ALLIANCE RESOURCE PARTNERS LP - Quarter Report: 2014 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

          Washington, D.C. 20549          

 

FORM 10-Q

 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2014

 

OR

 

oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

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)

 

 

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)

 

Large Accelerated Filer [X]	Accelerated Filer [   ]	Non-Accelerated Filer [   ]	Smaller Reporting Company [   ]
		(Do not check if smaller reporting company)

 

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 November 7, 2014, 74,060,634 common units are outstanding.

 

 

 

Table of Contents

 

TABLE OF CONTENTS

 

PART I
FINANCIAL INFORMATION
		Page
ITEM 1.	Financial Statements (Unaudited)
	ALLIANCE RESOURCE PARTNERS, L.P. AND SUBSIDIARIES
	Condensed Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013	1
	Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2014 and 2013	2
	Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2014 and 2013	3
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013	4
	Notes to Condensed Consolidated Financial Statements	5
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
ITEM 3.	Quantitative and Qualitative Disclosures about Market Risk	34
ITEM 4.	Controls and Procedures	35
	Forward-Looking Statements	36
PART II
OTHER INFORMATION
ITEM 1.	Legal Proceedings	38
ITEM 1A.	Risk Factors	38
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38
ITEM 3.	Defaults Upon Senior Securities	38
ITEM 4.	Mine Safety Disclosures	38
ITEM 5.	Other Information	38
ITEM 6.	Exhibits	39

 

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PART I

 

FINANCIAL INFORMATION

 

ITEM 1.                FINANCIAL STATEMENTS

 

ALLIANCE RESOURCE PARTNERS, L.P. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except unit data)

(Unaudited)

 

ASSETS			September 30,					December 31,
			2014					2013
CURRENT ASSETS:
Cash and cash equivalents			$	14,829				$	93,654
Trade receivables			175,770					153,662
Other receivables			857					776
Due from affiliates			2,532					1,964
Inventories			67,896					44,214
Advance royalties			10,779					11,454
Prepaid expenses and other assets			2,779					16,186
Total current assets			275,442					321,910
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment, at cost			2,771,664					2,645,872
Less accumulated depreciation, depletion and amortization			(1,126,199		)			(1,031,493		)
Total property, plant and equipment, net			1,645,465					1,614,379
OTHER ASSETS:
Advance royalties			16,312					18,813
Due from affiliate			11,256					11,560
Equity investments in affiliates			201,624					130,410
Other long-term assets			23,503					24,826
Total other assets			252,695					185,609
TOTAL ASSETS			$	2,173,602				$	2,121,898
LIABILITIES AND PARTNERS’ CAPITAL
CURRENT LIABILITIES:
Accounts payable			$	98,884				$	79,371
Due to affiliates			367					290
Accrued taxes other than income taxes			20,355					19,061
Accrued payroll and related expenses			50,231					47,105
Accrued interest			6,021					996
Workers’ compensation and pneumoconiosis benefits			9,287					9,065
Current capital lease obligations			1,305					1,288
Other current liabilities			15,436					18,625
Current maturities, long-term debt			230,000					36,750
Total current liabilities			431,886					212,551
LONG-TERM LIABILITIES:
Long-term debt, excluding current maturities			527,500					831,250
Pneumoconiosis benefits			52,131					48,455
Accrued pension benefit			16,290					18,182
Workers’ compensation			52,603					54,949
Asset retirement obligations			76,660					80,807
Long-term capital lease obligations			16,005					17,135
Other liabilities			6,031					7,332
Total long-term liabilities			747,220					1,058,110
Total liabilities			1,179,106					1,270,661
COMMITMENTS AND CONTINGENCIES
PARTNERS’ CAPITAL:
Limited Partners - Common Unitholders 74,060,634 and 73,926,108 units outstanding, respectively			1,266,269					1,128,519
General Partners’ deficit			(261,845		)			(267,563		)
Accumulated other comprehensive loss			(9,928		)			(9,719		)
Total Partners’ Capital			994,496					851,237
TOTAL LIABILITIES AND PARTNERS’ CAPITAL			$	2,173,602				$	2,121,898

 

See notes to condensed consolidated financial statements.

 

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ALLIANCE RESOURCE PARTNERS, L.P. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except unit and per unit data)

(Unaudited)

 

		Three Months Ended September 30,										Nine Months Ended September 30,
		2014					2013					2014					2013
SALES AND OPERATING REVENUES:
Coal sales			$	548,357				$	518,447				$	1,649,093				$	1,594,530
Transportation revenues			6,001					11,554					17,816					23,459
Other sales and operating revenues			14,970					7,228					43,019					20,866
Total revenues			569,328					537,229					1,709,928					1,638,855
EXPENSES:
Operating expenses (excluding depreciation, depletion and amortization)			349,170					346,045					1,024,305					1,042,057
Transportation expenses			6,001					11,554					17,816					23,459
Outside coal purchases			3					636					7					2,028
General and administrative			16,995					14,893					54,201					46,736
Depreciation, depletion and amortization			69,646					66,099					203,539					198,688
Total operating expenses			441,815					439,227					1,299,868					1,312,968
INCOME FROM OPERATIONS			127,513					98,002					410,060					325,887
Interest expense (net of interest capitalized for the three months ended September 30, 2013 of $2,816 and the nine months ended September 30, 2014 and 2013 of $833 and $8,220, respectively)			(8,584		)			(6,168		)			(25,395		)			(19,004		)
Interest income			432					252					1,238					564
Equity in income (loss) of affiliates, net			68					(5,990		)			(13,546		)			(15,556		)
Other income			549					372					1,178					999
INCOME BEFORE INCOME TAXES			119,978					86,468					373,535					292,890
INCOME TAX BENEFIT			—					(718		)			—					(1,307		)
NET INCOME			$	119,978				$	87,186				$	373,535				$	294,197
GENERAL PARTNERS’ INTEREST IN NET INCOME			$	35,316				$	31,052				$	103,465				$	91,414
LIMITED PARTNERS’ INTEREST IN NET INCOME			$	84,662				$	56,134				$	270,070				$	202,783
BASIC AND DILUTED NET INCOME PER LIMITED PARTNER UNIT (Note 7)			$	1.13				$	0.75				$	3.59				$	2.71
DISTRIBUTIONS PAID PER LIMITED PARTNER UNIT			$	0.625				$	0.57625				$	1.835				$	1.695
WEIGHTED AVERAGE NUMBER OF UNITS OUTSTANDING – BASIC AND DILUTED			74,060,634					73,926,108					74,038,952					73,897,062

 

See notes to condensed consolidated financial statements.

 

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ALLIANCE RESOURCE PARTNERS, L.P. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

 

 

		Three Months Ended September 30,										Nine Months Ended September 30,
		2014					2013					2014					2013
NET INCOME			$	119,978				$	87,186				$	373,535				$	294,197
OTHER COMPREHENSIVE (LOSS)/INCOME:
Defined benefit pension plan:
Amortization of actuarial loss (1)			193					557					580					1,675
Total defined benefit pension plan adjustments			193					557					580					1,675
Pneumoconiosis benefits:
Amortization of actuarial (gain)/loss (1)			(263		)			168					(789		)			503
Total pneumoconiosis benefits adjustments			(263		)			168					(789		)			503
OTHER COMPREHENSIVE (LOSS)/INCOME			(70		)			725					(209		)			2,178
TOTAL COMPREHENSIVE INCOME			$	119,908				$	87,911				$	373,326				$	296,375

 

(1)          Amortization of actuarial (gain)/loss is included in the computation of net periodic benefit cost (see Notes 8 and 10 for additional details).

 

See notes to condensed consolidated financial statements.

 

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ALLIANCE RESOURCE PARTNERS, L.P. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Nine Months Ended September 30,
		2014					2013
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES			$	586,393				$	550,385
CASH FLOWS FROM INVESTING ACTIVITIES:
Property, plant and equipment:
Capital expenditures			(233,659		)			(242,653		)
Changes in accounts payable and accrued liabilities			145					(354		)
Proceeds from sale of property, plant and equipment			272					124
Proceeds from insurance settlement for property, plant and equipment			4,512					-
Purchases of equity investments in affiliate			(85,250		)			(47,500		)
Payments to affiliate for acquisition and development of coal reserves			(1,401		)			(21,318		)
Advances/loans to affiliate			-					(7,500		)
Net cash used in investing activities			(315,381		)			(319,201		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments under term loan			(12,500		)			-
Borrowings under revolving credit facilities			221,800					211,000
Payments under revolving credit facilities			(301,800		)			(216,000		)
Payment on long-term debt			(18,000		)			(18,000		)
Payments on capital lease obligations			(1,113		)			(886		)
Net settlement of employee withholding taxes on vesting of Long-Term Incentive Plan			(2,991		)			(3,015		)
Cash contributions by General Partners			111					114
Distributions paid to Partners			(235,344		)			(213,809		)
Net cash used in financing activities			(349,837		)			(240,596		)
NET CHANGE IN CASH AND CASH EQUIVALENTS			(78,825		)			(9,412		)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			93,654					28,283
CASH AND CASH EQUIVALENTS AT END OF PERIOD			$	14,829				$	18,871
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest			$	20,381				$	21,638
NON-CASH INVESTING AND FINANCING ACTIVITY:
Accounts payable for purchase of property, plant and equipment			$	18,069				$	20,618
Market value of common units issued under Long-Term Incentive and Directors Deferred Compensation Plans before minimum statutory tax withholding requirements			$	8,417				$	8,583
Disposition of property, plant and equipment:
Net change in assets			$	846				$	-
Book value of liabilities transferred			(5,246		)			-
Gain recognized			$	(4,400	)			$	-

 

See notes to condensed consolidated financial statements.

 

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ALLIANCE RESOURCE PARTNERS, L.P. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 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 31,088,338 common units of ARLP.

 

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 September 30, 2014 and December 31, 2013, the results of our operations and comprehensive income for the three and nine months ended September 30, 2014 and 2013 and the cash flows for the nine months ended September 30, 2014 and 2013.  All of our intercompany transactions and accounts have been eliminated.

 

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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, 2013.

 

On June 16, 2014, we completed a two-for-one split of our common units, whereby holders of record as of May 30, 2014 received a one unit distribution on each unit outstanding on that date.  The unit split resulted in the issuance of 37,030,317 common units.  All references to the number of units and per unit net income and distribution amounts included in this report have been adjusted to give effect for this unit split for all periods presented.  Also, ARLP’s partnership agreement was amended effective June 16, 2014, to reduce by half the target thresholds for the incentive distribution rights per unit.

 

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 Not Yet Adopted

 

In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”).  ASU 2014-08 changes the requirements for reporting discontinued operations in Accounting Standards Codification 205, Presentation of Financial Statements, by updating the criteria for determining which disposals can be presented as discontinued operations and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of discontinued operations.  ASU 2014-08 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014.  We do not anticipate the adoption of ASU 2014-08 on January 1, 2015 will have a material impact on our consolidated financial statements.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”).  ASU 2014-09 is a new revenue recognition standard that provides a five-step analysis of transactions to determine when and how revenue is recognized.  The core principle of the new standard is an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016 and shall be applied retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption.  Early adoption is not permitted.  We are currently evaluating the effect of adopting ASU 2014-09 on January 1, 2017.

 

In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”).  ASU 2014-15 provides guidance on management’s responsibility in evaluating whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures.  ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter with early adoption permitted.  We do not anticipate the adoption of ASU 2014-15 will have a material impact on our 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.                                    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, accounts payable, due from affiliates and due to affiliates approximate fair value because of the short maturity of those instruments.  At September 30, 2014 and December 31, 2013, the estimated fair value of our long-term debt, including current maturities, was approximately $776.1 million and $884.8 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 5). 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.

 

5.                                    LONG-TERM DEBT

 

Long-term debt consists of the following (in thousands):

 

		September 30, 2014					December 31, 2013
Revolving Credit facility			$	170,000				$	250,000
Senior notes			-					18,000
Series A senior notes			205,000					205,000
Series B senior notes			145,000					145,000
Term loan			237,500					250,000
			757,500					868,000
Less current maturities			(230,000		)			(36,750		)
Total long-term debt			$	527,500				$	831,250

 

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Our Intermediate Partnership has $205.0 million in Series A and $145.0 million in Series B senior notes (collectively, the “2008 Senior Notes”), a $700.0 million revolving credit facility (“Revolving Credit Facility”) and a $237.5 million term loan (“Term Loan”) (collectively, with the 2008 Senior Notes and the Revolving Credit Facility, the “ARLP Debt Arrangements”), which are guaranteed by all of the material direct and indirect subsidiaries of our Intermediate Partnership.  At September 30, 2014, current maturities include Series A Senior notes, due in June 2015, and a portion of the Term Loan.  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, incurrence of additional indebtedness and liens, sale of assets, investments, mergers and consolidations and 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 (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 0.97 to 1.0 and 22.9 to 1.0, respectively, for the trailing twelve months ended September 30, 2014.  We were in compliance with the covenants of the ARLP Debt Arrangements as of September 30, 2014.

 

At September 30, 2014, we had borrowings of $170.0 million and $5.4 million of letters of credit outstanding with $524.6 million available for borrowing under the Revolving Credit Facility.  We utilize the Revolving Credit Facility, as appropriate, for working capital requirements, capital expenditures and investments in affiliates, scheduled debt payments and distribution payments.  We incur an annual commitment fee of 0.25% on the undrawn portion of the Revolving Credit Facility.

 

6.                                    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.  The initial longwall system commenced operation in late October 2014.  The transactions with White Oak feature several components, including an equity investment in White Oak (represented by “Series A Units” containing certain distribution and liquidation preferences), the acquisition and lease-back of certain coal reserves and surface rights and a construction loan.  Our initial investment funding to White Oak at the Transaction Date, consummated utilizing existing cash on hand, was $69.5 million and we have funded White Oak $303.3 million between the Transaction Date and September 30, 2014.  We expect to fund a total of approximately $395.5 million to $435.5 million from the Transaction Date through December 31, 2015, which includes the funding made to White Oak through September 30, 2014 discussed above.  We will continue to assess and provide funding, as needed, to White Oak after December 31, 2015.  We expect to fund additional commitments utilizing existing cash balances, future cash flows from operations, borrowings under credit facilities and cash provided from the issuance of debt or equity.  On the Transaction Date, we also entered into a coal handling and preparation agreement, pursuant to which we constructed and are operating a preparation plant and other surface facilities.  The following information discusses each component of these transactions in further detail.

 

Hamilton County, Illinois Reserve Acquisition

 

On the Transaction Date, 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 have been developed for 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’s Pattiki mine is located.  The asset purchase price of $33.8 million cash paid at closing was allocated to owned and leased coal rights.  Between the Transaction Date and December 31, 2012, WOR Properties provided $51.6 million to White Oak for development of the acquired coal reserves, fulfilling its initial commitment for further development

 

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funding.  During the twelve months ended December 31, 2013, WOR Properties acquired from White Oak, for $25.3 million cash paid at various closings, an additional 90.1 million tons of reserves.  During the nine months ended September 30, 2014, WOR Properties acquired from White Oak, for $1.4 million cash paid at closing, an additional 5.1 million tons of reserves.  Of the additional tons acquired in 2013 and the nine months ended September 30, 2014, 48.5 million tons have been developed for mining by White Oak.  At September 30, 2014, WOR Properties had provided $112.1 million to acquire a total of 300.1 million tons of coal reserves and fund the development of the acquired reserves.  WOR Properties has a remaining commitment of $27.9 million for additional coal reserve acquisitions.

 

Equity Investment – Series A Units

 

Concurrent with the Reserve Acquisition, our subsidiary, Alliance WOR Processing, LLC (“WOR Processing”), made an initial equity investment of $35.7 million in White Oak to purchase Series A Units representing ownership in White Oak.  WOR Processing purchased $129.3 million of additional Series A Units between the Transaction Date and December 31, 2013, and fulfilled WOR Processing’s minimum equity investment commitment of $150.0 million.  During the nine months ended September 30, 2014, WOR Processing purchased $85.3 million of additional Series A Units, bringing our total investment in Series A Units to $250.3 million at September 30, 2014.

 

WOR Processing’s ownership and member’s voting interest in White Oak at September 30, 2014 were 37.5% based upon currently outstanding voting units.  The remainder of the equity ownership in White Oak, represented by Series A and 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 with White Oak and continue to conclude that 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 September 30, 2014, WOR Processing had invested $250.3 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 exclusive of capitalized interest.  White Oak has made no distributions to us.

 

We record WOR Processing’s equity in income or losses of affiliates under the hypothetical liquidation at book value (“HLBV”) method of accounting due to the preferences to which WOR Processing is entitled to distributions.  We were allocated $39,000 of losses for the three months ended September 30, 2014 due primarily to losses incurred by White Oak offset in part by the impact of changes in allocations of equity income or losses resulting from the purchase of Series A Units during the period by another White Oak owner concurrent with the continued purchase of Series A Units by WOR Processing.  Series A Unit purchases impact the future preferred distributions allocable to each owner and the ongoing allocation of income and losses for GAAP purposes under the HLBV method.  For the three months ended September 30, 2013, we were allocated losses of $6.2 million.  For the nine months ended September 30, 2014 and 2013, we were allocated losses of $13.8 million and $16.3 million, respectively.

 

Services Agreement

 

Simultaneous with the closing of the Reserve Acquisition, WOR Processing entered into a Coal Handling and Preparation 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.  WOR Processing earned throughput fees of $2.7 million and $10.1 million, for the three and nine months ended September 30, 2014, respectively, and $0.6 million for each of the three and nine months ended September 30, 2013, from White Oak for processing and loading coal through the facilities.  Throughput fees earned from White Oak are included in the other sales and operating revenues line item within our condensed consolidated statements of income.

 

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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 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 had borrowed the entire amount available under the Construction Loan as of September 30, 2014.

 

7.                                    NET INCOME PER LIMITED PARTNER UNIT

 

We apply the provisions of FASB ASC 260, Earnings Per Share, which requires 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 $0.1375 per unit, 25% of the amount we distribute in excess of $0.15625 per unit, and 50% of the amount we distribute in excess of $0.1875 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, 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 nine months ended September 30, 2014 and 2013 (in thousands, except per unit data):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2014			2013			2014			2013
Net income		$	119,978		$	87,186		$	373,535		$	294,197
Adjustments:
Managing general partner’s priority distributions		(33,588)			(29,906)			(97,954)			(87,275)
General partners’ 2% equity ownership		(1,728)			(1,146)			(5,511)			(4,139)
Limited partners’ interest in net income		84,662			56,134			270,070			202,783
Less:
Distributions to participating securities		(751)			(597)			(2,188)			(1,749)
Undistributed earnings attributable to participating securities		(585)			(167)			(2,027)			(1,012)
Net income available to limited partners		$	83,326		$	55,370		$	265,855		$	200,022
Weighted average limited partner units outstanding – basic and diluted		74,061			73,926			74,039			73,897
Basic and diluted net income per limited partner unit (1)		$	1.13		$	0.75		$	3.59		$	2.71

 

(1)   Diluted EPU gives effect to all dilutive potential common units outstanding during the period using the treasury stock method. Diluted EPU excludes all dilutive potential units calculated under the treasury stock method if their effect is anti-dilutive.  For the three and nine months ended September 30, 2014 and 2013, the combined total of LTIP, SERP and Deferred Compensation Plan units of 843,976, 710,518, 776,094 and 656,628 respectively, were considered anti-dilutive under the treasury stock method.

 

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8.                                    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):

 

		Three Months Ended September 30,										Nine Months Ended September 30,
		2014					2013					2014					2013
Beginning balance			$	61,515				$	80,630				$	62,909				$	77,046
Accruals increase			1,291					452					8,755					8,399
Payments			(2,667		)			(2,553		)			(8,194		)			(8,156		)
Interest accretion			646					621					1,939					1,861
Valuation gain (1)			-					-					(4,624		)			-
Ending balance			$	60,785				$	79,150				$	60,785				$	79,150

 

(1)      Our liability for the estimated present value of current workers' compensation benefits is based on our actuarial estimates.  Our actuarial calculations are based on a blend of actuarial projection methods and numerous assumptions including claim development patterns, mortality, medical costs and interest rates.  We conducted a mid-year review of our actuarial assumptions which resulted in a valuation gain in June 2014 primarily attributable to favorable changes in claims development, offset partially by a decrease in the discount rate used to calculate the estimated present value of future obligations from 4.11% at December 31, 2013 to 3.67% at June 30, 2014.

 

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):

 

		Three Months Ended September 30,										Nine Months Ended September 30,
		2014					2013					2014					2013
Service cost			$	857				$	953				$	2,571				$	2,858
Interest cost			566					563					1,697					1,690
Amortization of net (gain)/loss (1)			(263		)			168					(789		)			503
Net periodic benefit cost			$	1,160				$	1,684				$	3,479				$	5,051

 

(1)      Amortization of net (gain)/loss is included in the operating expenses line item within our condensed consolidated statements of income.

 

9.                                    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 22, 2014, the Compensation Committee determined that the vesting requirements for the 2011 grants of 202,742 restricted units (which is net of 14,090 forfeitures) had been satisfied as of January 1, 2014.  As a result of this vesting, on February 14, 2014, we issued 128,610 unrestricted common units to the LTIP

 

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