NATURAL RESOURCE PARTNERS LP - Annual Report: 2008 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

 

 

 

Commission file number: 1-31465

NATURAL RESOURCE PARTNERS L.P.

(Exact name of registrant as specified in its charter)

 

 

(713) 751-7507

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 the filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

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

 

The aggregate market value of the Common Units held by non-affiliates of the registrant (treating all executive officers and directors of the registrant and holders of 10% or more of the Common Units outstanding, for this purpose, as if they were affiliates of the registrant) was approximately $1.6 billion on June 30, 2008 based on a price of $41.20 per unit, which was the closing price of the Common Units as reported on the daily composite list for transactions on the New York Stock Exchange on that date.

 

As of February 27, 2009, there were 64,891,136 Common Units outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE.
None.

 

 

Table of Contents

 

Forward-Looking Statements

 

Statements included in this Form 10-K are forward-looking statements. In addition, we and our representatives may from time to time make other oral or written statements which are also forward-looking statements.

 

Such forward-looking statements include, among other things, statements regarding capital expenditures and acquisitions, expected commencement dates of mining, projected quantities of future production by our lessees producing from our reserves, and projected demand or supply for coal and aggregates that will affect sales levels, prices and royalties realized by us.

 

These forward-looking statements are made based upon management’s current plans, expectations, estimates, assumptions and beliefs concerning future events impacting us and therefore involve a number of risks and uncertainties. We caution that forward-looking statements are not guarantees and that actual results could differ materially from those expressed or implied in the forward-looking statements.

 

You should not put undue reliance on any forward-looking statements. Please read “Item 1A. Risk Factors” for important factors that could cause our actual results of operations or our actual financial condition to differ.

 

 

Natural Resource Partners L.P. is a limited partnership formed in April 2002, and we completed our initial public offering in October 2002. We engage principally in the business of owning and managing coal properties in the three major coal-producing regions of the United States: Appalachia, the Illinois Basin and the Western United States. As of December 31, 2008, we owned or controlled approximately 2.1 billion tons of proven and probable coal reserves. We do not operate any mines, but lease coal reserves to experienced mine operators under long-term leases that grant the operators the right to mine our coal reserves in exchange for royalty payments. Our lessees are generally required to make payments to us based on the higher of a percentage of the gross sales price or a fixed price per ton of coal sold, in addition to minimum payments. As of December 31, 2008, our coal reserves were subject to 201 leases with 73 lessees. In 2008, our lessees produced 60.6 million tons of coal from our properties and our coal royalty revenues were $226.3 million.

 

Beginning in 2006, we added two new businesses: coal infrastructure and ownership of aggregate reserves that are leased to operators in exchange for royalty payments similar to our coal royalty business. During 2008, our lessees produced 4.8 million tons of aggregates and our aggregate royalties were $9.1 million, which includes a $2.8 million bonus payment under the terms of one of our leases. Coal processing fees and coal transportation fees added $8.8 million and $11.7 million, respectively.

 

Partnership Structure and Management

 

Our operations are conducted through, and our operating assets are owned by, our subsidiaries. We own our subsidiaries through a wholly owned operating company, NRP (Operating) LLC. NRP (GP) LP, our general partner, has sole responsibility for conducting our business and for managing our operations. Because our general partner is a limited partnership, its general partner, GP Natural Resource Partners LLC, conducts its business and operations, and the board of directors and officers of GP Natural Resource Partners LLC makes decisions on our behalf. Robertson Coal Management LLC, a limited liability company wholly owned by Corbin J. Robertson, Jr., owns all of the membership interest in GP Natural Resource Partners LLC. Subject to the Investor Rights Agreement with Adena Minerals, LLC, Mr. Robertson is entitled to nominate nine directors, five of whom must be independent directors, to the board of directors of GP Natural Resource Partners LLC. Mr. Robertson has delegated the right to nominate two of the directors, one of whom must be independent, to Adena Minerals.

 

Western Pocahontas Properties Limited Partnership, New Gauley Coal Corporation and Great Northern Properties Limited Partnership are three privately held companies that are primarily engaged in owning and managing mineral properties. We refer to these companies collectively as the WPP Group. Mr. Robertson owns the general partner of Western Pocahontas Properties, 85% of the general partner of Great Northern Properties and is the Chairman, Chief Executive Officer and controlling stockholder of New Gauley Coal Corporation.

 

The senior executives and other officers who manage the WPP Group assets also manage us. They are employees of Western Pocahontas Properties and Quintana Minerals Corporation, another company controlled by Mr. Robertson, and they allocate varying percentages of their time to managing our operations. Neither our general partner, GP Natural Resource Partners LLC, nor any of their affiliates receive any management fee or other compensation in connection with the management of our business, but they are entitled to be reimbursed for all direct and indirect expenses incurred on our behalf.

 

Our operations headquarters are located at 5260 Irwin Road, Huntington, West Virginia 25705 and the telephone number is (304) 522-5757. Our principal executive offices are located at 601 Jefferson Street, Suite 3600, Houston, Texas 77002 and our phone number is (713) 751-7507.

 

Coal Royalty Business

 

Coal royalty businesses principally own and manage coal reserves. As an owner of coal reserves, we typically are not responsible for operating mines, but instead enter into leases with coal mine operators

granting them the right to mine and sell coal reserves from our property in exchange for a royalty payment. A typical lease has a 5- to 10-year base term, with the lessee having an option to extend the lease for additional terms. Leases may include the right to renegotiate rents and royalties for the extended term.

 

Under our standard lease, lessees calculate royalty and wheelage payments due us and are required to report tons of coal removed or hauled across our property as well as the sales prices of coal. Therefore, to a great extent, amounts reported as royalty and wheelage revenue are based upon the reports of our lessees. We periodically audit this information by examining certain records and internal reports of our lessees, and we perform periodic mine inspections to verify that the information that has been submitted to us is accurate. Our audit and inspection processes are designed to identify material variances from lease terms as well as differences between the information reported to us and the actual results from each property. Our audits and inspections, however, are in periods subsequent to when the revenue is reported and any adjustment identified by these processes might be in a reporting period different from when the royalty or wheelage revenue was initially recorded.

 

Coal royalty revenues are affected by changes in long-term and spot coal prices, lessees’ supply contracts and the royalty rates in our leases. The prevailing price for coal depends on a number of factors, including the supply-demand relationship, the price and availability of alternative fuels, global economic conditions and governmental regulations. In addition to their royalty obligation, our lessees are often subject to pre-established minimum monthly, quarterly or annual payments. These minimum rentals reflect amounts we are entitled to receive even if no mining activity occurred during the period. Minimum rentals are usually credited against future royalties that are earned as coal is produced.

 

Because we do not operate any mines, we do not bear ordinary operating costs and have limited direct exposure to environmental, permitting and labor risks. As operators, our lessees are subject to environmental laws, permitting requirements and other regulations adopted by various governmental authorities. In addition, the lessees generally bear all labor-related risks, including retiree health care legacy costs, black lung benefits and workers’ compensation costs associated with operating the mines. We typically pay property taxes and then are reimbursed by the lessee for the taxes on their leased property, pursuant to the terms of the lease.

 

Our business is not seasonal, although at times severe weather can cause a short-term decrease in coal production by our lessees due to the weather’s negative impact on production and transportation.

 

Acquisitions

 

We are a growth-oriented company and have closed a number of acquisitions over the last several years. For a discussion of our recent acquisitions, please see “Recent Acquisitions” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Coal Royalty Revenues, Reserves and Production

 

The following table sets forth coal royalty revenues and average coal royalty revenue per ton from the properties that we owned or controlled for the years ending December 31, 2008, 2007 and 2006. Coal royalty revenues were generated from the properties in each of the areas as follows:

 

 

The following table sets forth production data and reserve information for the properties that we owned or controlled for the years ending December 31, 2008, 2007 and 2006. All of the reserves reported below are recoverable reserves as determined by Industry Guide 7. In excess of 90% of the reserves listed below are currently leased to third parties. Coal production data and reserve information for the properties in each of the areas is as follows:

 

Production and Reserves

 

 

We classify low sulfur coal as coal with a sulfur content of less than 1.0%, medium sulfur coal as coal with a sulfur content between 1.0% and 1.5% and high sulfur coal as coal with a sulfur content of greater than 1.5%. Compliance coal is coal which meets the standards of Phase II of the Clean Air Act and is that portion of low sulfur coal that, when burned, emits less than 1.2 pounds of sulfur dioxide per million Btu. As of December 31, 2008, approximately 59% of our reserves were low sulfur coal and 38% of our reserves were compliance coal. Unless otherwise indicated, we present the quality of the coal throughout this Form 10-K on an as-received basis, which assumes 6% moisture for Appalachian reserves, 12% moisture for Illinois Basin reserves and 25% moisture for Northern Powder River Basin reserves. We own both steam and metallurgical

coal reserves in Northern, Central and Southern Appalachia, and we own steam coal reserves in the Illinois Basin and the Northern Powder River Basin. In 2008, approximately 22% of the production and 30% of the coal royalty revenues from our properties were from metallurgical coal.

 

The following table sets forth our estimate of the sulfur content, the typical quality of our coal reserves and the type of coal in each area as of December 31, 2008.

 

Sulfur Content, Typical Quality and Type of Coal

 

 

 

 

In 2005, we engaged Marshall Miller and Associates, Inc. and Stagg Resource Consultants, Inc. to conduct reserve studies of our existing properties. However, as a result of the extensive nature of our reserve holdings and the large number of acquisitions that we have completed, these studies will be an ongoing process. As of December 31, 2008, studies had been completed with respect to approximately 59% of the tons we owned when we began the process, and we anticipate completing studies on an additional 10% to 20% of those reserves by the end of 2009. In connection with acquisitions, we have either commissioned new studies or relied on recent reports done prior to the acquisition. In addition to these studies, we base our estimates of reserve information on engineering, economic and geological data assembled and analyzed by our internal geologists and engineers. There are numerous uncertainties inherent in estimating the quantities and qualities of recoverable reserves, including many factors beyond our control. Estimates of economically recoverable coal reserves depend upon a number of variable factors and assumptions, any one of which may, if incorrect, result in an estimate that varies considerably from actual results. Some of these factors and assumptions include:

 

 

As a result, actual coal tonnage recovered from identified reserve areas or properties may vary from estimates or may cause our estimates to change from time to time. Any inaccuracy in the estimates related to our reserves could result in royalties that vary from our expectations.

 

Coal Transportation and Processing Revenues

 

We own preparation plants and related coal handling facilities. Similar to our coal royalty structure, the throughput fees are based on a percentage of the ultimate sales price for the coal that is processed. These facilities generated $8.8 million in coal processing revenues for 2008.

 

In addition to our preparation plants, we own coal handling and transportation infrastructure associated with the Gatling mining complex in West Virginia and beltlines and rail load-out facilities associated with the Pond Creek No. 1 mine in Illinois. For the year ended December 31, 2008, we recognized $11.7 million in revenue from these assets. In contrast to our typical royalty structure, we are operating the coal handling and transportation infrastructure and have subcontracted out that responsibility to third parties.

 

Aggregates Royalty Revenues, Reserves and Production

 

We own an estimated 59 million tons of aggregate reserves located in DuPont, Washington. Of these reserves, approximately 14 million tons are currently permitted. If the remaining tons are not permitted by December 2016, the title to those tons will revert back to the seller of the reserves. In addition, we own a small number of aggregate reserves in West Virginia. During 2008, our lessees produced 4.8 million tons of aggregates and our aggregate royalties were $9.1 million, which includes a $2.8 million bonus payment under the terms of one of our leases.

 

Oil and Gas Properties

 

In 2008, we derived approximately 2.7% of our total revenues from oil and gas royalties in Kentucky, Virginia and Tennessee.

 

Significant Customers

 

In 2008, Alpha Natural Resources, Inc. and its various subsidiaries, as lessees, collectively provided approximately 11% of our total revenues. Although the loss of Alpha as a lessee could have a material adverse effect on us, we do not believe that the loss of a single mine on any of our properties would have a material adverse effect on us. No other lessee contributed more than 10% of our total revenues in 2008.

 

Competition

 

We face competition from other land companies, coal producers, as well as private equity firms in purchasing coal reserves and royalty producing properties. Numerous producers in the coal industry make coal marketing intensely competitive. Our lessees compete among themselves and with coal producers in various regions of the United States for domestic sales. The industry has undergone significant consolidation since 1976. The top ten producers have increased their share of total domestic coal production from 38% in 1976 to 65% in 2007. This consolidation has led to a number of our lessees’ parent companies having significantly larger financial and operating resources than their competitors. Our lessees compete with both large and small producers nationwide on the basis of coal price at the mine, coal quality, transportation cost from the mine to the customer and the reliability of supply. Continued demand for our coal and the prices that our lessees obtain are also affected by demand for electricity and steel, as well as government regulations, technological developments and the availability and the cost of generating power from alternative fuel sources, including nuclear, natural gas and hydroelectric power.

 

Regulation and Environmental Matters

 

General.  Our lessees are obligated to conduct mining operations in compliance with all applicable federal, state and local laws and regulations. These laws and regulations include matters involving the discharge of materials into the environment, employee health and safety, mine permits and other licensing requirements, reclamation and restoration of mining properties after mining is completed, management of materials generated by mining operations, surface subsidence from underground mining, water pollution, legislatively mandated benefits for current and retired coal miners, air quality standards, protection of

wetlands, plant and wildlife protection, limitations on land use, storage of petroleum products and substances which are regarded as hazardous under applicable laws and management of electrical equipment containing PCBs. Because of extensive and comprehensive regulatory requirements, violations during mining operations are not unusual and, notwithstanding compliance efforts, we do not believe violations by our lessees can be eliminated entirely. However, to our knowledge none of the violations to date, nor the monetary penalties assessed, have been material to our lessees. We do not currently expect that future compliance will have a material effect on us.

 

While it is not possible to quantify the costs of compliance by our lessees with all applicable federal, state and local laws and regulations, those costs have been and are expected to continue to be significant. The lessees post performance bonds pursuant to federal and state mining laws and regulations for the estimated costs of reclamation and mine closures, including the cost of treating mine water discharge when necessary. We do not accrue for such costs because our lessees are both contractually liable and liable under the permits they hold for all costs relating to their mining operations, including the costs of reclamation and mine closures. Although the lessees typically accrue adequate amounts for these costs, their future operating results would be adversely affected if they later determined these accruals to be insufficient. In recent years, compliance with these laws and regulations has substantially increased the cost of coal mining for all domestic coal producers.

 

In addition, the electric utility industry, which is the most significant end-user of coal, is subject to extensive regulation regarding the environmental impact of its power generation activities, which could affect demand for coal mined by our lessees. The possibility exists that new legislation or regulations could be adopted that have a significant impact on the mining operations of our lessees or their customers’ ability to use coal and may require our lessees or their customers to change operations significantly or incur substantial costs that could impact us.

 

Air Emissions.  The Federal Clean Air Act and corresponding state and local laws and regulations affect all aspects of our business. The Clean Air Act directly impacts our lessees’ coal mining and processing operations by imposing permitting requirements and, in some cases, requirements to install certain emissions control equipment, on sources that emit various hazardous and non-hazardous air pollutants. The Clean Air Act also indirectly affects coal mining operations by extensively regulating the air emissions of coal-fired electric power generating plants. There have been a series of federal rulemakings that are focused on emissions from coal-fired electric generating facilities. Installation of additional emissions control technology and additional measures required under U.S. Environmental Protection Agency (or EPA) laws and regulations will make it more costly to operate coal-fired power plants and, depending on the requirements of individual state and regional implementation plans, could make coal a less attractive fuel source in the planning and building of power plants in the future. Any reduction in coal’s share of power generating capacity could negatively impact our lessees’ ability to sell coal, which would have a material effect on our coal royalty revenues.

 

In 1997, the EPA promulgated a rule, referred to as the “NOx SIP Call,” that required coal-fired power plants and other large stationary sources in 21 eastern states and Washington D.C. to make substantial reductions in nitrogen oxide emissions in an effort to reduce the impacts of ozone transport between states. Additionally, in March 2005, the EPA issued the final Clean Air Interstate Rule (or CAIR), which, if it remains in effect, will permanently cap nitrogen oxide and sulfur dioxide emissions in 28 eastern states and Washington, D.C. beginning in 2009 and 2010, respectively. CAIR will require these states to achieve the required emission reductions by requiring power plants to either participate in an EPA-administered “cap-and-trade” program that caps emission in two phases, or by meeting an individual state emissions budget through measures established by the state. We believe that the financial impact of the CAIR on coal markets has been factored into the price of coal nationally and that its impact on demand has largely been taken into account by the marketplace. However, the CAIR was challenged and the Federal District Court of Appeals for the D.C. Circuit vacated the CAIR on July 11, 2008. North Carolina v. EPA, No. 05-1244 (D.C. Cir. Jul. 11, 2008). The vacatur caused significant uncertainty regarding state implementing regulations that were based on the CAIR. Upon request for reconsideration, though, the Court on December 23, 2008, subsequently revised its remedy to a remand to EPA without providing a response deadline. Accordingly, all state regulations that were based on the CAIR are still in effect, but we are unable to predict the outcome of EPA’s response to the remand and, therefore, unable to predict any effect on NRP.

In March 2005, the EPA finalized the Clean Air Mercury Rule (or CAMR), which establishes a two-part, nationwide cap on mercury emissions from coal-fired power plants beginning in 2010. The CAMR was vacated in early 2008 by the Federal Court of Appeals for the District of Columbia Circuit in State of New Jersey v. EPA, No. 05-1097 (D.C. Cir. Feb. 8, 2008) and the appeal process has not concluded. However, if fully implemented, CAMR would permit states to implement their own mercury control regulations or participate in an interstate cap-and-trade program for mercury emission allowances.

 

The EPA adopted new, more stringent national air quality standards for fine particulate matter in 2005 and ozone in 2008. As a result, some states will be required to amend their existing state implementation plans to attain and maintain compliance with the new air quality standards. For example, in December 2004, the EPA designated specific areas in the United States as “non-attainment” areas, meaning that the designated areas failed to meet the new national ambient air quality standard for fine particulate matter. In May of 2007, EPA published a final rule requiring that each State having a nonattainment area submit to EPA by April 5, 2008, an attainment demonstration and adopt regulations ensuring that the area will attain the standards as expeditiously as practicable, but no later than 2015. The same process is being played out with respect to the new ozone standard, but with later attainment dates. Because coal mining operations and coal-fired electric generating facilities emit particulate matter, our lessees’ mining operations and their customers could be affected when the new standards are implemented by the applicable states.

 

In June 2005, the EPA announced final amendments to its regional haze program originally developed in 1999 to improve visibility in national parks and wilderness areas. Under the Regional Haze Rule, affected states were to have developed implementation plans by December 17, 2007 that, among other things, identify facilities that will have to reduce emissions and comply with stricter emission limitations. The vast majority of states failed to submit their plans by December 17, 2007, and EPA issued a Finding of Failure to Submit plans on January 15, 2009 (74 Fed. Reg. 2392), which could trigger Federal plan implementation. This program may restrict construction of new coal-fired power plants where emissions are projected to reduce visibility in protected areas. In addition, this program may require certain existing coal-fired power plants to install emissions control equipment to reduce haze-causing emissions such as sulfur dioxide, nitrogen oxide and particulate matter.

 

The U.S. Department of Justice, on behalf of the EPA, has filed lawsuits against a number of utilities with coal-fired electric generating facilities alleging violations of the new source review provisions of the Clean Air Act. The EPA has alleged that certain modifications have been made to these facilities without first obtaining permits issued under the new source review program. Several of these lawsuits have settled, but others remain pending. Depending on the ultimate resolution of these cases, demand for our coal could be affected, which could have an adverse effect on our coal royalty revenues.

 

Carbon Dioxide Emissions.  In the mid-1990’s, the Kyoto Protocol to the United Nations Framework Convention on Climate Change called for developed nations to reduce their emissions of greenhouse gases to five percent below 1990 levels by 2012. Carbon dioxide, which is a major byproduct of the combustion of coal and other fossil fuels, is subject to the Kyoto Protocol. The Kyoto Protocol went into effect on February 16, 2005 for those nations that ratified the treaty. The United States has not ratified the Kyoto Protocol.

 

Nonetheless, the United States Congress has begun considering multiple bills that would regulate domestic carbon dioxide emissions, but no such bill has yet received sufficient Congressional support for passage into law. Several states have also either passed legislation or announced initiatives focused on decreasing or stabilizing carbon dioxide emissions associated with the combustion of fossil fuels, and many of these measures have focused on emissions from coal-fired electric generating facilities. For example, in December 2005, seven northeastern states agreed to implement a regional cap-and-trade program to stabilize carbon dioxide emissions from regional power plants beginning in 2009. Other regional programs are being considered in several regions of the country.

 

It is possible that future federal and state initiatives to control carbon dioxide emissions could result in increased costs associated with coal consumption, such as costs to install additional controls to reduce carbon dioxide emissions or costs to purchase emissions reduction credits to comply with future emissions trading

programs. Such increased costs for coal consumption could result in some customers switching to alternative sources of fuel, which could negatively impact our lessees’ coal sales, and thereby have an adverse effect on our coal royalty revenues.

 

Surface Mining Control and Reclamation Act of 1977.  The Surface Mining Control and Reclamation Act of 1977 (or SMCRA) and similar state statutes impose on mine operators the responsibility of reclaiming the land and compensating the landowner for types of damages occurring as a result of mining operations, and require mine operators to post performance bonds to ensure compliance with any reclamation obligations. In conjunction with mining the property, our coal lessees are contractually obligated under the terms of our leases to comply with all Federal, state and local laws, including SMCRA. Upon completion of the mining, reclamation generally is completed by seeding with grasses or planting trees for use as pasture or timberland, as specified in the approved reclamation plan. In addition, higher and better uses of the reclaimed property are encouraged. Regulatory authorities may attempt to assign the liabilities of our coal lessees to us if any of these lessees are not financially capable of fulfilling those obligations.

 

Hazardous Materials and Waste.  The Federal Comprehensive Environmental Response, Compensation and Liability Act (or CERCLA or the Superfund law), and analogous state laws, impose liability, without regard to fault or the legality of the original conduct, on certain classes of persons that are considered to have contributed to the release of a “hazardous substance” into the environment. These persons include the owner or operator of the site where the release occurred and companies that disposed or arranged for the disposal of the hazardous substances found at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources.

 

Some products used by coal companies in operations generate waste containing hazardous substances. We could become liable under federal and state Superfund and waste management statutes if our lessees are unable to pay environmental cleanup costs. CERCLA authorizes the EPA and, in some cases, third parties, to take actions in response to threats to the public health or the environment, and to seek recovery from the responsible classes of persons of the costs they incurred in connection with such response. It is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by hazardous substances or other wastes released into the environment.

 

Water Discharges.  Our lessees’ operations can result in discharges of pollutants into waters. The Clean Water Act and analogous state laws and regulations impose restrictions and strict controls regarding the discharge of pollutants into waters of the United States. The unpermitted discharge of pollutants such as from spill or leak incidents is prohibited. The Clean Water Act and regulations implemented thereunder also prohibit discharges of fill material and certain other activities in wetlands unless authorized by an appropriately issued permit.

 

Our lessees’ mining operations are strictly regulated by the Clean Water Act, particularly with respect to the discharge of overburden and fill material into waters, including wetlands. Recent federal district court decisions in West Virginia, and related litigation filed in federal district court in Kentucky, have created uncertainty regarding the future ability to obtain certain general permits authorizing the construction of valley fills for the disposal of overburden from mining operations. A July 2004 decision by the Southern District of West Virginia in Ohio Valley Environmental Coalition v. Bulen enjoined the Huntington District of the U.S. Army Corps of Engineers from issuing further permits pursuant to Nationwide Permit 21, which is a general permit issued by the U.S. Army Corps of Engineers to streamline the process for obtaining permits under Section 404 of the Clean Water Act. While the decision was reversed and remanded to district court by the Fourth Circuit Court of Appeals in November 2005, the district court is currently considering additional challenges to Nationwide Permit 21. Additionally, a similar lawsuit filed in federal district court in Kentucky seeks to enjoin the issuance of permits pursuant to Nationwide Permit 21 by the Louisville District of the U.S. Army Corps of Engineers. In the event that such lawsuits prove to be successful, some of our lessees may be required to apply for individual discharge permits pursuant to Section 404 of the Clean Water Act in areas where they would have otherwise utilized Nationwide Permit 21. Such a change will result in delays in

our lessees obtaining the required mining permits to conduct their operations, which could in turn have an adverse effect on our coal royalty revenues. Moreover, such individual permits are also subject to challenge.

 

In 2007, two decisions by the Southern District of West Virginia in Ohio Valley Environmental Coalition v. Strock complicated the ability of our lessees both to obtain individual permits from the Corps of Engineers without performing a full environmental impact statement and to construct in-stream sediment ponds to control sediment from their excess spoil valley fills. The first decision, dated March 23, 2007, rescinded four individual permits issued to Massey Energy Company subsidiaries as a result of the Corps’ failure to properly evaluate the impacts of filling on small headwater streams and to ensure such impacts were appropriately minimized with mitigation efforts. This order has had the effect of slowing the flow of new “fill” permits from the Corps’ Huntington, West Virginia, District Office.

 

The second order, dated June 13, 2007, ruled that discharges of sediment from valley fills into sediment ponds constructed in-stream to collect and treat that sediment must meet the same standards as are applied to discharges from these sediment ponds. Because of the rugged terrain in central Appalachia, often the only practicable location for these ponds is in streams. The effect of the ruling is not yet clear, but it may require our lessees to disturb substantially more surface area to construct sediment structures out of the stream channels. A similar lawsuit (Kentucky Waterways Alliance, Inc. v. United States Army Corps of Engineers, Civil Action No. 3:07-cv-00677 (W.D. Ky. 2007)) was filed in the Western District of Kentucky and may affect future permitting by the Louisville, Kentucky District Office as well.

 

The Fourth Circuit reversed both orders on February 13, 2009, but the order will not take effect until a “mandate” is issued by that Court. A mandate will not issue for at least 14 days and could be delayed by a request for reconsideration. Thereafter, the original plaintiffs have 90 days in which to ask the United States Supreme Court to review the decision. If the Fourth Circuit decision stands, then a backlog of permits pending before the Corps of Engineers may ease.

 

Federal and state surface mining laws require mine operators to post reclamation bonds to guarantee the costs of mine reclamation. West Virginia’s bonding system requires coal companies to post site-specific bonds in an amount up to $5,000 per acre and imposes a per-ton tax on mined coal currently set at $0.07/ton, which is paid to the West Virginia Special Reclamation Fund (“SRF”). The site-specific bonds are used to reclaim the mining operations of companies which default on their obligations under the West Virginia Surface Coal Mining and Reclamation Act. The SRF is used where the site-specific bonds are insufficient to accomplish reclamation. In The West Virginia Highlands Conservancy, Plaintiff, v. Dirk Kempthorne, Secretary of the Department of the Interior, et al., Defendants, and the West Virginia Coal Association, Intervenor/Defendant, Civil Action No. 2:00-cv-1062 (United States District Court for the Southern District of West Virginia), an environmental group is claiming that the SRF is underfunded and that the Federal Office of Surface Mining (OSM) has an obligation under the Federal Surface Mining Act to ensure that the SRF funds are increased to cover the supposed shortfall. On March 23, 2007, the plaintiff moved to reopen this long inactive case on the grounds that a recommendation of the state’s “Special Reclamation Advisory Council” regarding the establishment of a $175 million trust fund for water treatment at future bond forfeiture sites has not been approved. A one-year increase in the reclamation tax was enacted in the 2008 Legislative Session. Following this legislative action, the plaintiff moved the Court to defer ruling on its motion to reopen the case until it is determined whether the increase will be re-enacted and whether it will be sufficient if WVDEP is required to obtain NPDES permits at 21 bond forfeiture sites — relief sought in two separate citizens suits pending against WVDEP. In a May 15, 2008 Order, the Court denied plaintiff’s motion to reopen without prejudice, denied the plaintiff’s motion to defer, except insofar as it sought denial of the motion to reopen without prejudice, and retained the case on the inactive docket of the Court. In a companion case, West Virginia Highlands Conservancy v. Huffman, Civil Action No. 1:07-cv-87 (United States District Court, Northern District of West Virginia), the Court granted summary judgment on January 14, 2009 and required the WVDEP to obtain NPDES permits for bond forfeiture sites in the northern part of West Virginia. The WVDEP has indicated that it intends to appeal this decision following the entry of final orders expected in March 2009.

If the Court ultimately rules that OSM has an obligation either to assume federal control of the State bonding program or to require the State to increase the money in the SRF, our lessees could be forced to bear an increase in the tax on mined coal to increase the size of the SRF.

 

The Clean Water Act also requires states to develop anti-degradation policies to ensure non-impaired water bodies in the state do not fall below applicable water quality standards. These and other regulatory developments may restrict our lessees’ ability to develop new mines, or could require our lessees to modify existing operations, which could have an adverse effect on our coal royalty revenues.

 

The Federal Safe Drinking Water Act (or SDWA) and its state equivalents affect coal mining operations by imposing requirements on the underground injection of fine coal slurries, fly ash and flue gas scrubber sludge, and by requiring permits to conduct such underground injection activities. In addition to establishing the underground injection control program, the SDWA also imposes regulatory requirements on owners and operators of “public water systems.” This regulatory program could impact our lessees’ reclamation operations where subsidence or other mining-related problems require the provision of drinking water to affected adjacent homeowners.

 

Mine Health and Safety Laws.  The operations of our lessees are subject to stringent health and safety standards that have been imposed by federal legislation since the adoption of the Mine Health and Safety Act of 1969. The Mine Health and Safety Act of 1969 resulted in increased operating costs and reduced productivity. The Mine Safety and Health Act of 1977, which significantly expanded the enforcement of health and safety standards of the Mine Health and Safety Act of 1969, imposes comprehensive health and safety standards on all mining operations. In addition, the Black Lung Acts require payments of benefits by all businesses conducting current mining operations to coal miners with black lung or pneumoconiosis and to some beneficiaries of miners who have died from this disease.

 

Mining accidents in recent years have received national attention and instigated responses at the state and national level that have resulted in increased scrutiny of current safety practices and procedures at all mining operations, particularly underground mining operations. In January 2006, West Virginia passed a law imposing stringent new mine safety and accident reporting requirements and increased civil and criminal penalties for violations of mine safety laws. Similarly, on April 27, 2006, the Governor of Kentucky signed mine safety legislation that includes requirements for increased inspections of underground mines and additional mine safety equipment and authorizes the assessment of penalties of up to $5,000 per incident for violations of mine ventilation or roof control requirements.

 

On June 15, 2006, President Bush signed new mining safety legislation that mandates similar improvements in mine safety practices; increases civil and criminal penalties for non-compliance; requires the creation of additional mine rescue teams, and expands the scope of federal oversight, inspection and enforcement activities. Earlier, the federal Mine Safety and Health Administration announced the promulgation of new emergency rules on mine safety that took effect immediately upon their publication in the Federal Register on March 9, 2006. These rules address mine safety equipment, training, and emergency reporting requirements.

 

Mining Permits and Approvals.  Numerous governmental permits or approvals are required for mining operations. In connection with obtaining these permits and approvals, our lessees may be required to prepare and present to federal, state or local authorities data pertaining to the effect or impact that any proposed production of coal may have upon the environment. The requirements imposed by any of these authorities may be costly and time consuming and may delay commencement or continuation of mining operations.

 

In order to obtain mining permits and approvals from state regulatory authorities, mine operators, including our lessees, must submit a reclamation plan for reclaiming the mined property, upon the completion of mining operations. Typically, our lessees submit the necessary permit applications between 12 and 24 months before they plan to begin mining a new area. In our experience, permits generally are approved within 12 months after a completed application is submitted. In the past, our lessees have generally obtained their mining permits without significant delay. Our lessees have obtained or applied for permits to mine a majority of the reserves that are currently planned to be mined over the next five years. Our lessees are also in the planning phase for obtaining permits for the additional reserves planned to be mined over the following

five years. However, there are no assurances that they will not experience difficulty and delays in obtaining mining permits in the future.

 

Employees and Labor Relations

 

We do not have any employees. To carry out our operations, affiliates of our general partner employ approximately 69 people who directly support our operations. None of these employees are subject to a collective bargaining agreement.

 

Segment Information

 

We conduct all of our operations in a single segment — the ownership and leasing of mineral properties and related transportation and processing infrastructure. Substantially all of our owned properties are subject to leases, and revenues are earned based on the volume and price of minerals extracted, processed or transported. We consider revenues from timber and oil and gas acquired as part of the acquisition of our mineral reserves to be incidental to our business focus and those revenues constitute less than 10% of our total revenues and assets. We anticipate that these assets will continue to be incidental to our primary business in the future. Please see “Item 8. Financial Statements and Supplementary Data” for financial information regarding our segment.

 

Website Access to Company Reports

 

Our internet address is www.nrplp.com. We make available free of charge on or through our internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Also included on our website are our “Code of Business Conduct and Ethics” and our “Corporate Governance Guidelines” adopted by our Board of Directors and the charters for our Audit Committee, Conflicts Committee and Compensation, Nominating and Governance Committee. Also, copies of our annual report, our Code of Business Conduct and Ethics, our Corporate Governance Guidelines and our committee charters will be made available upon written request.

 

 

Risks Related to our Business

 

We may not be able to expand and our business will be adversely affected if we are unable to replace or increase our reserves, obtain other mineral reserves through acquisitions or effectively integrate new assets into our existing business.

 

Because our reserves decline as our lessees mine our coal, our future success and growth depend, in part, upon our ability to acquire additional coal reserves or other mineral reserves that are economically recoverable. If we are unable to replace or increase our coal reserves or acquire other mineral reserves on acceptable terms, our royalty revenues will decline as our reserves are depleted. Our ability to acquire additional coal reserves or other mineral reserves is dependent in part on our ability to access the capital markets, which could be difficult given the deterioration of the credit and capital markets. In addition, if we are unable to successfully integrate the companies, businesses or properties we are able to acquire, our royalty revenues may decline and we could experience a material adverse effect on our business, financial condition or results of operations.

 

If we acquire additional reserves, there is a possibility that any acquisition could be dilutive to our earnings and reduce our ability to make distributions to unitholders. Any debt we incur to finance an acquisition may also reduce our ability to make distributions to unitholders. Our ability to make acquisitions in the future also could be limited by restrictions under our existing or future debt agreements, competition from other mineral companies for attractive properties or the lack of suitable acquisition candidates.

A substantial or extended decline in coal prices could reduce our coal royalty revenues and the value of our reserves.

 

Primarily as a result of the recent downturn in the global economy, coal prices have declined significantly from the highs reached in 2008. The prices our lessees receive for their coal depend upon other factors beyond their or our control, including:

 

 

A substantial or extended decline in coal prices could materially and adversely affect us in two ways. First, lower prices may reduce the quantity of coal that may be economically produced from our properties. This, in turn, could reduce our coal royalty revenues and the value of our coal reserves. Second, even if production is not reduced, the royalties we receive on each ton of coal sold may be reduced.

 

Our ability to make acquisitions and pay distributions to our unitholders depends, in part, upon our ability to access the capital markets. We may not be able to obtain long-term financing on acceptable terms or obtain funding under our current credit facility because of the deterioration of the credit and capital markets.

 

Global financial markets and economic conditions have been, and continue to be, disrupted and volatile. The debt and equity capital markets have been distressed. These issues, along with significant write-offs in the financial services sector, the re-pricing of credit risk and the current weak economic conditions have made, and will likely continue to make it difficult to obtain funding.

 

In particular, the cost of raising money in the debt and equity capital markets has increased substantially while the availability of funds from those markets generally has diminished. Also, as a result of concerns about the stability of financial markets generally and the solvency of counterparties specifically, the cost of obtaining money from the credit markets has increased as many lenders and institutional investors have increased interest rates, enacted tighter lending standards, refused to refinance existing debt at maturity at all or on terms similar to our current debt and reduced and, in some cases, ceased to provide funding to borrowers. In addition, we may be unable to obtain adequate funding under our current credit facility because our lending counterparties may be unwilling or unable to meet their funding obligations.

 

Due to these factors, we cannot be certain that funding will be available if needed and to the extent required, on acceptable terms. If funding is not available when needed, or is available only on unfavorable terms, we may be unable to complete acquisitions or otherwise take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on our revenues, results of operations and quarterly distributions.

 

Any decrease in the demand for metallurgical coal could result in lower coal production by our lessees, which would reduce our coal royalty revenues.

 

Our lessees produce a significant amount of the metallurgical coal that is used in both the U.S. and foreign steel industries. In 2008, approximately 22% of the coal production and 30% of the coal royalty revenues from our properties were from metallurgical coal. Since the amount of steel that is produced is tied to global economic conditions, a decline in those conditions could result in the decline of steel, coke and metallurgical coal production. Since metallurgical coal is priced higher than steam coal, some mines on our properties may only operate profitably if all or a portion of their production is sold as metallurgical coal. If these mines are unable to sell metallurgical coal, they may not be economically viable and may close. The

steel industry has increasingly relied on electric arc furnaces or pulverized coal processes to make steel. If this trend continues, the amount of metallurgical coal that our lessees mine could decrease.

 

Some of our lessees may be adversely impacted by the current deterioration in the credit markets.

 

Many of our lessees finance their activities through cash flow from operations, the incurrence of debt, the use of commercial paper or the issuance of equity. Recently, there has been a significant deterioration in the credit markets and the availability of credit. The lack of availability of debt or equity financing may result in a significant reduction in our lessees’ spending related to development of new mines or expansion of existing mines on our properties. It may also impact our lessees’ ability to pay current obligations and continue ongoing operations on our properties. Any significant reductions in spending related to our lessees’ operations could have a material adverse effect on our revenues and ability to pay our quarterly distributions.

 

Increased regulation of greenhouse gas emissions could cause a reduction in the use of coal as a fuel source, which could result in lower coal production by our lessees and reduce our coal royalty revenues.

 

Recent scientific studies have suggested that emissions of certain gases, commonly referred to as “greenhouse gases” and including carbon dioxide, may be contributing to warming of the Earth’s atmosphere. Combustion of fossil fuels, such as coal results in the emission of carbon dioxide into the atmosphere. The U.S. Congress is considering legislation to reduce emissions of greenhouse gases. President Obama has expressed support for legislation to restrict or regulate emissions of greenhouse gases. More than one-third of the states already have begun implementing legal measures to reduce emissions of greenhouse gases. In addition, the Supreme Court’s holding in 2007 in Massachusetts, et al. v. EPA that greenhouse gases including carbon dioxide fall under the federal Clean Air Act’s definition of “air pollutant” may also result in future regulation of carbon dioxide and other greenhouse gas emissions from stationary sources such as power plants. In July 2008, EPA released an “Advance Notice of Proposed Rulemaking” regarding possible future regulation of greenhouse gas emissions under the Clean Air Act, in response to the Court’s decision in Massachusetts. Although the notice did not propose any specific new regulatory requirements for greenhouse gases, it indicates that federal regulation of greenhouse gas emissions could occur in the near future even if Congress does not adopt new legislation specifically addressing emissions of greenhouse gases. In addition, there have been an increasing number of challenges and objections to permits for the construction of new coal-fired power plants based on concerns over greenhouse gas emissions, and permits for several proposed new coal-fired power plants have been denied or delayed.

 

Future federal and state initiatives to control carbon dioxide emissions could result in increased costs associated with coal consumption, such as costs to install additional controls to reduce carbon dioxide emissions or costs to purchase emissions reduction credits to comply with future emissions trading programs. Such increased costs for coal consumption could result in reduced demand for coal and some customers switching to alternative sources of fuel, which could have a material adverse effect on our business, financial condition, and results of operations. In addition, increased difficulty or inability of our customers to obtain permits for construction of new or expansion of existing coal-fired power plants could adversely affect demand for our coal and have an adverse effect on our business and results of operation.

 

Our lessees’ coal mining operations are subject to operating risks that could result in lower coal royalty revenues to us.

 

Our coal royalty revenues are largely dependent on our lessees’ level of production from our coal reserves. The level of our lessees’ production is subject to operating conditions or events beyond their or our control including:

 

 

 

Our lessees may also incur costs and liabilities resulting from claims for damages to property or injury to persons arising from their operations. If our lessees are pursued for these sanctions, costs and liabilities, their mining operations and, as a result, our coal royalty revenues could be adversely affected.

 

There have been several recent lawsuits filed that will potentially make it much more difficult for our lessees to obtain permits to mine our coal. The most likely impact of the litigation will be to increase both the cost to our lessees of acquiring permits and the time that it will take for them to receive the permits. These conditions may increase our lessees’ cost of mining and delay or halt production at particular mines for varying lengths of time or permanently. Any interruptions to the production of coal from our reserves may reduce our coal royalty revenues.

 

Our lessees are subject to federal, state and local laws and regulations that may limit their ability to produce and sell coal from our properties.

 

Our lessees may incur substantial costs and liabilities under increasingly strict federal, state and local environmental, health and safety laws, including regulations and governmental enforcement policies. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, the imposition of cleanup and site restoration costs and liens, the issuance of injunctions to limit or cease operations, the suspension or revocation of permits and other enforcement measures that could have the effect of limiting production from our lessees’ operations.

 

New environmental legislation, new regulations and new interpretations of existing environmental laws, including regulations governing permitting requirements, could further regulate or tax the coal industry and may also require our lessees to change their operations significantly, to incur increased costs or to obtain new or different permits, any of which could decrease our coal royalty revenues.

 

If our lessees do not manage their operations well, their production volumes and our coal royalty revenues could decrease.

 

We depend on our lessees to effectively manage their operations on our properties. Our lessees make their own business decisions with respect to their operations within the constraints of their leases, including decisions relating to:

 

 

 

A failure on the part of one of our lessees to make coal royalty payments could give us the right to terminate the lease, repossess the property and enforce payment obligations under the lease. If we repossessed any of our properties, we would seek a replacement lessee. We might not be able to find a replacement lessee and, if we did, we might not be able to enter into a new lease on favorable terms within a reasonable period of time. In addition, the existing lessee could be subject to bankruptcy proceedings that could further delay the execution of a new lease or the assignment of the existing lease to another operator. If we enter into a new lease, the replacement operator might not achieve the same levels of production or sell coal at the same price as the lessee it replaced. In addition, it may be difficult for us to secure new or replacement lessees for small or isolated coal reserves, since industry trends toward consolidation favor larger-scale, higher-technology mining operations in order to increase productivity.

 

Fluctuations in transportation costs and the availability or reliability of transportation could reduce the production of coal mined from our properties.

 

Transportation costs represent a significant portion of the total delivered cost of coal for the customers of our lessees. Increases in transportation costs could make coal a less competitive source of energy or could make coal produced by some or all of our lessees less competitive than coal produced from other sources. On the other hand, significant decreases in transportation costs could result in increased competition for our lessees from coal producers in other parts of the country.

 

Our lessees depend upon railroads, barges, trucks and beltlines to deliver coal to their customers. Disruption of those transportation services due to weather-related problems, mechanical difficulties, strikes, lockouts, bottlenecks and other events could temporarily impair the ability of our lessees to supply coal to their customers. Our lessees’ transportation providers may face difficulties in the future that may impair the ability of our lessees to supply coal to their customers, resulting in decreased coal royalty revenues to us.

 

Lessees could satisfy obligations to their customers with coal from properties other than ours, depriving us of the ability to receive amounts in excess of minimum royalty payments.

 

Coal supply contracts do not generally require operators to satisfy their obligations to their customers with coal mined from specific reserves. Several factors may influence a lessee’s decision to supply its customers with coal mined from properties we do not own or lease, including the royalty rates under the lessee’s lease with us, mining conditions, mine operating costs, cost and availability of transportation, and customer coal specifications. If a lessee satisfies its obligations to its customers with coal from properties we do not own or lease, production on our properties will decrease, and we will receive lower coal royalty revenues.

 

Our growing coal infrastructure business exposes us to risks that we do not experience in the royalty business.

 

Over the past three years, we have acquired several coal preparation plants, load-out facilities and beltlines. These facilities are subject to mechanical and operational breakdowns that could halt or delay the transportation and processing of coal, and therefore decrease our revenues. In addition, we have assumed the operating risks associated with the transportation infrastructure at two mines. Although we have sub-contracted out this work to a third party, we could experience increased costs as well as increased liability exposure associated with operating these facilities.

 

Our reserve estimates depend on many assumptions that may be inaccurate, which could materially adversely affect the quantities and value of our reserves.

 

Our reserve estimates may vary substantially from the actual amounts of coal our lessees may be able to economically recover from our reserves. There are numerous uncertainties inherent in estimating quantities of

reserves, including many factors beyond our control. Estimates of coal reserves necessarily depend upon a number of variables and assumptions, any one of which may, if incorrect, result in an estimate that varies considerably from actual results. These factors and assumptions relate to:

 

 

Actual production, revenue and expenditures with respect to our reserves will likely vary from estimates, and these variations may be material. As a result, you should not place undue reliance on our coal reserve data that is included in this report.

 

A lessee may incorrectly report royalty revenues, which might not be identified by our lessee audit process or our mine inspection process or, if identified, might be identified in a subsequent period.

 

We depend on our lessees to correctly report production and royalty revenues on a monthly basis. Our regular lessee audits and mine inspections may not discover any irregularities in these reports or, if we do discover errors, we might not identify them in the reporting period in which they occurred. Any undiscovered reporting errors could result in a loss of coal royalty revenues and errors identified in subsequent periods could lead to accounting disputes as well as disputes with our lessees.

 

Risks Inherent in an Investment in Natural Resource Partners L.P.

 

Cash distributions are not guaranteed and may fluctuate with our performance and the establishment of financial reserves.

 

Because distributions on the common units are dependent on the amount of cash we generate, distributions may fluctuate based on our performance. The actual amount of cash that is available to be distributed each quarter will depend on numerous factors, some of which are beyond our control and the control of the general partner. Cash distributions are dependent primarily on cash flow, including cash flow from financial reserves and working capital borrowings, and not solely on profitability, which is affected by non-cash items. Therefore, cash distributions might be made during periods when we record losses and might not be made during periods when we record profits.

 

Cost reimbursements due to our general partner may be substantial and will reduce our cash available for distribution to unitholders.

 

Prior to making any distribution on the common units, we will reimburse our general partner and its affiliates, including officers and directors of the general partner, for all expenses incurred on our behalf. The reimbursement of expenses and the payment of fees could adversely affect our ability to make distributions. The general partner has sole discretion to determine the amount of these expenses. In addition, our general partner and its affiliates may provide us services for which we will be charged reasonable fees as determined by the general partner.

 

Unitholders may not be able to remove our general partner even if they wish to do so.

 

Our general partner manages and operates NRP. Unlike the holders of common stock in a corporation, unitholders have only limited voting rights on matters affecting our business. Unitholders have no right to elect the general partner or the directors of the general partner on an annual or any other basis.

 

Furthermore, if unitholders are dissatisfied with the performance of our general partner, they currently have little practical ability to remove our general partner or otherwise change its management. Our general

partner may not be removed except upon the vote of the holders of at least 662/3% of our outstanding units (including units held by our general partner and its affiliates). Because the owners of our general partner, along with directors and executive officers and their affiliates, own a significant percentage of our outstanding common units, the removal of our general partner would be difficult without the consent of both our general partner and its affiliates.

 

In addition, the following provisions of our partnership agreement may discourage a person or group from attempting to remove our general partner or otherwise change our management:

 

 

As a result of these provisions, the price at which the common units will trade may be lower because of the absence or reduction of a takeover premium in the trading price.

 

We may issue additional common units without unitholder approval, which would dilute a unitholder’s existing ownership interests.

 

Our general partner may cause us to issue an unlimited number of common units, without unitholder approval (subject to applicable NYSE rules). We may also issue at any time an unlimited number of equity securities ranking junior or senior to the common units without unitholder approval (subject to applicable NYSE rules). The issuance of additional common units or other equity securities of equal or senior rank will have the following effects:

 

 

Our general partner has a limited call right that may require unitholders to sell their units at an undesirable time or price.

 

If at any time our general partner and its affiliates own 80% or more of the common units, the general partner will have the right, but not the obligation, which it may assign to any of its affiliates, to acquire all, but not less than all, of the remaining common units held by unaffiliated persons at a price generally equal to the then current market price of the common units. As a result, unitholders may be required to sell their common units at a time when they may not desire to sell them or at a price that is less than the price they would like to receive. They may also incur a tax liability upon a sale of their common units.

 

Unitholders may not have limited liability if a court finds that unitholder actions constitute control of our business.

 

Our general partner generally has unlimited liability for our obligations, such as our debts and environmental liabilities, except for those contractual obligations that are expressly made without recourse to our general partner. Under Delaware law, however, a unitholder could be held liable for our obligations to the same extent as a general partner if a court determined that the right of unitholders to remove our general partner or to take other action under our partnership agreement constituted participation in the “control” of our business. In addition, Section 17-607 of the Delaware Revised Uniform Limited Partnership Act provides that under some circumstances, a unitholder may be liable to us for the amount of a distribution for a period of three years from the date of the distribution.

Conflicts of interest could arise among our general partner and us or the unitholders.

 

These conflicts may include the following:

 

 

The control of our general partner may be transferred to a third party without unitholder consent. A change of control may result in defaults under certain of our debt instruments and the triggering of payment obligations under compensation arrangements.

 

Our general partner may transfer its general partner interest to a third party in a merger or in a sale of all or substantially all of its assets without the consent of our unitholders. Furthermore, there is no restriction in our partnership agreement on the ability of the general partner of our general partner from transferring its general partnership interest in our general partner to a third party. The new owner of our general partner would then be in a position to replace the board of directors and officers with its own choices and to control their decisions and actions.

 

In addition, a change of control would constitute an event of default under our revolving credit agreement. During the continuance of an event of default under our revolving credit agreement, the administrative agent may terminate any outstanding commitments of the lenders to extend credit to us and/or declare all amounts payable by us immediately due and payable. A change of control also may trigger payment obligations under various compensation arrangements with our officers.

 

Tax Risks to Common Unitholders

 

Our tax treatment depends on our status as a partnership for federal income tax purposes as well as our not being subject to a material amount of entity-level taxation by individual states. If the IRS were to treat us as a corporation for federal income tax purposes or we were to become subject to additional amounts of entity-level taxation for state tax purposes, then our cash available for distribution to you would be substantially reduced.

 

The anticipated after-tax economic benefit of an investment in our common units depends largely on our being treated as a partnership for federal income tax purposes. We have not requested, and do not plan to request, a ruling from the IRS on this or any other tax matter affecting us.

 

Despite the fact that we are a limited partnership under Delaware law, it is possible in certain circumstances for a partnership such as ours to be treated as a corporation for federal income tax purposes. Although we do not believe based upon our current operations that we are so treated, a change in our business (or a change in current law) could cause us to be treated as a corporation for federal income tax purposes or otherwise subject us to taxation as an entity.

If we were treated as a corporation for federal income tax purposes, we would pay federal income tax on our taxable income at the corporate tax rate, which is currently a maximum of 35%, and would likely pay state income tax at varying rates. Distributions to you would generally be taxed again as corporate distributions, and no income, gains, losses or deductions would flow through to you. Because a tax would be imposed upon us as a corporation, our cash available for distribution to you would be substantially reduced. Therefore, treatment of us as a corporation would result in a material reduction in the anticipated cash flow and after-tax return to the unitholders, likely causing a substantial reduction in the value of our common units.

 

Current law may change so as to cause us to be treated as a corporation for federal income tax purposes or otherwise subject us to entity-level taxation. At the federal level, legislation has been proposed that would eliminate partnership tax treatment for certain publicly traded partnerships. Although such legislation would not apply to us as currently proposed, it could be amended prior to enactment in a manner that does apply to us. We are unable to predict whether any of these changes or other proposals will ultimately be enacted. Moreover, any modification to the federal income tax laws and interpretations thereof may or may not be applied retroactively. Any such changes could negatively impact of an investment in our common units. At the state level, because of widespread state budget deficits and other reasons, several states are evaluating ways to subject partnerships to entity-level taxation through the imposition of state income, franchise and other forms of taxation. Imposition of such a tax on us by any state will reduce the cash available for distribution to you.

 

Our partnership agreement provides that if a law is enacted or existing law is modified or interpreted in a manner that subjects us to taxation as a corporation or otherwise subjects us to entity-level taxation for federal, state or local income tax purposes, the minimum quarterly distribution amount and the target distribution amounts may be adjusted to reflect the impact of that law on us.

 

If the IRS contests the federal income tax positions we take, the market for our common units may be adversely impacted and the cost of any IRS contest will reduce our cash available for distribution to you.

 

We have not requested a ruling from the IRS with respect to our treatment as a partnership for federal income tax purposes or any other matter affecting us. The IRS may adopt positions that differ from the positions we take. It may be necessary to resort to administrative or court proceedings to sustain some or all of the positions we take. A court may not agree with some or all of the positions we take. Any contest with the IRS may materially and adversely impact the market for our common units and the price at which they trade. In addition, our costs of any contest with the IRS will be borne indirectly by our unitholders and our general partner because the costs will reduce our cash available for distribution.

 

You will be required to pay taxes on your share of our income even if you do not receive any cash distributions from us.

 

Because our unitholders will be treated as partners to whom we will allocate taxable income which could be different in amount than the cash we distribute, you will be required to pay any federal income taxes and, in some cases, state and local income taxes on your share of our taxable income even if you receive no cash distributions from us. You may not receive cash distributions from us equal to your share of our taxable income or even equal to the actual tax liability that results from that income.

 

Tax gain or loss on the disposition of our common units could be more or less than expected.

 

If you sell your common units, you will recognize a gain or loss equal to the difference between the amount realized and your tax basis in those common units. Because distributions in excess of your allocable share of our net taxable income decrease your tax basis in your common units, the amount, if any, of such prior excess distributions with respect to the units you sell will, in effect, become taxable income to you if you sell such units at a price greater than your tax basis in those units, even if the price you receive is less than your original cost. Furthermore, a substantial portion of the amount realized, whether or not representing gain, may be taxed as ordinary income due to potential recapture items, including depletion and depreciation recapture. In addition, because the amount realized includes a unitholder’s share of our nonrecourse liabilities, if you sell your units, you may incur a tax liability in excess of the amount of cash you receive from the sale.

Tax-exempt entities and non-U.S. persons face unique tax issues from owning our common units that may result in adverse tax consequences to them.

 

Investment in common units by tax-exempt entities, such as employee benefit plans and individual retirement accounts (known as IRAs), and non-U.S. persons raises issues unique to them. For example, virtually all of our income allocated to organizations that are exempt from federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and will be taxable to them. Distributions to non-U.S. persons will be reduced by withholding taxes at the highest applicable effective tax rate, and non-U.S. persons will be required to file United States federal tax returns and pay tax on their share of our taxable income. If you are a tax exempt entity or a non-U.S. person, you should consult your tax advisor before investing in our common units.

 

We will treat each purchaser of common units as having the same tax benefits without regard to the actual common units purchased. The IRS may challenge this treatment, which could adversely affect the value of the common units.

 

Because we cannot match transferors and transferees of common units and because of other reasons, we will adopt depreciation and amortization positions that may not conform to all aspects of existing Treasury Regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefits available to you. It also could affect the timing of these tax benefits or the amount of gain from your sale of common units and could have a negative impact on the value of our common units or result in audit adjustments to your tax returns.

 

We prorate our items of income, gain, loss and deduction between transferors and transferees of our units each month based upon the ownership of our units on the first day of each month, instead of on the basis of the date a particular unit is transferred. The IRS may challenge this treatment, which could change the allocation of items of income, gain, loss and deduction among our unitholders.

 

We prorate our items of income, gain, loss and deduction between transferors and transferees of our units each month based upon the ownership of our units on the first day of each month, instead of on the basis of the date a particular unit is transferred. The use of this proration method may not be permitted under existing Treasury Regulations. If the IRS were to challenge this method or new Treasury Regulations were issued, we may be required to change the allocation of items of income, gain, loss and deduction among our unitholders.

 

A unitholder whose units are loaned to a “short seller” to cover a short sale of units may be considered as having disposed of those units. If so, he would no longer be treated for tax purposes as a partner with respect to those units during the period of the loan and may recognize gain or loss from the disposition.

 

Because a unitholder whose units are loaned to a “short seller” to cover a short sale of units may be considered as having disposed of the loaned units, he may no longer be treated for tax purposes as a partner with respect to those units during the period of the loan to the short seller and the unitholder may recognize gain or loss from such disposition. Moreover, during the period of the loan to the short seller, any of our income, gain, loss or deduction with respect to those units may not be reportable by the unitholder and any cash distributions received by the unitholder as to those units could be fully taxable as ordinary income. Unitholders desiring to assure their status as partners and avoid the risk of gain recognition from a loan to a short seller are urged to modify any applicable brokerage account agreements to prohibit their brokers from borrowing their units.

 

We will adopt certain valuation methodologies that may result in a shift of income, gain, loss and deduction between the general partner and the unitholders. The IRS may challenge this treatment, which could adversely affect the value of the common units.

 

When we issue additional units or engage in certain other transactions, we will determine the fair market value of our assets and allocate any unrealized gain or loss attributable to our assets to the capital accounts of our unitholders and our general partner. Our methodology may be viewed as understating the value of our

assets. In that case, there may be a shift of income, gain, loss and deduction between certain unitholders and the general partner, which may be unfavorable to such unitholders. Moreover, under our valuation methods, subsequent purchasers of common units may have a greater portion of their Internal Revenue Code Section 743(b) adjustment allocated to our tangible assets and a lesser portion allocated to our intangible assets. The IRS may challenge our valuation methods, or our allocation of the Section 743(b) adjustment attributable to our tangible and intangible assets, and allocations of income, gain, loss and deduction between the general partner and certain of our unitholders.

 

A successful IRS challenge to these methods or allocations could adversely affect the amount of taxable income or loss being allocated to our unitholders. It also could affect the amount of gain from our unitholders’ sale of common units and could have a negative impact on the value of the common units or result in audit adjustments to our unitholders’ tax returns without the benefit of additional deductions.

 

The sale or exchange of 50% or more of our capital and profits interests during any twelve-month period will result in the termination of our partnership for federal income tax purposes.

 

We will be considered to have terminated for federal income tax purposes if there is a sale or exchange of 50% or more of the total interests in our capital and profits within a twelve-month period. Our termination would, among other things, result in the closing of our taxable year for all unitholders, which would result in us filing two tax returns (and our unitholders could receive two Schedules K-1) for one fiscal year and could result in a significant deferral of depreciation deductions allowable in computing our taxable income. In the case of a unitholder reporting on a taxable year other than a fiscal year ending December 31, the closing of our taxable year may also result in more than twelve months of our taxable income or loss being includable in his taxable income for the year of termination. Our termination currently would not affect our classification as a partnership for federal income tax purposes, but instead, we would be treated as a new partnership for tax purposes. If treated as a new partnership, we must make new tax elections and could be subject to penalties if we are unable to determine that a termination occurred.

 

As a result of investing in our common units, you may become subject to state and local taxes and return filing requirements in jurisdictions where we operate or own or acquire property.

 

In addition to federal income taxes, you will likely be subject to other taxes, including foreign, state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we conduct business or own property now or in the future, even if you do not live in any of those jurisdictions. You will likely be required to file foreign, state and local income tax returns and pay state and local income taxes in some or all of these various jurisdictions. Further, you may be subject to penalties for failure to comply with those requirements. We own property and conduct business in a number of states in the United States. Most of these states impose an income tax on individuals, corporations and other entities. As we make acquisitions or expand our business, we may own assets or conduct business in additional states that impose a personal income tax. It is your responsibility to file all United States federal, foreign, state and local tax returns.

 

 

None.

 

 

Major Coal Properties

 

The following is a summary of our major coal producing properties in each region. For information regarding our Coal Reserves and Production as well as other information related to our coal properties, please see “Item 1. Business.”

Northern Appalachia

 

Beaver Creek.  The Beaver Creek property is located in Grant and Tucker Counties, West Virginia. In 2008, 2.5 million tons were produced from this property. This property includes the reserves which were acquired in our Mettiki acquisition in 2007. We lease this property to Mettiki Coal, LLC, a subsidiary of Alliance Resource Partners L.P. Coal is produced from an underground longwall mine. It is transported by truck to a preparation plant operated by the lessee. Coal is shipped primarily by truck to the Mount Storm power plant of Dominion Power.

 

AFG-Southwest PA.  The AFG property is located in Washington County, Pennsylvania. We acquired this property in November 2005. In 2008, 1.1 million tons were produced from this property. We lease this property to Conrhein Coal Company, a subsidiary of Consol Energy. Coal is produced from an underground mine and is transported by belt to a preparation plant operated by the lessee. Coal is shipped by both the CSX and Norfolk Southern railways to utility customers, such as American Electric Power and Allegheny Energy.

 

Kingwood.  The Kingwood property is located in Preston County, West Virginia. In 2008, 898,000 tons were produced from this property. We lease this property to Kingwood Mining Company, LLC, a subsidiary of Alpha Natural Resources L.P. Although our lease is still in effect, in December 2008 Alpha announced that it was closing its mine on the Kingwood property.

 

Gatling.  The Gatling property is located in Mason County, West Virginia. We acquired the property in January 2007 as part of the larger Cline transaction. In 2008, 629,000 tons were produced from the property. Coal from this property is mined from an underground mine and transported via belt line to a preparation plant on the property. Clean coal is transported via beltline either directly to American Electric Power or to a barge loading facility.

 

The map on the following page shows the location of our properties in Northern Appalachia.

 

Central Appalachia

 

VICC/Alpha.  The VICC/Alpha property is located in Wise, Dickenson, Russell and Buchanan Counties, Virginia. In 2008, 5.9 million tons were produced from this property. We primarily lease this property to Alpha Land and Reserves, LLC, a subsidiary of Alpha Natural Resources, Inc. Production comes from both underground and surface mines and is trucked to one of four preparation plants. Coal is shipped via both the CSX and Norfolk Southern railroads to utility and metallurgical customers. Major customers include American Electric Power, Southern Company, Tennessee Valley Authority, VEPCO and U.S. Steel and to various export metallurgical customers.

 

D.D. Shepard.  The D.D. Shepard property is located in Boone County, West Virginia. This property is primarily leased to a subsidiary of Patriot Coal Corp. We acquired the property in 2006. In 2008, 5.0 million tons were produced from the property. Both steam and metallurgical coal are produced by the lessees from

underground and surface mines. Coal is transported from the mines via belt or truck to preparation plants on the property. Coal is shipped via the CSX railroad to customers such as AEP and to various export metallurgical customers.

 

Lynch.  The Lynch property is located in Harlan and Letcher Counties, Kentucky. In 2008, 4.9 million tons were produced from this property. We primarily lease the property to Resource Development, LLC, an independent coal producer. Production comes from both underground and surface mines. Coal is transported by truck to a preparation plant on the property and is shipped primarily on the CSX railroad to utility customers such as Georgia Power and Orlando Utilities.

 

Dingess-Rum.  The Dingess-Rum property is located in Logan, Clay and Nicholas Counties, West Virginia. This property is leased to subsidiaries of Massey Energy and Patriot Coal. We acquired this property in 2007. In 2008, 4.5 million tons were produced from the property. Both steam and metallurgical coal are produced from underground and surface mines and transported by belt or truck to preparation plants on the property. Coal is shipped via the CSX railroad to steam customers such as American Electric Power, Dayton Power and Light, Detroit Edison and to various export metallurgical customers.

 

VICC/Kentucky Land.  The VICC/Kentucky Land property is located primarily in Perry, Leslie and Pike Counties, Kentucky. In 2008, 2.9 million tons were produced from this property. Coal is produced from a number of lessees from both underground and surface mines. Coal is shipped primarily by truck but also on the CSX and Norfolk Southern railroads to customers such as Southern Company, Tennessee Valley Authority, and American Electric Power.

 

Pardee.  The Pardee property is located in Letcher County, Kentucky and Wise County Virginia. In 2008, 2.3 million tons were produced from this property. We lease the property to Ark Land Company, a subsidiary of Arch Coal, Inc. Production comes from underground and surface mines and is transported by truck or beltline to a preparation plant on the property and shipped primarily on the Norfolk Southern railroad to utility customers such as Georgia Power and the Tennessee Valley Authority and domestic and export metallurgical customers such as Algoma Steel and Arcelor.

 

Lone Mountain.  The Lone Mountain property is located in Harlan County, Kentucky. In 2008, 2.2 million tons were produced from this property. We lease the property to Ark Land Company, a subsidiary of Arch Coal, Inc. Production comes from underground mines and is transported primarily by beltline to a preparation plant on adjacent property and shipped on the Norfolk Southern or CSX railroads to utility customers such as Georgia Power and the Tennessee Valley Authority.

 

The map on the following page shows the location of our properties in Central Appalachia.

 

Southern Appalachia

 

BLC Properties.  The BLC properties are located in Kentucky, Tennessee, and Alabama. In 2008, 3.2 million tons were produced from these properties. We lease this property to a number of operators including Appolo Fuels Inc., Bell County Coal Corporation and Kopper-Glo Fuels. Production comes from both underground and surface mines and is trucked to preparation plants and loading facilities operated by our lessees. Coal is transported by truck and is shipped via both CSX and Norfolk & Southern railroads to utility and industrial customers. Major customers include Southern Company, South Carolina Electric & Gas, and numerous medium and small industrial customers.

 

Oak Grove.  The Oak Grove property is located in Jefferson County, Alabama. In 2008, 959,000 tons were produced from this property. We lease the property to Oak Grove Resources, LLC, a subsidiary of Cliffs Natural Resources, Inc. Production comes from an underground mine and is transported primarily by beltline to a preparation plant. The metallurgical coal is then shipped via railroad and barge to both domestic and export customers.

 

The map below shows the location of our properties in Southern Appalachia.

 

 

Illinois Basin

 

Williamson Development.  The Williamson Development property is located in Franklin and Williamson Counties, Illinois. The property is under lease to an affiliate of the Cline Group, and in 2008, 5.5 million tons were mined on the property. This production is from a longwall mine. Production is shipped primarily via CN railroad to customers such as Duke and to various export customers.

 

Hocking-Wolford/Cummings.  The Hocking-Wolford property and the Cummings property are both located in Sullivan County, Indiana. In 2008, 1.4 million tons were produced from the properties. Both properties are under common lease to Black Beauty Coal Company, an affiliate of Peabody Energy Corporation. Production is currently from a surface mine, and coal is shipped by truck and railroad to customers such as Public Service of Indiana and Indianapolis Power and Light.

 

Sato.  The Sato property is located in Jackson County, Illinois. In 2008, 938,000 tons were produced from the property. The property is under lease to Knight Hawk Coal LLC, an independent coal producer. Production is currently from a surface mine, and coal is shipped by truck and railroad to various Midwest and southeast utilities.

 

The map below shows the location of our properties in Illinois Basin.

 

 

Northern Powder River Basin

 

Western Energy.  The Western Energy property is located in Rosebud and Treasure Counties, Montana. In 2008, 6.2 million tons were produced from our property. Western Energy Company, a subsidiary of Westmoreland Coal Company, has two coal leases on the property. Western Energy produces coal by surface dragline mining, and the coal is transported by either truck or beltline to the four-unit 2,200-megawatt Colstrip generation station located at the mine mouth and by the Burlington Northern Santa Fe railroad to Minnesota Power. A small amount of coal is transported by truck to other customers.

The map below shows the location of our properties in Northern Powder River Basin.

 

 

Title to Property

 

Of the approximately 2.1 billion tons of proven and probable coal reserves that we owned or controlled as of December 31, 2008, we owned approximately 99% of the reserves in fee. We lease approximately 2 million tons, or 1% of our reserves, from unaffiliated third parties. We believe that we have satisfactory title to all of our mineral properties, but we have not had a qualified title company confirm this belief. Although title to these properties is subject to encumbrances in certain cases, such as customary easements, rights-of-way, interests generally retained in connection with the acquisition of real property, licenses, prior reservations, leases, liens, restrictions and other encumbrances, we believe that none of these burdens will materially detract from the value of our properties or from our interest in them or will materially interfere with their use in the operations of our business.

 

For most of our properties, the surface, oil and gas and mineral or coal estates are owned by different entities. Some of those entities are our affiliates. State law and regulations in most of the states where we do business require the oil and gas owner to coordinate the location of wells so as to minimize the impact on the intervening coal seams. We do not anticipate that the existence of the severed estates will materially impede development of the minerals on our properties.

 

We are involved, from time to time, in various legal proceedings arising in the ordinary course of business. While the ultimate results of these proceedings cannot be predicted with certainty, we believe these claims will not have a material effect on our financial position, liquidity or operations.

 

 

None.

 

 

Our common units are listed and traded on the New York Stock Exchange (NYSE) under the symbol “NRP”. As of February 11, 2009, there were approximately 28,300 beneficial and registered holders of our common units. The computation of the approximate number of unitholders is based upon a broker survey.

 

The following table sets forth the high and low sales prices per common unit, as reported on the New York Stock Exchange Composite Transaction Tape from January 1, 2007 to December 31, 2008, and the quarterly cash distribution declared and paid with respect to each quarter per common unit. All historical trading prices that occurred prior to April 18, 2007 have been adjusted to reflect the two-for-one unit split that occurred on that date.

 

 

Our general partner holds 65% of our incentive distribution rights (IDRs) and the remaining IDRs are held by affiliates of our general partner. The IDRs entitle the holders to incentive distributions if the amount we distribute with respect to any quarter exceeds the specified target levels shown below:

 

Percentage Allocations of Available Cash from Operating Surplus

 

Cash Distributions to Partners

 

 

We must distribute all of our cash on hand at the end of each quarter, less cash reserves established by our general partner. We refer to this cash as “available cash” as that term is defined in our partnership agreement. The amount of available cash may be greater than or less than the minimum quarterly distribution. Provisions of our credit facility and note purchase agreement may restrict our ability to make distributions under certain limited circumstances. In general, we intend to increase our cash distributions in the future assuming we are able to increase our “available cash” from operations and through acquisitions, provided there is no adverse change in operations, economic conditions and other factors. However, we cannot guarantee that future distributions will continue at such levels.

 

The following table shows selected historical financial data for Natural Resource Partners L.P. for the periods and as of the dates indicated. We derived the information in the following tables from, and the information should be read together with and is qualified in its entirety by reference to, the historical financial statements and the accompanying notes included in Item 8, “Financial Statements and Supplementary Data.” These tables should be read together with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

NATURAL RESOURCE PARTNERS L.P.

 

 

The following discussion of the financial condition and results of operations should be read in conjunction with the historical financial statements and notes thereto included elsewhere in this filing. For more detailed information regarding the basis of presentation for the following financial information, see the Notes to the Consolidated Financial Statements.

 

Executive Overview

 

Our Business

 

We engage principally in the business of owning, managing and leasing coal properties in the three major coal-producing regions of the United States: Appalachia, the Illinois Basin and the Western United States. As of December 31, 2008, we owned or controlled approximately 2.1 billion tons of proven and probable coal reserves, and 59% of our reserves were low sulfur coal. We lease coal reserves to experienced mine operators under long-term leases that grant the operators the right to mine and sell coal from our reserves in exchange for royalty payments.

 

Our revenue and profitability are dependent on our lessees’ ability to mine and market our coal reserves. Most of our coal is produced by large companies, many of which are publicly traded, with experienced and professional sales departments. A significant portion of our coal is sold by our lessees under coal supply contracts that have terms of one year or more. However, over the long term, our coal royalty revenues are affected by changes in the market price of coal.

 

In our coal royalty business, our lessees make payments to us based on the greater of a percentage of the gross sales price or a fixed royalty per ton of coal they sell, subject to minimum monthly, quarterly or annual payments. These minimum royalties are generally recoupable over a specified period of time (usually three to five years) if sufficient royalties are generated from coal production in those future periods. We do not recognize these minimum coal royalties as revenue until the applicable recoupment period has expired or they are recouped through production. Until recognized as revenue, these minimum royalties are recorded as deferred revenue, a liability on our balance sheet.

 

In addition to coal royalty revenues, we generated approximately 22% of our 2008 revenues from other sources, compared to 20% in 2007. The increase represents our commitment to continuing to diversify our sources of revenue. These other sources include: aggregate royalties; coal processing and transportation fees; rentals; royalties on oil and gas; overriding royalties; wheelage payments and timber.

 

Current Market Conditions and our Liquidity

 

Our business model depends in large part on our ability to make acquisitions and finance those acquisitions through the issuance of long-term debt or equity in the capital markets. As of December 31, 2008, we had in excess of $250 million in available capacity under our existing credit facility, as well as approximately $90 million in cash. Following our Macoupin acquisition in January 2009, we had $169 million in available capacity under the facility, and have committed to fund another $60 million as certain performance milestones are met in connection with the development of the Shay No. 1 mine in Illinois. Our credit facility does not mature until March 2012. In addition, because we amortize substantially all of our long-term debt, we have no need to pay off or refinance any debt obligations in 2009, other than our regularly scheduled principal payments. However, given the number of potential acquisitions that we evaluate on a regular basis, we could use up this capacity in a short period of time. In the past, we have been able to pay down our credit line by issuing equity or long-term senior notes at attractive interest rates.

 

As a result of concerns about the stability of financial markets generally and the solvency of counterparties specifically, the cost of obtaining money from the credit markets has increased as many lenders and institutional investors have increased interest rates, enacted tighter lending standards, and refused to refinance existing debt at maturity at all or on similar terms. Although the lenders under our credit facility have indicated to us that they intend to honor their commitments, we are aware of some cases in which lenders have refused to provide funding to borrowers in spite of existing commitments.

If funding is not available when needed, or is available only on unfavorable terms, we may be unable to complete acquisitions or otherwise take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on our revenues, results of operations and quarterly distributions.

 

Current Results and Outlook

 

As of December 31, 2008, our reserves were subject to 201 leases with 73 lessees. For the year ended December 31, 2008, our lessees produced 60.6 million tons of coal generating $226.3 million in coal royalty revenues from our properties, and our total revenues were $291.7 million.

 

Global and domestic prices for physical delivery of coal by our lessees remained high during most of 2008, resulting in a substantial increase in our royalty per ton in Appalachia and the Illinois Basin compared to the same period in 2007. In recent months, however, commodity prices, including coal prices, have declined in the financial markets, and we expect to see lower prices for coal that is not contracted in 2009. As of the end of 2008, our lessees had contracted to sell approximately 90% of their steam coal in 2009 and approximately 60% of their metallurgical coal. We also expect that some metallurgical coal customers will decline to take delivery of contracted tons in 2009, which could ultimately result in a decline in production from our properties.

 

Even though coal royalty revenues from our Appalachian properties represented 66% of our total revenues in 2008, this percentage has continued to decline and we are diligently working to diversify our holdings by expanding our presence in the Illinois Basin, where our coal royalty revenues nearly tripled over 2007. Through our relationship with the Cline Group, we expect our Illinois assets to contribute even more significantly to our total revenues in 2009.

 

In addition, in 2008 we benefited from our significant exposure to metallurgical coal. Approximately 30% of our coal royalty revenues and 22% of the related production during 2008 were from metallurgical coal, which is used in the production of steel. The U.S. coal market, especially for Appalachian metallurgical coal, is being impacted by the global economic slowdown and it is difficult to determine how this will impact coal production from our properties or the prices that our lessees receive for the sale of the coal.

 

In addition to the issues being created by the current economy, the political, legal and regulatory environment is becoming increasingly difficult for the coal industry. The recent judicial decisions by the Southern District of West Virginia regarding permits issued under Section 404 of the Clean Water Act in West Virginia, together with a similar lawsuit filed in Kentucky, have created substantial regulatory uncertainty. If these cases have adverse outcomes, it could have long-term negative implications for the future of all coal mining in Appalachia, which would impact our coal royalty revenues derived from that region. The Fourth Circuit reversed both orders on February 13, 2009, but the order will not take effect until a “mandate” is issued by that Court. A mandate will not issue for at least 14 days and could be delayed by a request for reconsideration. Thereafter, the original plaintiffs have 90 days in which to ask the United States Supreme Court to review the decision. If the Fourth Circuit decision stands, then a backlog of permits pending before the Corps of Engineers may ease.

 

Distributable Cash Flow

 

Under our partnership agreement, we are required to distribute all of our available cash each quarter. Because distributable cash flow is a significant liquidity metric that is an indicator of our ability to generate cash flows at a level that can sustain or support an increase in quarterly cash distributions paid to our partners, we view it as the most important measure of our success as a company. Distributable cash flow is also the quantitative standard used in the investment community with respect to publicly traded partnerships.

 

Our distributable cash flow represents cash flow from operations less actual principal payments and cash reserves set aside for future scheduled principal payments on our senior notes. Although distributable cash flow is a “non-GAAP financial measure,” we believe it is a useful adjunct to net cash provided by operating activities under GAAP. Distributable cash flow is not a measure of financial performance under GAAP and

should not be considered as an alternative to cash flows from operating, investing or financing activities. Distributable cash flow may not be calculated the same for NRP as for other companies. A reconciliation of distributable cash flow to net cash provided by operating activities is set forth below.

 

Reconciliation of GAAP “Net cash provided by operating activities”
to Non-GAAP “Distributable cash flow”

 

 

Recent Acquisitions

 

We are a growth-oriented company and have closed a number of acquisitions over the last several years. Our most recent acquisitions are briefly described below.

 

Macoupin.  On January 27, 2009, we acquired coal reserves and infrastructure assets related to the Shay No. 1 mine in Macoupin County, Illinois for $143.7 million from Macoupin Energy, LLC, an affiliate of the Cline Group. Upon closing, we paid $83.7 million and will make three subsequent payments of $20 million each in 2009 based upon performance measures associated with the development of a new mine.

 

Coal Properties.  In October 2008, we acquired an overriding royalty for $5.5 million from Coal Properties Inc. This overriding royalty agreement is for coal reserves located in the states of Illinois and Kentucky.

 

Mid-Vol Coal Preparation Plant.  In April 2008, we completed construction of a coal preparation plant and coal handling infrastructure under our memorandum of understanding with Taggart Global USA, LLC. The total cost to build the facilities was $12.7 million.

 

Licking River Preparation Plant.  In March 2008, we signed an agreement for the construction of a coal preparation plant facility under our memorandum of understanding with Taggart Global USA, LLC. The cost for the facility, located in Eastern Kentucky, is estimated to be approximately $8.7 million, of which $8.4 million had been paid as of December 31, 2008 for construction costs incurred to date.

 

Massey Energy.  In December 2007, we acquired an overriding royalty interest from Massey Energy for $6.6 million. The override relates to low-vol metallurgical coal reserves that are being produced from the Pinnacle Mine in West Virginia.

 

National Resources.  In December 2007, we acquired approximately 17.5 million tons of high quality low-vol metallurgical coal reserves in Wyoming and McDowell Counties in West Virginia from National Resources, Inc., a subsidiary of Bluestone Coal. Total consideration for this purchase was $27.2 million.

 

Cheyenne Resources.  In August 2007, we acquired a rail load-out facility and rail spur from Cheyenne Resources for $5.5 million. This facility is located in Perry County, Kentucky.

 

Mettiki.  In April 2007, we acquired approximately 35 million tons of coal reserves in Grant and Tucker Counties in Northern West Virginia in exchange for 500,000 common units and approximately $10.2 million in cash. The assets were acquired from Western Pocahontas Properties Limited Partnership under our omnibus

agreement. Western Pocahontas Properties has retained an overriding royalty interest on approximately 16 million tons of non-permitted reserves, which will be offered to us at the time those reserves are permitted.

 

Westmoreland.  In February 2007, we acquired an overriding royalty from Westmoreland Coal Company for $12.7 million on 225 million tons of coal that are being mined by a subsidiary of Peabody Energy in the Powder River Basin. The reserves are located in the Rocky Butte Reserve in Wyoming.

 

Dingess-Rum.  In January 2007, we acquired 92 million tons of coal reserves and approximately 33,700 acres of surface and timber in Logan, Clay and Nicholas Counties in West Virginia from Dingess-Rum Properties, Inc. As consideration for the acquisition, we issued 4,800,000 common units to Dingess-Rum.

 

Cline.  On January 2007, we acquired 49 million tons of coal reserves in Williamson County, Illinois and Mason County, West Virginia that are leased to affiliates of The Cline Group. In addition, we acquired transportation assets and related infrastructure at those mines. As consideration for the transaction we issued 8,910,072 units representing limited partner interests in NRP.

 

Critical Accounting Policies

 

Coal and Aggregate Royalties.  Coal and aggregate royalty revenues are recognized on the basis of tons of mineral sold by the Partnership’s lessees and the corresponding revenue from those sales. Generally, the lessees make payments to the Partnership based on the greater of a percentage of the gross sales price or a fixed price per ton of mineral they sell, subject to minimum annual or quarterly payments.

 

Coal Processing and Transportation Fees.  Coal processing fees are recognized on the basis of tons of coal processed through the facilities by the Partnership’s lessees and the corresponding revenue from those sales. Generally, the lessees of the coal processing facilities make payments to us based on the greater of a percentage of the gross sales price or a fixed price per ton of coal that is processed and sold from the facilities. The coal processing leases are structured in a manner so that the lessees are responsible for operating and maintenance expenses associated with the facilities. Coal transportation fees are recognized on the basis of tons of coal transported over the beltlines. Under the terms of the transportation contracts, we receive a fixed price per ton for all coal transported on the beltlines.

 

Oil and Gas Royalties.  Oil and gas royalties are recognized on the basis of volume of hydrocarbons sold by lessees and the corresponding revenue from those sales. Generally, the lessees make payments based on a percentage of the selling price. Some are subject to minimum annual payments or delay rentals.

 

Minimum Royalties.  Most of our lessees must make minimum annual or quarterly payments which are generally recoupable over certain time periods. These minimum payments are recorded as deferred revenue. The deferred revenue attributable to the minimum payment is recognized as revenues either when the lessee recoups the minimum payment through production or when the period during which the lessee is allowed to recoup the minimum payment expires.

 

Depreciation and Depletion.  We depreciate our plant and equipment on a straight line basis over the estimated useful life of the asset. We deplete mineral properties on a units-of-production basis by lease, based upon minerals mined in relation to the net cost of the mineral properties and estimated proven and probable tonnage in those properties. We estimate proven and probable mineral reserves with the assistance of third-party mining consultants, and we use estimation techniques and recoverability assumptions. We update our estimates of mineral reserves periodically and this may result in material adjustments to mineral reserves and depletion rates that we recognize prospectively. Historical revisions have not been material. Timberlands are stated at cost less depletion. We determine the cost of the timber harvested based on the volume of timber harvested in relation to the amount of estimated net merchantable volume by geographic areas. We estimate our timber inventory using statistical information and data obtained from physical measurements and other information gathering techniques. We update these estimates annually, which may result in adjustments of timber volumes and depletion rates that we recognize prospectively. Changes in these estimates have no effect on our cash flow.

Asset Impairment.  If facts and circumstances suggest that a long-lived asset or an intangible asset may be impaired, the carrying value is reviewed. If this review indicates that the value of the asset will not be recoverable, as determined based on projected undiscounted cash flows related to the asset over its remaining life, then the carrying value of the asset is reduced to its estimated fair value.

 

Share-Based Payments.  We account for awards under our Long-Term Incentive Plan under Financial Accounting Standards Board Statement No. 123R, Share Based Payment. FAS 123R provides that grants must be accounted for using the fair value method, which requires us to estimate the fair value of the grant and charge or credit the estimated fair value to expense over the service or vesting period of the grant based on fluctuations in value. In addition, FAS 123R requires that estimated forfeitures be included in the periodic computation of the fair value of the liability and that the fair value be recalculated at each reporting date over the service or vesting period of the grant.

 

Recent Accounting Pronouncements

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value methods. This statement does not require any new fair value measurements. Instead, it provides for increased consistency and comparability in fair value measurements and for expanded disclosure surrounding the fair value measurements whenever other standards require (or permit) the measurement of assets or liabilities at fair value. This statement is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Accordingly, we adopted SFAS No. 157 on January 1, 2008. The adoption of this statement did not have a material impact our financial position, results of operations or cash flows. In February 2008, the FASB issued FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157, which delays the effective date of SFAS No. 157 for one year for nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).

 

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. We did not elect the fair value option for any financial assets or financial liabilities as of January 1, 2008, the effective date of the standard.

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations”. The statement establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. SFAS No. 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. Accordingly, any business combinations we complete in 2009 or thereafter will be recorded and disclosed following the new standard. We expect SFAS No. 141R to have an impact our consolidated financial statements when we complete a business combination, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions we consummate after the effective date.

 

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements,” which provides guidance for accounting and reporting of non-controlling (minority) interests in consolidated financial statements. The statement is effective for fiscal years and interim periods within fiscal years beginning on or after December 15, 2008. At the current time, we do not hold minority interests in subsidaries, therefore we expect that SFAS No. 160 will have no impact on our financial condition or results of operations.

 

In March 2008, the FASB issued EITF No. 07-4, which considers whether the incentive distribution rights, or IDRs, of a master limited partnership represent a participating security when considered in the calculation of earnings per unit under the two-class method. The EITF considers whether the partnership

agreement contains any contractual limitations concerning distributions to IDR holders that would impact the amount of earnings to allocate to the IDR holders for each reporting period. If distributions are contractually limited to the IDR holders’ share of currently designated available cash for distributions as defined under the partnership agreement, undistributed earnings in excess of available cash should not be allocated to the IDR holders. In addition, the EITF presents alternative methods for inclusion of IDRs in the earnings per unit computation. When cash distributions exceed net income for the period, net income should be reduced by the distributions made to the holders of the general partner interest, the holders of the limited partner interests and IDR holders for the period. The provisions of EITF No. 07-4 are effective for fiscal years beginning after December 15, 2008. We are currently evaluating the requirements of EITF No. 07-4 to determine the impact, if any, on our consolidated financial statements.

 

In June 2008, the FASB issued Staff Position (“FSP”) No. EITF No. 03-6-1 “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities.” This FSP affects entities that accrue cash dividends on share-based payment awards during the awards’ service period when the dividends do not need to be returned if the employees forfeit the award. The FSP requires that all outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends participate in undistributed earnings with common shareholders and are considered participating securities. Because the awards are considered participating securities, the issuing entity is required to apply the two-class method of computing basic and diluted earnings per share. The provisions of FSP No. EITF No. 03-6-1 are effective for fiscal years beginning after December 15, 2008. We are currently evaluating the requirements of FSP No. EITF 03-6-1, to determine the impact and do not expect this to have any impact on our consolidated financial statements.

Results of Operations

 

Summary of 2008 and 2007 Royalties and Production

 

Coal Royalty Revenues and Production

 

Coal royalty revenues comprised approximately 78% and 80% of our total revenue for the years ended December 31, 2008 and 2007, respectively. The following is a discussion of the coal royalty revenues and production derived from our major coal producing regions:

 

Appalachia.  Primarily as result of higher coal prices, coal royalty revenues increased by $40.7 million in 2008, even though production was slightly lower than in 2007. The decline in production was primarily the result of a longwall mine in Northern Appalachia that had a substantial percentage of its production come from adjacent property.

 

Illinois Basin.  Coal royalty revenues were $13.7 million higher in 2008 and production was 4.6 million tons higher. As a result of a full year of operation at our Williamson property, coal royalty revenues attributable to that property were $15.8 million for the year ended December 31, 2008 compared to $2.6 million for 2007. Similarly, production attributable to that property was 5.5 million tons for 2008 compared to 1.0 million tons in 2007.

 

Northern Powder River Basin.  The increase in both coal royalty revenues of $0.5 million and production of 0.4 million tons on our Western Energy property was due to the normal variations that occur due to the checkerboard nature of our ownership.

 

Aggregates Royalty Revenues and Production

 

In December 2006, we acquired aggregate reserves located in DuPont, Washington. For the year ended December 31, 2008 and 2007, we recorded $6.3 million and $6.8 million, respectively in royalty revenues from aggregates and had production of 4.8 million tons and 5.7 million tons for each of these years. Nearly all of this production and revenue is attributable to the aggregate reserves in DuPont, Washington. In 2008 we received a bonus royalty payment of $2.8 million compared to $0.7 million in 2007.

Summary of 2007 and 2006 Royalties and Production

 

 

Coal Royalty Revenues and Production

 

Coal royalty revenues comprised approximately 80% and 87% of our total revenue for the years ended December 31, 2007 and 2006, respectively. The following is a discussion of the coal royalty revenues and production derived from our major coal producing regions:

 

Appalachia.  As a result of higher coal prices and several large acquisitions completed since the end of 2006, both coal royalty revenues and production in Appalachia increased in 2007. The coal royalty

revenues attributable to acquisitions completed in 2007 in Central Appalachia alone were $33.5 million and production attributable to those acquisitions was 9.2 million tons.

 

Illinois Basin.  Coal royalty revenues and production attributable to our Williamson and James River acquisitions was $2.9 million and production attributable to those acquisitions was 1.2 million tons in 2007.

 

Northern Powder River Basin.  The decrease in production on our Western Energy property was due to the normal variations that occur due to the checkerboard nature of our ownership, but was partially offset by higher prices being received by our lessee.

 

Aggregates Royalty Revenues and Production

 

In December 2006, we acquired aggregate reserves located in DuPont, Washington. For the year ended December 31, 2007, we recorded $6.8 million in royalty revenues from aggregates and had production of 5.7 million tons.

 

Other Operating Results for the Years Ended December 31, 2008, 2007 and 2006

 

Other revenues.  Other revenues declined in 2008 since there were no material sales of land and timber. Included in other revenues for the year ended December 31, 2007 is a gain of $1.2 million from the sale of surface acreage in Wise County, Virginia. We received total proceeds in 2007 of $1.4 million related to this sale. During 2006, we recorded the sale of timber and related surface acreage located on our property in Wise and Dickenson Counties, Virginia. We received proceeds from the sale of $7.1 million, resulting in a gain of $3.5 million for the year ended December 31, 2006.

 

Operating costs and expenses.  Included in total expenses are:

 

 

Interest Expense.  Interest expense was $28.4 million, $28.7 million and $16.4 million for the years ended December 31, 2008, 2007 and 2006, respectively. Interest expense is attributed to borrowings on our credit facility and the issuance of senior notes used to fund acquisitions in 2006 and 2007. During 2008, we did not incur any additional debt to fund acquisitions.

 

Related Party Transactions

 

Partnership Agreement

 

Our general partner does not receive any management fee or other compensation for its management of Natural Resource Partners L.P. However, in accordance with our partnership agreement, we reimburse our

general partner and its affiliates for expenses incurred on our behalf. All direct general and administrative expenses are charged to us as incurred. We also reimburse indirect general and administrative costs, including certain legal, accounting, treasury, information technology, insurance, administration of employee benefits and other corporate services incurred by our general partner and its affiliates. Cost reimbursements due our general partner may be substantial and will reduce our cash available for distribution to unitholders. The reimbursements to our general partner for services performed by Western Pocahontas Properties and Quintana Minerals Corporation totaled $5.6 million in 2008, $5.0 million in 2007 and $4.0 million in 2006. For additional information, please read “Certain Relationships and Related Transactions, and Director Independence — Omnibus Agreement.”

 

The Cline Group

 

On January 4, 2007, we acquired four entities from Adena Minerals, LLC that own approximately 49 million tons of coal reserves in West Virginia and Illinois that are leased to active mining operations, as well as associated transportation and infrastructure assets at those mines. The reserves consist of 37 million tons at Adena’s Gatling mining operation in Mason County, West Virginia and 12 million tons adjacent to reserves currently owned by us at Adena affiliate Williamson Energy’s Pond Creek No. 1 mine in Southern Illinois. In consideration therefor, Adena received 8,910,072 units, now representing a 13.8% limited partner interest in NRP and a 22% interest in our general partner and in our outstanding incentive distribution rights. Adena is an affiliate of The Cline Group, a private coal company that controls over 3 billion tons of coal reserves in the Illinois and Northern Appalachian coal basins. In 2008 and 2007, we received $27.9 million and $12.1 million, respectively in revenues from affiliates of The Cline Group. In addition we also received $9.8 million in advance minimum royalty payments that have not been recouped. At December 31, 2008, NRP had accounts receivable from the Cline Group of $2.3 million.

 

Second Contribution Agreement.  At the closing, we executed a Second Contribution Agreement, pursuant to which we agreed to acquire from Adena two entities that own coal reserves in Meigs County, Ohio and associated transportation infrastructure. As consideration, Adena will receive 4,560,000 common units, as well as an additional 9% interest in the general partner and our outstanding incentive distribution rights. The transactions contemplated by the Second Contribution Agreement are expected to close in the second quarter of 2009.

 

Restricted Business Contribution Agreement.  As part of the transaction, Christopher Cline, Foresight Reserves LP and Adena (collectively, the “Cline Entities”) and NRP entered into a Restricted Business Contribution Agreement. Pursuant to the terms of the Restricted Business Contribution Agreement, the Cline Entities and their affiliates are obligated to offer to NRP any business owned, operated or invested in by the Cline Entities, subject to certain exceptions, that either (a) owns, leases or invests in hard minerals or (b) owns, operates, leases or invests in certain transportation infrastructure relating to future mine developments by the Cline Entities in Illinois. In addition, we created an area of mutual interest (the “AMI”) encompassing the properties to be acquired by us pursuant to the Contribution Agreement and the Second Contribution Agreement. During the applicable term of the Restricted Business Contribution Agreement, the Cline Entities will be obligated to contribute to us any coal reserves held or acquired by the Cline Entities or their affiliates within the AMI. In connection with the offer of any additional mineral properties by the Cline Entities to NRP, the parties to the Restricted Business Contribution Agreement will negotiate and agree upon an area of mutual interest around such minerals, which will supplement and become a part of the AMI.

 

Investor Rights Agreement.  Also at the closing, NRP and certain affiliates and Adena executed an Investor Rights Agreement pursuant to which Adena was granted certain management rights. Specifically, Adena has the right to name two directors (one of which will be independent) to the board of directors of our managing general partner so long as Adena beneficially owns either 5% of our limited partnership interest or 5% of our general partner’s limited partnership interest and so long as certain rights under our managing general partner’s LLC Agreement have not been exercised by Adena or Corbin J. Robertson, Jr. Adena nominated J. Matthew Fifield, Managing Director of Adena, and Leo A. Vecellio to serve as the two directors. Mr. Vecellio serves on our Compensation, Nominating and Governance Committee. Adena also has the right,

pursuant to the terms of the Investor Rights Agreement, to withhold its consent to the sale or other disposition of any entity or assets contributed by the Cline entities to NRP.

 

Quintana Capital Group GP, Ltd.

 

Corbin J. Robertson, Jr. is a principal in Quintana Capital Group GP, Ltd., which controls several private equity funds focused on investments in the energy business. In connection with the formation of Quintana Capital, NRP’s Board of Directors adopted a formal conflicts policy that establishes the opportunities that will be pursued by NRP and those that will be pursued by Quintana Capital. The governance documents of Quintana Capital’s affiliated investment funds reflect the guidelines set forth in NRP’s conflicts policy. For a more detailed description of this policy, please see “Item 13. Certain Relationships and Related Transactions, and Director Independence” in this Form 10-K.

 

In February 2007, a fund controlled by Quintana Capital acquired a 43% membership interest in Taggart Global, including the right to nominate two members of Taggart’s 5-person board of directors. NRP currently has a memorandum of understanding with Taggart Global pursuant to which the two companies have agreed to jointly pursue the development of coal handling and preparation plants. NRP will own and lease the plants to Taggart Global, which will design, build and operate the plants. The lease payments are based on the sales price for the coal that is processed through the facilities. NRP and Taggart Global have jointly developed four such plants in West Virginia. In 2008, NRP received $5.0 million in revenue from Taggart compared to $2.7 million in 2007. At December 31, 2008, NRP had accounts receivable from Taggart of $0.4 million.

 

In June 2007, a fund controlled by Quintana Capital acquired Kopper-Glo, a small coal mining company with operations in Tennessee. Kopper-Glo is an NRP lessee that paid us $1.4 million in coal royalties in 2008 and $1.9 million in 2007. At December 31, 2008, NRP had accounts receivable of $0.1 million from Kopper-Glo.

 

Office Building in Huntington, West Virginia

 

In 2008, Western Pocahontas Properties Limited Partnership completed construction of an office building in Huntington, West Virginia. On January 1, 2009, we began leasing substantially all of two floors of the building from Western Pocahontas at market rates. The terms of the lease were approved by our conflicts committee.

 

Liquidity and Capital Resources

 

Cash Flows and Capital Expenditures

 

We satisfy our working capital requirements with cash generated from operations. Since our initial public offering, we have financed our property acquisitions with available cash, borrowings under our revolving credit facility, and the issuance of our senior notes and additional units. Our capital expenditures, other than for acquisitions, have historically been minimal. However, given the current global financial crisis, we cannot be certain that proceeds from capital markets issuances will be available or sufficient to finance future acquisitions. While our ability to satisfy our debt service obligations and pay distributions to our unitholders depends in large part on our future operating performance, our ability to make acquisitions will depend on prevailing economic conditions in the financial markets as well as the coal industry and other factors, some of which are beyond our control.

 

We had approximately $90 million of cash available at the end of the year and do not currently have any need to raise capital through the equity markets. Following our Macoupin acquisition in January 2009, we had $169 million in available capacity under the facility, and have committed to fund another $60 million as certain performance milestones are met in connection with the development of the Shay No. 1 mine in Illinois.

 

Our credit facility does not expire until 2012, and our credit ratios are well within our debt covenants for both our credit facility and our outstanding senior notes. In addition, we are amortizing substantially all of our long-term debt and have no immediate need to refinance. For a more complete discussion of factors that will affect our liquidity, please read “Item 1A. Risk Factors”. During 2008, we reviewed our banking relationships and our internal policies regarding deposit concentrations with specific attention to effectively managing risk in the current banking environment.

Net cash provided by operations for the years ended December 31, 2008, 2007 and 2006 was $230.0 million, $168.2 million and $138.8 million, respectively. A significant portion of our cash provided by operations is generated from coal royalty revenues.

 

Net cash used in investing activities for the years December 31, 2008, 2007 and 2006 was $9.8 million, $79.6 million and $257.7 million, respectively. In each of those years, substantially all of our investing activities consisted of acquiring coal reserves and other mineral rights, but we spent $10.6 million, $16.7 million and $24.2 million in 2008, 2007 and 2006, respectively, on coal infrastructure acquisitions. Also, in December 2006, we acquired aggregate reserves for $23.5 million and sold non-core timberlands for gross proceeds totaling $7.1 million. In 2007, we sold surface acreage in Wise County, Virginia for gross proceeds of $1.4 million.

 

Net cash used for financing activities for the year ended December 31, 2008 and 2007 was $188.5 million and $96.2 million, respectively. Net cash generated from financing was $137.2 million for the year ended December 31, 2006. All loan proceeds from our credit facility have been used to fund acquisitions. We issued $50 million in senior notes in 2006 and $225 million in senior notes in 2007. We used those proceeds to pay down our credit facility. We also made $17.2 million in principal payments on our senior notes in 2008. We made principal payments of $9.4 million in each of the years ended December 31, 2007 and 2006. Cash distributions to our partners were $171.3 million, $147.0 million and $92.4 million for the years ended December 31, 2008, 2007 and 2006, respectively. In 2007, as a part of the Dingess-Rum and Mettiki acquisitions we received a $2.6 million cash contribution from our general partner to maintain its 2% interest.

 

Contractual Obligations and Commercial Commitments

 

Long-Term Debt

 

At December 31, 2008, our debt consisted of:

 

 

Other than the 5.55% senior notes due 2013, which have only semi-annual interest payments, all of our senior notes require annual principal payments in addition to semi-annual interest payments. The scheduled principal payments on the 5.05% senior notes due 2020 began in July 2008, and the principal payments on the 5.82% senior notes due 2024 do not begin until March 2010. We also make annual principal and interest payments on the utility local improvement obligation.

 

Credit Facility.  In March 2007, we completed an amendment and extension of our $300 million revolving credit facility. The amendment extends the term of the credit facility by two years to 2012 and lowers the borrowing costs and commitment fees. The amendment also includes an option to increase the credit facility up to a maximum of $450 million under the same terms. However, under current market conditions, we cannot be certain that our lenders will elect to participate in the accordion feature. To the extent the lenders decline to participate, we may attempt to bring new lenders into the facility, but we cannot make any assurance that any new lenders would elect to participate or that the excess credit capacity will be available to us at all or on the existing terms.

Our obligations under the credit facility are unsecured but are guaranteed by our operating subsidiaries. We may prepay all loans at any time without penalty. Indebtedness under the revolving credit facility bears interest, at our option, at either:

 

 

We incur a commitment fee on the unused portion of the revolving credit facility at a rate ranging from 0.10% to 0.30% per annum.

 

The credit agreement contains covenants requiring us to maintain:

 

 

Senior Notes.  NRP Operating LLC issued the senior notes under a note purchase agreement. The senior notes are unsecured but are guaranteed by our operating subsidiaries. We may prepay the senior notes at any time together with a make-whole amount (as defined in the note purchase agreement). If any event of default exists under the note purchase agreement, the noteholders will be able to accelerate the maturity of the senior notes and exercise other rights and remedies.

 

The note purchase agreement contains covenants requiring our operating subsidiary to:

 

 

The following table reflects our long-term non-cancelable contractual obligations as of December 31, 2008 (in millions):

 

 

 

 

Two-for-One Limited Partner Unit Split

 

On April 18, 2007, we completed a two-for-one split of all of our limited partner units. Accordingly, all unit and per unit amounts reported reflect the split.

Off-Balance Sheet Transactions

 

We do not have any off-balance sheet arrangements with unconsolidated entities or related parties and accordingly, there are no off-balance sheet risks to our liquidity and capital resources from unconsolidated entities.

 

Inflation

 

Inflation in the United States has been relatively low in recent years and did not have a material impact on operations for the years ended December 31, 2008, 2007 and 2006.

 

Environmental

 

The operations our lessees conduct on our properties are subject to federal and state environmental laws and regulations. As an owner of surface interests in some properties, we may be liable for certain environmental conditions occurring on the surface properties. The terms of substantially all of our coal leases require the lessee to comply with all applicable laws and regulations, including environmental laws and regulations. Lessees post reclamation bonds assuring that reclamation will be completed as required by the relevant permit, and substantially all of the leases require the lessee to indemnify us against, among other things, environmental liabilities. Some of these indemnifications survive the termination of the lease. Because we have no employees, employees of Western Pocahontas Properties Limited Partnership make regular visits to the mines to ensure compliance with lease terms, but the duty to comply with all regulations rests with the lessees. We believe that our lessees will be able to comply with existing regulations and do not expect any lessee’s failure to comply with environmental laws and regulations to have a material impact on our financial condition or results of operations. We have neither incurred, nor are aware of, any material environmental charges imposed on us related to our properties for the period ended December 31, 2008. We are not associated with any environmental contamination that may require remediation costs. However, our lessees do conduct reclamation work on the properties under lease to them. Because we are not the permittee of the mines being reclaimed, we are not responsible for the costs associated with these reclamation operations. In addition, West Virginia has established a fund to satisfy any shortfall in reclamation obligations.

 

 

We are exposed to market risk, which includes adverse changes in commodity prices and interest rates.

 

Commodity Price Risk

 

We are dependent upon the efficient marketing of the coal mined by our lessees. Our lessees sell the coal under various long-term and short-term contracts as well as on the spot market. We estimate that over 80% of our coal is currently sold by our lessees under coal supply contracts that have terms of one year or more. Current conditions in the coal industry may make it difficult for our lessees to extend existing contracts or enter into supply contracts with terms of one year or more. Our lessees’ failure to negotiate long-term contracts could adversely affect the stability and profitability of our lessees’ operations and adversely affect our coal royalty revenues. If more coal is sold on the spot market, coal royalty revenues may become more volatile due to fluctuations in spot coal prices.

 

Interest Rate Risk

 

Our exposure to changes in interest rates results from our current borrowings under our credit facility, which are subject to variable interest rates based upon LIBOR or the federal funds rate plus an applicable margin. Management monitors interest rates and may enter into interest rate instruments to protect against increased borrowing costs. At December 31, 2008, we had $48 million outstanding in variable interest debt. If interest rates were to increase by 1%, annual interest expense would increase $480,000, assuming the same principal amount remained outstanding during the year.

 

INDEX TO FINANCIAL STATEMENTS

 

NATURAL RESOURCE PARTNERS L.P.
CONSOLIDATED FINANCIAL STATEMENTS

 

The Partners of Natural Resource Partners L.P.

 

We have audited the accompanying consolidated balance sheets of Natural Resource Partners L.P. as of December 31, 2008 and 2007, and the related consolidated statements of income, partners’ capital and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Natural Resource Partners L.P. at December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Natural Resource Partners L.P.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2009 expressed an unqualified opinion thereon.

 

ERNST & YOUNG LLP

 

Houston, Texas

February 27, 2009

NATURAL RESOURCE PARTNERS L.P.

 

CONSOLIDATED BALANCE SHEETS