1% to $21.5 million for the 2012 Period, compared to $25.9 million for the 2011 Period. The decrease of $4.4 million was primarily attributable to increased operating expenses at our new Tunnel Ridge mine and higher cost per ton of purchased coal, which were partially offset by improved contract pricing in the export coal markets resulting in a higher average sales price of $76.04 per ton sold for the 2012 Period compared to $73.20 per ton sold for the 2011 Period. The start-up of longwall production in May 2012 resulted in higher tons sold, which increased 10.8% to 1.8 million tons in the 2012 Period from 1.6 million tons in the 2011 Period. Total Segment Adjusted EBITDA Expense for the 2012 Period increased 29.9% to $120.7 million from $92.9 million in the 2011 Period and increased $10.05 per ton sold to $68.13 from $58.08
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per ton sold, primarily as a result of higher cost per ton of purchased coal, higher cost of initial longwall production at the new Tunnel Ridge mine and the impact of difficult mining conditions at the Mountain View mine, as well as other cost increases described above under consolidated operating expenses.
White Oak – Segment Adjusted EBITDA was $(6.9) million in the 2012 Period primarily attributable to losses allocated to us due to our equity interest in White Oak.
Other and Corporate – Segment Adjusted EBITDA increased $1.4 million in the 2012 Period from the 2011 Period. This increase was primarily attributable to higher coal brokerage sales and higher Matrix Group safety equipment sales. Segment adjusted EBITDA Expense increased 90.1% to $34.8 million for the 2012 Period, primarily due to increased outside coal purchases, as well as increased component expenses associated with safety equipment sales by the Matrix Group.
Liquidity and Capital Resources
Liquidity
We have historically satisfied our working capital requirements and funded our capital expenditures and debt service obligations from cash generated from operations, cash provided by the issuance of debt or equity and borrowings under revolving credit facilities. We believe that existing cash balances, future cash flows from operations, borrowing under revolving credit facilities and cash provided from the issuance of debt or equity will be sufficient to meet our working capital requirements, anticipated capital expenditures and additional equity investments, scheduled debt payments, commitments and distribution payments. Our ability to satisfy our obligations, commitments and planned expenditures will depend upon our future operating performance and access to and cost of financing sources, which will be affected by prevailing economic conditions generally and in the coal industry specifically, which are beyond our control. Based on our recent operating results, current cash position, anticipated future cash flows and sources of financing that we expect to have available, we do not anticipate any significant liquidity constraints in the foreseeable future. However, to the extent operating cash flow or access to and cost of financing sources are materially different than expected, future liquidity may be adversely affected. Please read “Item 1A. Risk Factors” in the Annual Report on Form 10-K for the year ended December 31, 2011.
Cash Flows
Cash provided by operating activities was $255.5 million for the 2012 Period compared to $261.4 million for the 2011 Period. The decrease in cash provided by operating activities was principally attributable to lower net income, a decrease in the change in accounts payable during the 2012 Period compared to the 2011 Period and an increase in higher cost per ton coal inventory during the 2012 Period as compared to the 2011 Period.
Net cash used in investing activities was $390.3 million for the 2012 Period compared to $147.0 million for the 2011 Period. The increase in cash used in investing activities was primarily attributable to the purchase of the Onton mine, higher mine infrastructure and equipment capital expenditures at the Dotiki and River View mines, increased capital expenditures related to infrastructure improvements at various other mines and our funding of the White Oak project during the 2012 Period. For information regarding the acquisition of the Onton mine and White Oak, please read “Item 1. Financial Statements (Unaudited) – Note 4. Acquisition of Business” and “Item 1. Financial Statements (Unaudited) – Note 7. White Oak Transactions” of this Quarterly Report on Form 10-Q.
Net cash used in financing activities was $127.3 million for the 2012 Period compared to $106.8 million for the 2011 Period. The increase in cash used in financing activities was primarily attributable to
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the repayment of the $300 million term loan and increased distributions paid to partners in the 2012 Period, partially offset by the proceeds from the $250 million term loan completed on May 23, 2012 and borrowings under our revolving credit facility during the 2012 Period, which is discussed in more detail below under “–Debt Obligations.”
Capital Expenditures
Capital expenditures increased to $238.3 million in the 2012 Period from $142.4 million in the 2011 Period. See “—Cash Flows” above for additional information regarding capital expenditures.
Our anticipated total capital expenditures for the year ending December 31, 2012 are estimated in a range of $565.0 to $610.0 million, which includes the acquisition of the Onton mine in April 2012 and approximately $95.0 to $110.0 million related to White Oak for the acquisition of coal reserves and construction of surface facilities. Management anticipates funding remaining 2012 capital requirements with cash and cash equivalents ($11.4 million as of June 30, 2012), cash flows provided by operations, borrowings available under the revolving credit facility and, as necessary, accessing the debt or equity capital markets. We will continue to have significant capital requirements over the long-term, which may require us to obtain additional debt or equity capital. The availability and cost of additional capital will depend upon prevailing market conditions, the market price of our common units and several other factors over which we have limited control, as well as our financial condition and results of operations.
Debt Obligations
Credit Facility. On May 23, 2012, our Intermediate Partnership entered into a credit agreement (the “Credit Agreement”) with various financial institutions for a revolving credit facility (the “Revolving Credit Facility”) of $700 million and a term loan (the “Term Loan”) in the aggregate principal amount of $250 million (collectively, the Revolving Credit Facility and Term Loan are referred to as the “Credit Facility”). The Credit Facility replaces the $142.5 million revolving credit facility that would have matured September 25, 2012. Borrowings under the Credit Agreement bear interest at a Base Rate or Eurodollar Rate, at our election, plus an applicable margin which fluctuates depending upon the ratio of Consolidated Debt to Consolidated Cash Flow (as defined in the Credit Agreement). We have elected the Eurodollar Rate which, with applicable margin, was 1.9% on borrowings outstanding as of June 30, 2012. The Credit Facility matures May 23, 2017, at which time all amounts outstanding under the Revolving Credit Facility and the Term Loan are required to be repaid. Interest is payable quarterly, with principal of the Term Loan due as follows: commencing with the quarter ending June 30, 2014 and for each quarter thereafter ending on March 31, 2016, an amount per quarter equal to 2.50% of the aggregate amount of the Term Loan advances outstanding, 20% of the aggregate amount of the Term Loan advances outstanding per quarter beginning June 30, 2016 through December 31, 2016 with the remaining balance of the Term Loan advances being due May 23, 2017. We have the option to prepay the Term Loan at any time in whole or in part subject to terms and conditions described in the Credit Agreement. Upon a “change of control” (as defined in the Credit Agreement), the unpaid principal amount of the Credit Facility, all interest thereon and all other amounts payable under the Credit Agreement will become due and payable.
Also on May 23, 2012, our Intermediate Partnership terminated early its $300 million term loan agreement dated December 29, 2010. As of May 23, 2012, the aggregate unpaid principal amount of $300 million and all unpaid interest were repaid, using the proceeds of the Term Loan and borrowings under the Revolving Credit Facility. Our Intermediate Partnership did not incur any early termination penalties in connection with the prepayment of the term loan.
At June 30, 2012, we had borrowings of $55.0 million and $29.9 million of letters of credit outstanding with $615.1 million available for borrowing under the Revolving Credit Facility. We utilize
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the Revolving Credit Facility, as appropriate, to meet working capital requirements, anticipated capital expenditures, scheduled debt payments or distribution payments. We incur an annual commitment fee of 0.25% on the undrawn portion of the Revolving Credit Facility.
We incurred debt issuance costs of approximately $4.3 million in 2012 associated with the Credit Agreement, which have been deferred and are being amortized as a component of interest expense over the duration of the Credit Agreement. We expensed $1.1 million of previously deferred debt issuance cost associated with the terminated $300 million term loan.
Senior Notes. Our Intermediate Partnership has $54.0 million principal amount of 8.31% senior notes due August 20, 2014, payable in three remaining equal annual installments of $18.0 million with interest payable semi-annually (“Senior Notes”).
Series A Senior Notes. On June 26, 2008, our Intermediate Partnership entered into a Note Purchase Agreement (the “2008 Note Purchase Agreement”) with a group of institutional investors in a private placement offering. We issued $205.0 million of Series A senior notes, which bear interest at 6.28% and mature on June 26, 2015 with interest payable semi-annually.
Series B Senior Notes. On June 26, 2008, we issued under the 2008 Note Purchase Agreement $145.0 million of Series B senior notes (together with the Series A senior notes, the “2008 Senior Notes”), which bear interest at 6.72% and mature on June 26, 2018 with interest payable semi-annually.
The Senior Notes, 2008 Senior Notes and the Credit Facility described above (collectively, “ARLP Debt Arrangements”) are guaranteed by all of the material direct and indirect subsidiaries of our Intermediate Partnership. The ARLP Debt Arrangements contain various covenants affecting our Intermediate Partnership and its subsidiaries restricting, among other things, the amount of distributions by our Intermediate Partnership, the incurrence of additional indebtedness and liens, the sale of assets, the making of investments, the entry into mergers and consolidations and the entry into transactions with affiliates, in each case subject to various exceptions. The ARLP Debt Arrangements also require the Intermediate Partnership to remain in control of a certain amount of mineable coal reserves relative to its annual production. In addition, the ARLP Debt Arrangements require our Intermediate Partnership to maintain the following: (a) debt to cash flow ratio of not more than 3.0 to 1.0 and (b) cash flow to interest expense ratio of not less than 3.0 to 1.0, in each case, during the four most recently ended fiscal quarters. The debt to cash flow ratio and cash flow to interest expense ratio were 1.24 to 1.0 and 16.2 to 1.0, respectively, for the trailing twelve months ended June 30, 2012. We were in compliance with the covenants of the ARLP Debt Arrangements as of June 30, 2012.
Other. In addition to the letters of credit available under the Credit Facility discussed above, we also have agreements with two banks to provide additional letters of credit in an aggregate amount of $31.1 million to maintain surety bonds to secure certain asset retirement obligations and our obligations for workers’ compensation benefits. At June 30, 2012, we had $30.7 million in letters of credit outstanding under agreements with these two banks.
Related-Party Transactions
We have continuing related-party transactions with our managing general partner, AHGP and SGP and its affiliates. These related-party transactions relate principally to the provision of administrative services to AHGP and Alliance Resource Holdings II, Inc. and their respective affiliates, and mineral and equipment leases with SGP and its affiliates. We also have ongoing transactions with White Oak and related entities to support development of a longwall mining operation currently under construction.
On March 1, 2012, JC Air, LLC (“JC Air”), a wholly-owned subsidiary of our special general partner, was acquired by and merged into our subsidiary, ASI. JC Air’s sole assets were two airplanes,
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one of which was previously subject to a time sharing agreement between SGP Land, LLC (“SGP Land”), another subsidiary of our special general partner, and us. In consideration for this merger, we paid SGP approximately $8.0 million cash at closing. Because the transaction was between entities under common control, it was reviewed by the board of directors of our managing general partner (the “Board of Directors”) and its conflicts committee (the “Conflicts Committee”). Based on this review, the Conflicts Committee determined that the transaction reflected market-clearing terms and conditions. As a result, the Board of Directors and the Conflicts Committee approved the transaction as fair and reasonable to us and our limited partners.
ASI has agreements with SGP Land (a subsidiary of SGP), and with Mr. Craft, providing for the use of aircraft owned by ASI by SGP Land and Mr. Craft. In addition, Alliance Coal has an agreement with JC Land LLC, an entity owned by Mr. Craft, providing for the use of aircraft owned by JC Land LLC by Alliance Coal.
Please read our Annual Report on Form 10-K for the year ended December 31, 2011, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Related-Party Transactions” for additional information concerning related-party transactions.
New Accounting Standards
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On July 6, 2012, new federal legislation entitled Moving Ahead for Progress in the 21st Century Act was passed, which includes a provision aimed at stabilizing the interest rates used to calculate pension plan liabilities for pension funding purposes. We are currently evaluating the impact of this legislation; however, we anticipate that as a result of this legislation, we will not make any further contributions to our pension plan for the 2012 plan year.
Proposed Regulation
On March 27, 2012, the EPA proposed New Source Performance Standards (“NSPS”) for certain greenhouse gas emissions from new and modified electricity generation units (“EGUs”). The proposed NSPS set the first numerical limits for carbon dioxide emissions for an entire source category. The proposed NSPS, if promulgated as proposed, would pose significant challenges for the construction of new coal-fired EGUs for some time. The proposed rule does not regulate existing EGUs or new EGUs that already have been permitted. If the rule is finalized as proposed, we would anticipate the rule would be legally challenged.
Commodity Price Risk
We have significant long-term coal supply agreements. Virtually all of the long-term coal supply agreements are subject to price adjustment provisions, which permit an increase or decrease periodically in the contract price principally to reflect changes in specified price indices or items such as taxes, royalties or actual production costs resulting from regulatory changes.
We have exposure to price risk for items that are used directly or indirectly in the normal course of coal production such as steel, electricity and other supplies. We manage our risk for these items through strategic sourcing contracts for normal quantities required by our operations. We do not utilize any commodity price-hedges or other derivatives related to these risks.
Credit Risk
Most of our sales tonnage is consumed by electric utilities. Therefore, our credit risk is primarily with domestic electric power generators. Our policy is to independently evaluate each customer’s creditworthiness prior to entering into transactions and to constantly monitor outstanding accounts receivable against established credit limits. When deemed appropriate by our credit management department, we will take steps to reduce our credit exposure to customers that do not meet our credit standards or whose credit has deteriorated. These steps may include obtaining letters of credit or cash collateral, requiring prepayments for shipments or establishing customer trust accounts held for our benefit in the event of a failure to pay.
Exchange Rate Risk
All of our transactions are currently denominated in U.S. dollars, and as a result, we do not have material exposure to currency exchange-rate risks.
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Interest Rate Risk
Borrowings under the Credit Facility are at variable rates and, as a result, we have interest rate exposure. Historically, our earnings have not been materially affected by changes in interest rates. We do not utilize any interest rate derivative instruments related to our outstanding debt. We had $55.0 million in borrowings under the Revolving Credit Facility and $250.0 million outstanding under the Term Loan Agreement at June 30, 2012. A one percentage point increase in the interest rates related to the Revolving Credit Facility and Term Loan Agreement would result in an annualized increase in 2012 interest expense of $3.1 million, based on borrowing levels at June 30, 2012. With respect to our fixed-rate borrowings, a one percentage point increase in interest rates would result in a decrease of approximately $15.0 million in the estimated fair value of these borrowings.
As of June 30, 2012, the estimated fair value of the ARLP Debt Arrangements was approximately $759.4 million. The fair values of long-term debt are estimated using discounted cash flow analyses, based upon our current incremental borrowing rates for similar types of borrowing arrangements as of June 30, 2012. There were no other changes in our quantitative and qualitative disclosures about market risk as set forth in our Annual Report on Form 10-K for the year ended December 31, 2011.
We maintain controls and procedures designed to provide reasonable assurance that information required to be disclosed in the reports we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. As required by Rule 13a-15(b) of the Exchange Act, we have evaluated, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) of the Securities Exchange Act of 1934) as of June 30, 2012. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these controls and procedures are effective as of June 30, 2012.
During the quarterly period ended June 30, 2012, there have not been any changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) identified in connection with this evaluation that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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FORWARD-LOOKING STATEMENTS
Certain statements and information in this Quarterly Report on Form 10-Q may constitute “forward-looking statements.” These statements are based on our beliefs as well as assumptions made by, and information currently available to, us. When used in this document, the words “anticipate,” “believe,” “continue,” “estimate,” “expect,” “forecast,” “may,” “project,” “will,” and similar expressions identify forward-looking statements. Without limiting the foregoing, all statements relating to our future outlook, anticipated capital expenditures, future cash flows and borrowings and sources of funding are forward-looking statements. These statements reflect our current views with respect to future events and are subject to numerous assumptions that we believe are reasonable, but are open to a wide range of uncertainties and business risks, and actual results may differ materially from those discussed in these statements. Among the factors that could cause actual results to differ from those in the forward-looking statements are:
changes in competition in coal markets and our ability to respond to such changes;
changes in coal prices, which could affect our operating results and cash flows;
risks associated with the expansion of our operations and properties;
the impact of health care legislation;
deregulation of the electric utility industry or the effects of any adverse change in the coal industry, electric utility industry, or general economic conditions;
dependence on significant customer contracts, including renewing customer contracts upon expiration of existing contracts;
changing global economic conditions or in industries in which our customers operate;
liquidity constraints, including those resulting from any future unavailability of financing;
customer bankruptcies, cancellations or breaches to existing contracts, or other failures to perform;
customer delays, failure to take coal under contracts or defaults in making payments;
adjustments made in price, volume or terms to existing coal supply agreements;
fluctuations in coal demand, prices and availability due to labor and transportation costs and disruptions, equipment availability, governmental regulations, including those related to carbon dioxide emissions, and other factors;
legislation, regulatory and court decisions and interpretations thereof, including issues related to air and water quality and miner health and safety;
our productivity levels and margins earned on our coal sales;
unexpected changes in raw material costs;
unexpected changes in the availability of skilled labor;
our ability to maintain satisfactory relations with our employees;
any unanticipated increases in labor costs, adverse changes in work rules, or unexpected cash payments or projections associated with post-mine reclamation and workers’ compensation claims;
any unanticipated increases in transportation costs and risk of transportation delays or interruptions;
greater than expected environmental regulation, costs and liabilities;
a variety of operational, geologic, permitting, labor and weather-related factors;
risks associated with major mine-related accidents, such as mine fires, or interruptions;
results of litigation, including claims not yet asserted;
difficulty maintaining our surety bonds for mine reclamation as well as workers’ compensation and black lung benefits;
difficulty in making accurate assumptions and projections regarding pension, black lung benefits and other post-retirement benefit liabilities;
coal market’s share of electricity generation, including as a result of environmental concerns related to coal mining and combustion and the cost and perceived benefits of alternative sources of energy, such as natural gas, nuclear energy and renewable fuels;
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uncertainties in estimating and replacing our coal reserves;
a loss or reduction of benefits from certain tax credits;
difficulty obtaining commercial property insurance, and risks associated with our participation (excluding any applicable deductible) in the commercial insurance property program;
difficulty in making accurate assumptions and projections regarding future revenues and costs associated with equity investments in companies we do not control; and
other factors, including those discussed in “Part II. Item 1A. Risk Factors” and “Part II. Item 1. Legal Proceedings” of this Quarterly Report on Form 10-Q.
If one or more of these or other risks or uncertainties materialize, or should underlying assumptions prove incorrect, our actual results may differ materially from those described in any forward-looking statement. When considering forward-looking statements, you should also keep in mind the risks described in “Risk Factors” below. These risks could also cause our actual results to differ materially from those contained in any forward-looking statement. We disclaim any obligation to update the above list or to announce publicly the result of any revisions to any of the forward-looking statements to reflect future events or developments.
You should consider the information above when reading or considering any forward-looking statements contained in:
this Quarterly Report on Form 10-Q;
other reports filed by us with the SEC;
our press releases;
our website http://www.arlp.com; and
written or oral statements made by us or any of our officers or other authorized persons acting on our behalf.
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The information in Note 3. Contingencies to the Unaudited Condensed Consolidated Financial Statements included in “Part I. Item 1. Financial Statements (Unaudited)” of this Quarterly Report on Form 10-Q herein is hereby incorporated by reference. See also “Item 3. Legal Proceedings” of the Annual Report on Form 10-K for the year ended December 31, 2011.
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011 which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K and this Quarterly Report on Form 10-Q are not our only risks. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial based on current knowledge and factual circumstances, if such knowledge or facts change, also may materially adversely affect our business, financial condition and/or operating results in the future.
None.
Information concerning mine safety violations or other regulatory matters required by Section 1503(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) and Item 104 of Regulation S-K (17 CFR 229.104) is included in Exhibit 95.1 to this Quarterly Report on Form 10-Q.
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Incorporated by Reference
Exhibit
Number
Exhibit Description
Form
SEC
File No. and
Film No.
Filing Date
FiledHerewith*
000-26823
12865660
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in Tulsa, Oklahoma, on August 8, 2012.
By:
Alliance Resource Management GP, LLC
its managing general partner
/s/ Joseph W. Craft, III
President, Chief Executive Officer
and Director, duly authorized to sign on behalf of the registrant.
/s/ Brian L. Cantrell
Senior Vice President and
Chief Financial Officer
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