ITEM 1. BUSINESS
General
We are a Delaware limited partnership listed on the NASDAQ Global Select Market under the ticker symbol “AHGP.” We own, directly and indirectly, 100% of the members’ interest in MGP, the managing general partner of ARLP. We completed our initial public offering (“IPO”) in May 2006.
Currently, our only cash-generating assets are our ownership interests in ARLP, which consist of the following:
· a 1.98% general partner interest in ARLP, which we hold through our 100% ownership interest in MGP;
· the incentive distribution rights (“IDRs”) in ARLP;
· 31,088,338 common units of ARLP, representing approximately 42.0% of the common units of ARLP as of December 31, 2014; and
· a 0.001% managing interest in Alliance Coal, which we hold through our 100% ownership interest in MGP.
We are owned 100% by our limited partners. Our general partner, AGP, has a non-economic interest in us and is owned by Joseph W. Craft III, the Chairman, President and Chief Executive Officer of AGP as well as the President and Chief Executive Officer and a Director of MGP.
The following diagram depicts our organization and ownership as of December 31, 2015:
(1) The units held by SGP and most of the units held by the Management Group (some of whom are current or former members of management) are subject to a transfer restrictions agreement that, subject to a number of exceptions (including certain transfers by Mr. Craft in which the other parties to the agreement are entitled or required to participate), prohibits the transfer of such units unless approved by a majority of the disinterested members of the board of directors of AGP (“Board of Directors”) pursuant to certain procedures set forth in the agreement or as otherwise provided in the agreement. Certain provisions of the transfer restrictions agreement may cause the parties to it to comprise a group under Rule 13d-5(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Our primary business objective is to increase our cash distributions to our unitholders by actively assisting ARLP in executing its business strategy. ARLP’s business strategy is to create sustainable, capital-efficient growth in available cash to maximize its distributions to its unitholders.
The ARLP Partnership is a diversified producer and marketer of coal primarily to major United States (“U.S.”) utilities and industrial users. The ARLP Partnership began mining operations in 1971 and, since then, has grown through
acquisitions and internal development to become the second-largest coal producer in the eastern U.S. At December 31, 2015, the ARLP Partnership had approximately 1.8 billion tons of coal reserves in Illinois, Indiana, Kentucky, Maryland, Pennsylvania and West Virginia. In 2015, the ARLP Partnership sold a record 40.2 million tons of coal and produced a record 41.2 million tons of coal, of which 3.6% was low-sulfur coal, 17.3% was medium-sulfur coal and 79.1% was high-sulfur coal. In 2015, the ARLP Partnership sold 96.1% of its total tons to electric utilities, of which 99.7% was sold to utility plants with installed pollution control devices. These devices, also known as scrubbers, eliminate substantially all emissions of sulfur dioxide. The ARLP Partnership classifies low-sulfur coal as coal with a sulfur content of less than 1%, medium-sulfur coal as coal with a sulfur content of 1% to 2%, and high-sulfur coal as coal with a sulfur content of greater than 2%.
The ARLP Partnership operates ten underground mining complexes in Illinois, Indiana, Kentucky, Maryland and West Virginia. The ARLP Partnership also operates a coal loading terminal on the Ohio River at Mt. Vernon, Indiana. The ARLP Partnership’s mining activities are conducted in two geographic regions commonly referred to in the coal industry as the Illinois Basin and Appalachian regions. The ARLP Partnership has grown historically primarily through expansion of its operations by adding and developing mines and coal reserves in these regions.
Our internet address is http://www.ahgp.com, and we make available free of charge on our website our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, Forms 3, 4 and 5 for our Section 16 filers and other documents (and amendments and exhibits, such as press releases, to such filings) as soon as reasonably practicable after we electronically file with or furnish such material to the SEC. Information on our website or any other website is not incorporated by reference into this report and does not constitute a part of this report.
The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including us, that file electronically with the SEC. The public can obtain any documents that we file with the SEC at http://www.sec.gov.
Mining Operations
The ARLP Partnership produces a diverse range of steam coal with varying sulfur and heat contents, which enables it to satisfy the broad range of specifications required by its customers. The following chart summarizes the ARLP Partnership’s coal production by region for the last five years.
1. As a result of acquiring the remaining equity interests in White Oak Resources LLC (“White Oak”), the ARLP Partnership included White Oak Mine No. 1 (now known as Hamilton Mine No. 1) as part of the Illinois Basin production starting on July 31, 2015. Please see “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions” for a discussion on this acquisition.
2. Other includes production from the former Pontiki Coal, LLC (“Pontiki”) mine, which is located in Martin County, Kentucky. The Pontiki mine ceased operations in November 2013. As a result of the cessation the ARLP Partnership evaluated the ongoing management of the mining operations and coal sales efforts to ensure that resources were appropriately allocated to maximize overall results. Based on this evaluation, the ARLP Partnership has realigned the management of its operating and marketing teams and we have changed our reportable segment presentation to reflect this realignment.
The following map shows the location of the ARLP Partnership’s mining complexes and projects:
Illinois Basin Operations
The ARLP Partnership’s Illinois Basin mining operations are located in western Kentucky, southern Illinois and southern Indiana. As of February 11, 2016, the ARLP Partnership had 2,955 employees, and operates seven mining complexes in the Illinois Basin.
Dotiki Complex. The ARLP Partnership’s subsidiary, Webster County Coal, LLC (“Webster County Coal”), operates Dotiki, which is an underground mining complex located near the city of Providence in Webster County, Kentucky. The complex was opened in 1966, and the ARLP Partnership purchased the mine in 1971. The Dotiki complex utilizes continuous mining units employing room-and-pillar mining techniques to produce high-sulfur coal. In connection with the transition of mining operations from the No. 9 and the No. 11 seams, where it has historically operated, to the No. 13 seam, Dotiki constructed a new preparation plant that became operational in early 2012 and has throughput capacity of 1,800 tons of raw coal per hour. Coal from the Dotiki complex is shipped via the CSX Transportation, Inc. (“CSX”) and Paducah & Louisville Railway, Inc. (“PAL”) railroads and by truck on U.S. and state highways directly to customers or to various transloading facilities, including the ARLP Partnership’s Mt. Vernon Transfer Terminal, LLC (“Mt. Vernon”) transloading facility, for barge deliveries.
Warrior Complex. The ARLP Partnership’s subsidiary, Warrior Coal, LLC (“Warrior”), operates an underground mining complex located near the city of Madisonville in Hopkins County, Kentucky. The Warrior complex was opened in 1985, and the ARLP Partnership acquired it in February 2003. Warrior utilizes continuous mining units employing room-and-pillar mining techniques to produce high-sulfur coal. Warrior completed construction of a new preparation plant in 2009, which has throughput capacity of 1,200 tons of raw coal per hour. Warrior’s production is shipped via the CSX and PAL railroads and by truck on U.S. and state highways directly to customers or to various transloading facilities, including the Mt. Vernon transloading facility, for barge deliveries. Warrior is currently in the process of transitioning from the No. 11 seam to the No. 9 seam, which is expected to continue over the next one to two years.
Pattiki Complex. The ARLP Partnership’s subsidiary, White County Coal, LLC (“White County Coal”), operates Pattiki, an underground mining complex located near the city of Carmi in White County, Illinois. The ARLP Partnership began construction of the complex in 1980 and has operated it since its inception. The Pattiki complex utilizes continuous mining units employing room-and-pillar mining techniques to produce high-sulfur coal. The preparation plant has throughput capacity of 1,000 tons of raw coal per hour. Coal from the Pattiki complex is shipped via the Evansville Western Railway, Inc. (“EVW”) railroad directly, or via connection with the CSX railroad, to customers or to various transloading facilities, including the Mt. Vernon transloading facility, for barge deliveries.
Hopkins Complex. The Hopkins complex, which the ARLP Partnership acquired in January 1998, is located near the city of Madisonville in Hopkins County, Kentucky. The ARLP Partnership’s subsidiary, Hopkins County Coal, LLC (“Hopkins County Coal”) operates the Elk Creek underground mine using continuous mining units employing room-and-pillar mining techniques to produce high-sulfur coal. Coal produced from the Elk Creek mine is processed and shipped through Hopkins County Coal’s preparation plant, which has throughput capacity of 1,200 tons of raw coal per hour. Elk Creek’s production is shipped via the CSX and PAL railroads and by truck on U.S. and state highways directly to customers or to various transloading facilities, including the Mt. Vernon transloading facility, for barge deliveries. The Elk Creek mine is currently expected to cease production in early 2016. Hopkins County Coal also controls the Fies property for potential future development.
Gibson Complex. The ARLP Partnership’s subsidiary, Gibson County Coal, LLC (“Gibson County Coal”), operates the Gibson North mine, an underground mine located near the city of Princeton in Gibson County, Indiana. The Gibson North mine began production in November 2000 and utilizes continuous mining units employing room-and-pillar mining techniques to produce medium-sulfur coal. The Gibson North mine was idled on December 18, 2015. The Gibson North mine’s preparation plant, which is leased from an affiliate, has throughput capacity of 700 tons of raw coal per hour. Production from the Gibson North mine is either shipped by truck on U.S. and state highways or transported by rail on the CSX and Norfolk Southern Railway Company (“NS”) railroads directly to customers or to various transloading facilities, including the Mt. Vernon transloading facility, for barge deliveries.
Gibson County Coal operates the Gibson South mine, also located near the city of Princeton in Gibson County, Indiana. The Gibson South mine is an underground mine and utilizes continuous mining units employing room-and-pillar mining techniques to produce medium-sulfur coal. The Gibson South mine’s preparation plant has throughput capacity of 1,800 tons of raw coal per hour. Production from the Gibson South mine is shipped by truck on U.S. and state highways or transported by rail from the Gibson North rail loadout facility directly to customers or to various transloading facilities, including the Mt. Vernon transloading facility, for barge delivery. Production from the mine began in April 2014.
River View Complex. The ARLP Partnership’s subsidiary, River View Coal, LLC (“River View”), operates the River View mine, which is located in Union County, Kentucky and is currently the largest room-and-pillar underground coal mine in the U.S. The River View mine began production in 2009, and utilizes continuous mining units to produce high-sulfur coal. River View’s preparation plant has throughput capacity of 2,700 tons of raw coal per hour. Coal produced from the River View mine is transported by overland belt to a barge loading facility on the Ohio River.
Sebree Mining Complex. On April 2, 2012, the ARLP Partnership acquired substantially all of Green River Collieries, LLC’s (“Green River”) assets related to its coal mining business and operations located in Webster and Hopkins Counties, Kentucky, including the Onton No. 9 mining complex (“Onton mine”). The Onton mine is operated by the ARLP Partnership’s subsidiary, Sebree Mining, LLC (“Sebree Mining”). Sebree Mining utilizes continuous mining units employing room-and-pillar mining techniques to produce high-sulfur coal. The Onton mine’s preparation plant, which is leased from a third-party, has throughput capacity of 750 tons of raw coal per hour. Coal from Sebree Mining’s mining complex is transported by overland belt to a barge loading facility on the Green River for shipment to customers, or is shipped via truck on U.S. and state highways directly to customers. The Onton mine was idled on November 6, 2015.
Hamilton Mining Complex. In July 2015, the ARLP Partnership acquired the remaining equity interest in White Oak, thereby gaining complete ownership and control of the Mine No. 1 mine (“Mine No. 1”), located near the city of McLeansboro, Illinois. The ARLP Partnership’s subsidiary, Hamilton County Coal, LLC (“Hamilton”, formerly known as Alliance WOR Processing, LLC), operates Mine No. 1 which is an underground longwall mining operation producing high-sulfur coal from the Herrin No. 6 seam. Initial development production from the continuous miner units began in
2013, and longwall mining began in October 2014. As part of the initial transaction with White Oak in 2011, Hamilton acquired a preferred equity interest in White Oak and constructed, owned, and operated the coal handling and processing facilities associated with Mine No. 1, which has throughput capacity of 2,000 tons of raw coal per hour. Hamilton has the ability to ship production from the Mine No. 1 via the CSX and EVW rail directly to customers or to various transloading facilities, including the ARLP Partnership’s Mt. Vernon transloading facility, for barge deliveries. For more information about the White Oak transactions, please read “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions”
Alliance WOR Properties, LLC. Alliance Resource Properties owns or controls coal reserves that it leases to certain of the ARLP Partnership’s subsidiaries that operate its mining complexes. In September 2011, and in subsequent follow-up transactions, Alliance Resource Properties’ subsidiary, Alliance WOR Properties, LLC (“WOR Properties”), acquired from and leased back to White Oak the rights to approximately 309.6 million tons of proven and probable high-sulfur coal reserves. Prior to the July 31, 2015 acquisition of White Oak, White Oak paid WOR Properties earned royalties during the period beginning January 1, 2015 and ending July 31, 2015 in the amount of $11.4 million. Earned royalties from coal production in 2014 and 2013 in the amount of $0.2 million and $15.0 thousand were paid to WOR Properties by White Oak. Following the acquisition royalty activities under leases between Hamilton and Alliance Resource Properties are accounted for as intercompany transactions and are eliminated upon consolidation.
Appalachian Operations
The ARLP Partnership’s Appalachian mining operations are located in eastern Kentucky, Maryland and West Virginia. As of February 11, 2016, the ARLP Partnership had 916 employees, and operates three mining complexes in Appalachia.
MC Mining Complex. The MC Mining Complex is located near the city of Pikeville in Pike County, Kentucky. The ARLP Partnership acquired the mine in 1989. The ARLP Partnership’s subsidiary, MC Mining, LLC (“MC Mining”), owns the mining complex and controls the reserves, and its subsidiary, Excel Mining, LLC (“Excel”) conducts all mining operations. The underground operation utilizes continuous mining units employing room-and-pillar mining techniques to produce low-sulfur coal. The preparation plant has throughput capacity of 1,000 tons of raw coal per hour. Substantially all of the coal produced at MC Mining in 2015 met or exceeded the compliance requirements of Phase II of the Federal Clean Air Act (“CAA”) (see “-Regulation and Laws-Air Emissions” below). Coal produced from the mine is shipped via the CSX railroad directly to customers or to various transloading facilities on the Ohio River for barge deliveries, or by truck via U.S. and state highways directly to customers or to various docks on the Big Sandy River for barge deliveries.
Mettiki Complex. The Mettiki Complex comprises the Mountain View mine located in Tucker County, West Virginia operated by the ARLP Partnership’s subsidiary Mettiki Coal (WV), LLC (“Mettiki (WV)”) and a preparation plant located near the city of Oakland in Garrett County, Maryland operated by its subsidiary Mettiki Coal, LLC (“Mettiki (MD)”). In addition, production from the Mountain View mine can be supplemented with production from a temporarily sealed smaller-scale mine in Maryland controlled by another of the ARLP Partnership’s subsidiaries, Backbone Mountain, LLC. Mettiki (WV) began continuous miner development of the Mountain View mine in July 2005 and began longwall mining in November 2006. The Mountain View mine produces medium-sulfur coal, which is transported by truck either to the Mettiki (MD) preparation plant for processing or directly to the coal blending facility at the Virginia Electric and Power Company Mt. Storm Power Station. The Mettiki (MD) preparation plant has throughput capacity of 1,350 tons of raw coal per hour. Coal processed at the preparation plant can be trucked to the blending facility at Mt. Storm or shipped via the CSX railroad, which provides the opportunity to ship into the domestic and international thermal and metallurgical coal markets.
Tunnel Ridge Complex. The ARLP Partnership’s subsidiary, Tunnel Ridge, LLC (“Tunnel Ridge”), operates the Tunnel Ridge mine, an underground longwall mine in the Pittsburgh No. 8 coal seam, located near Wheeling, West Virginia. Tunnel Ridge began construction of the mine and related facilities in 2008. Development mining began in 2010, and longwall mining operations began at Tunnel Ridge in May 2012. Coal produced from the Tunnel Ridge mine is transported by conveyor belt to a barge loading facility on the Ohio River. Through an agreement with a third party, Tunnel Ridge has the ability to transload coal from barges for rail shipment on the Wheeling and Lake Erie Railway.
Other Operations
Mt. Vernon Transfer Terminal, LLC
The ARLP Partnership’s subsidiary, Mt. Vernon, leases land and operates a coal loading terminal on the Ohio River at Mt. Vernon, Indiana. Coal is delivered to Mt. Vernon by both rail and truck. The terminal has a capacity of 8.0 million tons per year with existing ground storage of approximately 60,000 to 70,000 tons. During 2015, the terminal loaded approximately 3.4 million tons for customers of Gibson County Coal, Hamilton County Coal, Hopkins County Coal and White County Coal.
Coal Brokerage
As markets allow, the ARLP Partnership buys coal from non-affiliated producers principally throughout the eastern U.S., which it then resells. The ARLP Partnership has a policy of matching its outside coal purchases and sales to minimize market risks associated with buying and reselling coal. In 2015, the ARLP Partnership did not make outside coal purchases for brokerage activity.
Matrix Group
The ARLP Partnership’s subsidiaries, Matrix Design Group, LLC (“Matrix Design”) and its subsidiaries Matrix Design International, LLC and Matrix Design Africa (PTY) LTD, and Alliance Design Group, LLC (“Alliance Design”) (collectively the Matrix Design entities and Alliance Design are referred to as the “Matrix Group”), provide a variety of mine products and services for the ARLP Partnership’s mining operations and certain products and services to unrelated parties. The ARLP Partnership acquired this business in September 2006. Matrix Group’s products and services include design of systems for automating and controlling various aspects of industrial and mining environments; and design and sale of mine safety equipment, including its miner and equipment tracking and proximity detection systems.
Alliance Minerals
On November 10, 2014 (“the “Cavalier Formation Date”), the ARLP Partnership’s subsidiary, Alliance Minerals, LLC (“Alliance Minerals”) purchased a 96% ownership interest in Cavalier Minerals JV, LLC (“Cavalier Minerals”). Cavalier Minerals acquired a 71.7% limited partner interest in AllDale Minerals, L.P. (“AllDale I”) and subsequently acquired a 72.8% limited partner interest in AllDale Minerals II, L.P. (“AllDale II”, collectively with AllDale I, “AllDale Minerals”), entities created to purchase oil and gas mineral interests in various geographic locations within producing basins in the continental U.S. Between the Cavalier Formation Date and December 31, 2015, Cavalier Minerals contributed $65.9 million to AllDale Minerals, of which $63.1 million was funded by Alliance Minerals. For more information about Cavalier Minerals, please read “Item 8. Financial Statements and Supplementary Data-Note 11. Variable Interest Entities.” For more information about AllDale Minerals, please read “Item 8. Financial Statements and Supplementary Data-Note 13. Equity Investments.”
Additional Services
The ARLP Partnership develops and markets additional services in order to establish itself as the supplier of choice for its customers. Historically, and in 2015, revenues from these services were immaterial. In addition, the ARLP Partnership’s affiliate, Mid-America Carbonates, LLC (“MAC”), which was a joint venture of White County Coal, manufactures and sells rock dust to the ARLP Partnership and to unrelated parties. Effective January 1, 2015, White County Coal acquired the remainder of the interest in MAC, which is now a wholly owned subsidiary of Alliance Coal.
Reportable Segments
Please read “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Segment Information under “Item 8. Financial Statements and Supplementary Data-Note 22. Segment Information” for information concerning our reportable segments.
Coal Marketing and Sales
As is customary in the coal industry, the ARLP Partnership has entered into long-term coal supply agreements with many of its customers. These arrangements are mutually beneficial to the ARLP Partnership and its customers in that they provide greater predictability of sales volumes and sales prices. Although many utility customers recently have
appeared to favor a shorter term contracting strategy, in 2015 approximately 92.2% and 93.1% of the ARLP Partnership’s sales tonnage and total coal sales, respectively, were sold under long-term contracts (contracts having a term of one year or greater) with committed term expirations ranging from 2016 to 2021. As of February 22, 2016, the ARLP Partnership’s nominal commitment under long-term contracts was approximately 34.3 million tons in 2016, 19.1 million tons in 2017, 14.5 million tons in 2018 and 7.1 million tons in 2019. The commitment of coal under contract is an approximate number because a limited number of the contracts contain provisions that could cause the nominal commitment to increase or decrease; however, the overall variance to total committed sales is minimal. The contractual time commitments for customers to nominate future purchase volumes under these contracts are typically sufficient to allow the ARLP Partnership to balance its sales commitments with prospective production capacity. In addition, the nominal commitment can otherwise change because of reopener provisions contained in certain of these long-term contracts.
The provisions of long-term contracts are the results of both bidding procedures and extensive negotiations with each customer. As a result, the provisions of these contracts vary significantly in many respects, including, among other factors, price adjustment features, price and contract reopener terms, permitted sources of supply, force majeure provisions, coal qualities and quantities. Virtually all of the ARLP Partnership’s long-term contracts are subject to price adjustment provisions, which periodically permit an increase or decrease in the contract price, typically to reflect changes in specified indices or changes in production costs resulting from regulatory changes, or both. These provisions, however, may not assure that the contract price will reflect every change in production or other costs. Failure of the parties to agree on a price pursuant to an adjustment or a reopener provision can, in some instances, lead to early termination of a contract. Some of the long-term contracts also permit the contract to be reopened for renegotiation of terms and conditions other than pricing terms, and where a mutually acceptable agreement on terms and conditions cannot be concluded, either party may have the option to terminate the contract. The long-term contracts typically stipulate procedures for transportation of coal, quality control, sampling and weighing. Most contain provisions requiring the ARLP Partnership to deliver coal within stated ranges for specific coal characteristics such as heat, sulfur, ash, moisture, grindability, volatility and other qualities. Failure to meet these specifications can result in economic penalties, rejection or suspension of shipments or termination of the contracts. While most of the contracts specify the approved seams and/or approved locations from which the coal is to be mined, some contracts allow the coal to be sourced from more than one mine or location. Although the volume to be delivered pursuant to a long-term contract is stipulated, the buyers often have the option to vary the volume within specified limits.
Reliance on Major Customers
The ARLP Partnership’s two largest customers in 2015 were Louisville Gas and Electric Company and Tennessee Valley Authority. During 2015, the ARLP Partnership derived approximately 28.5% of its total revenues from these two customers and at least 10.0% of its total revenues from each of the two. For more information about these customers, please read “Item 8. Financial Statements and Supplementary Data-Note 21. Concentration of Credit Risk and Major Customers.”
Competition
The coal industry is intensely competitive. The most important factors on which the ARLP Partnership competes are coal price, coal quality (including sulfur and heat content), transportation costs from the mine to the customer and the reliability of supply. The ARLP Partnership’s principal competitors include Alpha Natural Resources, Inc., Arch Coal, Inc., CNX Coal Resources LP, CONSOL Energy Inc. (“CONSOL”), Foresight Energy LP, Murray Energy, Inc., and Peabody Energy Corporation. While a number of the ARLP Partnership’s competitors are experiencing significant financial distress as a result of deteriorating market conditions, and some are involved in reorganization in bankruptcy, the ARLP Partnership believes these events will not result in a material diminution in available coal supply and that they or their reorganized successors will remain significant competition for ongoing coal sales. The ARLP Partnership also competes directly with a number of smaller producers in the Illinois Basin and Appalachian regions. The prices the ARLP Partnership is able to obtain for its coal are primarily linked to coal consumption patterns of domestic electricity generating utilities, which in turn are influenced by economic activity, government regulations, weather and technological developments. At times, the ARLP Partnership has exported a portion of its coal into the international coal markets and historically the prices the ARLP Partnership obtained for its export coal have been influenced by a number of factors, such as global economic conditions, weather patterns and political instability, among others. Further, coal competes with other fuels such as petroleum, natural gas, nuclear energy and renewable energy sources for electrical power generation. Over time, costs and other factors, such as safety and environmental considerations, may affect the overall demand for coal as a fuel. For additional information, please see “Item 1A.
ITEM 1A. RISK FACTORS
Risks Inherent in an Investment in Us
In the future, we may not have sufficient cash to pay distributions at our current quarterly distribution level or to increase distributions.
Currently, our earnings and cash flow consist solely of cash distributions from ARLP. Therefore, the amount of distributions we are able to make to our unitholders may fluctuate based on the level of distributions ARLP makes to its partners. We cannot assure you that ARLP will continue to make quarterly distributions at its current level or increase its quarterly distributions in the future. In addition, while we would expect to increase or decrease distributions to our unitholders if ARLP increases or decreases distributions to us, the timing and amount of such increased or decreased distributions, if any, will not necessarily be comparable to the timing and amount of the increase or decrease in distributions made by ARLP to us.
Our ability to distribute cash received from ARLP to our unitholders could be limited by a number of factors, including:
· interest expense and principal payments on indebtedness;
· restrictions on distributions contained in any current or future debt agreements;
· our general and administrative expenses;
· expenses of our subsidiaries other than ARLP, including tax liabilities of our corporate subsidiaries, if any;
· reserves necessary for us to make capital contributions to maintain our 1.98% general partner interest in ARLP as required by the partnership agreement of ARLP upon the issuance of additional partnership securities by ARLP; and
· reserves our general partner believes prudent for us to maintain for the proper conduct of our business or to provide for future distributions.
We cannot guarantee that in the future we will be able to pay distributions or that any distributions we do make will be at or above our current quarterly distribution level. The actual amount of cash that is available for distribution to our unitholders will depend on numerous factors, many of which are beyond our control or the control of our general partner.
ARLP’s cash distributions are not guaranteed and may fluctuate with its performance and other external factors.
The amount of cash that ARLP can distribute to holders of its common units or other partnership securities, including us, each quarter principally depends on the amount of cash it generates from its operations, which will fluctuate from quarter to quarter based on, among other things:
· the amount of coal the ARLP Partnership is able to produce from its properties;
· the price at which it is able to sell coal, which is affected by the supply of and demand for domestic and foreign coal;
· the level of its operating costs;
· weather conditions and patterns;
· the proximity to and capacity of transportation facilities;
· domestic and foreign governmental regulations and taxes;
· regulatory, administrative, and judicial decisions;
· competition within the coal industry;
· the price and availability of alternative fuels;
· the effect of worldwide energy consumption; and
· prevailing economic conditions.
In addition, the actual amount of cash that ARLP will have available for distribution will depend on other factors, including:
· the level of its capital expenditures;
· the cost of acquisitions, if any;
· its debt service requirements and restrictions on distributions contained in its current or future debt agreements;
· fluctuations in its working capital needs;
· unavailability of financing resulting in unanticipated liquidity constraints;
· the ability of ARLP to borrow under its credit agreement to make distributions to its unitholders; and
· the amount, if any, of cash reserves established by MGP, in its discretion, for the proper conduct of ARLP’s business.
Because of these and other factors, ARLP may not have sufficient available cash to pay a specific level of cash distributions to its unitholders. Furthermore, the amount of cash that ARLP has available for distribution depends primarily upon its cash flow, including cash flow from financial reserves and working capital borrowing, and is not solely a function of profitability, which will be affected by non-cash items. As a result, ARLP may be able to make cash distributions during periods when it records net losses and may be unable to make cash distributions during periods when it records net income. Please read “-Risks Related to ARLP’s Business” for a discussion of further risks affecting ARLP’s ability to generate available cash and “Item 8. Financial Statements and Supplementary Data-Note 11 - Variable Interest Entities for further discussion of restrictions on the cash available for distribution.
ARLP’s managing general partner, with our consent, may limit or modify the incentive distributions we are entitled to receive in order to facilitate ARLP’s growth strategy. Our general partner’s board of directors can give this consent without a vote of our unitholders.
We own ARLP’s managing general partner, which owns the IDRs in ARLP that entitle us to receive increasing percentages, up to a maximum of 48%, of any cash distributed by ARLP, as certain target distribution levels are reached in excess of $0.1375 per ARLP unit in any quarter. The IDRs currently participate at the maximum 48% target cash distribution level at current ARLP distribution levels. A substantial portion of the cash flow we receive from ARLP is provided by these IDRs. The board of directors of MGP (“MGP Board of Directors”) may reduce the distributions related to the IDRs payable to us with our consent, which we may provide without the approval of our unitholders.
A reduction in ARLP’s distributions will disproportionately affect the amount of cash distributions to which we are currently entitled.
MGP’s ownership of the IDRs in ARLP entitles us to receive specified percentages of total cash distributions made by ARLP with respect to any particular quarter only in the event that ARLP distributes more than $0.1375 per unit for such quarter. As a result, the holders of ARLP’s common units have a priority over the holders of ARLP’s IDRs to the extent of cash distributions by ARLP up to and including $0.1375 per unit for any quarter.
MGP’s ownership of the IDRs in ARLP entitles us to receive up to 48% of all cash distributed by ARLP. Because the IDRs participate at the maximum 48% target cash distribution level at current ARLP distribution levels, future growth in distributions we receive from ARLP will not result from an increase in the target cash distribution level associated with the IDRs.
Furthermore, a decrease in the amount of distributions by ARLP to less than $0.1875 per common unit per quarter would reduce MGP’s percentage of the incremental cash distributions above to 23% of the amount above $0.15625 per common unit per quarter, a decrease in the ARLP distribution to less than $0.15625 would reduce MGP’s percentage to 13% of the amount above $0.1375, and a decrease below that level would reduce the percentage of incremental cash distributions to zero. As a result, any such reduction in quarterly cash distributions from ARLP would disproportionately reduce the amount of all distributions that we receive from ARLP as compared to the impact on the holders of ARLP common units.
Restrictions in future financing agreements could limit ARLP’s ability to make distributions to its unitholders, borrow additional funds or capitalize on business opportunities.
Any future credit facility could include such provisions and the ARLP Partnership’s ability to comply with them may be affected by events beyond its control, including prevailing economic, financial and industry conditions. Failure to comply with any such restrictions or covenants could have significant consequences, such as causing a significant portion of the indebtedness under such a facility to become immediately due and payable or the ARLP Partnership’s lenders’ commitment to make further loans to it under such facility to terminate. The ARLP Partnership might not have, or be able to obtain, sufficient funds to make such payments.
The ARLP Partnership’s payment of principal and interest on any future indebtedness will reduce its cash available for distribution on its units. In addition, any future levels of indebtedness may:
· adversely affect the ARLP Partnership’s ability to obtain additional financing for future operations or capital needs;
· limit its ability to pursue acquisitions and other business opportunities; or
· make its results of operations more susceptible to adverse economic or operating conditions.
Our unitholders do not elect our general partner or vote on our general partner’s officers or directors. Units held by the Management Group (some of whom are current or former members of management) and their affiliates currently own 70.7% of our units, a sufficient number of our common units to block any attempt to remove our general partner.
Unlike the holders of common stock in a corporation, our unitholders have only limited voting rights on matters affecting our business and, therefore, limited ability to influence management’s decisions regarding our business. Our unitholders do not have the ability to elect our general partner or the officers or directors of our general partner. The Board of Directors, including our independent directors, is chosen by the members of our general partner.
Furthermore, if our unitholders are dissatisfied with the performance of our general partner, they will have little ability to remove our general partner. Our general partner may not be removed except upon the vote of the holders of at least 2/3rds of our outstanding units. Because the Management Group (some of whom are current or former members of management) and their affiliates currently own 70.7% of our outstanding common units, it is not currently possible for our general partner to be removed without their consent. As a result, the price at which our units trade may be lower because of the absence or reduction of a takeover premium in the trading price.
We may issue an unlimited number of limited partner interests, on terms and conditions established by our general partner, without the consent of our unitholders, which will dilute your ownership interest in us and may increase the risk that we will not have sufficient available cash to maintain or increase our per unit distribution level.
The issuance by us of additional common units or other equity securities of equal or senior rank will have the following effects:
· our unitholders’ proportionate ownership interest in us will decrease;
· the amount of cash available for distribution on each unit may decrease;
· the relative voting strength of each previously outstanding unit may be diminished;
· the ratio of taxable income to distributions may increase; and
· the market price of our common units may decline.
The market price of our common units could be adversely affected by sales of substantial amounts of our common units in the public markets, including sales by our existing unitholders.
The Management Group and their affiliates currently own 70.7% of our units. Sales by any of our existing unitholders of a substantial number of our common units in the public markets could have a material adverse effect on the price of our common units or could impair our ability to obtain capital through an offering of equity securities. We do not know whether any such sales would be made in the public market or in private placements, nor do we know what impact such potential or actual sales would have on our unit price in the future.
Control of our general partner and the IDRs in ARLP may be transferred to a third party without unitholder consent.
Our general partner may transfer its general partner interest in us to a third party in a merger or in a sale of its equity securities without the consent of our unitholders. Furthermore, there is no restriction in our partnership agreement on the ability of the owner of our general partner to sell or transfer all or part of its ownership interest in our general partner to a third-party. The new owner or owners of our general partner would then be in a position to replace the directors and officers of our general partner and control the decisions made and actions taken by its board of directors and officers. In addition, the owner of our general partner controls MGP, the owner of the IDRs in ARLP. Control of MGP can likewise be transferred to a third party without unitholder consent.
Our ability to sell our partnership interests in ARLP may be limited by securities law restrictions and liquidity constraints.
Of the 31,088,338 common units of ARLP that we own, 12,845,062 common units are unregistered, restricted securities within the meaning of Rule 144 under the Securities Act. Unless we exercise our registration rights with
respect to these common units, we are limited to selling into the market in any three-month period an amount of ARLP common units that does not exceed the greater of 1% of the total number of common units outstanding or the average weekly reported trading volume of the common units for the four calendar weeks prior to the sale. We face contractual limitations on our ability to sell our general partner interest and IDRs, and the market for such interests is illiquid.
We depend on the leadership and involvement of Joseph W. Craft III and other key personnel for the success of our and ARLP’s business.
We depend on the leadership and involvement of Mr. Craft, the Chairman, President and Chief Executive Officer of our general partner and a Director and President and Chief Executive Officer of ARLP’s managing general partner. Mr. Craft has been integral to the success of ARLP and us, due in part to his ability to identify and develop internal growth projects and accretive acquisitions, make strategic decisions and attract and retain key personnel. The loss of his leadership and involvement or the services of any members of our or ARLP’s senior management team could have a material adverse effect on our business, financial condition and results of operations and those of ARLP.
Your liability as a limited partner may not be limited, and our unitholders may have to repay distributions or make additional contributions to us under certain circumstances.
As a limited partner in a partnership organized under Delaware law, you could be held liable for our obligations to the same extent as a general partner if you participate in the “control” of our business. Our general partner generally has unlimited liability for the obligations of the partnership, except for those contractual obligations of the partnership that are expressly made without recourse to our general partner. Additionally, the limitations on the liability of holders of limited partner interests for the obligations of a limited partnership have not been clearly established in many jurisdictions.
Under certain circumstances, our unitholders may have to repay amounts wrongfully distributed to them. Under Delaware law, neither we nor ARLP may make a distribution to our unitholders if the distribution would cause our or ARLP’s respective liabilities to exceed the fair value of our respective assets. Delaware law provides that for a period of three years from the date of the impermissible distribution, partners who received the distribution and who knew at the time of the distribution that it violated Delaware law will be liable to the partnership for the distribution amount. Liabilities to partners on account of their partnership interest and liabilities that are non-recourse to the partnership are not counted for purposes of determining whether a distribution is permitted.
An increase in interest rates may cause the market price of our common units to decline.
Like all equity investments, an investment in our common units is subject to certain risks. In exchange for accepting these risks, investors may expect to receive a higher rate of return than would otherwise be obtainable from lower-risk investments. Accordingly, as interest rates rise, the ability of investors to obtain higher risk-adjusted rates of return by purchasing government-backed debt securities may cause a corresponding decline in demand for riskier investments generally, including yield-based equity investments such as publicly traded limited partnership interests. Reduced demand for our common units resulting from investors seeking other more favorable investment opportunities may cause the trading price of our common units to decline.
If in the future we cease to manage and control ARLP, we may be deemed to be an investment company under the Investment Company Act of 1940.
If we cease to manage and control ARLP and are deemed to be an investment company under the Investment Company Act of 1940 because of our ownership of ARLP partnership interests, we would either have to register as an investment company under the Investment Company Act, obtain exemptive relief from the SEC or modify our organizational structure or our contract rights to fall outside the definition of an investment company. Registering as an investment company could, among other things, materially limit our ability to engage in transactions with affiliates, including the purchase and sale of certain securities or other property to or from our affiliates, restrict our ability to borrow funds or engage in other transactions involving leverage and require us to add additional directors who are independent of us or our affiliates.
The price of our common units may be volatile, and the trading market for our common units may not provide you with adequate liquidity.
The market price of our common units could be subject to significant fluctuations. Factors that could affect our common unit price include:
· ARLP’s operating and financial performance and prospects;
· quarterly variations in the rate of growth of our financial indicators, such as net income and revenues;
· changes in revenue or earnings estimates or publication of research reports by analysts;
· the current economic downturn;
· the price of coal and expectations for the future of the coal industry;
· speculation by the press or investment community;
· sales of our common units by our unitholders;
· actions by our existing unitholders prior to their disposition of our common units;
· announcements by ARLP or its competitors of significant contracts, acquisitions, strategic partnerships, joint ventures, securities offerings or capital commitments;
· general market conditions; and
· domestic and international economic, legal and regulatory factors related to ARLP’s performance.
The equity markets in general are subject to volatility that may be unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common units. In addition, potential investors may be deterred from investing in our common units for various reasons, including the very limited number of publicly traded entities whose assets consist almost exclusively of partnership interests in a publicly traded partnership. The lack of liquidity may also contribute to significant fluctuations in the market price of our common units and limit the number of investors who are able to buy our common units.
Our common units and ARLP’s common units may not trade in simple relation or proportion to one another. Instead, the trading prices may diverge because, among other things:
· ARLP’s cash distributions to its common unitholders have a priority over distributions on its IDRs;
· we participate in the IDRs in ARLP, while ARLP’s common unitholders do not; and
· we may enter into other businesses separate and apart from ARLP or any of its affiliates.
Our partnership agreement restricts the rights of unitholders owning 20% or more of our units.
Our unitholders’ voting rights are restricted by the provision in our partnership agreement generally providing that any units held by a person that owns 20% or more of any class of units then outstanding, other than our general partner, its affiliates, their transferees and persons who acquired such units with the prior approval of the Board of Directors, cannot be voted on any matter. In addition, our partnership agreement contains provisions limiting the ability of our unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting our unitholders’ ability to influence the manner or direction of our management. As a result, the price at which our common units will trade may be lower because of the absence or reduction of a takeover premium in the trading price.
ARLP may issue additional units, which may increase the risk that ARLP will not have sufficient available cash to maintain or increase its per unit distribution level.
ARLP has wide latitude to issue additional units on terms and conditions established by MGP, including units that rank senior to the ARLP common units and the IDRs as to quarterly cash distributions. The payment of distributions on those additional units may increase the risk that ARLP may not have sufficient cash available to maintain or increase its per unit distribution level, which in turn may impact the available cash that we have to distribute to our unitholders. To the extent these units are senior to the common units or the IDRs, there is an increased risk that we will not receive the same level or increased distributions on the common units and IDRs. Neither the common units nor the IDRs are entitled to any arrearages from prior quarters.
Risks Related to Conflicts of Interest
Conflicts of interest exist and may arise in the future among us, ARLP and our respective general partners and affiliates. Future conflicts of interest may arise among us and the entities affiliated with any general partner interests we
acquire or among ARLP and such entities. For a further discussion of conflicts of interest that may arise, please read “Item 13. Certain Relationships and Related-Party Transactions, and Director Independence.”
Although we control ARLP through our ownership of ARLP’s managing general partner, ARLP’s managing general partner owes fiduciary duties to ARLP and ARLP’s unitholders, which may conflict with our interests.
Conflicts of interest exist and may arise in the future as a result of the relationships between us and our affiliates, including ARLP’s managing general partner, on the one hand, and ARLP and its limited partners, on the other hand. The directors and officers of ARLP’s managing general partner have fiduciary duties to manage ARLP in a manner beneficial to us, its owner. At the same time, ARLP’s managing general partner has a fiduciary duty to manage ARLP in a manner beneficial to ARLP and its limited partners. The MGP Board of Directors will resolve any such conflict and has broad latitude to consider the interests of all parties to the conflict. The resolution of these conflicts may not always be in our best interest or that of our unitholders.
For example, conflicts of interest may arise in the following situations:
· the allocation of shared overhead expenses to ARLP and us;
· the interpretation and enforcement of contractual obligations between us and our affiliates, on the one hand, and ARLP, on the other hand;
· the determination and timing of the amount of cash to be distributed to ARLP’s partners and the amount of cash to be reserved for the future conduct of ARLP’s business;
· the decision as to whether ARLP should make acquisitions, and on what terms;
· the determination of whether ARLP should use cash on hand, borrow or issue equity to raise cash to finance acquisition or expansion capital projects, repay indebtedness, meet working capital needs, pay distributions to ARLP’s partners or otherwise; and
· any decision we make in the future to engage in business activities independent of, or in competition with, ARLP.
The fiduciary duties of our general partner’s officers and directors may conflict with those of ARLP’s general partner’s officers and directors.
Our general partner’s officers and directors have fiduciary duties to manage our business in a manner beneficial to us and our partners. However, all of our general partner’s executive officers also serve as executive officers of MGP. In addition, our general partner’s non-independent director and one of our independent directors also serve as directors of MGP. As a result, these executive officers and directors have fiduciary duties to manage the business of ARLP in a manner beneficial to ARLP and its partners. Consequently, these directors and officers may encounter situations in which their fiduciary obligations to ARLP, on one hand, and us, on the other hand, are in conflict. The resolution of these conflicts may not always be in our best interest or that of our unitholders.
If we are presented with certain business opportunities, ARLP will have the first right to pursue such opportunities.
Pursuant to an agreement among ARLP, SGP, MGP, ARH, ARH II, our general partner and us, among others, (referred to as the omnibus agreement), we have agreed to certain business opportunity arrangements to address potential conflicts that may arise between us and ARLP. If a business opportunity in respect of any coal mining, marketing and transportation assets is presented to us, our general partner, ARLP or its general partners, then ARLP will have the first right to acquire such assets. The omnibus agreement provides, among other things, that ARLP will be presumed to desire to acquire the assets until such time as it advises us that it has abandoned the pursuit of such business opportunity, and we may not pursue the acquisition of such assets prior to that time.
ARLP and affiliates of our general partner are not limited in their ability to compete with us, which could cause conflicts of interest and limit our ability to acquire additional assets or businesses which in turn could adversely affect our results of operations and cash available for distribution to our unitholders.
Neither our partnership agreement nor the omnibus agreement prohibits ARLP or affiliates of our general partner from owning assets or engaging in businesses that compete directly or indirectly with us or one another. In addition, ARLP and its affiliates or affiliates of our general partner, may acquire, construct or dispose of additional assets related to the mining, marketing and transportation of coal or other assets in the future, without any obligation to offer us the opportunity to purchase or construct any of those assets. As a result, competition among these entities could adversely impact ARLP’s or our results of operations and cash available for distribution.
Potential conflicts of interest may arise among our general partner, its affiliates and us. Our general partner and its affiliates have limited fiduciary duties to us and our unitholders, which may permit them to favor their own interests to the detriment of us and our unitholders.
Conflicts of interest may arise among our general partner and its affiliates, on the one hand, and us and our unitholders, on the other hand. As a result of these conflicts, our general partner may favor its own interests and the interests of its affiliates over the interests of our unitholders. These conflicts include, among others, the following:
· Our general partner is allowed to take into account the interests of parties other than us, including ARLP and its affiliates and any other businesses acquired in the future, in resolving conflicts of interest, which has the effect of limiting its fiduciary duty to our unitholders.
· Our general partner has limited its liability and reduced its fiduciary duties under the terms of our partnership agreement, while also restricting the remedies available to our unitholders for actions that, without these limitations, might constitute breaches of fiduciary duties. As a result of purchasing our units, unitholders consent to various actions and conflicts of interest that might otherwise constitute a breach of fiduciary or other duties under applicable state law.
· Our general partner determines the amount and timing of our investment transactions, borrowings, issuances of additional partnership securities and reserves, each of which can affect the amount of cash that is available for distribution to our unitholders.
· Our general partner determines which costs incurred by it and its affiliates are reimbursable by us.
· Our partnership agreement does not restrict our general partner from causing us to pay it or its affiliates for any services rendered, or from entering into additional contractual arrangements with any of these entities on our behalf, so long as the terms of any such payments or additional contractual arrangements are fair and reasonable to us.
· Our general partner controls the enforcement of obligations owed to us by it and its affiliates.
· Our general partner decides whether to retain separate counsel, accountants or others to perform services for us.
The president and chief executive officer of both our general partner and ARLP’s managing general partner effectively controls us and ARLP through his control of our general partner and ARLP’s managing general partner.
Mr. Craft, the president and chief executive officer of both our general partner and ARLP’s managing general partner, controls ARLP’s managing general partner, indirectly jointly owns SGP and owns or controls 42.3% of ARLP’s common units. Mr. Craft also currently holds, directly or indirectly or may be deemed to be the beneficial owner of, 68.6% of our common units. These interests give Mr. Craft substantial control over our and ARLP’s business and operations and the ability to control the outcome of many matters that require unitholder approval. Mr. Craft is not restricted from disposing of all or a part of his equity interests in our general partner, in ARLP’s managing general partner or in ARLP’s special general partner.
Our partnership agreement limits our general partner’s fiduciary duties to us and our unitholders and restricts the remedies available to our unitholders for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty.
Our partnership agreement contains provisions that reduce the standards to which our general partner would otherwise be held by state fiduciary duty law. For example, our partnership agreement:
· permits our general partner to make a number of decisions in its individual capacity, as opposed to in its capacity as our general partner. This entitles our general partner to consider only the interests and factors that it desires, and it has no duty or obligation to give any consideration to any interest of, or factors affecting, us, our affiliates or any limited partner. Examples include the exercise of its limited call right, its voting rights with respect to the units it owns, its registration rights and its determination whether or not to consent to any merger or consolidation of our partnership or amendment to our partnership agreement;
· provides that our general partner will not have any liability to us or our unitholders for decisions made in its capacity as a general partner so long as it acted in good faith, meaning it believed the decisions were in the best interests of our partnership;
· generally provides that affiliated transactions and resolutions of conflicts of interest not approved by the audit and conflicts committee of the Board of Directors and not involving a vote of unitholders must be on terms no less favorable to us than those generally being provided to or available from unrelated third-parties or be “fair
and reasonable” to us and that, in determining whether a transaction or resolution is “fair and reasonable,” our general partner may consider the totality of the relationships among the parties involved, including other transactions that may be particularly advantageous or beneficial to us;
· provides that in resolving conflicts of interest, it will be presumed that in making its decision our general partner acted in good faith, and in any proceeding brought by or on behalf of any limited partner or us, the person bringing or prosecuting such proceeding will have the burden of overcoming such presumption; and
· provides that our general partner and its officers and directors will not be liable for monetary damages to us, our limited partners or assignees for any acts or omissions unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that the general partner or those other persons acted in bad faith or engaged in fraud or willful misconduct or, in the case of a criminal matter, acted with knowledge that such person’s conduct was criminal.
In becoming a limited partner of our partnership, a common unitholder is bound by the provisions in the partnership agreement, including the provisions discussed above.
Our general partner has a limited call right that may require you to sell your units at an undesirable time or price.
If at any time our general partner and its affiliates own more than 85% of our outstanding units, our general partner will have the right, but not the obligation, which it may assign to any of its affiliates or to us, to acquire all, but not less than all, of the units held by unaffiliated persons at a price not less than their then-current market price. As a result, you may be required to sell your units at an undesirable time or price and may not receive any return on your investment. You may also incur a tax liability upon a sale of your units.
Risks Related to ARLP’s Business
Because our cash flow consists exclusively of distributions from ARLP, risks to the ARLP Partnership’s business are also risks to us. We have set forth below many of the risks to ARLP’s business or results of operations, the occurrence of which could negatively impact the ARLP Partnership’s financial performance and decrease the amount of cash it is able to distribute to us, thereby decreasing the amount of cash we have available for distribution to our unitholders.
Global economic conditions or economic conditions in any of the industries in which the ARLP Partnership customers operate as well as sustained uncertainty in financial markets may have material adverse impacts on its business and financial condition that it currently cannot predict.
Weakness in global economic conditions or economic conditions in any of the industries the ARLP Partnership serves or in the financial markets could materially adversely affect the ARLP Partnership’s business and financial condition. For example:
· the demand for electricity in the U.S. may decline if economic conditions deteriorate, which may negatively impact the revenues, margins and profitability of the ARLP Partnership’s business;
· any inability of the ARLP Partnership’s customers to raise capital could adversely affect its ability to honor its obligations to us; and
· ARLP Partnership’s future ability to access the capital markets may be restricted as a result of future economic conditions, which could materially impact the ARLP Partnership’s ability to grow its business, including development of its coal reserves.
A substantial or extended decline in coal prices could negatively impact the ARLP Partnership’s results of operations.
The ARLP Partnership’s results of operations are primarily dependent upon the prices it receives for its coal, as well as its ability to improve productivity and control costs. The prices the ARLP Partnership receives for its production depends upon factors beyond the ARLP Partnership’s control, including:
· the supply of and demand for domestic and foreign coal;
· weather conditions and patterns;
· the proximity to and capacity of transportation facilities;
· domestic and foreign governmental regulations and taxes;
· the price and availability of alternative fuels;
· the effect of worldwide energy consumption; and
· prevailing economic conditions.
Any adverse change in these factors could result in weaker demand and lower prices for the ARLP Partnership’s products. A substantial or extended decline in coal prices could materially and adversely affect the ARLP Partnership by decreasing its revenues to the extent that it is not protected by the terms of existing coal supply agreements.
Fluctuations in the oil and natural gas industry could affect the ARLP Partnership’s profitability.
Through its affiliate, Cavalier Minerals, the ARLP Partnership has investments in oil and gas mineral interests in the continental U.S. Consequently, the value of the investment as well as any resulting cash flows, may fluctuate with changes in the market and prices for oil and natural gas. During 2015, the oil and natural gas industry experienced a significant decrease in commodity prices driven by a global supply/demand imbalance for oil and an oversupply of natural gas in the U.S. The decline in commodity prices and the global economic conditions contributing to the decline have continued into 2016, and low commodity prices may exist for an extended period. If commodity prices continue to decline or remain depressed, the ARLP Partnership could see a decrease in the value of these investments or in the cash flows they generate. For more information on the ARLP Partnership’s involvement with AllDale Minerals, please read “Item 8. Financial Statements and Supplementary Data-Note 12. Equity Investments” of this Annual Report on Form 10-K.
Competition within the coal industry may adversely affect the ARLP Partnership’s ability to sell coal, and excess production capacity in the industry could put downward pressure on coal prices.
The ARLP Partnership competes with other coal producers in various regions of the U.S. for domestic coal sales. The most important factors on which the ARLP Partnership competes are delivered price (i.e., the cost of coal delivered to the customer, including transportation costs, which are generally paid by customers either directly or indirectly), coal quality characteristics, contract flexibility (e.g., volume optionality and multiple supply sources) and reliability of supply. Some competitors may have, among other things, larger financial and operating resources, lower per ton cost of production, or relationships with specific transportation providers. The competition among coal producers may impact the ARLP Partnership’s ability to retain or attract customers and could adversely impact revenues and cash available for distribution. In addition, declining prices from an oversupply of coal in the market could reduce revenues and cash available for distribution.
Changes in consumption patterns by utilities regarding the use of coal have affected the ARLP Partnership’s ability to sell the coal it produces. Since 2000, coal’s share of U.S. electricity production has fallen from 53% to 31%, while natural gas’ share has increased from 16% to 35%.
The domestic electric utility industry accounts for over 93.0% of domestic coal consumption. The amount of coal consumed by the domestic electric utility industry is affected primarily by the overall demand for electricity, environmental and other governmental regulations, and the price and availability of competing fuels for power plants such as nuclear, natural gas and fuel oil as well as alternative sources of energy. Gas-fueled generation has the potential to displace coal-fueled generation, particularly from older, less efficient coal-powered generators. The ARLP Partnership expects that many of the new power plants needed in the U.S. to meet increasing demand for electricity generation will be fueled by natural gas because gas-fired plants are cheaper to construct and permits to construct these plants are easier to obtain.
In addition, future environmental regulation of GHG emissions could accelerate the use by utilities of fuels other than coal. In addition, state and federal mandates for increased use of electricity derived from renewable energy sources could affect demand for coal. For example, the EPA’s CPP will likely incentivize additional electric generation from natural gas and renewable sources, and Congress has extended tax credits for renewables. In addition, a number of states have enacted mandates that require electricity suppliers to rely on renewable energy sources in generating a certain percentage of power. Such mandates, combined with other incentives to use renewable energy sources, such as tax credits, could make alternative fuel sources more competitive with coal. A decrease in coal consumption by the domestic electric utility industry could adversely affect the price of coal, which could negatively impact the ARLP Partnership’s results of operations and reduce its cash available for distribution to us.
Extensive environmental laws and regulations affect coal consumers, and have corresponding effects on the demand for coal as a fuel source.
Federal, state and local laws and regulations extensively regulate the amount of sulfur dioxide, particulate matter, nitrogen oxides, mercury and other compounds emitted into the air from coal-fired electric power plants, which are the ultimate consumers of much of the ARLP Partnership’s coal. These laws and regulations can require significant emission control expenditures for many coal-fired power plants, and various new and proposed laws and regulations may require further emission reductions and associated emission control expenditures. These laws and regulations may affect demand and prices for coal. There is also continuing pressure on state and federal regulators to impose limits on carbon dioxide emissions from electric power plants, particularly coal-fired power plants. Further, far-reaching federal regulations promulgated by the EPA in the last five years, such as CSAPR and MATS, have led to the premature retirement of coal-fired generating units and a significant reduction in the amount of coal-fired generating capacity in the U.S. At the President’s direction the EPA proposed CO2 emissions requirements, known as the CPP, for existing and modified power plants and published such rules on October 23, 2015. As a result of these current and proposed laws, regulations and regulatory initiatives, electricity generators may elect to switch to other fuels that generate less of these emissions or by-products, further reducing demand for coal. Please read “Item 1. Business-Regulation and Laws-Air Emissions,” “-Carbon Dioxide Emissions” and “-Hazardous Substances and Wastes.”
Increased regulation of GHG emissions could result in increased operating costs and reduced demand for coal as a fuel source, which could reduce demand for the ARLP Partnership’s products, decrease its revenues and reduce its profitability.
Combustion of fossil fuels, such as the coal the ARLP Partnership produces, results in the emission of carbon dioxide into the atmosphere. On December 15, 2009, the EPA published the Endangerment Finding asserting that emissions of carbon dioxide and other GHGs present an endangerment to public health and the environment, and the EPA has begun to regulate GHG emissions pursuant to the CAA. The EPA has finalized a rule to regulate GHG emissions from new power plants. The finalized standard requires CCS, a technology that is not yet commercially feasible without government subsidies and that has not been demonstrated in the marketplace. This requirement effectively prevents construction of new coal fired power plants. In August 2015, the EPA finalized GHG emissions regulations for modified and existing power plants. The rule for modified sources requires reducing GHG emissions from any modified or reconstructed source and could limit the ability of generators to upgrade coal-fired power plants thereby reducing the demand for coal. The rule for existing sources proposes to establish different target emission rates (lbs per megawatt hour) for each state and has an overall goal to achieve a 32% reduction of carbon dioxide emissions from 2005 levels by 2030. If upheld by courts, the regulation could lead to premature retirements of coal-fired electric generating units and significantly reduce the demand for coal. In addition, many states and regions have adopted GHG initiatives. Also, there have been numerous protests of, and challenges to, the permitting of new coal-fired power plants by environmental organizations and state regulators due to concerns related to GHG emissions. Please read “Item 1. Business-Regulation and Laws-Air Emissions” and “-Carbon Dioxide Emissions.”
Numerous political and regulatory authorities and governmental bodies, as well as environmental activist groups, are devoting substantial resources to anti-coal activities to minimize or eliminate the use of coal as a source of electricity generation, domestically and internationally, thereby further reducing the demand and pricing for coal and potentially materially and adversely impacting the ARLP Partnership’s future financial results, liquidity and growth prospects.
Concerns about the environmental impacts of coal combustion, including perceived impacts on global climate issues, are resulting in increased regulation of coal combustion in many jurisdictions, unfavorable lending policies by lending institutions and divestment efforts affecting the investment community, which could significantly affect demand for the ARLP Partnership’s products or its securities. Global climate issues continue to attract public and scientific attention. Some scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts and floods and other climatic events. Numerous reports, such as the Fourth and Fifth Assessment Report of the Intergovernmental Panel on Climate Change, have also engendered concern about the impacts of human activity, especially fossil fuel combustion, on global climate issues. In turn, increasing government attention is being paid to global climate issues and to emissions of GHGs, including emissions of carbon dioxide from coal combustion by power plants.
Federal, state and local governments may pass laws mandating the use of alternative energy sources, such as wind power and solar energy, which may decrease demand for coal products. The CPP is one of a number of recent developments aimed at limiting GHG emissions which could limit the market for some of the ARLP Partnership’s products by encouraging electric generation from sources that do not generate the same amount of GHG emissions. Enactment of laws or passage of regulations regarding emissions from the combustion of coal by the U.S., states, or other countries, could also result in electricity generators further switching from coal to other fuel sources or additional coal-fueled power plant closures. For example, the agreement resulting from the 2015 United Nations Framework Convention on Climate Change contains voluntary commitments by numerous countries to reduce their GHG emissions, and could result in additional firm commitments by various nations with respect to future GHG emissions. These commitments could further disfavor coal-fired generation, particularly in the medium- to long-term.
Congress has extended certain tax credits for renewable sources of electric generation, which will increase the ability of these sources to compete with coal products in the market. In addition, the U.S. Department of Interior recently announced a moratorium on issuing certain new coal leases on federal land while the Bureau of Land Management undertakes a programmatic review of the federal coal program. While none of the ARLP Partnership’s operations are located on federal lands impacted by this moratorium, it does signal increased attention at the federal level to coal mining practices and the GHG emissions resulting from coal combustion.
There have also been efforts in recent years affecting the investment community, including investment advisors, sovereign wealth funds, public pension funds, universities and other groups, promoting the divestment of fossil fuel equities and also pressuring lenders to limit funding to companies engaged in the extraction of fossil fuel reserves. In California, for example, legislation was signed into law in October 2015 that requires California’s state pension funds to divest investments in companies that generate 50% or more of their revenue from coal mining by July 2017. Other activist campaigns have urged banks to cease financing coal-driven businesses. As a result, at least ten major banks have enacted such policies in 2015. The impact of such efforts may adversely affect the demand for and price of securities issued by the ARLP Partnership, and impact its access to the capital and financial markets.
In addition, several well-funded non-governmental organizations have explicitly undertaken campaigns to minimize or eliminate the use of coal as a source of electricity generation. Collectively, these actions and campaigns could adversely impact the ARLP Partnership’s future financial results, liquidity and growth prospects.
Government regulations have resulted and could continue to result in significant retirements of coal-fired electric generating units. Retirements of coal-fired electric generating units decrease the overall capacity to burn coal and negatively impact coal demand.
Since 2010, utilities have formally announced the retirement or conversion of 499 coal-fired electric generating units through 2030. These retirements and conversions amount to over 81,000 megawatts (“MW”) or approximately 25% of the 2010 total coal electric generating capacity. At the end of 2015 retirement and conversions affecting 47,000 MW, or approximately 15% of the 2010 total coal electric generating capacity, are estimated to have occurred. Most of these announced and completed retirements and conversions have been attributed to the EPA regulations, although other factors such as an aging coal fleet and low natural gas prices have also played a role. The reduction in coal electric capacity negatively impacts overall coal demand. Additional regulations, such as the EPA’s CPP approved earlier this year, and other factors could lead to additional retirements and conversions and, thereby, additional reductions in the demand for coal.
Plaintiffs in federal court litigation have attempted to pursue tort claims based on the alleged effects of climate change.
In 2004, eight states and New York City sued five electric utility companies in Connecticut v. American Electric Power Co. Invoking the federal and state common law of public nuisance, plaintiffs sought an injunction requiring defendants to abate their contribution to the nuisance of climate change by capping carbon dioxide emissions and then reducing them. In June 2011, the U.S. Supreme Court issued a unanimous decision holding that the plaintiffs’ federal common law claims were displaced by federal legislation and regulations. The U.S. Supreme Court did not address the plaintiffs’ state law tort claims and remanded the issue of preemption for the district court to consider. While the U.S. Supreme Court held that federal common law provides no basis for public nuisance claims against utilities due to their carbon dioxide emissions, tort-type liabilities remain a possibility and a source of concern. Proliferation of successful climate change litigation could adversely impact demand for coal and ultimately have a material adverse effect on our business, financial condition and results of operations.
The stability and profitability of the ARLP Partnership’s operations could be adversely affected if its customers do not honor existing contracts or do not extend existing or enter into new long-term contracts for coal.
In 2015, the ARLP Partnership sold approximately 92.2% of its sales tonnage under contracts having a term greater than one year, which the ARLP Partnership refers to as long-term contracts. Long-term sales contracts have historically provided a relatively secure market for the amount of production committed under the terms of the contracts. From time to time industry conditions may make it more difficult for the ARLP Partnership to enter into long-term contracts with its electric utility customers, and if supply exceeds demand in the coal industry, electric utilities may become less willing to lock in price or quantity commitments for an extended period of time. Accordingly, the ARLP Partnership may not be able to continue to obtain long-term sales contracts with reliable customers as existing contracts expire, which could subject a portion of the ARLP Partnership’s revenue stream to the increased volatility of the spot market.
The ARLP Partnership’s business can be negatively impacted by customers refusing to honor existing contracts. For example, the ARLP Partnership initiated litigation on January 15, 2015 alleging that a customer anticipatorily breached a coal supply contract when it notified the ARLP Partnership that it would not accept coal shipments under the contract after April 15, 2015. See “Item 3. Legal Proceedings.”
Some of the ARLP Partnership’s long-term coal sales contracts contain provisions allowing for the renegotiation of prices and, in some instances, the termination of the contract or the suspension of purchases by customers.
Some of the ARLP Partnership’s long-term contracts contain provisions that allow for the purchase price to be renegotiated at periodic intervals. These price reopener provisions may automatically set a new price based on the prevailing market price or, in some instances, require the parties to the contract to agree on a new price. Any adjustment or renegotiation leading to a significantly lower contract price could adversely affect the ARLP Partnership’s operating profit margins. Accordingly, long-term contracts may provide only limited protection during adverse market conditions. In some circumstances, failure of the parties to agree on a price under a reopener provision can also lead to early termination of a contract.
Several of the ARLP Partnership’s long-term contracts also contain provisions that allow the customer to suspend or terminate performance under the contract upon the occurrence or continuation of certain events that are beyond the customer’s reasonable control. Such events may include labor disputes, mechanical malfunctions and changes in government regulations, including changes in environmental regulations rendering use of the ARLP Partnership’s coal inconsistent with the customer’s environmental compliance strategies. Additionally, most of the ARLP Partnership’s long-term contracts contain provisions requiring it to deliver coal within stated ranges for specific coal characteristics. Failure to meet these specifications can result in economic penalties, rejection or suspension of shipments or termination of the contracts. In the event of early termination of any of the ARLP Partnership’s long-term contracts, if it is unable to enter into new contracts on similar terms, its business, financial condition and results of operations could be adversely affected.
The ARLP Partnership depends on a few customers for a significant portion of its revenues, and the loss of one or more significant customers could affect its ability to maintain the sales volume and price of the coal it produces.
During 2015, the ARLP Partnership derived approximately 28.5% of its total revenues from two customers and at least 10.0% of its 2015 total revenues from each of the two. If the ARLP Partnership were to lose either of these customers without finding replacement customers willing to purchase an equivalent amount of coal on similar terms, or if these customers were to decrease the amounts of coal purchased or the terms, including pricing terms, on which they buy coal from the ARLP Partnership, it could have a material adverse effect on the ARLP Partnership’s business, financial condition and results of operations.
Litigation resulting from disputes with the ARLP Partnership’s customers may result in substantial costs, liabilities and loss of revenues.
From time to time the ARLP Partnership has disputes with its customers over the provisions of long-term coal supply contracts relating to, among other things, coal pricing, quality, quantity and the existence of specified conditions beyond the ARLP Partnership or its customers control that suspend performance obligations under the particular contract. Disputes may occur in the future and the ARLP Partnership may not be able to resolve those disputes in a satisfactory manner, which could have a material adverse effect on the ARLP Partnership’s business, financial condition and results of operations. See “Item 3. Legal Proceedings.”
The ARLP Partnership’s ability to collect payments from its customers could be impaired if their creditworthiness declines or if they fail to honor their contracts with the ARLP Partnership.
The ARLP Partnership’s ability to receive payment for coal sold and delivered depends on the continued creditworthiness of its customers. If the creditworthiness of its customers declines significantly, its business could be adversely affected. In addition, if a customer refuses to accept shipments of the ARLP Partnership’s coal for which they have an existing contractual obligation, the ARLP Partnership’s revenues will decrease and it may have to reduce production at its mines until its customer’s contractual obligations are honored.
The ARLP Partnership’s profitability may decline due to unanticipated mine operating conditions and other events that are not within its control and that may not be fully covered under its insurance policies.
The ARLP Partnership’s mining operations are influenced by changing conditions or events that can affect production levels and costs at particular mines for varying lengths of time and, as a result, can diminish its profitability.
These conditions and events include, among others:
· mining and processing equipment failures and unexpected maintenance problems;
· unavailability of required equipment;
· prices for fuel, steel, explosives and other supplies;
· fines and penalties incurred as a result of alleged violations of environmental and safety laws and regulations;
· variations in thickness of the layer, or seam, of coal;
· amounts of overburden, partings, rock and other natural materials;
· weather conditions, such as heavy rains, flooding, ice and other natural events affecting operations, transportation or customers;
· accidental mine water discharges and other geological conditions;
· fires;
· employee injuries or fatalities;
· labor-related interruptions;
· increased reclamation costs;
· inability to acquire, maintain or renew mining rights or permits in a timely manner, if at all;
· fluctuations in transportation costs and the availability or reliability of transportation; and
· unexpected operational interruptions due to other factors.
These conditions have the potential to significantly impact the ARLP Partnership’s operating results. Prolonged disruption of production at any of the ARLP Partnership’s mines would result in a decrease in its revenues and profitability, which could materially adversely impact its quarterly or annual results.
Effective October 1, 2015, the ARLP Partnership renewed its annual property and casualty insurance program. The ARLP Partnership’s property insurance was procured from its wholly owned captive insurance company, Wildcat Insurance, LLC (“Wildcat Insurance”). Wildcat Insurance charged certain of the ARLP Partnership’s subsidiaries for the premiums on this program and in return purchased reinsurance for the program in the standard market at a reduced cost. The maximum limit in the commercial property program is $100.0 million per occurrence excluding a $1.5 million deductible for property damage, a 75, 90 or 120-day waiting period for underground business interruption depending on the mining complex and a $10.0 million overall aggregate deductible. The ARLP Partnership can make no assurances that it will not experience significant insurance claims in the future that could have a material adverse effect on its business, financial condition, results of operations and ability to purchase property insurance in the future.
Although none of the ARLP Partnership’s employees are members of unions, its work force may not remain union-free in the future.
None of the ARLP Partnership’s employees are represented under collective bargaining agreements. However, all of its work force may not remain union-free in the future, and legislative, regulatory or other governmental action could make it more difficult to remain union-free. If some or all of the ARLP Partnership’s currently union-free operations were to become unionized, it could adversely affect its productivity and increase the risk of work stoppages at its mining complexes. In addition, even if the ARLP Partnership remains union-free, its operations may still be adversely affected by work stoppages at unionized companies, particularly if union workers were to orchestrate boycotts against the ARLP Partnership’s operations.
The ARLP Partnership’s mining operations are subject to extensive and costly laws and regulations, and such current and future laws and regulations could increase current operating costs or limit the ARLP Partnership’s ability to produce coal.
The ARLP Partnership is subject to numerous federal, state and local laws and regulations affecting the coal mining industry, including laws and regulations pertaining to employee health and safety, permitting and licensing requirements, air and water quality standards, plant and wildlife protection, reclamation and restoration of mining properties after mining is completed, the discharge or release of materials into the environment, surface subsidence from underground mining and the effects that mining has on groundwater quality and availability. Certain of these laws and regulations may impose strict liability without regard to fault or legality of the original conduct. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, the imposition of remedial liabilities, and the issuance of injunctions limiting or prohibiting the performance of operations. Complying with these laws and regulations may be costly and time consuming and may delay commencement or continuation of exploration or production operations. The possibility exists that new laws or regulations may be adopted, or that judicial interpretations or more stringent enforcement of existing laws and regulations may occur, which could materially affect the ARLP Partnership’s mining operations, cash flow, and profitability, either through direct impacts on the ARLP Partnership’s
existing mining operations, or indirect impacts that discourage or limit the ARLP Partnership’s customers’ use of coal. Please read “Item 1. Business-Regulations and Laws.”
State and federal laws addressing mine safety practices impose stringent reporting requirements and civil and criminal penalties for violations. Federal and state regulatory agencies continue to interpret and implement these laws and propose new regulations and standards. Implementing and complying with these laws and regulations has increased and will continue to increase the ARLP Partnership’s operational expense and to have an adverse effect on its results of operation and financial position. For more information, please read “Item 1. Business-Regulation and Laws-Mine Health and Safety Laws.”
The ARLP Partnership may be unable to obtain and renew permits necessary for its operations, which could reduce its production, cash flow and profitability.
Mining companies must obtain numerous governmental permits or approvals that impose strict conditions and obligations relating to various environmental and safety matters in connection with coal mining. The permitting rules are complex and can change over time. Regulatory authorities exercise considerable discretion in the timing and scope of permit issuance. The public has the right to comment on permit applications and otherwise participate in the permitting process, including through court intervention. Accordingly, permits required to conduct the ARLP Partnership’s operations may not be issued, maintained or renewed, or may not be issued or renewed in a timely fashion, or may involve requirements that restrict the ARLP Partnership’s ability to economically conduct its mining operations. Limitations on the ARLP Partnership’s ability to conduct its mining operations due to the inability to obtain or renew necessary permits or similar approvals could reduce the ARLP Partnership’s production, cash flow and profitability. Please read “Item 1. Business-Regulations and Laws-Mining Permits and Approvals.”
The EPA has begun reviewing permits required for the discharge of overburden from mining operations under Section 404 of the CWA. Various initiatives by the EPA regarding these permits have increased the time required to obtain and the costs of complying with such permits. In addition, the EPA previously exercised its “veto” power to withdraw or restrict the use of previously issued permits in connection with one of the largest surface mining operations in Appalachia. The EPA’s action was ultimately upheld by a federal court. As a result of these developments, the ARLP Partnership may be unable to obtain or experience delays in securing, utilizing or renewing Section 404 permits required for its operations, which could have an adverse effect on its results of operation and financial position. Please read “Item 1. Business-Regulations and Laws-Water Discharge.”
In addition, some of the ARLP Partnership’s permits could be subject to challenges from the public, which could result in additional costs or delays in the permitting process, or even an inability to obtain permits, permit modifications, or permit renewals necessary for our operations.
Fluctuations in transportation costs and the availability or reliability of transportation could reduce revenues by causing the ARLP Partnership to reduce its production or by impairing its ability to supply coal to its customers.
Transportation costs represent a significant portion of the total cost of coal for the ARLP Partnership’s customers and, as a result, the cost of transportation is a critical factor in a customer’s purchasing decision. Increases in transportation costs could make coal a less competitive source of energy or could make the ARLP Partnership’s coal production less competitive than coal produced from other sources. Disruption of transportation services due to weather-related problems, flooding, drought, accidents, mechanical difficulties, strikes, lockouts, bottlenecks or other events could temporarily impair the ARLP Partnership’s ability to supply coal to its customers. The ARLP Partnership’s transportation providers may face difficulties in the future that may impair its ability to supply coal to its customers, resulting in decreased revenues. If there are disruptions of the transportation services provided by the ARLP Partnership’s primary rail or barge carriers that transport its coal and the ARLP Partnership is unable to find alternative transportation providers to ship its coal, its business could be adversely affected.
Conversely, significant decreases in transportation costs could result in increased competition from coal producers in other parts of the country. For instance, difficulty in coordinating the many eastern coal loading facilities, the large number of small shipments, the steeper average grades of the terrain and a more unionized workforce are all issues that combine to make coal shipments originating in the eastern U.S. inherently more expensive on a per-mile basis than coal shipments originating in the western U.S. Historically, high coal transportation rates from the western coal producing areas into certain eastern markets limited the use of western coal in those markets. Lower rail rates from the western coal producing areas to markets served by eastern U.S. coal producers have created major competitive challenges for eastern coal producers. In the event of further reductions in transportation costs from western coal producing areas, the
increased competition with certain eastern coal markets could have a material adverse effect on the ARLP Partnership’s business, financial condition and results of operations.
It is possible that states in which the ARLP Partnership’s coal is transported by truck may modify or increase enforcement of their laws regarding weight limits or coal trucks on public roads. Such legislation and enforcement efforts could result in shipment delays and increased costs. An increase in transportation costs could have an adverse effect on the ARLP Partnership’s ability to increase or to maintain production and could adversely affect revenues.
The ARLP Partnership may not be able to successfully grow through future acquisitions.
Since ARLP’s formation and the acquisition of its predecessor in August 1999, the ARLP Partnership has expanded its operations by adding and developing mines and coal reserves in existing, adjacent and neighboring properties. The ARLP Partnership continually seeks to expand its operations and coal reserves. The ARLP Partnership’s future growth could be limited if it is unable to continue to make acquisitions, or if it is unable to successfully integrate the companies, businesses or properties it acquires. The ARLP Partnership may not be successful in consummating any acquisitions and the consequences of undertaking these acquisitions are unknown. Moreover, any acquisition could be dilutive to earnings and distributions to unitholders and any additional debt incurred to finance an acquisition could affect the ARLP Partnership’s ability to make distributions to unitholders. The ARLP Partnership’s ability to make acquisitions in the future could require significant amounts of financing that may not be available to the ARLP Partnership under acceptable terms and may be limited by restrictions under its existing or future debt agreements, competition from other coal companies for attractive properties or the lack of suitable acquisition candidates.
Expansions and acquisitions involve a number of risks, any of which could cause the ARLP Partnership not to realize the anticipated benefits.
If the ARLP Partnership is unable to successfully integrate the companies, businesses or properties it acquires, its profitability may decline and it could experience a material adverse effect on its business, financial condition, or results of operations. Expansion and acquisition transactions involve various inherent risks, including:
· uncertainties in assessing the value, strengths, and potential profitability of, and identifying the extent of all weaknesses, risks, contingent and other liabilities (including environmental or mine safety liabilities) of, expansion and acquisition opportunities;
· the ability to achieve identified operating and financial synergies anticipated to result from an expansion or an acquisition;
· problems that could arise from the integration of the new operations; and
· unanticipated changes in business, industry or general economic conditions that affect the assumptions underlying the ARLP Partnership’s rationale for pursuing the expansion or acquisition opportunity.
Any one or more of these factors could cause the ARLP Partnership not to realize the benefits anticipated to result from an expansion or acquisition. Any expansion or acquisition opportunities the ARLP Partnership pursues could materially affect its liquidity and capital resources and may require it to incur indebtedness, seek equity capital or both. In addition, future expansions or acquisitions could result in the ARLP Partnership assuming more long-term liabilities relative to the value of the acquired assets than it has assumed in its previous expansions and/or acquisitions.
Completion of growth projects and future expansion could require significant amounts of financing that may not be available to the ARLP Partnership on acceptable terms, or at all.
The ARLP Partnership plans to fund capital expenditures for its current growth projects with existing cash balances, future cash flows from operations, borrowings under revolving credit and securitization facilities and cash provided from the issuance of debt or equity. Weakness in the energy sector in general and coal in particular has significantly impacted access to the debt and equity capital markets. Accordingly, the ARLP Partnership’s funding plans may be negatively impacted by this constrained environment as well as numerous other factors, including higher than anticipated capital expenditures or lower than expected cash flow from operations. In addition, the ARLP Partnership may be unable to refinance its current revolving credit and securitization facilities when they expire or obtain adequate funding prior to expiry because its lending counterparties may be unwilling or unable to meet their funding obligations. Furthermore, additional growth projects and expansion opportunities may develop in the future that could also require significant amounts of financing that may not be available to the ARLP Partnership on acceptable terms or in the amounts it expects, or at all.
Various factors could adversely impact the debt and equity capital markets as well as the ARLP Partnership’s credit ratings or its ability to remain in compliance with the financial covenants under its then current debt agreements, which in turn could have a material adverse effect on its financial condition, results of operations and cash flows. If the ARLP Partnership is unable to finance its growth and future expansions as expected, it could be required to seek alternative financing, the terms of which may not be attractive to it, or to revise or cancel its plans.
The unavailability of an adequate supply of coal reserves that can be mined at competitive costs could cause the ARLP Partnership’s profitability to decline.
The ARLP Partnership’s profitability depends substantially on its ability to mine coal reserves that have the geological characteristics that enable them to be mined at competitive costs and to meet the quality needed by the ARLP Partnership’s customers. Because the ARLP Partnership depletes its reserves as it mines coal, its future success and growth depend, in part, upon its ability to acquire additional coal reserves that are economically recoverable. Replacement reserves may not be available when required or, if available, may not be mineable at costs comparable to those of the depleting mines. The ARLP Partnership may not be able to accurately assess the geological characteristics of any reserves that it acquires, which may adversely affect its profitability and financial condition. Exhaustion of reserves at particular mines also may have an adverse effect on the ARLP Partnership’s operating results that is disproportionate to the percentage of overall production represented by such mines. The ARLP Partnership’s ability to obtain other reserves in the future could be limited by restrictions under its existing or future debt agreements, competition from other coal companies for attractive properties, the lack of suitable acquisition candidates or the inability to acquire coal properties on commercially reasonable terms.
The estimates of the ARLP Partnership’s coal reserves may prove inaccurate and could result in decreased profitability.
The estimates of the ARLP Partnership’s coal reserves may vary substantially from actual amounts of coal it is able to economically recover. The reserve data set forth in “Item 2. Properties” represent the ARLP Partnership’s engineering estimates. All of the reserves presented in this Annual Report on Form 10-K constitute proven and probable reserves. There are numerous uncertainties inherent in estimating quantities of reserves, including many factors beyond the ARLP Partnership’s control. Estimates of coal reserves necessarily depend upon a number of variables and assumptions, any one of which may vary considerably from actual results. These factors and assumptions relate to:
· geological and mining conditions, which may not be fully identified by available exploration data and/or differ from the ARLP Partnership’s experiences in areas where it currently mines;
· the percentage of coal in the ground ultimately recoverable;
· historical production from the area compared with production from other producing areas;
· the assumed effects of regulation and taxes by governmental agencies; and
· assumptions concerning future coal prices, operating costs, capital expenditures, severance and excise taxes and development and reclamation costs.
For these reasons, estimates of the recoverable quantities of coal attributable to any particular group of properties, classifications of reserves based on risk of recovery and estimates of future net cash flows expected from these properties as prepared by different engineers, or by the same engineers at different times, may vary substantially. Actual production, revenue and expenditures with respect to the ARLP Partnership’s reserves will likely vary from estimates, and these variations may be material. Any inaccuracy in the estimates of the ARLP Partnership’s reserves could result in higher than expected costs and decreased profitability.
Mining in certain areas in which the ARLP Partnership operates is more difficult and involves more regulatory constraints than mining in other areas of the U.S., which could affect the mining operations and cost structures of these areas.
The geological characteristics of some of the ARLP Partnership’s coal reserves, such as depth of overburden and coal seam thickness, make them difficult and costly to mine. As mines become depleted, replacement reserves may not be available when required or, if available, may not be mineable at costs comparable to those characteristic of the depleting mines. In addition, permitting, licensing and other environmental and regulatory requirements associated with certain of the ARLP Partnership’s mining operations are more costly and time-consuming to satisfy. These factors could materially adversely affect the mining operations and cost structures of, and the ARLP Partnership’s customers’ ability to use coal produced by, the ARLP Partnership’s mines.
Some of the ARLP Partnership’s operating subsidiaries lease a portion of the surface properties upon which their mining facilities are located.
The ARLP Partnership’s operating subsidiaries do not, in all instances, own all of the surface properties upon which their mining facilities have been constructed. Certain of the operating companies have constructed and now operate all or some portion of their facilities on properties owned by unrelated third parties with whom the subsidiary has entered into a long-term lease. The ARLP Partnership has no reason to believe that there exists any risk of loss of these leasehold rights given the terms and provisions of the subject leases and the nature and identity of the third-party lessors; however, in the unlikely event of any loss of these leasehold rights, operations could be disrupted or otherwise adversely impacted as a result of increased costs associated with retaining the necessary land use.
Unexpected increases in raw material costs could significantly impair the ARLP Partnership’s operating profitability.
The ARLP Partnership’s coal mining operations are affected by commodity prices. The ARLP Partnership uses significant amounts of steel, petroleum products and other raw materials in various pieces of mining equipment, supplies and materials, including the roof bolts required by the room-and-pillar method of mining. Steel prices and the prices of scrap steel, natural gas and coking coal consumed in the production of iron and steel fluctuate significantly and may change unexpectedly. There may be acts of nature or terrorist attacks or threats that could also impact the future costs of raw materials. Future volatility in the price of steel, petroleum products or other raw materials will impact the ARLP Partnership’s operational expenses and could result in significant fluctuations in its profitability.
The ARLP Partnership’s indebtedness may limit its ability to borrow additional funds, make distributions to unitholders or capitalize on business opportunities.
The ARLP Partnership has long-term indebtedness, consisting of its outstanding senior unsecured notes, revolving credit facility and its term loan agreement. At December 31, 2015, the ARLP Partnership’s total long-term indebtedness outstanding was $819.3 million. The ARLP Partnership’s leverage may:
· adversely affect its ability to finance future operations and capital needs;
· limit its ability to pursue acquisitions and other business opportunities;
· make its results of operations more susceptible to adverse economic or operating conditions; and
· make it more difficult to self-insure for the ARLP Partnership’s workers’ compensation obligations.
In addition, the ARLP Partnership has unused borrowing capacity under its revolving credit facility. Future borrowings, under credit facilities or otherwise, could result in a significant increase in the ARLP Partnership’s leverage.
The ARLP Partnership’s payments of principal and interest on any indebtedness will reduce the cash available for distribution on its units. The ARLP Partnership will be prohibited from making cash distributions:
· during an event of default under any of its indebtedness; or
· if either before or after such distribution, it fails to meet a coverage test based on the ratio of its consolidated debt to its consolidated cash flow.
Various limitations in the ARLP Partnership’s debt agreements may reduce its ability to incur additional indebtedness, to engage in some transactions and to capitalize on business opportunities. Any subsequent refinancing of the ARLP Partnership’s current indebtedness or any new indebtedness could have similar or greater restrictions.
Federal and state laws require bonds to secure the ARLP Partnership’s obligations related to statutory reclamation requirements and workers’ compensation and black lung benefits. The ARLP Partnership’s inability to acquire or failure to maintain surety bonds that are required by state and federal law would have a material adverse effect on it.
Federal and state laws require the ARLP Partnership to place and maintain bonds to secure its obligations to repair and return property to its approximate original state after it has been mined (often referred to as “reclaim” or “reclamation”), to pay federal and state workers’ compensation and pneumoconiosis, or black lung, benefits and to satisfy other miscellaneous obligations. These bonds provide assurance that the ARLP Partnership will perform its statutorily required obligations and are referred to as “surety” bonds. These bonds are typically renewable on a yearly basis. The failure to maintain or the inability to acquire sufficient surety bonds, as required by state and federal laws, could subject
the ARLP Partnership to fines and penalties and result in the loss of its mining permits. Such failure could result from a variety of factors, including:
· lack of availability, higher expense or unreasonable terms of new surety bonds;
· the ability of current and future surety bond issuers to increase required collateral, or limitations on availability of collateral for surety bond issuers due to the terms of the ARLP Partnership’s credit agreements; and
· the exercise by third-party surety bond holders of their rights to refuse to renew the surety.
The ARLP Partnership has outstanding surety bonds with governmental agencies for reclamation, federal and state workers’ compensation and other obligations. At December 31, 2015, the ARLP Partnership’s total of such obligations was $234.0 million. The ARLP Partnership may have difficulty maintaining its surety bonds for mine reclamation as well as workers’ compensation and black lung benefits. In addition, those governmental agencies may increase the amount of bonding required. The ARLP Partnership’s inability to acquire or failure to maintain these bonds, or a substantial increase in the bonding requirements, would have a material adverse effect on it.
The ARLP Partnership and its subsidiaries are subject to various legal proceedings, which may have a material effect on its business.
The ARLP Partnership is party to a number of legal proceedings incident to its normal business activities. There is the potential that an individual matter or the aggregation of multiple matters could have an adverse effect on the ARLP Partnership’s cash flows, results of operations or financial position. Please see “Item 8. Financial Statements and Supplementary Data-Note 20. Commitments and Contingencies” for further discussion.
Tax Risks to Our Common Unitholders
Our tax treatment depends on our status as a partnership for federal tax purposes, as well as our not being subject to a material amount of entity-level taxation by individual states. If the Internal Revenue Service (“IRS”) treats us as a corporation for federal income tax purposes, or we or ARLP become subject to entity-level taxation for state tax purposes, our cash available for distribution to you would be substantially reduced.
The anticipated after-tax benefit of an investment in our units depends largely on AHGP being treated as a partnership for U.S. federal income tax purposes. The value of our investment in ARLP depends largely on ARLP being treated as a partnership for federal income tax purposes.
Despite the fact that we and ARLP are organized as limited partnerships under Delaware law, we and ARLP would be treated as corporations for U.S. federal income tax purposes unless we and ARLP satisfy a “qualifying income” requirement. Based upon ARLP’s current operations, we believe we and ARLP satisfy the qualifying income requirement. However, neither we nor ARLP have requested, and do not plan to request, a ruling from the IRS on this or any other matter affecting us or ARLP. Failing to meet the qualifying income requirement or a change in current law could cause us or ARLP to be treated as a corporation for U.S. federal income tax purposes or otherwise subject us or ARLP to taxation as an entity.
If we or ARLP were treated as a corporation for U.S. federal income tax purposes, we would pay U.S. federal income tax on our income at the corporate tax rate, which is currently a maximum of 35%, and would likely be liable for state income tax at varying rates. Distributions to our unitholders would generally be taxed again as corporate distributions, and no income, gains, losses, deductions or credits would flow through to our unitholders. Because taxes would be imposed upon us as a corporation, our cash available for distribution to our unitholders would be substantially reduced. Therefore, our treatment as a corporation would result in a material reduction in the anticipated cash flow and after-tax return to our unitholders, likely causing a substantial reduction in the value of the units.
ARLP’s partnership agreement provides that if a law is enacted or existing law is modified or interpreted in a manner that subjects ARLP to taxation as a corporation or otherwise subjects ARLP to entity-level taxation for U.S. federal, state or local income tax purposes, the minimum quarterly distribution (“MQD”) amount and the target distribution amounts may be adjusted to reflect the impact of that law on ARLP. Likewise, our cash distributions to you will be reduced if we or ARLP is subjected to any form of such entity-level taxation. At the state level, several states have been evaluating ways to subject partnerships to entity-level taxation through the imposition of state income, franchise or other forms of taxation. If any state were to impose a tax upon us or ARLP as an entity, the cash available for distribution to you would be reduced and the value of our common units or ARLP common units could be negatively impacted.
The tax treatment of publicly traded partnerships or an investment in our units could be subject to potential legislative, judicial or administrative changes or differing interpretations, possibly on a retroactive basis.
The present U.S. federal income tax treatment of publicly traded partnerships, including us and ARLP, or an investment in our common units may be modified by administrative, legislative or judicial changes or differing interpretations at any time. For example, the Obama administration’s budget proposal for fiscal year 2017 recommends that certain publicly traded partnerships earning income from activities related to fossil fuels be taxed as corporations beginning in 2022. From time to time, members of Congress propose and consider such substantive changes to the existing federal income tax laws that affect publicly traded partnerships. If successful, the Obama administration’s proposal or other similar proposals could eliminate the qualifying income exception to the treatment of all publicly-traded partnerships as corporations upon which we and ARLP rely for our treatment as a partnership for U.S. federal income tax purposes.
In addition, the IRS, on May 5, 2015, issued proposed regulations concerning which activities give rise to qualifying income within the meaning of Section 7704 of the Internal Revenue Code. We do not believe the proposed regulations affect our ability to qualify as a publicly traded partnership. However, finalized regulations could modify the amount of our gross income that we are able to treat as qualifying income for the purposes of the qualifying income requirement.
Any modification to the U.S. federal income tax laws may be applied retroactively and could make it more difficult or impossible for us or ARLP to meet the exception for certain publicly traded partnerships to be treated as partnerships for U.S. federal income tax purposes. We are unable to predict whether any of these changes or other proposals will ultimately be enacted. Any such changes could negatively impact the amount of our common unit distributions and the value of an investment in our common units.
If the IRS were to contest the federal income tax positions we take, it may adversely impact the market for our common units or ARLP common units, and the costs of any such contest would reduce cash available for distribution to ARLP and our unitholders. Recently enacted legislation alters the procedures for assessing and collecting taxes due for taxable years beginning after December 31, 2017, in a manner that could substantially reduce 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. The IRS may adopt positions that differ from the positions that we or ARLP take, even positions taken with the advice of counsel. It may be necessary to resort to administrative or court proceedings to sustain some or all of the positions we or ARLP take. A court may not agree with some or all of the positions we or ARLP take. Any contest with the IRS may materially and adversely impact the market for our common units or ARLP’s common units and the prices at which they trade. In addition, the costs of any contest with the IRS will be borne by ARLP and therefore indirectly by us, as a unitholder and as the owner of the managing general partner of ARLP. Moreover, the costs of any contest between us and the IRS will result in a reduction in cash available for distribution to our unitholders and thus will be borne indirectly by our unitholders.
Recently enacted legislation applicable to us for taxable years beginning after December 31, 2017 alters the procedures for auditing large partnerships and also alters the procedures for assessing and collecting taxes due (including applicable penalties and interest) as a result of an audit. Unless we are eligible to (and choose to) elect to issue revised Schedules K-1 to our partners with respect to an audited and adjusted return, the IRS may assess and collect taxes (including any applicable penalties and interest) directly from us in the year in which the audit is completed under the new rules. If we are required to pay taxes, penalties and interest as the result of audit adjustments, cash available for distribution to our unitholders may be substantially reduced. In addition, because payment would be due for the taxable year in which the audit is completed, unitholders during that taxable year would bear the expense of the adjustment even if they were not unitholders during the audited taxable year.
Even if you do not receive any cash distributions from us, you will be required to pay taxes on your share of our taxable income.
You will be required to pay federal income taxes and, in some cases, state and local income taxes, on your share of our taxable income, whether or not you receive cash distributions from us. For example, if the ARLP Partnership sells assets and uses the proceeds to repay existing debt or fund capital expenditures, you may be allocated taxable income and gain resulting from the sale and our cash available for distribution would not increase. Similarly, taking advantage of opportunities to reduce existing debt, such as debt exchanges, debt repurchases, or modifications of existing debt
could result “cancellation of indebtedness income” being allocated to our unitholders as taxable income without any increase in our cash available for distribution. You may not receive cash distributions from us equal to your share of our taxable income or even equal to the actual tax liability which results from your share of our taxable income.
Tax gain or loss on the disposition of our units could be more or less than expected.
If you sell your units, you will recognize gain or loss equal to the difference between the amount realized and your tax basis in those units. Because distributions in excess of your allocable share of our net taxable income result in a decrease in your tax basis in your 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 therein, even if the price you receive is less than your original cost. In addition, because the amount realized includes a unitholder’s share of our non-recourse liabilities, if you sell your units, you may incur a tax liability in excess of the amount of cash you receive from the sale.
A substantial portion of the amount realized from the sale of your units, whether or not representing gain, may be taxed as ordinary income to you due to potential recapture items, including depreciation recapture. Thus, you may recognize both ordinary income and capital loss from the sale of your units if the amount realized on a sale of your units is less than your adjusted basis in the units. Net capital loss may only offset capital gains and, in the case of individuals, up to $3,000 of ordinary income per year. In the taxable period in which you sell your units, you may recognize ordinary income from our allocations of income and gain to you prior to the sale and from recapture items that generally cannot be offset by any capital loss recognized upon the sale of units.
Tax-exempt entities and non-U.S. persons owning our units face unique tax issues that may result in adverse tax consequences to them.
Investment in our units by tax-exempt entities, such as employee benefit plans, individual retirement accounts (“IRAs”) and non-U.S. persons, raises issues unique to them. For example, virtually all of our income allocated to organizations exempt from federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and will be taxable to them. Allocations and/or 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 U.S. federal income 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 treat each purchaser of our units as having the same tax benefits without regard to the units purchased. The IRS may challenge this treatment, which could adversely affect the value of our units.
Because we cannot match transferors and transferees of units, we 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 units and could have a negative impact on the value of our 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 generally 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 U.S. Department of Treasury recently adopted final Treasury Regulations allowing a similar monthly simplifying convention for taxable years beginning on or after August 3, 2015. However, such regulations do not specifically authorize the use of the proration method we have adopted for our 2015 taxable year and may not specifically authorize all aspects of our proration method thereafter. If the IRS were to challenge our proration method, we may be required to change the allocation of items of income, gain, loss and deduction among our unitholders.
A unitholder whose units are the subject of a securities loan (e.g., a loan 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 there is no tax concept of loaning a partnership interest, a unitholder whose units are the subject of a securities loan may be considered as having disposed of the loaned units. In that case, the unitholder may no longer be treated for tax purposes as a partner with respect to those units during the period of the loan and the unitholder may recognize gain or loss from such disposition. Moreover, during the period of the loan, 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 securities loan are urged to modify any applicable brokerage account agreements to prohibit their brokers from borrowing their units.
ARLP has adopted certain valuation methodologies in determining unitholder’s allocations of income, gain, loss and deduction. The IRS may challenge these methods or the resulting allocations, and such a challenge could adversely affect the value of the common units.
In determining the items of income, gain, loss and deduction allocable to our unitholders, ARLP must routinely determine the fair market value of its respective assets. Although ARLP may from time to time consult with professional appraisers regarding valuation matters, ARLP makes many fair market value estimates using a methodology based on the market value of its common units as a means to measure the fair market value of its respective assets. The IRS may challenge these valuation methods and the resulting allocations or character of income, gain, loss and deduction.
A successful IRS challenge to these methods or allocations could adversely affect the amount, character, and timing 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.
Certain federal income tax deductions currently available with respect to coal mining and production may be eliminated as a result of future legislation.
The Obama administration has indicated a desire to eliminate certain key U.S. federal income tax provisions currently applicable to coal companies, including the percentage depletion allowance with respect to coal properties. No legislation with that effect has been proposed and elimination of those provisions would not impact the ARLP Partnership’s financial statements or results of operations. However, elimination of the provisions could result in unfavorable tax consequences for its unitholders and, as a result, could negatively impact its unit price as well as our unitholders and unit price.
The sale or exchange of 50% or more of our capital and profits interests within a twelve-month period will result in the termination of us as a partnership for federal income tax purposes.
We will be considered to have terminated as a partnership 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. For purposes of determining whether the 50% threshold has been met, multiple sales of the same interest will be counted only once. 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 for one calendar 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 calendar year, the closing of our taxable year may also result in more than twelve months of our taxable income or loss being includable in taxable income for the unitholder’s taxable year that includes our termination. A termination would not affect our classification as a partnership for federal income tax purposes, but it would result in our being treated as a new partnership for U.S. federal income tax purposes following the termination. If we were treated as a new partnership, we would be required to make new tax elections and could be subject to penalties if we were unable to determine that a termination occurred. The IRS has implemented relief procedures whereby if a publicly traded partnership that has technically terminated, requests and the IRS grants special relief, among other things, the partnership may be permitted to provide only a single Schedule K-1 to unitholders for the two short tax periods included in the year in which the termination occurs.
You will likely be subject to state and local taxes and income tax return filing requirements in jurisdictions where you do not live as a result of investing in our units.
In addition to U.S. federal income taxes, you will likely be subject to other taxes, such as state and local income taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we do business or own property now or in the future. You will likely be required to file 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 currently own assets and conduct business in a variety of states which currently impose a personal 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 U.S. federal, state and local tax returns.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Coal Reserves
The ARLP Partnership must obtain permits from applicable regulatory authorities before beginning to mine particular reserves. For more information on this permitting process, and matters that could hinder or delay the process, please read “Item 1. Business-Regulation and Laws-Mining Permits and Approvals.”
The ARLP Partnership’s reported coal reserves are those it believes can be economically and legally extracted or produced at the time of the filing of this Annual Report on Form 10-K. In determining whether its reserves meet this economic and legal standard, the ARLP Partnership takes into account, among other things, its potential ability or inability to obtain mining permits, the possible necessity of revising mining plans changes in future cash flows caused by changes in estimated future costs, changes in mining permits, variations in quantity and quality of coal, and varying levels of demand and their effects on selling prices.
At December 31, 2015, the ARLP Partnership had approximately 1.8 billion tons of coal reserves. All of the estimates of reserves which are presented in this Annual Report on Form 10-K are of proven and probable reserves (as defined below) and closely adhere to the standards described in U.S. Geological Survey (“USGS”) Circular 831 and USGS Bulletin 1450-B. For information on the locations of the ARLP Partnership’s mines, please read “Mining Operations” under “Item 1. Business.”
The following table sets forth reserve information at December 31, 2015 about the ARLP Partnership’s mining operations:
(1) U = Underground and S = Surface
The ARLP Partnership’s reserve estimates are prepared from geological data assembled and analyzed by its staff of geologists and engineers. This data is obtained through the ARLP Partnership’s extensive, ongoing exploration drilling and in-mine channel sampling programs. The ARLP Partnership’s drill spacing criteria adhere to standards as defined by the USGS. The maximum acceptable distance from seam data points varies with the geologic nature of the coal seam being studied, but generally the standard for (a) proven reserves is that points of observation are no greater than ½ mile apart and are projected to extend as a ¼ mile wide belt around each point of measurement and (b) probable reserves is that points of observation are between ½ and 1 ½ miles apart and are projected to extend as a ½ mile wide belt that lies ¼ mile from the points of measurement.
Reserve estimates will change from time to time to reflect mining activities, additional analysis, new engineering and geological data, acquisition or divestment of reserve holdings, modification of mining plans or mining methods, and other factors. Weir International Mining Consultants performed an audit of the ARLP Partnership’s reserves and calculation methods in July 2015.
Reserves represent that part of a mineral deposit that can be economically and legally extracted or produced, and reflect estimated losses involved in producing a saleable product. All of the ARLP Partnership’s reserves are steam coal, except for reserves at Mettiki that can be delivered to the steam or metallurgical markets. The 6.0 million tons of reserves listed at MC Mining as <1.2 pounds of SO2 per million British thermal units (“MMBTU”) are marketable as compliance coal under Phase II of CAA.
Assigned reserves are those reserves that have been designated for mining by a specific operation. Unassigned reserves are those reserves that have not yet been designated for mining by a specific operation. British thermal units (“BTU”) values are reported on an as shipped, fully washed basis. Shipments that are either fully or partially raw will have a lower BTU value.
The ARLP Partnership owns or controls certain leases for coal deposits that do not currently meet the criteria to be reflected as reserves but may be reclassified as reserves in the future. These tons are classified as non-reserve coal deposits and are not included in the ARLP Partnership’s reported reserves. These non-reserve coal deposits include the following: Mettiki--3.8 million tons, Tunnel Ridge--3.6 million tons, Hamilton County--36.5 million tons, Warrior--8.2 million tons, Dotiki-2.3 million tons, Onton-4.6 million tons, River View--0.1 million tons, Gibson (North)--0.1 million tons, Gibson (South)--1.3 million tons and Pattiki--15.5 million tons. The Henderson/Union County Undeveloped Reserves account for the majority of the ARLP Partnership’s non-reserve coal deposits with 206.1 million tons. In addition, there are 47.8 million tons located near the Dotiki complex for total non-reserve coal deposits of 329.9 million tons. For more information on reserve acquisitions see “Item 8. Financial Statements and Supplementary Data--Note 3. Acquisitions.”
The ARLP Partnership leases most of its reserves and generally has the right to maintain leases in force until the exhaustion of mineable and merchantable coal located within the leased premises or a larger coal reserve area. These leases provide for royalties to be paid to the lessor at a fixed amount per ton or as a percentage of the sales price. Many leases require payment of minimum royalties, payable either at the time of the execution of the lease or in periodic installments, even if no mining activities have begun. These minimum royalties are normally credited against the production royalties owed to a lessor once coal production has commenced.
Mining Operations
The following table sets forth production and other data about the ARLP Partnership’s mining operations:
CSX
-
CSX Railroad
NS
-
Norfolk Southern Railroad
PAL
-
Paducah & Louisville Railroad
CM
-
Continuous Miner
LW
-
Longwall
EVWR
-
Evansville Western Railroad
WLE
-
Wheeling & Lake Erie Railroad
TS
-
Truck, Shovel, Front End Loader or Dozer
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are not engaged in any material litigation. From time to time the ARLP Partnership is a party to litigation matters incidental to the conduct of its business. The ARLP Partnership initiated litigation on January 15, 2015 alleging that a customer anticipatorily breached a coal supply contract when it notified the ARLP Partnership that it would not accept coal shipments under the contract after April 15, 2015. The contract obligates the customer to purchase more than 5.0 million tons during the period between April 16, 2015 and the end of the contract term on December 31, 2021. The ARLP Partnership is seeking to recover damages resulting from the customer’s alleged breach of contract.
It is the opinion of management that the ultimate resolution of the ARLP Partnership’s pending litigation matters will not have a material adverse effect on our financial condition, results of operation or liquidity. However, we cannot assure you that disputes or litigation will not arise or that the ARLP Partnership will be able to resolve any such future disputes or litigation in a satisfactory manner. The information under “General Litigation” and “Other” in “Item 8. Financial Statements and Supplementary Data-Note 20. Commitments and Contingencies” is incorporated herein by this reference.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Information concerning mine safety violations or other regulatory matters required by Section 1503(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act and Item 104 of Regulation S-K (17 CFR 229.104) is included in Exhibit 95.1 to this Annual Report on Form 10-K.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED UNITHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The common units representing limited partners’ interests are listed on the NASDAQ Global Select Market under the symbol “AHGP.” The common units began trading on May 10, 2006. On February 11, 2016, the closing market price for the common units was $12.45 per unit and there were 59,863,000 common units outstanding. There were approximately 10,126 record holders of common units at December 31, 2015.
The following table sets forth the range of high and low sales prices per common unit and the amount of cash distributions declared and paid with respect to the units, for the two most recent fiscal years:
High
Low
Distributions Per Unit
1st Quarter 2014
$63.53
$54.51
$0.8475 (paid May 20, 2014)
2nd Quarter 2014
$69.72
$59.38
$0.87 (paid August 19, 2014)
3rd Quarter 2014
$74.00
$64.12
$0.8925 (paid November 19, 2014)
4th Quarter 2014
$70.80
$55.10
$0.915 (paid February 19, 2015)
1st Quarter 2015
$62.59
$48.25
$0.9375 (paid May 20, 2015)
2nd Quarter 2015
$52.78
$38.36
$0.96 (paid August 19, 2015)
3rd Quarter 2015
$40.15
$29.81
$0.96 (paid November 19, 2015)
4th Quarter 2015
$35.76
$15.71
$0.96 (paid February 19, 2016)
We will distribute 100% of our available cash (including any held by MGP) within 50 days after the end of each quarter to unitholders of record. Available cash is generally defined as all cash and cash equivalents on hand at the end of each quarter less reserves established by AGP in its reasonable discretion for future cash requirements. These reserves are retained to provide for the conduct of our business, the payment of debt principal and interest and to provide funds for future distributions.
Equity Compensation Plans
The information relating to our equity compensation plans required by Item 5 is incorporated by reference to such information as set forth in “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Unitholder Matters” contained herein.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Since we own MGP, our financial statements reflect the consolidated results of the ARLP Partnership. The amount of earnings of the ARLP Partnership allocated to its limited partners’ interests not owned by us is reflected as a noncontrolling interest in our consolidated income statement and balance sheet. Our consolidated financial statements do not differ materially from those of the ARLP Partnership. The differences between our financial statements and those of the ARLP Partnership are primarily attributable to (a) amounts reported as noncontrolling interests and (b) additional general and administrative costs and taxes attributable to us. The additional general and administrative costs principally consist of costs incurred by us as a result of being a publicly traded partnership and amounts paid to Alliance Coal under an Administrative Services Agreement in addition to amounts paid to AGP under our partnership agreement.
Our historical financial data below were derived from the AHGP Partnership’s audited consolidated financial statements as of and for the years ended December 31, 2015, 2014, 2013, 2012 and 2011.
(1) Working capital is impacted by current maturities of long-term debt. For information regarding long-term debt, please read “Item 8. Financial Statements and Supplementary Data--Note 7. Long-Term Debt” of this Annual Report on Form 10-K.
(2) Long-term obligations include long-term portions of debt and capital lease obligations.
(3) Coal sales per ton sold are based on total coal sales divided by tons sold.
(4) Cost per ton sold is based on the total of operating expenses and outside coal purchases divided by tons sold.
(5) EBITDA and Adjusted EBITDA are financial measures not calculated in accordance with generally accepted accounting principles (“GAAP”). EBITDA is defined as net income (prior to the allocation of noncontrolling interest) before net interest expense, income taxes and depreciation, depletion and amortization and Adjusted EBITDA is EBITDA modified for certain items that may not reflect the trend of future results, such as non-cash impairments and gains and losses on acquisition related accounting. EBITDA is used as a supplemental financial measure by our management and by external users of our financial statements such as investors, commercial banks, research analysts and others, to assess:
· the financial performance of the ARLP Partnership’s assets without regard to financing methods, capital structure or historical cost basis;
· the ability of the ARLP Partnership’s assets to generate cash sufficient to pay interest costs and support its indebtedness;
· the ARLP Partnership’s operating performance and return on investment compared to those of other companies in the coal energy sector, without regard to financing or capital structures; and
· the viability of acquisitions and capital expenditure projects and the overall rates of return on alternative investment opportunities.
We believe Adjusted EBITDA is a useful measure for investors because it further demonstrates the performance of assets without regard to items that may not reflect the trend of future results.
EBITDA and Adjusted EBITDA should not be considered as alternatives to net income, income from operations, cash flows from operating activities or any other measure of financial performance presented in accordance with GAAP. EBITDA and Adjusted EBITDA are not intended to represent cash flow and do not represent the measure of cash available for distribution. Our method of computing EBITDA and Adjusted EBITDA may not be the same method used to compute similar measures reported by other companies, or EBITDA and Adjusted EBITDA may be computed differently by us in different contexts (e.g. public reporting versus computation under financing agreements).
The following table presents a reconciliation of (a) GAAP “Cash Flows Provided by Operating Activities” to non-GAAP Adjusted EBITDA and EBITDA and (b) non-GAAP Adjusted EBITDA and EBITDA to GAAP “Net income”:
(6) The ARLP Partnership’s maintenance capital expenditures, as defined under the terms of its partnership agreement, are those capital expenditures required to maintain, over the long-term, the operating capacity of its capital assets.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The following discussion of our financial condition and results of operations should be read in conjunction with the historical financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K. For more detailed information regarding the basis of presentation for the following financial information, please see “Item 8. Financial Statements and Supplementary Data-Note 1. Organization and Presentation and Note 2. Summary of Significant Accounting Policies.”
Executive Overview
The AHGP Partnership
Our cash flows currently consist of distributions from ARLP on our ARLP partnership interests, including the IDRs that we own. We reflect our ownership interest in the ARLP Partnership on a consolidated basis, which means that our financial results are combined with the ARLP Partnership’s financial results and the results of our other subsidiaries. The earnings of the ARLP Partnership allocated to its limited partners’ interests not owned by us and allocated to SGP’s general partner interest in ARLP are reflected as a noncontrolling interest in our consolidated income statement and balance sheet. Accordingly, the noncontrolling partners’ interest in the ARLP Partnership’s net income is reflected as reduction of consolidated net income in our results of operations. In addition to the ARLP Partnership, our historical consolidated results of operations include the results of operations of MGP, our wholly owned subsidiary.
The AHGP Partnership’s results of operations principally reflect the results of operations of the ARLP Partnership adjusted for noncontrolling partners’ interest in the ARLP Partnership’s net income. Accordingly, the discussion of our financial position and results of operations in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” reflects the operating activities and results of operations of the ARLP Partnership.
Our primary business objective is to increase our cash distributions to our unitholders by actively assisting ARLP in executing its business strategy. ARLP’s business strategy is to create sustainable, capital-efficient growth in available cash to maximize its distribution to its unitholders by:
· expanding its operations by adding and developing mines and coal reserves in existing, adjacent or neighboring properties;
· extending the lives of its current mining operations through acquisition and development of coal reserves using its existing infrastructure;
· continuing to make productivity improvements to remain a low-cost producer in each region in which it operates;
· strengthening its position with existing and future customers by offering a broad range of coal qualities, transportation alternatives and customized services;
· developing strategic relationships to take advantage of opportunities within the coal industry and MLP sector; and
· making equity investments for the purchase of oil and gas mineral interests in various geographic locations within producing basins in the continental U.S.
The ARLP Partnership
The ARLP Partnership is a diversified producer and marketer of coal primarily to major U.S. utilities and industrial users and was the first such producer and marketer in the nation to be a publicly traded master limited partnership. The ARLP Partnership is currently the second-largest coal producer in the eastern U. S. In 2015, the ARLP Partnership produced and sold a record 41.2 million and 40.2 million tons of coal, respectively. The coal it produced in 2015 was approximately 3.6% low-sulfur coal, 17.3% medium-sulfur coal and 79.1% high-sulfur coal. The ARLP Partnership classifies low-sulfur coal as coal with a sulfur content of less than 1%, medium-sulfur coal as coal with a sulfur content of 1% to 2%, and high-sulfur coal as coal with a sulfur content of greater than 2%.
The ARLP Partnership operates ten underground mining complexes, including the White Oak Mine No. 1 (now known as the Hamilton Mine No. 1), of which it assumed control in July 2015. Prior to assuming control, the ARLP Partnership owned a preferred equity interest in White Oak and purchased and funded development of coal reserves, and
operated surface facilities at White Oak’s mining complex in southern Illinois. The ARLP Partnership also operates a coal-loading terminal on the Ohio River at Mt. Vernon, Indiana. In addition, the ARLP Partnership owns through its consolidated affiliate, Cavalier Minerals, an equity interest and plan to make additional equity investments in AllDale Minerals for the purchase of oil and gas mineral interests in various geographic locations within producing basins in the continental U.S. At December 31, 2015, the ARLP Partnership had approximately 1.8 billion tons of proven and probable coal reserves in Illinois, Indiana, Kentucky, Maryland, Pennsylvania and West Virginia compared to 1.5 billion tons at December 31, 2014. We believe the ARLP Partnership controls adequate reserves to implement its currently contemplated mining plans. Please see “Item 1. Business-Mining Operations” for further discussion of the ARLP Partnership’s mines. For more information regarding control of White Oak and the increase in reserves, please read “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions.”
In 2015, approximately 96.1% of the ARLP Partnership’s sales tonnage was purchased by electric utilities, with the balance sold to third-party resellers and industrial consumers. Although many utility customers recent have appeared to favor a shorter-term contracting strategy, in 2015, approximately 92.2% of the ARLP Partnership’s sales tonnage was sold under long-term contracts. The ARLP Partnership’s long-term contracts contribute to its stability and profitability by providing greater predictability of sales volumes and sales prices. In 2015, approximately 98.6% of the medium- and high-sulfur coal was sold to utility plants with installed pollution control devices. These devices, also known as scrubbers, eliminate substantially all emissions of sulfur dioxide.
As discussed in more detail in “Item 1A. Risk Factors,” the ARLP Partnership’s results of operations could be impacted by prices for items that are used in coal production such as steel, electricity and other supplies, unforeseen geologic conditions or mining and processing equipment failures and unexpected maintenance problems, and by the availability or reliability of transportation for coal shipments. Additionally, the ARLP Partnership’s results of operations could be impacted by its ability to obtain and renew permits necessary for its operations, secure or acquire coal reserves, or find replacement buyers for coal under contracts with comparable terms to existing contracts. Moreover, the regulatory environment has grown increasingly stringent in recent years. As outlined in “Item 1. Business-Regulation and Laws,” a variety of measures taken by regulatory agencies in the U.S. and abroad in response to the perceived threat from climate change attributed to GHG emissions could substantially increase compliance costs for the ARLP Partnership and its customers and reduce demand for coal, which could materially and adversely impact its results of operations. For additional information regarding some of the risks and uncertainties that affect the ARLP Partnership’s business and the industry in which it operates, see “Item 1A. Risk Factors.”
The ARLP Partnership’s principal expenses related to the production of coal are labor and benefits, equipment, materials and supplies, maintenance, royalties and excise taxes. The ARLP Partnership employs a totally union-free workforce. Many of the benefits of the ARLP Partnership’s union-free workforce are related to higher productivity and are not necessarily reflected in its direct costs. In addition, transportation costs may be substantial and are often the determining factor in a coal consumer’s contracting decision. The ARLP Partnership’s mining operations are located near many of the major eastern utility generating plants and on major coal hauling railroads in the eastern U.S. The River View and Tunnel Ridge mines and Mt. Vernon transloading facility are located on the Ohio River and the Onton mine is located on the Green River in western Kentucky. Onton was idled in November 2015.
We have two reportable segments: Illinois Basin and Appalachia and an “all other” category referred to as Other and Corporate. Our reportable segments correspond to major coal producing regions in the eastern U.S. Factors similarly affecting financial performance of our operating segments within each of these two reportable segments generally include coal quality, geology, coal marketing opportunities, mining and transportation methods and regulatory issues.
As a result of the previously discussed acquisition of the remaining equity interests in White Oak, we restructured our reportable segments to include Hamilton as part of our Illinois Basin segment due to the similarities in product, management, location, and operation with other mines included in the segment. This new organization reflects how our chief operating decision maker manages and allocates resources to our various operations. Prior periods have been recast to include White Oak in our Illinois Basin segment. For more information on the ARLP Partnership’s acquisition of White Oak, please read “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions.”
· Illinois Basin reportable segment is comprised of multiple operating segments, including Webster County Coal’s Dotiki mining complex, Gibson County Coal’s mining complex, which includes the Gibson North mine and Gibson South mine, Hopkins County Coal’s mining complex, which includes the Elk Creek mine and the Fies property, White County Coal’s Pattiki mining complex, Warrior’s mining complex, Sebree Mining’s mining complex, which includes the Onton mine, Steamport and certain Sebree Reserves, River View’s mining complex, Hamilton’s mining complex discussed above, CR Services, LLC, certain properties and equipment of
Alliance Resource Properties, ARP Sebree, LLC (“ARP Sebree”), ARP Sebree South, LLC, UC Coal, LLC, UC Mining, LLC, and UC Processing, LLC. In April 2014, initial production began at the Gibson South mine. In the fourth quarter of 2014 and February 2015, Alliance Resource Properties acquired reserves that will significantly extend the life of the Dotiki mine, allow increased production from the River View mine and add three new potential development projects for the ARLP Partnership’s organic growth strategy. During the fourth quarter of 2015, the ARLP Partnership idled the Onton and Gibson North mines in response to market conditions and continued increases in coal inventories at its mines and customer locations. The Elk Creek mine is currently expected to cease production in early 2016. The Sebree Mining and Fies properties are held by the ARLP Partnership for future mine development. For information regarding the permitting process and matters that could hinder or delay the process, please read “Item 1. Business-Regulation and Laws-Mining Permits and Approvals”. For information regarding the acquisition of reserves in December 2014 and February 2015 and the assumption of control at the Hamilton Mine No. 1 in July 2015, please read “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions” of this Annual Report on Form 10-K.
· Appalachia reportable segment is comprised of multiple operating segments, including the Mettiki mining complex, the Tunnel Ridge mining complex and the MC Mining mining complex. The Mettiki mining complex includes Mettiki Coal (WV)’s Mountain View mine and Mettiki Coal’s preparation plant. During the fourth quarter 2015, the ARLP Partnership surrendered the Penn Ridge leases as they were no longer a core part of its foreseeable development plans. Please read “Item 8. Financial Statements and Supplementary Data-Note 4. Long-Lived Asset Impairment” for further discussion of this surrender. In June 2013, Alliance Resource Properties acquired reserves that extended the life of the Mettiki (WV) Mountain View mine. For information regarding the reserves acquired, please read “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions” of this Annual Report on Form 10-K.
· Other and Corporate includes marketing and administrative expenses, Alliance Service, Inc. (“ASI”) and its subsidiary, Matrix Design Group, LLC and its subsidiaries Matrix Design International, LLC and Matrix Design Africa (PTY) LTD, Alliance Design Group, LLC (collectively the Matrix entities and Alliance Design, are referred to as “Matrix Design Group”), ASI’s ownership of aircraft, Mt. Vernon’s dock activities; coal brokerage activity, MAC’s manufacturing and sales (primarily to the ARLP Partnership’s mines) of rock dust, certain activities of Alliance Resource Properties, the Pontiki Coal mining complex, which ceased operations in November 2013 and sold most of its assets in May 2014, Wildcat Insurance, which was established in September 2014 to assist the ARLP Partnership with its insurance requirements, Alliance Minerals and its affiliate, Cavalier Minerals, which holds equity investments in AllDale Minerals and AROP Funding, LLC (“AROP Funding”). Please read “Item 8. Financial Statements and Supplementary Data-Note 7. Long-Term Debt”, “-Note 11. Variable Interest Entities” and “-Note 13. Equity Investments” of this Annual Report on Form 10-K for more information on AROP Funding, Alliance Minerals, Cavalier Minerals and AllDale Minerals.
How the ARLP Partnership Evaluates its Performance
The ARLP Partnership’s management uses a variety of financial and operational measurements to analyze its performance. Primary measurements include the following: (1) raw and saleable tons produced per unit shift; (2) coal sales price per ton; (3) Segment Adjusted EBITDA Expense per ton; (4) EBITDA; and (5) Segment Adjusted EBITDA.
Raw and Saleable Tons Produced per Unit Shift. The ARLP Partnership reviews raw and saleable tons produced per unit shift as part of its operational analysis to measure the productivity of its operating segments, which is significantly influenced by mining conditions and the efficiency of its preparation plants. A discussion of mining conditions and preparation plant costs are found below under “-Analysis of Historical Results of Operations” and therefore provides implicit analysis of raw and saleable tons produced per unit shift.
Coal Sales Price per Ton. The ARLP Partnership defines coal sales price per ton as total coal sales divided by tons sold. The ARLP Partnership reviews coal sales price per ton to evaluate marketing efforts and for market demand and trend analysis.
Segment Adjusted EBITDA Expense per Ton. The ARLP Partnership defines Segment Adjusted EBITDA Expense per ton (a non-GAAP financial measure) as the sum of operating expenses, outside coal purchases and other income divided by total tons sold. The ARLP Partnership reviews segment adjusted EBITDA expense per ton for cost trends.
EBITDA. The ARLP Partnership defines EBITDA (a non-GAAP financial measure) as net income (prior to the allocation of noncontrolling interest) before net interest expense, income taxes and depreciation, depletion and amortization. EBITDA is used as a supplemental financial measure by the ARLP Partnership’s management and by external users of its financial statements such as investors, commercial banks, research analysts and others, to assess:
· the financial performance of its assets without regard to financing methods, capital structure or historical cost basis;
· the ability of its assets to generate cash sufficient to pay interest costs and support its indebtedness;
· its operating performance and return on investment compared to those of other companies in the coal energy sector, without regard to financing or capital structures; and
· the viability of acquisitions and capital expenditure projects and the overall rates of return on alternative investment opportunities.
Segment Adjusted EBITDA. The ARLP Partnership defines Segment Adjusted EBITDA (a non-GAAP financial measure) as net income (prior to the allocation of noncontrolling interest) before net interest expense, income taxes, depreciation, depletion and amortization, asset impairment charge, acquisition gain, net and general and administrative expenses. Management therefore is able to focus solely on the evaluation of segment operating profitability as it relates to our revenues and operating expenses, which are primarily controlled by our segments.
Analysis of Historical Results of Operations
2015 Compared with 2014
We reported net income of $304.2 million for 2015 compared to $492.7 million for 2014. The decrease of $188.5 million was principally due to non-cash asset impairments of $100.1 million, lower average coal sales prices particularly at the Appalachian segment mines, increased depreciation, depletion and amortization and higher equity in loss of affiliates partially offset by record coal sales volumes, increased coal volumes at lower cost per ton operations, a net gain of $22.5 million related to the final business combination accounting for the acquisition of White Oak’s remaining equity on July 31, 2015 (the “Hamilton Acquisition”) and increased other sales and operating revenues primarily reflecting higher surface facility services and coal royalties from White Oak prior to the Hamilton Acquisition. For more information on the Hamilton Acquisition, please read “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions.” For more information on the non-cash asset impairments, please read “Item 8. Financial Statements and Supplementary Data-Note 4. Long-Lived Asset Impairments.”
Coal sales. Coal sales decreased 2.3% to $2.16 billion for 2015 from $2.21 billion for 2014. The decrease of $50.6 million in coal sales reflected lower average coal sales prices which reduced coal sales by $79.3 million, partially offset by the benefit of record tons sold which contributed $28.7 million in additional coal sales. Average coal sales prices decreased by $1.97 to $53.62 per ton sold in 2015 compared to $55.59 per ton sold in 2014, primarily as a result of current market conditions impacted by reduced coal demand at utilities due to low natural gas prices, regulatory pressures that caused coal to gas switching or plant closures and high inventories. The decline in average sales prices was particularly noticeable for our Appalachian segment decreasing $4.51 per ton to $60.75. In addition, average coal sales prices were impacted by lower-priced legacy contracts inherited in the Hamilton Acquisition. Sales and production volumes rose to 40.2 million tons sold and 41.2 million tons produced in 2015 compared to 39.7 million tons sold and 40.7 million tons produced in 2014, primarily due to the addition of Hamilton production beginning August 1, 2015, the ramp up of coal production at the Gibson South mine following the commencement of operations in April 2014 and increased sales at the Tunnel Ridge and Mettiki mines. Volume increases were partially offset by lower sales at the Warrior, Gibson North, River View and Onton mines due to shift reductions, the shutdown of operations at the Gibson North and Onton mines in the fourth quarter of 2015 and scaled backed production at the Tunnel Ridge mine during the
second half of 2015, all in response to weak coal demand, as well as an inventory build at several locations. In addition to shift reductions, reduced production from Warrior resulted from its continuing transition to a new mining area.
Operating expenses and outside coal purchases. Operating expenses and outside coal purchases decreased 0.4% to $1.38 billion in 2015 remaining comparable to 2014. Decreases primarily resulted from a production scale-back at various mines discussed above, lower compensation expense and reduced selling expense resulting from lower coal sales prices and a favorable sales mix. These decreases were partially offset by increased operating expenses resulting from the assumption of operations at the Hamilton Mine No. 1 and a full year of production operations at the Gibson South mine. On a per ton basis, operating expenses and outside coal purchases decreased by 1.7% to $34.22 per ton sold in 2015 from $34.82 per ton sold in 2014, primarily as a result of lower operating expenses discussed above and increased coal volumes at lower cost per ton mines, partially offset by the impact of scaled back production at the Tunnel Ridge mine. Operating expenses were impacted by various other factors, the most significant of which are discussed below:
· Labor and benefit expenses per ton produced, excluding workers’ compensation, decreased 1.5% to $11.55 per ton in 2015 from $11.72 per ton in 2014. This decrease of $0.17 per ton was primarily attributable to a favorable production mix in 2015 discussed above, lower production-related bonus compensation and reduced overtime hours as a result of reduced unit shifts at certain mines, offset partially by higher medical expenses in 2015;
· Material and supplies expenses per ton produced decreased 3.0% to $11.25 per ton in 2015 from $11.60 per ton in 2014. The decrease of $0.35 per ton produced resulted primarily from the benefits of increased production and a favorable production mix in 2015 discussed above and related decreases of $0.31 per ton for roof support supplies and $0.13 per ton for certain ventilation related materials and supplies expenses, partially offset by an increase of $0.10 per ton in longwall subsidence expense;
· Production taxes and royalties expenses incurred as a percentage of coal sales prices and volumes decreased $0.45 per produced ton sold in 2015 compared to 2014 primarily as a result of lower average coal sales prices and a favorable sales mix as discussed above and increased brokerage coal sales which have minimal production taxes and royalty expenses if any; and
· Operating expenses also benefited from a $4.4 million gain reflecting a reduction in the estimated value, due to lower coal sales prices, of contingent consideration potentially payable in the Hamilton Acquisition.
Operating expenses and outside coal purchases per ton decreases discussed above were partially offset by the following increases:
· Operating expenses for 2015 increased as a result of the benefit of $7.0 million of insurance proceeds in 2014 related to claims from an adverse geological event at the Onton mine in 2013 and a gain of $4.4 million recognized in 2014 on the sale of Pontiki’s assets, both of which were absent in 2015. In May 2014, Pontiki completed the sale of most of its assets, including certain coal reserves, mining equipment and infrastructure and surface facilities.
Other sales and operating revenues. Other sales and operating revenues are principally comprised of Mt. Vernon transloading revenues, Matrix Design Group sales, surface facility services and coal royalty revenues received from White Oak prior to the Hamilton Acquisition and other outside services. Other sales and operating revenues increased to $81.7 million for 2015 from $65.7 million for 2014. The increase of $16.0 million was primarily attributable to White Oak’s start-up of longwall production and resulting increased surface facility services and coal royalty revenues prior to the Hamilton Acquisition and increased revenues at the Mt. Vernon operations primarily due to increased transloading fees from White Oak prior to the Hamilton Acquisition, partially offset by decreased payments-in-lieu-of-shipments received from a customer related to an Appalachian coal supply agreement.
General and administrative. General and administrative expenses for 2015 decreased to $69.1 million compared to $76.7 million in 2014. The decrease of $7.6 million was primarily due to lower incentive compensation expenses.
Depreciation, depletion and amortization. Depreciation, depletion and amortization expense increased to $333.7 million for 2015 from $274.6 million for 2014. The increase of $59.1 million was attributable to the reduction of the economic mine life at the Elk Creek mine, which is expected to close near the end of the first quarter of 2016, increased production at the Gibson South mine, which commenced initial production in April 2014, amortization of coal supply agreements acquired in December 2014 and the addition of the Hamilton Mine No. 1 in late July 2015.
Interest expense. Interest expense, net of capitalized interest, decreased to $31.2 million in 2015 from $33.6 million in 2014. The decrease of $2.4 million was principally attributable to the repayment of the ARLP Series A senior notes in June 2015 partially offset by interest incurred on debt assumed in the Hamilton Acquisition and an increase in the principal balance of the revolving credit facility. The ARLP Partnership’s debt instruments are discussed in more detail below under “-Debt Obligations.”
Equity in loss of affiliates, net. Equity in loss of affiliates, net for 2015 includes the ARLP Partnership’s equity investments in White Oak prior to the Hamilton Acquisition and AllDale Minerals. In 2014, equity investments also include MAC. For 2015, equity in loss of affiliates of $49.0 million was recognized compared to $16.6 million for 2014. The increase in equity in loss of affiliates, net is primarily due to low coal sales price realizations and higher expenses related to White Oak’s ramp up of longwall operations in 2015 prior to the Hamilton Acquisition and the impact of changes in allocations of equity income or losses resulting from reduced equity contributions during 2015 from another White Oak partner.
Acquisition gain, net. In 2015, the ARLP Partnership recognized a $22.5 million non-cash net gain related to the final business combination accounting for the Hamilton Acquisition. For more information on the Hamilton Acquisition, please read “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions.”
Transportation revenues and expenses. Transportation revenues and expenses were $33.6 million and $26.0 million for 2015 and 2014, respectively. The increase of $7.6 million was primarily attributable to increased tonnage for which the ARLP Partnership arranges transportation at certain mines, partially offset by a decrease in average transportation rates in 2015. The cost of transportation services are passed through to customers. Consequently, no gain or loss is realized on transportation revenues.
Net income attributable to noncontrolling interests. The noncontrolling interests balance is comprised of non-affiliate and affiliate ownership interests in the net assets of the ARLP Partnership that we consolidate as well as the noncontrolling interest of Cavalier Minerals. The noncontrolling interest designated as affiliate represents SGP’s 0.01% general partner interest in ARLP and 0.01% general partner interest in the Intermediate Partnership as well as Bluegrass Minerals Management, LLC’s (“Bluegrass Minerals”) ownership interest in Cavalier Minerals which began in 2014. The noncontrolling interest designated as non-affiliates represents the limited partners’ interest in ARLP controlled through the common unit ownership, excluding the 31,088,338 common units of ARLP held by us. The net income attributable to noncontrolling interest was $92.8 million and $208.3 million in 2015 and 2014, respectively. The decrease in net income attributable to noncontrolling interest is due to a decrease in the consolidated net income of the ARLP Partnership due to the changes in revenues and expenses described above and by an increase in the ARLP Partnership’s managing general partners’ priority distribution to us, which is deducted from the ARLP Partnership’s net income in the allocation of net income attributable to noncontrolling interest.
Segment Information. Our 2015 Segment Adjusted EBITDA decreased 7.0% to $814.2 million from 2014 Segment Adjusted EBITDA of $875.8 million. Segment Adjusted EBITDA, tons sold, coal sales, other sales and operating revenues and Segment Adjusted EBITDA Expense by segment are as follows:
(1) Percentage change was greater than or equal to 100%.
(2) For a definition of Segment Adjusted EBITDA and Segment Adjusted EBITDA Expense and related reconciliations to comparable GAAP financial measures, please see below under “-Reconciliation of non-GAAP “Segment Adjusted EBITDA” to GAAP “net income” and reconciliation of non-GAAP “Segment Adjusted EBITDA Expense” to GAAP “Operating Expenses.”
Illinois Basin - Segment Adjusted EBITDA increased slightly by 0.1% to $617.1 million in 2015 from $616.7 million in 2014. The increase was primarily attributable to increased surface facility services and coal royalty revenues received from White Oak prior to the Hamilton Acquisition as well as decreased expenses per ton resulting from a favorable production mix, partially offset by lower coal sales, which decreased 2.4% to $1.57 billion in 2015 from $1.61 billion in 2014, and higher equity in loss of affiliates from White Oak prior to the Hamilton Acquisition as discussed above. The decrease of $38.1 million in coal sales primarily reflects lower average coal sales prices of $51.01 in 2015 compared to $52.67 in 2014 resulting from current market conditions discussed above and the assumption of lower-priced legacy contracts inherited in the Hamilton Acquisition, partially offset by increased tons sold which increased
0.8% to 30.8 million tons in 2015 compared to 30.5 million tons in 2014. Higher coal sales volumes resulted from the Gibson South mine and the assumption of operations at the Hamilton Mine No. 1 partially offset by lower recoveries and shift reductions at the River View, Warrior and Gibson North mines, shift reductions at the Onton mine, as well as the shutdown of operations at the Gibson North and Onton mines in the fourth quarter of 2015, all in response to weak coal demand. Segment Adjusted EBITDA Expense decreased 5.1% to $949.3 million in 2015 from $1.00 billion in 2014 and decreased $1.92 per ton sold to $30.82 from $32.74 per ton sold in 2014, primarily due to the favorable production mix in 2015, partially offset by insurance proceeds received in 2014 related to the Onton mine discussed above, as well as the impact of certain other cost increases and decreases described above under “-Operating expenses and outside coal purchases.”
Appalachia - Segment Adjusted EBITDA decreased to $183.9 million for 2015 as compared to $254.0 million for 2014. The decrease of $70.1 million was primarily attributable to lower average coal sales prices as a result of current market conditions, lower production recoveries across the region and decreased payments in lieu of shipments received from a customer related to a Tunnel Ridge coal supply agreement. Coal sales decreased 4.3% to $573.5 million in 2015 compared to $599.3 million in 2014. The decrease of $25.8 million was primarily attributable to lower average coal sales prices of $60.75 per ton sold during 2015 compared to $65.26 per ton sold in 2014 reflecting the impact of market conditions on sales from the Tunnel Ridge and MC Mining mines, partially offset by increased tons sold, which increased 2.8% to 9.4 million tons in 2015 compared to 9.2 million tons sold in 2014 as a result of increased sales volumes at the Tunnel Ridge and Mettiki mines. Segment Adjusted EBITDA Expense increased 9.9% to $400.7 million in 2015 from $364.7 million in 2014 and increased $2.73 per ton sold to $42.45 from $39.72 per ton sold in 2014, primarily due to lower recoveries and reduced production at the Tunnel Ridge mine as a result of lower coal demand and the need to manage coal inventories, partially offset by the benefit of fewer longwall move days in 2015, as well as the impact of certain other cost increases and decreases discussed above under “-Operating expenses and outside coal purchases.”
Other and Corporate - Segment Adjusted EBITDA increased $17.6 million to $25.8 million in 2015 from $8.2 million in 2014 and Segment Adjusted EBITDA Expense increased to $153.7 million for 2015 from $25.5 million in 2014. These increases were primarily as a result of increased Mt. Vernon transloading services and intercompany related activity such as increased coal brokerage activity, MAC sales and revenues and expenses of AROP Funding and Wildcat Insurance, which are eliminated upon consolidation. Segment Adjusted EBITDA Expense also increased in 2015 due to the absence of the benefit of a gain of $4.4 million recognized in the 2014 Period on the sale of Pontiki’s assets.
Elimination - Segment Adjusted EBITDA Expense and coal sales eliminations significantly increased in 2015 to $127.2 million and $120.0 million, respectively, reflecting additional intercompany coal sales to Alliance Coal to support increased coal brokerage activity resulting from coal supply agreements acquired from Patriot Coal Corporation (“Patriot”) on December 31, 2014. For more information on the Patriot acquisition, please read “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions.”
2014 Compared with 2013
We reported record net income of $492.7 million for 2014 compared to $391.6 million for 2013. The increase of $101.1 million was principally due to increased sales from low-cost production at the Tunnel Ridge mine in addition to increased coal sales and production volumes, which rose to 39.7 million tons sold and 40.7 million tons produced in 2014 compared to 38.8 million tons sold and produced in 2013. The increase in tons sold and produced resulted primarily from increased production as a result of improved mining conditions at the Tunnel Ridge, MC Mining and Dotiki mines and the start-up of coal production at the Gibson South mine in April 2014. Record net income also benefited from throughput fees received from surface facility services and coal royalties related to operations at the White Oak Mine No. 1 (now known as the Hamilton Mine No. 1) prior to the Hamilton Acquisition in July 2015 as discussed in “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions.” Lower operating expenses during 2014 resulted primarily from a coal inventory build during the year; improved productivity at the Tunnel Ridge, MC Mining and Dotiki mines; a significant increase in sales of lower-cost production from Tunnel Ridge; insurance proceeds received in 2014 related to an adverse geological event at the Onton mine that also increased operating expenses in 2013; the idling of a higher-cost third-party mining operation at the Mettiki mine; and the absence of higher-cost production at the Pontiki mine, which was closed in late 2013.
Coal sales. Coal sales increased 3.3% to $2.2 billion in 2014 from $2.1 billion in 2013. The increase of $71.2 million reflected the benefit of increased tons sold (contributing $49.3 million in additional coal sales) and higher average coal sales prices (contributing $21.9 million in additional coal sales). Average coal sales prices increased $0.55 per ton sold in 2014 to $55.59 per ton compared to $55.04 per ton sold in 2013, primarily as a result of increased contract pricing at the Mettiki mine, an increase of higher-priced coal sales at the Tunnel Ridge mine and the addition of higher-priced coal sales at the Gibson South mine, partially offset by the absence of higher-priced Pontiki sales in 2014.
Operating expenses and outside coal purchases. Operating expenses and outside coal purchases decreased 1.2% to $1.4 billion in 2014. On a per ton basis, operating expenses and outside coal purchases decreased 3.5% to $34.82 per ton from $36.07 per ton sold in 2013, primarily due to increased lower-cost production at the Tunnel Ridge mine, strong production performance at the MC Mining and Dotiki mines, improved production and operating conditions at the Onton mine and the absence of higher-cost production at the Pontiki mine. Operating expenses were impacted by various other factors, the most significant of which are discussed below:
· Labor and benefit expenses per ton produced, excluding workers’ compensation, decreased 2.7% to $11.72 per ton in 2014 from $12.04 per ton in 2013. The decrease of $0.32 per ton was primarily attributable to lower labor cost per ton resulting from increased production discussed above, lower medical expenses at the Mettiki mine and the absence of higher-cost per ton labor and benefits at the Pontiki mine;
· Materials and supplies expenses per ton produced decreased slightly to $11.60 per ton in 2014 from $11.63 per ton in 2013. The decrease of $0.03 per ton produced resulted primarily from increased production discussed above and a decrease in cost for certain products and services, primarily safety related materials and supplies (decrease of $0.09 per ton), lower longwall subsidence expense (decrease of $0.04 per ton) offset partially by increased roof supports (increase of $0.06 per ton) and ventilation-related materials and supplies (increase of $0.05 per ton);
· Maintenance expenses per ton produced decreased 2.5% to $3.90 per ton in 2014 from $4.00 per ton in 2013. The decrease of $0.10 per ton produced was primarily from the benefits of increased production at certain locations, as discussed above, and the absence of higher-cost per ton maintenance expenses at the Pontiki mine;
·
Contract mining expenses decreased $4.8 million in 2014 compared to 2013. The decrease primarily reflects lower production resulting from the idling of a third-party mining operation at the Mettiki mine complex in 2013 due to reduced metallurgical coal export market opportunities;
·
Operating expenses benefited from insurance proceeds of $7.0 million received in 2014 related to claims from an adverse geological event at the Onton mine in 2013 and the absence of $3.8 million of asset retirements that occurred in 2013 resulting from the Onton mine’s previously mentioned adverse geological event.
Operating expenses and outside coal purchases per ton decreases discussed above were partially offset by the following increase:
· Workers’ compensation and black lung expenses per ton produced increased to $0.30 per ton in 2014 from $0.17 per ton in 2013. The increase of $0.13 per ton resulted primarily from a decrease in the discount rate used to calculate the estimated present value of future obligations and reduced favorable claim trends and disability incident rate assumptions in 2014 compared to 2013.
Other sales and operating revenues. Other sales and operating revenues are principally comprised of Mt. Vernon transloading revenues, Matrix Design sales, throughput fees received from White Oak prior to the Hamilton Acquisition
and other outside services. Other sales and operating revenues increased to $65.7 million in 2014 from $35.1 million in 2013. The increase of $30.6 million was primarily attributable to White Oak throughput fees and payments in lieu of shipments received from a customer in 2014 related to an Appalachian coal sales contract.
General and administrative. General and administrative expenses for 2014 increased to $76.7 million compared to $65.2 million in 2013. The increase of $11.5 million was primarily due to increased compensation-related expenses.
Depreciation, depletion and amortization. Depreciation, depletion and amortization expense increased to $274.6 million in 2014 compared to $264.9 million in 2013. The increase of $9.7 million was primarily attributable to increased production volumes mentioned above, as well as capital expenditures related to production expansion and infrastructure investments at various operations.
Interest expense. Interest expense, net of capitalized interest, increased to $33.6 million in 2014 from $27.0 million in 2013. The increase of $6.6 million was principally attributable to decreased capitalized interest on the equity investment in White Oak, partially offset by decreased interest resulting from principal repayments made during 2014 of $18.8 million and $18.0 million on the term loan and original senior notes issued in 1999, respectively. The term loan and senior notes are discussed in more detail below under “-Debt Obligations.”
Equity in loss of affiliates, net. Equity in loss of affiliates, net includes the ARLP Partnership’s share of the results of operations of the equity investments in White Oak prior to the Hamilton Acquisition, AllDale Minerals and MAC prior to its acquisition in January 2015. Equity in loss of affiliates, net was $16.6 million in 2014 compared to $24.4 million in 2013. The decrease in net equity in loss of affiliates is primarily related to the equity investment in White Oak prior to the Hamilton Acquisition and the impact of changes in allocations of equity income or losses resulting from equity contributions during 2014 by another White Oak owner, partially offset by increased losses incurred by White Oak during 2014. Prior to the Hamilton Acquisition, equity contributions impacted the future preferred distributions allocable to each owner and the ongoing allocation of income and losses for GAAP purposes.
Transportation revenues and expenses. Transportation revenues and expenses decreased to $26.0 million in 2014 from $32.6 million in 2013. The decrease of $6.6 million was primarily attributable to a decrease in average transportation rates reflecting the absence of export sales to a certain customer from the Warrior mine in 2014 compared to 2013, as well as decreased tonnage for which the ARLP Partnership arranged transportation at certain other mines in 2014. The cost of transportation services are passed through to customers. Consequently, we do not realize any gain or loss on transportation revenues.
Income tax expense. Income tax expense decreased $1.4 million in 2014. Income taxes are primarily due to the operations of Matrix Design. The decrease in income tax expense was primarily due to a large valuation allowance of ASI’s deferred tax assets in 2013.
Net income attributable to noncontrolling interests. The noncontrolling interests balance is comprised of non-affiliate and affiliate ownership interests in the net assets of the ARLP Partnership that we consolidate as well as the noncontrolling interest of Cavalier Minerals. The noncontrolling interest designated as affiliate represents SGP’s 0.01% general partner interest in ARLP and 0.01% general partner interest in the Intermediate Partnership as well as Bluegrass Minerals ownership interest in Cavalier Minerals which began in 2014. The noncontrolling interest designated as non-affiliates represents the limited partners’ interest in ARLP controlled through the common unit ownership, excluding the 31,088,338 common units of ARLP held by us. The net income attributable to noncontrolling interest was $208.3 million and $157.7 million in 2014 and 2013, respectively. The increase in net income attributable to noncontrolling interest is due to an increase in the consolidated net income of the ARLP Partnership due to the changes in revenues and expenses described above, partially offset by an increase in ARLP’s managing general partner’s priority distribution to us, which is deducted from ARLP’s net income in the allocation of net income attributable to noncontrolling interest.
Segment Information. Our 2014 Segment Adjusted EBITDA increased 16.9% to $875.8 million from 2013 Segment Adjusted EBITDA of $749.2 million. Segment Adjusted EBITDA, tons sold, coal sales, other sales and operating revenues and Segment Adjusted EBITDA Expense by segment are as follows:
(1) Percentage change was greater than or equal to 100%.
(2) For a definition of Segment Adjusted EBITDA and Segment Adjusted EBITDA Expense and related reconciliations to comparable GAAP financial measures, please see below under “-Reconciliation of non-GAAP “Segment Adjusted EBITDA” to GAAP “net income” and reconciliation of non-GAAP “Segment Adjusted EBITDA Expense” to GAAP “Operating Expenses.”
Illinois Basin - Segment Adjusted EBITDA decreased 2.4% to $616.7 million in 2014 from $632.2 million in 2013. The decrease of $15.5 million was primarily attributable to decreased coal recoveries at the Warrior mine as it continues to transition into a new mining area and increased expenses per ton at the Pattiki and Hopkins mines due to difficult mining conditions, partially offset by improved sales and production from the Dotiki mine, improved production and operating conditions at the Onton mine, increased throughput revenues for surface facility services and coal royalties from White Oak and reduced losses allocated to the ARLP Partnership as a result of equity contributions made by another White Oak owner as discussed above under “-Equity in loss of affiliates, net.” Also benefiting 2014 were higher
average coal sales prices that increased slightly to $52.67 per ton sold compared to $52.39 per ton in 2013. Coal sales increased $3.9 million to $1.6 billion in 2014 primarily reflecting increased tons sold from the Dotiki mine and higher-priced coal sales from start-up production at the Gibson South mine, partially offset by reduced tons sold at the Warrior and Gibson North mines. Segment Adjusted EBITDA Expense increased 4.8% to $1.0 billion in 2014 and increased $1.61 per ton sold to $32.74 from $31.13 per ton sold in 2013, primarily as a result of difficult mining conditions and lower recoveries discussed above. The increase in Segment Adjusted EBITDA Expense was partially offset by insurance proceeds received in 2014 related to the impact of the adverse geological event at the Onton mine in 2013 mentioned above, as well as certain other cost decreases discussed above under “-Operating expenses and outside coal purchases”.
Appalachia - Segment Adjusted EBITDA increased to $254.0 million for 2014 compared to $105.1 million for 2013. The increase of $148.9 million was primarily attributable to increased tons sold, which rose 22.5% to 9.2 million tons sold, and higher average coal sales prices of $65.26 per ton sold during 2014 compared to $63.62 per ton sold during 2013. Coal sales increased 25.7% to $599.3 million in 2014 compared to $476.7 million in 2013. The increase of $122.6 million was primarily due to increased production at the Tunnel Ridge and MC Mining operations and higher contract coal sales prices at the Mettiki mine. Segment Adjusted EBITDA also benefited from increased other sales and operating revenues due to payments in lieu of shipments received from a customer in 2014. Segment Adjusted EBITDA Expense decreased 3.0% to $364.7 million in 2014 from $375.9 million in 2013 and decreased $10.45 per ton sold to $39.72 from $50.17 per ton sold in 2013, primarily due to improved productivity and geological conditions at the Tunnel Ridge mine and new Excel No. 4 mining area at the MC Mining operation, reduced contract mining expenses and lower employee benefit cost at the Mettiki mining complex, as well as certain other cost decreases discussed above under “-Operating expenses and outside coal purchases”.
Other and Corporate -Segment Adjusted EBITDA decreased $3.7 million in 2014 from 2013 and Segment Adjusted EBITDA Expense decreased 70.7% to $25.5 million for 2014. These decreases were primarily attributable to the absence of production and sales in 2014 from the former Pontiki mine discussed above.
Reconciliation of non-GAAP “Segment Adjusted EBITDA” to GAAP “net income” and reconciliation of non-GAAP “Segment Adjusted EBITDA Expense” to GAAP “Operating Expenses”
Segment Adjusted EBITDA (a non-GAAP financial measure) is defined as net income (prior to the allocation of noncontrolling interest) before net interest expense, income taxes, depreciation, depletion and amortization, asset impairment charge, acquisition gain, net and general and administrative expenses. Segment Adjusted EBITDA is a key component of consolidated EBITDA, which is used as a supplemental financial measure by management and by external users of our financial statements such as investors, commercial banks, research analysts and others, to assess:
· the financial performance of the ARLP Partnership’s assets without regard to financing methods, capital structure or historical cost basis;
· the ability of the ARLP Partnership’s assets to generate cash sufficient to pay interest costs and support its indebtedness;
· the ARLP Partnership’s operating performance and return on investment compared to those of other companies in the coal energy sector, without regard to financing or capital structures; and
· the viability of acquisitions and capital expenditure projects and the overall rates of return on alternative investment opportunities.
Segment Adjusted EBITDA is also used as a supplemental financial measure by our management for reasons similar to those stated in the previous explanation of consolidated EBITDA. In addition, the exclusion of corporate general and administrative expenses, which are discussed above under “-Analysis of Historical Results of Operations,” from Segment Adjusted EBITDA allows management to focus solely on the evaluation of segment operating profitability as it relates to our revenues and operating expenses, which are primarily controlled by our segments.
The following is a reconciliation of consolidated Segment Adjusted EBITDA to net income, the most comparable GAAP financial measure:
Segment Adjusted EBITDA Expense (a non-GAAP financial measure) includes operating expenses, outside coal purchases and other income. Transportation expenses are excluded as these expenses are passed through to the ARLP Partnership’s customers and, consequently, it does not realize any gain or loss on transportation revenues. Segment Adjusted EBITDA Expense is used as a supplemental financial measure by the ARLP Partnership’s management to assess the operating performance of the segments. In the ARLP Partnership’s evaluation of EBITDA, which is discussed above under “-How the ARLP Partnership Evaluates its Performance,” Segment Adjusted EBITDA Expense is a key component of Segment Adjusted EBITDA in addition to coal sales and other sales and operating revenues. The exclusion of corporate general and administrative expenses from Segment Adjusted EBITDA Expense allows management to focus solely on the evaluation of segment operating performance as it primarily relates to operating expenses. Outside coal purchases are included in Segment Adjusted EBITDA Expense because tons sold and coal sales include sales from outside coal purchases.
The following is a reconciliation of consolidated Segment Adjusted EBITDA Expense to operating expense, the most comparable GAAP financial measure:
Ongoing Acquisition Activities
Consistent with its business strategy, from time to time the ARLP Partnership engages in discussions with potential sellers regarding possible acquisitions of certain assets and/or companies of the sellers. For more information on acquisitions, please read “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions” of this Annual Report on Form 10-K.
Liquidity and Capital Resources
Liquidity
Our only cash generating assets are limited and general partnership interests in the ARLP Partnership, including IDRs, from which we receive quarterly distributions. We rely on distributions from the ARLP Partnership to fund our cash requirements.
The ARLP Partnership has historically satisfied its working capital requirements and funded its capital expenditures, equity investments and debt service obligations with cash generated from operations, cash provided by the issuance of debt or equity and borrowings under credit and securitization facilities. The ARLP Partnership believes that existing cash balances, future cash flows from operations, borrowings under credit facilities and cash provided from the issuance of debt or equity will be sufficient to meet its working capital requirements, capital expenditures and additional equity investments, debt payments, commitments and distribution payments. Nevertheless, the ARLP Partnership’s ability to satisfy its working capital requirements, to fund planned capital expenditures and equity investments, to service its debt obligations or to pay distributions will depend upon its future operating performance and access to and cost of financing sources, which will be affected by prevailing economic conditions generally and in the coal industry specifically, as well as other financial and business factors, some of which are beyond its control. Based on the ARLP Partnership’s recent operating results, current cash position, anticipated future cash flows and sources of financing that it expects to have available, the ARLP Partnership does not anticipate any significant liquidity constraints in the foreseeable future. However, to the extent operating cash flow or access to and cost of financing sources are materially different than expected, future liquidity may be adversely affected. Please see “Item 1A. Risk Factors.”
The ARLP Partnership’s consolidated affiliate, Cavalier Minerals, owns equity interests and plans to make additional equity investments in the AllDale Minerals entities for the purchase of oil and gas mineral interests in various geographic locations within producing basins in the continental U.S. As of December 31, 2015, Cavalier Minerals had provided funding of $65.9 million to AllDale Minerals and has a remaining commitment of $83.1 million, which it expects to fund over the next two years. At Alliance Minerals’ election, Cavalier Minerals will meet its remaining funding commitment to AllDale Minerals through contributions from Alliance Minerals and the other equity owner or from borrowings under the Cavalier Credit Facility (the Cavalier Credit Facility is discussed in more detail below under “-Debt Obligations”). For more information on these transactions, please read “Item 8. Financial Statements and Supplementary Data-Note 11. Variable Interest Entities” and “Note 13. Equity Investments” of this Annual Report on Form 10-K.
On September 22, 2011, the ARLP Partnership entered into a series of transactions with White Oak to support development of the White Oak longwall mining operation (now known as Hamilton Mine No. 1) including the purchase of preferred equity interests. On July 31, 2015 (“Acquisition Date”), the ARLP Partnership paid $50.0 million to acquire the remaining equity interest in White and assumed control of the mine. Prior to the Acquisition Date, the ARLP Partnership had funded $422.6 million to White Oak under various agreements inclusive of the preferred equity interest purchases. In conjunction with the acquisition of White Oak, the ARLP Partnership assumed $93.5 million of debt which was extinguished in the fourth quarter of 2015 and replaced with a $100 million equipment sale-leaseback arrangement. For more information on this sale-leaseback arrangement, please read “Item 8. Financial Statements and Supplementary Data-Note 20. Commitments and Contingencies” of this Annual Report on Form 10-K. In 2014 and 2015, the ARLP Partnership paid $48.0 million to Patriot and $11.6 million to CONSOL to acquire various assets, including certain mining equipment and reserves. The ARLP Partnership also paid $5.5 million in 2015 to acquire MAC. For more information on these acquisitions, please read “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions” of this Annual Report on Form 10-K.
Cash Flows
Cash provided by operating activities was $714.4 million in 2015 compared to $734.8 million in 2014. The decrease in cash provided by operating activities was primarily due to a decrease in net income adjusted for non-cash items, additional payments for accounts payable and other current liabilities in 2015 compared to 2014 related to beginning balances assumed in the Hamilton Acquisition, a decrease in payroll and related benefits accruals during 2015 compared to an increase during 2014 reflecting higher annual incentive compensation payments in 2015 and reduced incentive accruals as of December 31, 2015, an increase in advance royalties in 2015 compared to a decrease in 2014 primarily related to the ARLP Partnership’s first annual minimum royalties paid to WKY CoalPlay, LLC (“WKY CoalPlay”), offset by a favorable change in trade receivables during 2015 compared to 2014. For more information on royalties paid to WKY CoalPlay, please read “Item 8. Financial Statements and Supplementary Data-Note 19. Related-Party Transactions” of this Annual Report on Form 10-K.
Net cash used in investing activities was $355.9 million in 2015 compared to $441.2 million in 2014. The decrease in cash used in investing activities was primarily attributable to the lower capital expenditures for mine infrastructure and equipment at various mines, partially as a result of utilization of mining equipment acquired in the Patriot acquisition, significantly lower capital expenditures at the Gibson South mine, and a decrease in funding of the White Oak equity investment in 2015, partially offset by cash and loans extended in connection with the Hamilton Acquisition in 2015. For more information regarding acquisitions, please read “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions” of this Annual Report on Form 10-K.
Net cash used in financing activities was $348.1 million in 2015 compared to $363.7 million in 2014. The decrease in cash used in financing activities was primarily attributable to a decrease in payments and an increase in borrowings under the revolving credit facilities during 2015 as well as proceeds received from a sale-leaseback transaction in 2015, partially offset by a decrease in borrowings and an increase in payments under the securitization facility in 2015 and repayment of the ARLP Series A Senior Notes and a portion of the ARLP Term Loan as well as increased distributions paid to partners in 2015. For more information on debt obligations, please read “-Debt Obligations” below.
The ARLP Partnership has various commitments primarily related to long-term debt, including capital leases, operating lease commitments related to buildings and equipment, obligations for estimated future asset retirement obligations costs, workers’ compensation and pneumoconiosis, capital projects and pension funding. The ARLP Partnership expects to fund these commitments with existing cash balances, future cash flows from operations, borrowings under revolving credit and securitization facilities and cash provided from the issuance of debt or equity.
The following table provides details regarding the ARLP Partnership’s contractual cash obligations as of December 31, 2015:
(1) Interest on variable-rate, long-term debt was calculated using rates elected by the ARLP Partnership at December 31, 2015 for the remaining term of outstanding borrowings.
(2) Includes amounts classified as interest and maintenance cost.
(3) Future commitments for reclamation obligations, workers’ compensation and pneumoconiosis are shown at undiscounted amounts. These obligations are primarily statutory, not contractual.
The ARLP Partnership expects to contribute $2.6 million to the ARLP Partnership’s defined benefit pension plan during 2016.
In addition to the above described capital expenditures related to the ARLP Partnership’s operating activities, it currently anticipates funding to AllDale Minerals during the next two years approximately $83.1 million for the acquisition of oil and gas mineral interests in various geographic locations within producing basins in the continental U.S.
Off-Balance Sheet Arrangements
In the normal course of business, the ARLP Partnership is a party to certain off-balance sheet arrangements. These arrangements include coal reserve leases, indemnifications, transportation obligations and financial instruments with off-balance sheet risk, such as bank letters of credit and surety bonds. Liabilities related to these arrangements are not reflected in our consolidated balance sheets, and we do not expect these off-balance sheet arrangements to have any material adverse effects on financial condition, results of operations or cash flows.
The ARLP Partnership uses a combination of surety bonds and letters of credit to secure its financial obligations for reclamation, workers’ compensation and other obligations as follows as of December 31, 2015:
The ARLP Partnership’s involvement in its equity investment in AllDale Minerals consists of its support of AllDale Minerals’ acquisition of oil and gas mineral interests in various geographic locations within producing basins in the continental U.S. The ARLP Partnership incurred allocated losses related to Cavalier Minerals’ equity investment in AllDale Minerals of $0.5 million for the year ended December 31, 2015. For more information on the ARLP Partnership’s involvement with AllDale Minerals, please read “Item 8. Financial Statements and Supplementary Data-Note 13. Equity Investments” of this Annual Report on Form 10-K.
Capital Expenditures
Capital expenditures decreased to $212.8 million in 2015 compared to $307.4 million in 2014. See our discussion of “Cash Flows” above concerning this decrease in capital expenditures.
The ARLP Partnership currently projects average estimated annual maintenance capital expenditures over the next five years of approximately $4.75 per ton produced. The ARLP Partnership’s anticipated total capital expenditures, including maintenance capital expenditures, for 2016 are estimated in a range of $134.0 to $142.0 million. Management anticipates funding 2016 capital requirements with cash and cash equivalents, future cash flows from operations, borrowings under revolving credit and securitization facilities and cash provided from the issuance of debt or equity. The ARLP Partnership will continue to have significant capital requirements over the long-term, which may require it to incur debt or seek additional equity capital. The availability and cost of additional capital to the ARLP Partnership will depend upon prevailing market conditions, the market price of its common units and several other factors over which the ARLP Partnership has limited control, as well as its financial condition and results of operations.
Insurance
Effective October 1, 2015, the ARLP Partnership renewed its annual property and casualty insurance program. In an effort to reduce costs, the ARLP Partnership’s property insurance was procured from the ARLP Partnership’s wholly owned captive insurance company, Wildcat Insurance. Wildcat Insurance charged certain of the ARLP Partnership’s subsidiaries for the premiums on this program and in return purchased reinsurance for the program in the standard market. The maximum limit in the commercial property program is $100.0 million per occurrence, excluding a $1.5 million deductible for property damage, a 75, 90 or 120 day waiting period for underground business interruption depending on the mining complex and an additional $10.0 million overall aggregate deductible. We can make no assurances that the ARLP Partnership will not experience significant insurance claims in the future that could have a
material adverse effect on its business, financial condition, results of operations and ability to purchase property insurance in the future.
Debt Obligations
ARLP Credit Facility and Senior Notes
ARLP Credit Facility. On May 23, 2012, the Intermediate Partnership entered into a credit agreement (the “ARLP Credit Agreement”) with various financial institutions for a revolving credit facility (the “ARLP Revolving Credit Facility”) of $700.0 million and a term loan (the “ARLP Term Loan”) in the aggregate principal amount of $250.0 million (collectively, the ARLP Revolving Credit Facility and ARLP Term Loan are referred to as the “ARLP Credit Facility”). Borrowings under the ARLP Credit Agreement bear interest at a Base Rate or Eurodollar Rate, at the ARLP Partnership’s election, plus an applicable margin that fluctuates depending upon the ratio of Consolidated Debt to Consolidated Cash Flow (each as defined in the ARLP Credit Agreement). The ARLP Partnership has elected a Eurodollar Rate, which, with applicable margin, was 2.06% on borrowings outstanding as of December 31, 2015. The ARLP Credit Facility matures May 23, 2017, at which time all amounts then outstanding are required to be repaid. Interest is payable quarterly, with principal of the ARLP Term Loan due as follows: for each quarter commencing June 30, 2014 and ending March 31, 2016, quarterly principal payments in an amount per quarter equal to 2.50% of the aggregate amount of the ARLP Term Loan advances outstanding; for each quarter beginning June 30, 2016 through December 31, 2016, 20% of the aggregate amount of the ARLP Term Loan advances outstanding; and the remaining balance of the ARLP Term Loan advances at maturity. In June 2014, the ARLP Partnership began making quarterly principal payments on the ARLP Term Loan, leaving a balance of $206.3 million at December 31, 2015. The ARLP Partnership has the option to prepay the ARLP Term Loan at any time in whole or in part subject to terms and conditions described in the ARLP Credit Agreement. Upon a “change of control” (as defined in the ARLP Credit Agreement), the unpaid principal amount of the ARLP Credit Facility, all interest thereon and all other amounts payable under the ARLP Credit Agreement would become due and payable. On October 16, 2015, the ARLP Revolving Credit Facility was amended to increase the baskets for capital lease obligations from $10.0 million to $100.0 million and sale-leaseback arrangements from $10.0 million to $100.0 million per annum.
At December 31, 2015, the ARLP Partnership had borrowings of $385.0 million and $5.9 million of letters of credit outstanding with $309.1 million available for borrowing under the ARLP Revolving Credit Facility. The ARLP Partnership utilizes the ARLP Revolving Credit Facility, as appropriate, for working capital requirements, capital expenditures and investments in affiliates, scheduled debt payments and distribution payments. The ARLP Partnership incurs an annual commitment fee of 0.25% on the undrawn portion of the ARLP Revolving Credit Facility.
ARLP Series B Senior Notes. On June 26, 2008, the ARLP Partnership issued under the 2008 Note Purchase Agreement $145.0 million of Series B senior notes (“ARLP Series B Senior Notes”), which bear interest at 6.72% and mature on June 26, 2018 with interest payable semi-annually.
The ARLP Series B Senior Notes and the ARLP Credit Facility described above (collectively, “ARLP Debt Arrangements”) are guaranteed by all of the material direct and indirect subsidiaries of the Intermediate Partnership. The ARLP Debt Arrangements contain various covenants affecting the Intermediate Partnership and its subsidiaries restricting, among other things, the amount of distributions by the Intermediate Partnership, incurrence of additional indebtedness and liens, sale of assets, investments, mergers and consolidations and transactions with affiliates, in each case subject to various exceptions. The ARLP Debt Arrangements also require the Intermediate Partnership to remain in control of a certain amount of mineable coal reserves relative to its annual production. In addition, the ARLP Debt Arrangements require the Intermediate Partnership to maintain (a) debt to cash flow ratio of not more than 3.0 to 1.0 and (b) cash flow to interest expense ratio of not less than 3.0 to 1.0, in each case, during the four most recently ended fiscal quarters. The debt to cash flow ratio and cash flow to interest expense ratio were 1.19 to 1.0 and 24.2 to 1.0, respectively, for the trailing twelve months ended December 31, 2015. The ARLP Partnership was in compliance with the covenants of the ARLP Debt Arrangements as of December 31, 2015.
ARLP Accounts Receivable Securitization. On December 5, 2014, certain direct and indirect wholly owned subsidiaries of the Intermediate Partnership entered into a $100.0 million accounts receivable securitization facility (“ARLP Securitization Facility”) providing additional liquidity and funding. Under the ARLP Securitization Facility, certain subsidiaries sell trade receivables on an ongoing basis to the Intermediate Partnership, which then sells the trade receivables to AROP Funding, a wholly owned bankruptcy-remote special purpose subsidiary of the Intermediate Partnership, which in turn borrows on a revolving basis up to $100.0 million secured by the trade receivables. After the sale, Alliance Coal, as servicer of the assets, collects the receivables on behalf of AROP Funding. The ARLP
Securitization Facility bears interest based on a Eurodollar Rate. It was renewed in December 2015 and matures in December 2016. At December 31, 2015, the ARLP Partnership had $83.1 million outstanding under the ARLP Securitization Facility.
Cavalier Credit Agreement. On October 6, 2015, Cavalier Minerals entered into a credit agreement (the “Cavalier Credit Agreement”) with Mineral Lending, LLC (“Mineral Lending”) for a $100.0 million line of credit (the “Cavalier Credit Facility”). Mineral Lending is an entity owned by a) ARH II, the parent of ARH), b) an entity owned by an officer of ARH who is also a director of ARH II (“ARH Officer”) and c) foundations established by the President and Chief Executive Officer of MGP and Kathleen S. Craft. There is no commitment fee under the facility. Borrowings under the Cavalier Credit Facility bear interest at a one month LIBOR rate plus 6% with interest payable quarterly. Repayment of the principal balance will begin following the first fiscal quarter after the earlier of the date on which the aggregate amount borrowed exceeds $90.0 million or December 31, 2017, in quarterly payments of an amount equal to the greater of $1.3 million initially, escalated to $2.5 million after two years, or 50% of Cavalier Minerals’ excess cash flow. The Cavalier Credit Facility matures September 30, 2024, at which time all amounts then outstanding are required to be repaid. To secure payment of the facility, Cavalier Minerals pledged all of its partnership interests, then owned or later acquired, in AllDale Minerals, L.P. and AllDale Minerals II, L.P. Cavalier Minerals may prepay the Cavalier Credit Facility at any time in whole or in part subject to terms and conditions described in the Cavalier Credit Agreement. As of December 31, 2015, Cavalier Minerals’ had not drawn on the Cavalier Credit Facility.
Other. In addition to the letters of credit available under the ARLP Credit Facility discussed above, the ARLP Partnership also has agreements with two banks to provide additional letters of credit in an aggregate amount of $31.1 million to maintain surety bonds to secure certain asset retirement obligations and its obligations for workers’ compensation benefits. At December 31, 2015, the ARLP Partnership had $30.7 million in letters of credit outstanding under agreements with these two banks.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition, results of operations, liquidity and capital resources is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We discuss these estimates and judgments with the audit committee of AGP’s Board of Directors (“Audit Committee”) periodically. Actual results may differ from these estimates. We have provided a description of all significant accounting policies in the notes to our consolidated financial statements. The following critical accounting policies are materially impacted by judgments, assumptions and estimates used in the preparation of our consolidated financial statements:
Business Combinations and Goodwill
Business acquisitions are accounted for by using the purchase method of accounting. See “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions” of this Annual Report on Form 10-K for more information on acquisitions. Assets acquired and liabilities assumed are recorded at their estimated fair values at the acquisition date. The excess of purchase price over fair value of net assets acquired is recorded as goodwill. Given the time it takes to obtain pertinent information to finalize the acquired company’s balance sheet, it may be several quarters before the ARLP Partnership is able to finalize those initial fair value estimates. Accordingly, it is not uncommon for the initial estimates to be subsequently revised. The results of operations of acquired businesses are included in the consolidated financial statements from the acquisition date.
In the White Oak and MAC acquisitions the ARLP Partnership was required to value the previously held equity interests just prior to acquisition and record a gain or loss if fair value was determined to be different from the carrying value. The ARLP Partnership re-measured its equity investment immediately prior to the White Oak acquisition using a discounted cash flow model which resulted in a loss of $52.2 million. The assumptions used in the determination of the fair value include projected financial information, forward coal price curves and a risk adjusted discount rate. When valuing the previously held equity investment in MAC, a market approach was used to determine that the carrying value of the investment was equal to the fair value resulting in no gain or loss being recorded.
An additional part of the White Oak acquisition was valuing the pre-existing relationships that the ARLP Partnership had with White Oak. If pre-existing relationships are settled as part of a business combination the acquirer must evaluate the terms of the relationships compared to current market terms and record a gain or loss to the extent that
the relationships are considered above or below market. The ARLP Partnership developed a discounted cash flow model to determine the fair value of each of these agreements at market rates and compared the valuations to similar models using the contractual rates of the agreements to determine its gains or losses. The assumptions used in these valuation models include processing rates, royalty rates, transportation rates, marketing rates, forward coal price curves, current interest rates, projected financial information and risk-adjusted discount rates. After completing its analysis, the ARLP Partnership recorded a $74.8 million gain as a result of net above-market terms associated with the pre-existing relationships.
The only indefinite-lived intangible that the ARLP Partnership has is goodwill. At December 31, 2015, the ARLP Partnership had $136.4 million in goodwill. Goodwill is not amortized, but subject to annual reviews on November 30th for impairment at a reporting unit level. The reporting unit or units used to evaluate and measure goodwill for impairment are determined primarily from the manner in which the business is managed or operated. A reporting unit is an operating segment or a component that is one level below an operating segment. The ARLP Partnership has assessed the reporting unit definitions and determined that at December 31, 2015, the Hamilton reporting unit and the MAC reporting unit are the appropriate reporting units for testing goodwill impairment related to the White Oak and MAC acquisitions.
The ARLP Partnership computes the fair value of the reporting units primarily using the income approach (discounted cash flow analysis). The computations require management to make significant estimates. Critical estimates are used as part of these evaluations include, among other things, the discount rate applied to future earnings reflecting a weighted average cost of capital rate, and projected coal price assumptions. The ARLP Partnership’s estimate of the coal forward sales price curve and future sales volumes are critical assumptions used in its discounted cash flow analysis. In future periods, it is reasonably possible that a variety of circumstances could result in an impairment of goodwill.
A discounted cash flow analysis requires the ARLP Partnership to make various judgmental assumptions about sales, operating margins, capital expenditures, working capital and coal sales prices. Assumptions about sales, operating margins, capital expenditures and coal sales prices are based on the ARLP Partnership’s budgets, business plans, economic projections and anticipated future cash flows. In determining the fair value of its reporting units, the ARLP Partnership was required to make significant judgments and estimates regarding the impact of anticipated economic factors on its business. The forecast assumptions used in the period ended December 31, 2015 makes certain assumptions about future pricing, volumes and expected maintenance capital expenditures. Assumptions are also made for a “normalized” perpetual growth rate for periods beyond the long range financial forecast period.
The ARLP Partnership’s estimates of fair value are sensitive to changes in all of these variables, certain of which relate to broader macroeconomic conditions outside its control. As a result, actual performance in the near- and longer-term could be different from these expectations and assumptions. This could be caused by events such as strategic decisions made in response to economic and competitive conditions and the impact of economic factors, such as continued over production in coal and continued low prices of natural gas. In addition, some of the inherent estimates and assumptions used in determining fair value of the reporting units are outside the control of management, including interest rates, cost of capital and the ARLP Partnership’s credit ratings. While the ARLP Partnership believes it has made reasonable estimates and assumptions to calculate the fair value of the reporting units and other intangible assets, it is possible a material change could occur.
Coal Reserve Values
All of the reserves presented in this Annual Report on Form 10-K constitute proven and probable reserves. There are numerous uncertainties inherent in estimating quantities of reserves, including many factors beyond the ARLP Partnership’s control. Estimates of coal reserves necessarily depend upon a number of variables and assumptions, any one of which may vary considerably from actual results. These factors and assumptions relate to:
· geological and mining conditions, which may not be fully identified by available exploration data and/or differ from the ARLP Partnership’s experiences in areas where it currently mines;
· the percentage of coal in the ground ultimately recoverable;
· historical production from the area compared with production from other producing areas;
· the assumed effects of regulation and taxes by governmental agencies; and
· assumptions concerning future coal prices, operating costs, capital expenditures, severance and excise taxes and development and reclamation costs.
For these reasons, estimates of the recoverable quantities of coal attributable to any particular group of properties, classifications of reserves based on risk of recovery and estimates of future net cash flows expected from these properties as prepared by different engineers, or by the same engineers at different times, may vary substantially. Actual production, revenue and expenditures with respect to the ARLP Partnership’s reserves will likely vary from estimates, and these variations may be material. Certain account classifications within our financial statements such as depreciation, depletion, and amortization, impairment charges and certain liability calculations such as asset retirement obligations may depend upon estimates of coal reserve quantities and values. Accordingly, when actual coal reserve quantities and values vary significantly from estimates, certain accounting estimates and amounts within our consolidated financial statements may be materially impacted. Coal reserve values are reviewed annually, at a minimum, for consideration in our consolidated financial statements.
Workers’ Compensation and Pneumoconiosis (Black Lung) Benefits
The ARLP Partnership provides income replacement and medical treatment for work-related traumatic injury claims as required by applicable state laws. The ARLP Partnership generally provides for these claims through self-insurance programs. Workers’ compensation laws also compensate survivors of workers who suffer employment related deaths. The liability for traumatic injury claims is the ARLP Partnership’s estimate of the present value of current workers’ compensation benefits, based on its actuary estimates. The ARLP Partnership’s actuarial calculations are based on a blend of actuarial projection methods and numerous assumptions including claim development patterns, mortality, medical costs and interest rates. See “Item 8. Financial Statements and Supplementary Data-Note 18. Accrued Workers’ Compensation and Pneumoconiosis Benefits” for additional discussion. The ARLP Partnership had accrued liabilities of $54.6 million and $57.6 million for these costs at December 31, 2015 and 2014, respectively. A one-percentage-point reduction in the discount rate would have increased the liability and operating expense by approximately $4.3 million at December 31, 2015.
Coal mining companies are subject to CMHSA, as amended, and various state statutes for the payment of medical and disability benefits to eligible recipients related to coal worker’s pneumoconiosis, or black lung. The ARLP Partnership provides for these claims through self-insurance programs. The ARLP Partnership’s black lung benefits liability is calculated using the service cost method based on the actuarial present value of the estimated black lung obligation. The ARLP Partnership’s actuarial calculations are based on numerous assumptions including disability incidence, medical costs, mortality, death benefits, dependents and discount rates. The ARLP Partnership had accrued liabilities of $61.7 million and $56.4 million for these benefits at December 31, 2015 and 2014, respectively. A one-percentage-point reduction in the discount rate would have increased the expense recognized for the year ended December 31, 2015 by approximately $2.5 million. Under the service cost method used to estimate the black lung benefits liability, actuarial gains or losses attributable to changes in actuarial assumptions, such as the discount rate, are amortized over the remaining service period of active miners.
The discount rate for workers’ compensation and black lung is derived by applying the Citigroup Pension Discount Curve to the projected liability payout. Other assumptions, such as claim development patterns, mortality, disability incidence and medical costs, are based upon standard actuarial tables adjusted for the ARLP Partnership’s actual historical experiences whenever possible. The ARLP Partnership reviews all actuarial assumptions periodically for reasonableness and consistency and update such factors when underlying assumptions, such as discount rates, change or when sustained changes in its historical experiences indicate a shift in its trend assumptions are warranted.
Defined Benefit Plan
Eligible employees at certain of the ARLP Partnership’s mining operations participate in the Alliance Coal, LLC and Affiliates Pension Plan for Coal Employees (the “Pension Plans”) that it sponsors. The benefit formula for the Pension Plan is a fixed dollar unit based on years of service. The calculation of the ARLP Partnership’s net periodic benefit cost (pension expense) and benefit obligation (pension liability) associated with its Pension Plan requires the use of a number of assumptions. Changes in these assumptions can result in materially different pension expense and pension liability amounts. In addition, actual experiences can differ materially from the assumptions. Significant assumptions used in calculating pension expense and pension liability are shown in “Item 8. Financial Statements and Supplementary Data-Note 14. Employee Benefit Plans” of this Annual Report on Form 10-K and as follows:
· The ARLP Partnership’s expected long-term rate of return assumption is based on broad equity and bond indices, the investment goals and objectives, the target investment allocation and on the long-term historical rates of return for each asset class. The ARLP Partnership’s expected long-term rate of return used to determine its pension liability was 8.0% at December 31, 2015 and 2014. The ARLP Partnership’s expected long-term
rate of return used to determine its pension expense was 8.0% for the years ended December 31, 2015 and 2014. The expected long-term rate of return used to determine its pension liability is based on an asset allocation assumption of:
As of December 31, 2015
Asset allocation
assumption
Expected long-
term rate of
return
Domestic equity securities
70%
8.6%
Foreign equity securities
10%
5.3%
Fixed income securities/cash
20%
5.1%
100%
· The ARLP Partnership’s expected long-term rate of return is based on a 20-year-average annual total return for each investment group. Additionally, the ARLP Partnership bases its determination of pension expense on a smoothed market-related valuation of assets equal to the fair value of assets, which immediately recognizes all investment gains or losses. The actual return on plan assets was (2.0)% and 5.4% for the years ended December 31, 2015 and 2014, respectively. Lowering the expected long-term rate of return assumption by 1.0% (from 8.0% to 7.0%) at December 31, 2014 would have increased pension expense for the year ended December 31, 2015 by approximately $0.7 million; and
· The ARLP Partnership’s weighted-average discount rate used to determine its pension liability was 4.27% and 3.92% at December 31, 2015 and 2014, respectively. The ARLP Partnership’s weighted-average discount rate used to determine its pension expense was 3.92% and 4.89% at December 31, 2015 and 2014, respectively. The discount rate that the ARLP Partnership utilizes for determining it future pension obligation is based on a review of currently available high-quality fixed-income investments that receive one of the two highest ratings given by a recognized rating agency. The ARLP Partnership has historically used the average monthly yield for December of an A-rated utility bond index as the primary benchmark for establishing the discount rate. Lowering the discount rate assumption by 0.5% (from 3.92% to 3.42%) at December 31, 2014 would have increased pension expense for the year ended December 31, 2015 by approximately $0.1 million.
Long-Lived Assets
The ARLP Partnership reviews the carrying value of long-lived assets and certain identifiable intangibles whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Long-lived assets and certain intangibles are not reviewed for impairment unless an impairment indicator is noted. Several examples of impairment indicators include:
· A significant decrease in the market price of a long-lived asset;
· A significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset; or
· A significant adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition.
The above factors are not all inclusive, and management must continually evaluate whether other factors are present that would indicate a long-lived asset may be impaired. If there is an indication that carrying amount of an asset may not be recovered, the asset is monitored by management where changes to significant assumptions are reviewed. Individual assets are grouped for impairment review purposes based on the lowest level for which there is identifiable cash flows that are largely independent of the cash flows of other groups of assets, generally on a by-mine basis. The amount of impairment is measured by the difference between the carrying value and the fair value of the asset. The fair value of impaired assets is typically determined based on various factors, including the present values of expected future cash flows using a risk adjusted discount rate, the marketability of coal properties and the estimated fair value of assets that could be sold or used at other operations. The ARLP Partnership recorded an asset impairment charge of $100.1 million in 2015 (see “Item 8. Financial Statements and Supplementary Data-Note 4. Long-Lived Asset Impairments” of this Annual Report on Form 10-K). No impairment charges were recorded in 2014.
Mine Development Costs
Mine development costs are capitalized until production, other than production incidental to the mine development process, commences and are amortized on a units of production method based on the estimated proven and probable reserves. Mine development costs represent costs incurred in establishing access to mineral reserves and include costs associated with sinking or driving shafts and underground drifts, permanent excavations, roads and tunnels. The end of the development phase and the beginning of the production phase takes place when construction of the mine for economic extraction is substantially complete. The ARLP Partnership’s estimate of when construction of the mine for economic extraction is substantially complete is based upon a number of factors, such as expectations regarding the economic recoverability of reserves, the type of mine under development, and completion of certain mine requirements, such as ventilation. Coal extracted during the development phase is incidental to the mine’s production capacity and is not considered to shift the mine into the production phase. At December 31, 2015 and 2014, capitalized mine development costs were $5.9 million and $7.0 million, respectively, representing the carrying value of development costs attributable to properties where the ARLP Partnership has not reached the production stage of mining operations, and therefore, the mine development costs are not currently being amortized. The ARLP Partnership believes that the carrying value of these development costs will be recovered.
Asset Retirement Obligations
SMCRA and similar state statutes require that mined property be restored in accordance with specified standards and an approved reclamation plan. A liability is recorded for the estimated cost of future mine asset retirement and closing procedures on a present value basis when incurred or acquired and a corresponding amount is capitalized by increasing the carrying amount of the related long-lived asset. Those costs relate to permanently sealing portals at underground mines and to reclaiming the final pits and support acreage at surface mines. Examples of these types of costs, common to both types of mining, include, but are not limited to, removing or covering refuse piles and settling ponds, water treatment obligations, and dismantling preparation plants, other facilities and roadway infrastructure. Accrued liabilities of $123.7 million and $93.1 million for these costs are recorded at December 31, 2015 and 2014, respectively. See “Item 8. Financial Statements and Supplementary Data-Note 17. Asset Retirement Obligations” for additional information. The liability for asset retirement and closing procedures is sensitive to changes in cost estimates and estimated mine lives.
Accounting for asset retirement obligations also requires depreciation of the capitalized asset retirement cost and accretion of the asset retirement obligation over time. Depreciation is generally determined on a units-of-production basis and accretion is generally recognized over the life of the producing assets.
On at least an annual basis, the ARLP Partnership reviews its entire asset retirement obligation liability and makes necessary adjustments for permit changes approved by state authorities, changes in the timing of reclamation activities, and revisions to cost estimates and productivity assumptions, to reflect current experience. Adjustments to the liability associated with these assumptions resulted in a decrease of $1.4 million and an increase of $7.9 million for the years ended December 31, 2015 and 2014, respectively. The adjustments to the liability for the year ended December 31, 2015 were primarily attributable to decreased estimates of reclamation requirements at property acquired from CONSOL in 2014, offset by increased refuse site disturbed acreage and material required at the Pattiki operation, along with updated estimates at all other operations, the acquisition of additional property with certain existing reclamation liabilities, as well as the net impact of overall general changes in inflation and discount rates, current estimates of the costs and scope of remaining reclamation work, reclamation work completed and fluctuations in other projected mine life estimates.
While the precise amount of these future costs cannot be determined with certainty, the ARLP Partnership has estimated the costs and timing of future asset retirement obligations escalated for inflation, then discounted and recorded at the present value of those estimates. Discounting resulted in reducing the accrual for asset retirement obligations by $104.8 million and $88.8 million at December 31, 2015 and 2014. The ARLP Partnership estimated that the aggregate undiscounted cost of final mine closure is approximately $228.5 million at December 31, 2015. If the ARLP Partnership’s assumptions differ from actual experiences, or if changes in the regulatory environment occur, its actual cash expenditures and costs that it incurs could be materially different than currently estimated.
Contingencies
We are not engaged in any material litigation. The ARLP Partnership is currently involved in certain legal proceedings. The ARLP Partnership’s estimates of the probable costs and probability of resolution of these claims are based upon a number of assumptions, which it has developed in consultation with legal counsel involved in the defense of these matters and based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. Based on known facts and circumstances, the ARLP Partnership believes the ultimate outcome of these outstanding lawsuits, claims and regulatory proceedings will not have a material adverse effect on its financial condition, results of operations or liquidity. However, if the results of these matters were different from management’s current opinion and in amounts greater than the ARLP Partnership’s accruals, then they could have a material adverse effect.
Resale Shelf
In March 2011, we filed with the SEC a shelf registration statement allowing our unitholders to sell from time to time an indeterminate amount of their common units representing limited partner interests. At February 26, 2016, 2.75 million common units had been sold pursuant to this registration statement.
Universal Shelf
In February 2014, we filed with the SEC a universal shelf registration allowing us to issue from time to time an indeterminate amount of equity securities. At February 26, 2016, we had not utilized any amounts available under this registration statement.
Related-Party Transactions
Registration Rights
In connection with the IPO, we agreed to register for sale under the Securities Act and applicable state securities laws, subject to certain limitations, any common units proposed to be sold by SGP and the former owners of MGP or any of their respective affiliates. These registration rights required us to file one registration statement for each of these groups. We also agreed to include any securities held by the owners of SGP and the former owners of MGP or any of their respective affiliates in any registration statement that we file to offer securities for cash, except an offering relating solely to an employee benefit plan and other similar exceptions. We satisfied our requirement by registering 47,363,000 outstanding common units on Form S-3 filed with the SEC on June 1, 2007, declared effective on June 27, 2007, of which 2,710,721 have been sold as of February 10, 2016. A prospectus supplement was filed with the SEC on December 18, 2007. These registration rights are in addition to the registration rights that we agreed to provide AGP and its affiliates pursuant to our limited partnership agreement.
See “Item 8. Financial Statements and Supplementary Data-Note 19. Related-Party Transactions” for a discussion of the Partnership’s other related-party transactions.
Accruals of Other Liabilities
The ARLP Partnership had accruals for other liabilities, including current obligations, totaling $279.2 million and $228.5 million at December 31, 2015 and 2014, respectively. These accruals were chiefly comprised of workers’ compensation benefits, black lung benefits, and costs associated with asset retirement obligations. These obligations are self-insured except for certain excess insurance coverage for workers’ compensation. The accruals of these items were based on estimates of future expenditures based on current legislation, related regulations and other developments. Thus, from time to time, the ARLP Partnership’s results of operations may be significantly affected by changes to these liabilities. Please see “Item 8. Financial Statements and Supplementary Data-Note 17. Asset Retirement Obligations” and “Note 18. Accrued Workers’ Compensation and Pneumoconiosis Benefits.”
Inflation
Any future inflationary or deflationary pressures could adversely affect the results of the ARLP Partnership’s operations. For example, at times the ARLP Partnership’s results have been significantly impacted by price increases affecting many of the components of its operating expenses such as fuel, steel, maintenance expense and labor. Please see “Item 1A. Risk Factors.”
New Accounting Standards
See “Item 8. Financial Statements and Supplementary Data-Note 2. Summary of Significant Accounting Policies” for a discussion of new accounting standards.
Other Information
White Oak IRS Notice
The ARLP Partnership received notice that the Internal Revenue Service issued White Oak a “Notice of Beginning of Administrative Proceeding” in conjunction with an audit of the income tax return of White Oak for the tax year ended December 31, 2011.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our ownership interests, results of operations and cash flows principally reflect those of the ARLP Partnership. As such, our discussions of market risk reflect those risks as they apply to the ARLP Partnership.
Commodity Price Risk
The ARLP Partnership has significant long-term coal supply agreements as evidenced by approximately 93.1% of its sales tonnage, including approximately 94.1% of its medium- and high-sulfur coal sales tonnage, being sold under long-term contracts in 2015. Most of the long-term coal supply agreements are subject to price adjustment provisions, which periodically permit an increase or decrease in the contract price, typically to reflect changes in specified indices or changes in production costs resulting from regulatory changes, or both. For additional discussion of coal supply agreements, please see “Item 1. Business-Coal Marketing and Sales” and “Item 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
The Board of Directors of Alliance GP, LLC
and the Partners of Alliance Holdings GP, L.P.
We have audited the accompanying consolidated balance sheets of Alliance Holdings GP, L.P. and subsidiaries (the “Partnership”) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, cash flows, and partners’ capital for each of the three years in the period ended December 31, 2015. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these financial statements and schedule 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 Alliance Holdings GP, L.P. and subsidiaries at December 31, 2015 and 2014, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Partnership’s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 26, 2016 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Tulsa, Oklahoma
February 26, 2016
See notes to consolidated financial statements.
ALLIANCE HOLDINGS GP, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2015, 2014 AND 2013
(In thousands, except unit and per unit data)
See notes to consolidated financial statements.
ALLIANCE HOLDINGS GP, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2015, 2014 AND 2013
(In thousands)
(1) Amortization of actuarial gain or loss is included in the computation of net periodic benefit cost (see Notes 14 and 18 for additional details).
See notes to consolidated financial statements.
ALLIANCE HOLDINGS GP, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2015, 2014 AND 2013
(In thousands)
See notes to consolidated financial statements.
ALLIANCE HOLDINGS GP, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF PARTNERS’ CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 2015, 2014, AND 2013
(In thousands, except unit data)
See notes to consolidated financial statements.
ALLIANCE HOLDINGS GP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2015, 2014 AND 2013
1. ORGANIZATION AND PRESENTATION
Significant Relationships Referenced in Notes to Consolidated Financial Statements
· References to “we,” “us,” “our” or “AHGP” mean Alliance Holdings GP, L.P., individually as the parent company, and not on a consolidated basis.
· References to “AHGP Partnership” mean the business and operations of Alliance Holdings GP, L.P., the parent company, as well as its consolidated subsidiaries, including Alliance Resource Management GP, LLC and Alliance Resource Partners, L.P. and its consolidated subsidiaries.
· References to “AGP” mean Alliance GP, LLC, the general partner of Alliance Holdings GP, L.P., also referred to as our general partner.
· References to “ARLP Partnership” mean the business and operations of Alliance Resource Partners, L.P., the parent company, as well as its consolidated subsidiaries.
· References to “ARLP” mean Alliance Resource Partners, L.P., individually as the parent company, and not on a consolidated basis.
· References to “MGP” mean Alliance Resource Management GP, LLC, the managing general partner of Alliance Resource Partners, L.P.
· References to “SGP” mean Alliance Resource GP, LLC, the special general partner of Alliance Resource Partners, L.P.
· References to “Intermediate Partnership” mean Alliance Resource Operating Partners, L.P., the intermediate partnership of Alliance Resource Partners, L.P.
· References to “Alliance Resource Properties” mean Alliance Resource Properties, LLC, the land-holding company for the mining operations of Alliance Resource Operating Partners, L.P.
· References to “Alliance Coal” mean Alliance Coal, LLC, the holding company for the operations of Alliance Resource Operating Partners, L.P.
Organization and Formation
We are a Delaware limited partnership listed on the NASDAQ Global Select Market under the ticker symbol “AHGP”. We own directly and indirectly 100% of the members’ interest in MGP, ARLP’s managing general partner. The ARLP Partnership is a diversified producer and marketer of coal to major U.S. utilities and industrial users. ARLP conducts substantially all of its business through its wholly owned subsidiary, the Intermediate Partnership. ARLP and the Intermediate Partnership were formed in May 1999, to acquire upon completion of ARLP’s initial public offering on August 19, 1999, certain coal production and marketing assets of Alliance Resource Holdings, Inc. (“ARH”), a Delaware corporation. We and ARH, through its wholly owned subsidiary, SGP, maintain general partner interests in ARLP and the Intermediate Partnership. ARH is owned by Joseph W. Craft III, the Chairman, President and Chief Executive Officer of AGP as well as the President and Chief Executive Officer and a Director of MGP, and Kathleen S. Craft. SGP, a Delaware limited liability company, is owned by ARH and holds a 0.01% general partner interest in each of ARLP and the Intermediate Partnership.
We are owned 100% by limited partners. Our general partner, AGP, has a non-economic interest in us and is owned by Mr. Craft.
Alliance Resource Management GP, LLC, a Delaware limited liability company, and ARM GP Holdings, Inc., a Delaware corporation, are our direct subsidiaries. The Delaware limited partnerships, limited liability companies and corporation that comprise the ARLP Partnership, which we consolidate, are as follows: ARLP; Intermediate Partnership; Alliance Coal; Alliance Design Group, LLC, (“Alliance Design”); Alliance Land, LLC; Alliance Minerals, LLC (“Alliance Minerals”); Alliance Properties, LLC; Alliance Resource Properties; AROP Funding, LLC (“AROP Funding”); ARP Sebree, LLC (“ARP Sebree”); ARP Sebree South, LLC; Alliance WOR Properties, LLC (“WOR Properties”); Alliance Service, Inc. (“ASI”); Backbone Mountain, LLC; Cavalier Minerals JV, LLC (“Cavalier Minerals”); CR Services, LLC; Excel Mining, LLC; Gibson County Coal, LLC (“Gibson County Coal”); Hamilton County Coal, LLC (“Hamilton” previously known as Alliance WOR Processing, LLC); Hopkins County Coal, LLC
(“Hopkins County Coal”); Matrix Design Group, LLC (“Matrix Design”); Matrix Design International, LLC; Matrix Design Africa (PTY) LTD; MC Mining, LLC (“MC Mining”); Mettiki Coal, LLC (“Mettiki (MD)”); Mettiki Coal (WV), LLC (“Mettiki (WV)”); Mid-America Carbonates, LLC (“MAC”); Mt. Vernon Transfer Terminal, LLC (“Mt. Vernon”); Penn Ridge Coal, LLC (“Penn Ridge”); Pontiki Coal, LLC (“Pontiki”); River View Coal, LLC (“River View”); Rough Creek Mining, LLC; Sebree Mining, LLC (“Sebree Mining”); Steamport, LLC; Tunnel Ridge, LLC (“Tunnel Ridge”); UC Coal, LLC; UC Mining, LLC; UC Processing, LLC; Warrior Coal, LLC (“Warrior”); Webster County Coal, LLC (“Webster County Coal”); White County Coal, LLC (“White County Coal”); WOR Land 6, LLC; White Oak Resources LLC (“White Oak”) and Wildcat Insurance, LLC (“Wildcat Insurance”).
Initial Public Offering and Concurrent Transactions
On May 15, 2006, we completed our initial public offering (“IPO”) of 12,500,000 common units representing limited partner interests in us at a price of $25.00 per unit. In connection with the IPO, Alliance Management Holdings, LLC (“AMH”) and AMH II, LLC (“AMH II”) (which were the previous owners of MGP), AHGP and SGP entered into a contribution agreement (“Contribution Agreement”) pursuant to which 100% of the members’ interest in MGP (which includes ARLP’s incentive distribution rights (“IDRs”) and MGP’s general partner interests in ARLP), 15,550,628 of ARLP’s common units, as represented before the 2014 ARLP unit split as discussed below, and a 0.001% managing interest in Alliance Coal were contributed to us. As consideration for this contribution and in accordance with the terms of the Contribution Agreement, we distributed substantially all of the proceeds from our IPO to AMH and AMH II and issued 6,863,470, 19,858,362 and 20,641,168 of AHGP’s common units to AMH, AMH II and SGP, respectively. In June 2006, subsequent to the IPO, the AHGP common units and substantially all of the IPO proceeds distributed to AMH and AMH II were distributed to the individual members of AMH and AMH II. On April 26, 2007, our 0.001% managing interest in Alliance Coal was transferred to our subsidiary, MGP.
Basis of Presentation
Since we own MGP, our consolidated financial statements reflect the consolidated results of the ARLP Partnership. The earnings of the ARLP Partnership allocated to its limited partners’ interests not owned by us and allocated to SGP’s general partner interest in ARLP, are reflected as a noncontrolling interest in our consolidated income statement and balance sheet. Our consolidated financial statements do not differ materially from those of the ARLP Partnership. The differences between our financial statements and those of the ARLP Partnership are primarily attributable to (a) amounts reported as noncontrolling interests and (b) additional general and administrative costs and taxes attributable to us. The additional general and administrative costs principally consist of costs incurred by us as a result of being a publicly traded partnership, amounts billed by, and reimbursed to, Alliance Coal under an amended and restated administrative services agreement (“Administrative Services Agreement”) and amounts billed by, and reimbursed to, AGP under our partnership agreement (Note 19 - Related-Party Transactions).
The accompanying consolidated financial statements include the accounts and operations of the ARLP Partnership and present our financial position as of December 31, 2015 and 2014, and results of our operations, comprehensive income, cash flows and changes in partners’ capital for each of the three years in the period ended December 31, 2015. All of our intercompany transactions and accounts have been eliminated.
On July 31, 2015, the ARLP Partnership acquired the remaining equity interest in White Oak which resulted in the restructuring of our reportable segments. All prior periods have been recast to reflect this new segment presentation. See Note 3 - Acquisitions for further discussion on the acquisition and Note 22 - Segment Information for further discussion of our reportable segments.
On June 16, 2014, the ARLP Partnership completed a two-for-one split of its common units, whereby holders of record as of May 30, 2014 received a one unit distribution on each unit outstanding on that date. The unit split resulted in the issuance of 37,030,317 million ARLP common units. Accordingly, we received an additional 15,544,169 ARLP common units, which brought our total ownership to 31,088,338 ARLP common units. Unless otherwise noted, all references to the number of ARLP units and distribution amounts included in this report have been adjusted to give effect for this unit split for all periods presented. Also, ARLP’s partnership agreement was amended effective June 16, 2014, to reduce by half the target thresholds for the incentive distribution rights per unit.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Estimates-The preparation of consolidated financial statements in conformity with generally accepted accounting principles of the United States (“GAAP”) requires the ARLP Partnership’s management to make estimates and
assumptions that affect the reported amounts and disclosures in the consolidated financial statements. Actual results could differ from those estimates. Significant estimates and assumptions include:
· Impairment assessments of investments, property, plant and equipment, and goodwill;
· Asset retirement obligations;
· Pension valuation variables;
· Workers’ compensation and pneumoconiosis valuation variables;
· Acquisition related purchase price allocations; and
· Life of mine assumptions.
These significant estimates and assumptions are discussed throughout these notes to the consolidated financial statements.
Principles of Consolidation and Noncontrolling Interests-The consolidated financial statements include our accounts and those of MGP, ARLP, the Intermediate Partnership and the Intermediate Partnership’s operating subsidiaries in the consolidated group, after the elimination of intercompany accounts and transactions. The non-controlling interest on our consolidated balance sheet reflects the outside ownership interest in ARLP as well as Bluegrass Minerals Management, LLC’s (“Bluegrass Minerals”) ownership interest in Cavalier Minerals. See “Basis of Presentation” under Note 1 - Organization and Presentation for information regarding our consolidation of ARLP. See also “Note 12 - Noncontrolling Interests.”
Earnings per Unit- Basic earnings per limited partner unit is computed by dividing net income or loss allocated to limited partner interest by the weighted-average number of common units outstanding during a period. We currently have no dilutive securities. Total net income is allocated to the limited partner interest because the general partner’s interest is non-economic.
Fair Value Measurements-The ARLP Partnership applies fair value measurements to certain assets and liabilities. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Fair value is based upon assumptions that market participants would use when pricing an asset or liability, including assumptions about risk and risks inherent in valuation techniques and inputs to valuations. Fair value measurements assume that the transaction occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability (the market for which the reporting entity would be able to maximize the amount received or minimize the amount paid). Valuation techniques used in the ARLP Partnership’s fair value measurements are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the ARLP Partnership’s own market assumptions.
The ARLP Partnership uses the following fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels:
· Level 1 - Quoted prices for identical assets and liabilities in active markets that we have the ability to access at the measurement date.
· Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model derived valuations whose inputs are observable or whose significant value drivers are observable.
· Level 3 - Unobservable inputs for the asset or liability including situations where there is little, if any, market activity for the asset or liability.
The fair value hierarchy gives the highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable data (Level 3). In some cases, the inputs used to measure fair value might fall into different levels of the fair value hierarchy. The lowest level input that is significant to a fair value measurement determines the applicable level in the fair value hierarchy. Assessing the significance of a particular input to the fair value measurement requires judgment, considering factors specific to the asset or liability. Significant fair value measurements are used in the ARLP Partnership’s significant estimates and are discussed throughout these notes. See Note 8 - Fair Value Measurements for discussion of recurring fair value measurements not otherwise disclosed in these financial statements.
Cash and Cash Equivalents-Cash and cash equivalents include cash on hand and on deposit, including highly liquid investments with maturities of three months or less.
Cash Management-The cash flows from operating activities section of our Consolidated Statements of Cash Flows reflects an adjustment for $10.6 million and $1.7 million representing book overdrafts at December 31, 2015 and 2014, respectively. We had no book overdrafts at December 31, 2013.
Inventories-Coal inventories are stated at the lower of cost or market on a first-in, first-out basis. Supply inventories are stated at an average cost basis, less a reserve for obsolete and surplus items.
Business Combinations-For acquisitions accounted for as a business combination, the ARLP Partnership records the assets acquired, including identified intangible assets and liabilities assumed at their fair value, which in many instances involves estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques.
Goodwill-Goodwill represents the excess of cost over the fair value of net assets of acquired businesses. Goodwill is not amortized, but instead is evaluated for impairment periodically. The ARLP Partnership evaluates goodwill for impairment annually on November 30th, or more often if events or circumstances indicate that goodwill might be impaired. The reporting unit or units used to evaluate and measure goodwill for impairment are determined primarily from the manner in which the business is managed or operated. A reporting unit is an operating segment or a component that is one level below an operating segment. There were no impairments of goodwill during 2015. In future periods it is reasonably possible that a variety of circumstances could result in an impairment of the ARLP Partnership’s goodwill.
Property, Plant and Equipment-Expenditures which extend the useful lives of existing plant and equipment assets are capitalized. Interest costs associated with major asset additions are capitalized during the construction period. Maintenance and repairs that do not extend the useful life or increase productivity of the asset are charged to operating expense as incurred. Exploration expenditures are charged to operating expense as incurred, including costs related to drilling and study costs incurred to convert or upgrade mineral resources to reserves. Preparation plants and processing facilities are depreciated using the units-of-production method. Other plant and equipment assets are depreciated principally using the straight-line method over the estimated useful lives of the assets, ranging from 1 to 29 years, limited by the remaining estimated life of each mine. Depreciable lives for the mining equipment range from 1 to 22 years. Depreciable lives for buildings, office equipment and improvements range from 2 to 29 years. Gains or losses arising from retirements are included in operating expenses. Depletable lives for mineral rights, assuming current production expectations, range from 1 to 22 years. Depletion of mineral rights is provided on the basis of tonnage mined in relation to estimated recoverable tonnage, which equals estimated proven and probable reserves. Therefore, the ARLP Partnership’s mineral rights are depleted based on only proven and probable reserves derived in accordance with Industry Guide 7. At December 31, 2015 and 2014, land and mineral rights include $30.7 million and $53.2 million, respectively, representing the carrying value of coal reserves attributable to properties where the ARLP Partnership or a third-party to which the ARLP Partnership lease reserves are not currently engaged in mining operations or leasing to third parties, and therefore, the coal reserves are not currently being depleted. The ARLP Partnership believes that the carrying value of these reserves will be recovered.
Mine Development Costs-Mine development costs are capitalized until production, other than production incidental to the mine development process, commences and are amortized on a units of production method based on the estimated proven and probable reserves. Mine development costs represent costs incurred in establishing access to mineral reserves and include costs associated with sinking or driving shafts and underground drifts, permanent excavations, roads and tunnels. The end of the development phase and the beginning of the production phase takes place when construction of the mine for economic extraction is substantially complete. Coal extracted during the development phase is incidental to the mine’s production capacity and is not considered to shift the mine into the production phase. At December 31, 2015 and 2014, capitalized mine development costs were $5.9 million and $7.0 million, respectively, representing the carrying value of development costs attributable to properties where the ARLP Partnership has not reached the production stage of mining operations, and therefore, the mine development costs are not currently being amortized. The ARLP Partnership believes that the carrying value of these development costs will be recovered.
Long-Lived Assets-The ARLP Partnership reviews the carrying value of long-lived assets and certain identifiable intangibles whenever events or changes in circumstances indicate that the carrying amount may not be recoverable based upon estimated undiscounted future cash flows. To the extent the carrying amount is not recoverable based on undiscounted cash flows, the amount of impairment is measured by the difference between the carrying value and the fair value of the asset (See Note 4 - Long-Lived Asset Impairments).
Intangibles-Intangibles subject to amortization include contracts with covenants not to compete, customer contracts acquired from other parties and mining permits. Intangibles other than customer contracts are amortized on a straight-line basis over their useful life. Intangibles for customer contracts are amortized on a per unit basis over the
terms of the contracts. Amortization expense attributable to intangibles was $15.1 million, $3.0 million and $3.0 million for the years ending December 31, 2015, 2014 and 2013, respectively. The intangibles are included in Prepaid expenses and other assets, Other long-term assets, Other current liabilities and Other liabilities on our consolidated balance sheets at December 31, 2015 and 2014. Our intangibles at December 31 are summarized as follows:
Amortization expense attributable to intangible assets is estimated as follows:
Investments-Investments and ownership interests are accounted for under the equity method of accounting if the ARLP Partnership has the ability to exercise significant influence, but not control, over the entity. Investments accounted for under the equity method are initially recorded at cost, and the difference between the basis of the ARLP Partnership’s investment and the underlying equity in the net assets of the joint venture at the investment date, if any, is amortized over the lives of the related assets that gave rise to the difference. In the event the ARLP Partnership’s ownership entitles it to a disproportionate sharing of income or loss, the ARLP Partnership’s equity in earnings or losses of affiliates is allocated based on the hypothetical liquidation at book value (“HLBV”) method of accounting.
Under the HLBV method, equity in earnings or losses of affiliates is allocated based on the difference between the ARLP Partnership’s claim on the net assets of the equity method investee at the end and beginning of the period with consideration of certain eliminating entries regarding differences of accounting for various related-party transactions, after taking into account contributions and distributions, if any. The ARLP Partnership’s share of the net assets of the equity method investee is calculated as the amount it would receive if the equity method investee were to liquidate all of its assets at net book value and distribute the resulting cash to creditors, other investors and the ARLP Partnership according to the respective priorities.
The ARLP Partnership’s equity method investments during 2015 included AllDale Minerals, L.P. (“AllDale I”) and AllDale Minerals II, L.P. (“AllDale II”) (collectively “AllDale Minerals”) and White Oak prior to the ARLP Partnership’s acquisition of its remaining equity interests on July 31, 2015. See Note 12 - Equity Investments for further discussion of these equity method investments. In addition, during 2014 the ARLP Partnership’s equity method investments also included MAC prior to the ARLP Partnership’s acquisition of the remaining interest on January 1, 2015. For discussion of both acquisitions, see Note 3 - Acquisitions. The ARLP Partnership reviews its investments and ownership interests accounted for under the equity method of accounting for impairment whenever events or changes in circumstances indicate a loss in the value of the investment may be other than temporary.
Advance Royalties, net-Rights to coal mineral leases are often acquired and/or maintained through advance royalty payments. Where royalty payments represent prepayments recoupable against future production, they are recorded as an asset, with amounts expected to be recouped within one year classified as a current asset. As mining occurs on these leases, the royalty prepayments are charged to operating expenses. The ARLP Partnership assesses the recoverability of royalty prepayments based on estimated future production. The ARLP Partnership has recorded a $3.8 million and $1.3 million allowance against these prepayments as of December 31, 2015 and 2014, respectively. Royalty prepayments estimated to be nonrecoverable are expensed. The ARLP Partnership’s Advance royalties, net at December 31 are summarized as follows:
Asset Retirement Obligations-The ARLP Partnership records a liability for the estimated cost of future mine asset retirement and closing procedures on a present value basis when incurred or acquired and a corresponding amount is capitalized by increasing the carrying amount of the related long lived asset. Those costs relate to permanently sealing portals at underground mines and to reclaiming the final pits and support acreage at surface mines. Examples of these types of costs, common to both types of mining, include, but are not limited to, removing or covering refuse piles and settling ponds, water treatment obligations, and dismantling preparation plants, other facilities and roadway infrastructure. Accounting for asset retirement obligations also requires depreciation of the capitalized asset retirement cost and accretion of the asset retirement obligation over time. The depreciation is generally determined on a units-of-production basis and accretion is generally recognized over the life of the producing assets. As changes in estimates occur (such as mine plan revisions, changes in estimated costs or changes in timing of the performance of reclamation activities), the revisions to the obligation and asset are recognized at the appropriate credit-adjusted, risk-free interest rate. See Note 17 - Asset Retirement Obligations for more information.
Pension Benefits-The funded status of the ARLP Partnership’s pension benefit plan is recognized separately in its consolidated balance sheets as either an asset or liability. The funded status is the difference between the fair value of plan assets and the plan’s benefit obligation. Pension obligations and net periodic benefit costs are actuarially determined and impacted by various assumptions and estimates including expected return on assets, discount rates, mortality assumptions, employee turnover rates and retirement dates. The ARLP Partnership evaluates its assumptions periodically and make adjustments to these assumptions and the recorded liability as necessary. (See Note 14 - Employee Benefit Plans.)
The discount rate is determined for the ARLP Partnership’s pension benefit plan based on an approach specific to its plan. The year-end discount rate is determined considering a yield curve comprised of high-quality corporate bonds and the timing of the expected benefit cash flows.
The expected long-term rate of return on plan assets is determined based on a broad equity and bond indices, the investment goals and objectives, the target investment allocation and on the 20-year average annual total return for each asset class.
Unrecognized actuarial gains and losses and unrecognized prior service costs and credits are deferred and recorded in accumulated other comprehensive income (“AOCI”) until amortized as a component of net periodic benefit cost. Unrecognized actuarial gains and losses in excess of 10% of the greater of the benefit obligation or the market-related value of plan assets are amortized over the participants’ average remaining future years of service.
Workers’ Compensation and Pneumoconiosis (Black Lung) Benefits-The ARLP Partnership is generally self-insured for workers’ compensation benefits, including black lung benefits. The ARLP Partnership accrues a workers’
compensation liability for the estimated present value of workers’ compensation and black lung benefits based on its actuarially determined calculations (See Note 18 - Accrued Workers’ Compensation and Pneumoconiosis Benefits).
Revenue Recognition-Revenues from coal sales are recognized when title passes to the customer as the coal is shipped. Some coal supply agreements provide for price adjustments based on variations in quality characteristics of the coal shipped. In certain cases, a customer’s analysis of the coal quality is binding and the results of the analysis are received on a delayed basis. In these cases, the ARLP Partnership estimates the amount of the quality adjustment and adjust the estimate to actual when the information is provided by the customer. Historically, such adjustments have not been material. Non-coal sales revenues primarily consist of transloading fees, mine safety services and products, royalties and throughput fees earned from White Oak prior to July 31, 2015 as disclosed in Note 3 - Acquisitions, other coal contract fees and other handling and service fees. Transportation revenues are recognized in connection with the ARLP Partnership incurring the corresponding costs of transporting coal to customers through third-party carriers for which it is directly reimbursed through customer billings.
Common Unit-Based Compensation-The fair value of restricted common unit grants under the ARLP Long-Term Incentive Plan (“ARLP LTIP”), Supplemental Executive Retirement Plan (“SERP”), the AGP Amended and Restated Directors Annual Retainer and Deferred Compensation Plan (“AGP Deferred Compensation Plan”), and the MGP Amended and Restated Deferred Compensation Plan for Directors (“Deferred Compensation Plan”) are determined on the grant date of the award and recognized as compensation expense on a pro rata basis for ARLP LTIP and SERP awards, as appropriate, over the requisite service period. Compensation expense is fully recognized on the grant date for quarterly distributions credited to SERP accounts and the AGP Deferred Compensation Plan awards. The corresponding liability is classified as equity and included in limited partners’ capital in the consolidated financial statements. (See Note 15 - Compensation Plans).
Income Taxes-We are not a taxable entity for federal or state income tax purposes; the tax effect of our activities accrues to the unitholders. Although publicly traded partnerships as a general rule will be taxed as corporations, we qualify for an exemption because at least 90% of our income consists of qualifying income, as defined in Section 7704(c) of the Internal Revenue Code. Net income for financial statement purposes may differ significantly from taxable income reportable to unitholders as a result of differences between the tax basis and financial reporting basis of assets and liabilities and the taxable income allocation requirements under our partnership agreement. Individual unitholders have different investment bases depending upon the timing and price of acquisition of their partnership units. Furthermore, each unitholder’s tax accounting, which is partially dependent upon the unitholder’s tax position, differs from the accounting followed in our consolidated financial statements. Accordingly, the aggregate difference in the basis of our net assets for financial and tax reporting purposes cannot be readily determined because information regarding each unitholder’s tax attributes in our partnership is not available to us. The ARLP Partnership’s subsidiaries, ASI and Wildcat Insurance, are subject to federal and state income taxes. A valuation allowance is established if it is more likely than not that a deferred tax asset will not be realized.
Our tax counsel has provided an opinion that AHGP, MGP, the ARLP Partnership and Alliance Coal will each be treated as a partnership. However, as is customary, no ruling has been or will be requested from the Internal Revenue Service (“IRS”) regarding our classification as a partnership for federal income tax purposes.
Variable Interest Entity (“VIE”)-VIEs are primarily entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders, as a group, lack one or more of the following characteristics: (a) direct or indirect ability to make decisions, (b) obligation to absorb expected losses or (c) right to receive expected residual returns. A VIE must be evaluated quantitatively and qualitatively to determine the primary beneficiary, which is the reporting entity that has (a) the power to direct activities of a VIE that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. The primary beneficiary is required to consolidate the VIE for financial reporting purposes.
To determine a VIE’s primary beneficiary, we perform a qualitative assessment to determine which party, if any, has the power to direct activities of the VIE and the obligation to absorb losses and/or receive its benefits. This assessment involves identifying the activities that most significantly impact the VIE’s economic performance and determine whether it, or another party, has the power to direct those activities. When evaluating whether we are the primary beneficiary of a VIE, we perform a qualitative analysis that considers the design of the VIE, the nature of our involvement and the variable interests held by other parties. See Note 11 - Variable Interest Entities for further information.
New Accounting Standards Issued and Adopted-In September 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-16, Simplifying the Accounting for Measurement-Period Adjustments (“ASU 2015-16”). ASU 2015-16 requires that an acquirer within a business combination recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. ASU 2015-16 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015 with early adoption permitted and shall be applied prospectively after adoption. We elected to early adopt the standard in the third quarter of 2015. The adoption of ASU 2015-16 did not have a material impact on our consolidated financial statements as we did not have material measurement period adjustments in the third quarter of 2015. For more discussion of measurement period adjustments recorded in the fourth quarter of 2015 see Note 3 - Acquisitions.
In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”). ASU 2014-08 changes the requirements for reporting discontinued operations in Accounting Standards Codification (“ASC”) 205, Presentation of Financial Statements, by updating the criteria for determining which disposals can be presented as discontinued operations and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of discontinued operations. ASU 2014-08 was effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. The adoption of ASU 2014-08 did not have a material impact on our consolidated financial statements.
New Accounting Standards Issued and Not Yet Adopted-In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory (“ASU 2015-11”). ASU 2015-11 simplifies the subsequent measurement of inventory. It replaces the current lower of cost or market test with the lower of cost or net realizable value test. Net realizable value is defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The new standard should be applied prospectively and is effective for annual reporting periods beginning after December 15, 2016 and interim periods within those annual periods, with early adoption permitted. We are currently evaluating the effect of adopting ASU 2015-11, but do not expect it to have a material impact on our consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (“ASU 2015-03”). ASU 2015-03 changes the classification and presentation of debt issuance costs by requiring debt issuance costs to be reported as a direct deduction from the face amount of the debt liability rather than an asset. Amortization of the costs is reported as interest expense. The amendment does not affect the current guidance on the recognition and measurement of debt issuance costs. ASU 2015-03 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015 and shall be applied retrospectively to each period presented. We do not anticipate the adoption of ASU 2015-03 will have a material impact on our consolidated financial statements.
In February 2015, the FASB issued ASU 2015-02, Consolidation (“ASU 2015-02”). ASU 2015-02 changes the requirements and analysis required when determining the reporting entity’s need to consolidate an entity, including modifying the evaluation of limited partnership variable interest status, the presumption that a general partner should consolidate a limited partnership and the consolidation criterion applied by a reporting entity involved with a VIE. ASU 2015-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015 and shall be applied retrospectively to each period presented. We have evaluated the impact of the guidance and do not believe it has a material impact on our consolidated financial statements.
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 provides guidance on management’s responsibility in evaluating whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter with early adoption permitted. We do not anticipate the adoption of ASU 2014-15 will have a material impact on our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). ASU 2014-09 is a new revenue recognition standard that provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle of the new standard is an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard will be applied retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. ASU 2014-09 was originally effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date (“ASU 2015-14”), which defers the effective date by one year while providing the option to early adopt the standard on the original effective date.
The ARLP Partnership has developed an assessment team to determine the effect of adopting ASU 2014-09. The ARLP Partnership is still determining whether there will be any material impact on revenue recognized; however we believe there will be changes with respect to our disclosures on revenue from contracts that will be reflected in our consolidated financial statements. The ARLP Partnership’s assessment team will continue to work through the new guidance to finalize its evaluation later this year.
3. ACQUISITIONS
White Oak Resources
On July 31, 2015 (the “Hamilton Acquisition Date”) Hamilton acquired the remaining Series A and B Units, representing 60% of the voting interests of White Oak, from White Oak Finance Inc. and other parties (the “Sellers”) for total fair value consideration of $310.3 million (the “Hamilton Acquisition”). The following table summarizes the preliminary and final total fair value of consideration transferred at the Hamilton Acquisition Date:
Effective from the Hamilton Acquisition Date, the ARLP Partnership now owns 100% of the interests in White Oak and has assumed operating control of the White Oak Mine No. 1 (now known as Hamilton Mine No. 1), an underground longwall mining operation located in Hamilton County, Illinois. The Hamilton Acquisition is consistent with the ARLP Partnership’s general business strategy and a strategic complement to its current coal mining operations.
The contingent consideration is payable to the Sellers to the extent Hamilton’s quarterly average coal sales price exceeds a specified amount on future sales. Amounts payable under the contingent consideration arrangement are subject to a defined maximum of $110.0 million reduced for any payments that the ARLP Partnership makes under an overriding royalty agreement between White Oak and certain of the Sellers relating to undeveloped mineral interests controlled by White Oak. The ARLP Partnership estimated the fair value of the contingent consideration using a probability-weighted discounted cash flow model. The assumptions used in the model included a risk-adjusted discount rate, forward coal sales price curves, cost of debt, and probabilities of meeting certain threshold prices. The fair value measurement is based on significant inputs not observable in active markets and thus represents a Level 3 fair value measurement.
Prior to the Hamilton Acquisition Date, the ARLP Partnership accounted for its 40% interest in White Oak as an equity-method investment (See Note 12 - Equity Investments). The acquisition date fair value of the previous equity interest was $121.2 million and is included in the measurement of the consideration transferred. The ARLP Partnership re-measured its equity investment immediately prior to the Hamilton Acquisition using a discounted cash flow model which resulted in a loss of $52.2 million (“Re-measurement Loss”) which is recorded in the line item Acquisition gain, net in our consolidated statements of income. The assumptions used in the determination of the fair value include projected financial information, forward coal price curves, and a risk adjusted discount rate. The assumptions used in this fair value measurement are not observable in active markets and therefore represents a Level 3 fair value measurement.
In connection with the Hamilton Acquisition, the ARLP Partnership settled its pre-existing relationships with White Oak which included existing account balances of $49.6 million. The settlement of pre-existing relationships also included, under business combination accounting, a $74.8 million net gain from above-market terms associated with pre-existing contractual agreements which were comprised of coal leases, a coal handling and preparation agreement, a coal supply agreement, export marketing and transportation agreements and certain debt agreements. The net gain of $74.8 million associated with the settlement of the net above-market terms is recorded in the line item Acquisition gain, net in our consolidated statements of income partially offset by the Re-measurement Loss of $52.2 million discussed above which together, nets to $22.5 million. These settlements of account balances and settlements of net above-market terms are included in the measurement of consideration transferred for the Hamilton Acquisition. As part of the settlement of these agreements, it considered the rates at which a market participant would enter into these agreements and recognized
gains for the above-market rates and losses for the below-market rates contained in the various agreements. The ARLP Partnership developed a discounted cash flow model to determine the fair value of each of these agreements at market rates and compared the valuations to similar models using the contractual rates of the agreements to determine its gains or losses. The assumptions used in these valuation models include processing rates, royalty rates, transportation rates, marketing rates, forward coal price curves, interest rates, projected financial information and risk-adjusted discount rates. These fair value measurements were based on the previously discussed assumptions which are not observable in active markets and therefore represent Level 3 fair value measurements.
In the fourth quarter of 2015, the ARLP Partnership finalized its purchase price accounting which resulted in the following changes to the components of consideration transferred:
· An increase to the contingent consideration due to changes of various assumptions in the underlying valuation model such as the risk adjusted discount rate and the probabilities of meeting certain threshold coal sales prices.
· Adjustments in both the fair value of the settlement of pre-existing relationships and the re-measurement of the ARLP Partnership’s previously held equity investment in White Oak due to the finalization of depreciable lives and the identification of additional acquired assets and the finalization of value in property, plant and equipment (“PP&E”), which resulted in changes to projected depreciation included in the discounted cash flows used to determine fair values.
· As a result of these changes to our preliminary valuation, the ARLP Partnership recognized $23.0 million in measurement period adjustments to the fair value of the consideration transferred increasing the fair value of net assets acquired from $287.3 million to $310.3 million in the fourth quarter of 2015 as reflected in the table below.
The following table summarizes the preliminary and final fair value allocation of assets acquired and liabilities assumed at the Hamilton Acquisition Date, incorporating fair value adjustments made subsequent to the Hamilton Acquisition Date:
The goodwill recognized is attributable to expected synergies and operational cost reductions by using the ARLP Partnership’s other owned facilities and reserves as well as utilizing the ARLP Partnership’s centralized marketing, operations and administrative functions. All of the goodwill has been allocated to the ARLP Partnership’s Hamilton reporting unit included in the Illinois Basin reporting segment.
The ARLP Partnership recognized intangible assets and liabilities associated with the above- and below-market customer contracts in addition to a mining permit as follows:
The ARLP Partnership determined the fair value of cash and cash equivalents, trade receivables, prepaid expenses, advanced royalties, deposits, accounts payable, accrued expenses, and deferred revenue approximated White Oak’s carrying value given the highly liquid and short-term nature of these assets and liabilities. The ARLP Partnership determined the fair value of inventories, PP&E (inclusive of mineral interests) and mining permits using a market approach. The market approach included the development of an entity-wide value using discounted cash flows and allocating the entity-wide value back to the underlying assets based on observed market prices. The ARLP Partnership has recorded the fair value of the above- and below-market components of customer contracts acquired as assets and liabilities. The ARLP Partnership determined these fair values through comparison of the terms in the contracts against projected coal prices. The ARLP Partnership also evaluated the acquired asset retirement obligation to determine the cost to fulfill the obligation and apply an appropriate discount rate to determine the fair value. The assumptions used in these fair value measurements are not observable in active markets and thus represent Level 3 fair value measurements. The ARLP Partnership determined the fair value of the long-term debt acquired through comparison of similar debt instruments and interest rates in active markets, and thus the assumptions used for the long-term debt represent Level 2 fair value measurements. (See Note 2 - Summary of Significant Accounting Policies - Fair Value Measurements for more information regarding fair value hierarchy levels.)
In the fourth quarter of 2015, the ARLP Partnership finalized its purchase price accounting, which resulted in the following changes during the measurement period to the allocations of assets acquired and liabilities assumed (all of the changes to the underlying valuations were the result of new or additional information about the fair value of the underlying assets and liabilities as of the Hamilton Acquisition Date):
· PP&E increased $40.4 million to $299.2 million due to the identification of additional assets acquired and an increase in the value of mineral interests as a result of changes to the discounted cash flows used to determine total entity value when the additional assets were included.
· The increase of $7.2 million in Other Assets was a result of the identification of additional subsidence rights.
· The changes in Accrued Expenses and Other long-term liabilities were a result of a change in value and classification of acquired intangibles previously discussed. Other long-term liabilities were also affected by the removal of a liability associated with below market lease obligations which the ARLP Partnership subsequently determined were at market.
· Goodwill decreased by $25.6 million to $132.0 million. This decrease was the result of other changes identified above which increased the value of the underlying assets.
The amounts of revenue and earnings inclusive of the $22.5 million in net gains associated with the settlement of pre-existing relationships and the Re-Measurement Loss, both discussed above, included in our consolidated statements of income from the Hamilton Acquisition Date to the period ending December 31, 2015 are as follows:
The following represents the pro forma condensed consolidated income statement as if Hamilton had been included in the consolidated results of AHGP since January 1, 2014. These amounts have been calculated after applying the ARLP Partnership’s accounting. Additionally, our results have been adjusted to remove the effect of the ARLP Partnership’s equity investment in White Oak and the pre-existing relationships that it had in White Oak.
Patriot Coal Corporation
On December 31, 2014 (the “Initial Closing Date”), the ARLP Partnership entered into asset purchase agreements with Patriot Coal Corporation (“Patriot”) regarding certain assets relating to two of Patriot’s western Kentucky mining operations, including certain coal sales agreements, unassigned coal reserves and underground mining equipment and infrastructure. Both of the mining operations - the former Dodge Hill and Highland mining operations - were closed by Patriot in late 2014 prior to entering into these asset purchase agreements. Also on December 31, 2014, Patriot affiliates entered into agreements to sell other assets from Highland to a third party. Additional details of the transactions are discussed below.
On the Initial Closing Date, the ARLP Partnership’s subsidiary, Alliance Coal acquired the rights to certain coal supply agreements from an affiliate of Patriot for approximately $21.0 million. Of the $21.0 million purchase price, $9.3 million was paid into escrow subject to obtaining certain assignment consents. In February 2015, $7.5 million of the escrowed amount was released to Patriot for a consent received and $1.8 million was returned to Alliance Coal as a result of a consent not received, reducing the ARLP Partnership’s purchase price to $19.2 million. The acquired agreements provide for delivery of a total of approximately 5.1 million tons of coal from 2015 through 2017.
On February 3, 2015 (the “Acquisition Date”), Alliance Coal and Alliance Resource Properties acquired from Patriot an estimated 84.1 million tons of proven and probable high-sulfur coal reserves in western Kentucky (substantially all of which was leased by Patriot), and substantially all of Dodge Hill’s assets related to its former coal mining operation in western Kentucky, which principally included underground mining equipment and an estimated 43.2 million tons of non-reserve coal deposits (substantially all of which was leased by Dodge Hill). In addition, the ARLP Partnership assumed Dodge Hill’s reclamation liabilities totaling $2.3 million. Also on the Acquisition Date, the Intermediate Partnership’s subsidiaries, UC Mining, LLC and UC Processing, LLC, acquired certain underground mining equipment and spare parts inventory from Patriot’s former Highland mining operation.
The mining and reserve assets acquired from Patriot described above are located in Union and Henderson Counties, Kentucky. The mining equipment, spare parts and underground infrastructure that the ARLP Partnership acquired from Patriot has been and is continuing to be dispersed to its existing operations in the Illinois Basin region in accordance with their highest and best use. The ARLP Partnership’s purchase price of $19.2 million and $20.5 million paid on the Initial Closing Date and the Acquisition Date, respectively, described above was financed using existing cash on hand. In addition, the ARLP Partnership’s purchase price was increased by $8.3 million, comprising $2.1 million cash paid prior to the Acquisition Date related to the transaction and an agreement to pay approximately $6.2 million additional consideration as discussed below. As the ARLP Partnership has no intentions of operating the former Dodge Hill mining complex as a business and only acquired certain assets of Highland, the ARLP Partnership believes unaudited pro forma information of revenue and earnings is not meaningful as it relates to the acquisition of Patriot assets described above and furthermore not materially different than revenue and earnings as presented in the ARLP Partnership’s consolidated statements of income. The primary ongoing benefit derived from the transaction relates to the coal supply agreements acquired, which would have permitted the sale of 3.2 million tons at average pricing of $46.67 per ton sold during 2014 based on the contract price and sales volumes, if the ARLP Partnership had owned the contracts during that period.
Revenues generated by these contracts since the Initial Closing Date were $130.5 million for the year ended December 31, 2015.
In conjunction with the ARLP Partnership’s acquisitions on the Acquisition Date, WKY CoalPlay, LLC (“WKY CoalPlay”), a related-party, acquired approximately 39.1 million tons of proven and probable high-sulfur owned coal reserves located in Henderson and Union Counties, Kentucky from Central States Coal Reserves of Kentucky, LLC (“Central States”), a subsidiary of Patriot, for $25.0 million and in turn leased those reserves to the ARLP Partnership. See Note 19 - Related-Party Transactions for further information on the ARLP Partnership’s lease terms with WKY CoalPlay.
The fair value of the acquired tangible and intangible assets and assumed liabilities are based on discounted cash flow projections and estimated replacement cost valuation techniques. The ARLP Partnership used an estimate of replacement cost based on comparable market prices to value the acquired equipment and utilized discounted cash flows to value intangible assets and reserves. Key assumptions used in the valuations included projections of future cash flows, estimated weighted-average cost of capital, and internal rates of return. Due to the unobservable nature of these inputs, these estimates are considered Level 3 fair value measurements.
The following table summarizes the consideration transferred from the ARLP Partnership to Patriot and the preliminary and final fair value allocation of assets acquired and liabilities assumed as valued at the Acquisition Date, incorporating fair value adjustments made subsequent to the Acquisition Date:
Included in the above consideration transferred was an agreement to pay an additional $6.2 million related to the acquisition, which has been satisfied as of December 31, 2015. Additionally, a fair value adjustment of $3.1 million to increase liabilities and property, plant and equipment was recorded to reflect the impact of operating leases assumed in the acquisition. Other adjustments to the preliminary fair values resulted from additional information obtained about facts in existence on the Acquisition Date.
Intangible assets related to coal supply agreements, represented as “Customer contracts, net” in the table above are reflected in the Prepaid expenses and other assets and Other long-term assets line items in the ARLP Partnership’s consolidated balance sheets. For the year ended December 31, 2015, amortization expense for the acquired coal supply agreements of $11.8 million has been recognized based on the weighted-average term of the contracts on a per unit basis.
MAC
In March 2006, White County Coal, and Alexander J. House entered into a limited liability company agreement to form MAC. MAC was formed to engage in the development and operation of a rock dust mill and to manufacture and sell rock dust. White County Coal initially invested $1.0 million in exchange for a 50% equity interest in MAC. The ARLP Partnership’s equity investment in MAC was $1.6 million at December 31, 2014. Effective on January 1, 2015, the ARLP Partnership purchased the remaining 50% equity interest in MAC from Mr. House for $5.5 million cash paid
at closing. In conjunction with the acquisition, the ARLP Partnership assumed $0.2 million of liabilities and $7.3 million in assets, net of cash acquired, including $4.2 million of goodwill which is reflected in Other and Corporate in the segment presentation (Note 22 - Segment Information) and is included in Goodwill in our consolidated balance sheets.
Peabody Energy Corporation
In December 2014, Alliance Resource Properties acquired the rights to approximately 86.2 million tons of proven and probable high-sulfur leased coal reserves in western Kentucky from Midwest Coal Reserves of Kentucky, LLC (“Midwest”) and Cyprus Creek Land Company, both subsidiaries of Peabody Energy Corporation (“Peabody”), in exchange for an overriding royalty to be paid to Peabody based on a percentage of the sales price of coal mined from the reserves acquired. In addition, WKY CoalPlay acquired the rights to approximately 54.1 million tons of owned coal reserves in western Kentucky, through its purchase of a wholly owned subsidiary of Midwest for $29.6 million cash paid at closing. In conjunction with this acquisition, WKY CoalPlay’s subsidiary leased 22.6 million tons of the acquired reserves to the ARLP Partnership and, as partial consideration for entering the lease, conveyed the remaining 31.5 million tons to the ARLP Partnership. The conveyed reserves have minimal value as a result of uncertainty regarding inclusion in a mine plan. See Note 19 - Related-Party Transactions for further information on the ARLP Partnership’s lease terms with WKY CoalPlay. This transaction allowed the ARLP Partnership to extend the expected life of the River View mine and provides potential greenfield mining opportunities.
CONSOL Energy Inc.
In June 2013, the ARLP Partnership’s subsidiary, Alliance Resource Properties acquired the rights to approximately 11.6 million tons of proven and probable medium-sulfur coal reserves, and an additional 5.9 million resource tons, in Grant and Tucker Counties, West Virginia from Laurel Run Mining Company, a subsidiary of CONSOL Energy Inc. (“CONSOL”). The purchase price of $25.2 million was allocated to owned and leased coal rights and was financed using existing cash on hand. As a result of the coal reserve purchase, the ARLP Partnership reclassified certain tons of medium-sulfur, non-reserve coal deposits as reserves, which together with the reserves purchased above, extended the expected life of Mettiki (WV)’s Mountain View mine.
In November 2014, Alliance Resource Properties acquired the rights to approximately 124.2 million tons of proven and probable high-sulfur coal reserves, most of which are leased reserves, and various surface properties in western Kentucky from CNX RCPC, LLC (“CNX RCPC”) and Island Creek Coal Company (“Island Creek”), both subsidiaries of CONSOL. The purchase price of $11.6 million was financed using existing cash on hand and allocated to the owned and leased coal rights and surface properties acquired. The ARLP Partnership also assumed reclamation liabilities totaling $6.0 million.
In conjunction with this acquisition, WKY CoalPlay acquired approximately 86.6 million tons of proven and probable high-sulfur owned coal reserves in western Kentucky and southern Indiana through its purchase of two wholly owned subsidiaries of CNX RCPC and Island Creek for $57.2 million. In December 2014, WKY CoalPlay’s subsidiaries leased 72.3 million tons of the acquired reserves to the ARLP Partnership and, as partial consideration for entering the leases, conveyed the remaining 14.3 million tons of its acquired reserves to the ARLP Partnership. The conveyed reserves have minimal value as a result of uncertainty regarding inclusion in a mine plan. See Note 19 - Related-Party Transactions for further information on the ARLP Partnership’s lease terms with WKY CoalPlay. The reserves described in this paragraph extended the expected lives of the River View and Dotiki mines and provide potential greenfield mining opportunities.
4. LONG-LIVED ASSET IMPAIRMENTS
During the fourth quarter of 2015 the ARLP Partnership idled the Onton and Gibson North mines in response to market conditions and continued increases in coal inventories at the mines and customer locations. The ARLP Partnership’s decision to idle these mines, as well as continued low coal prices and regulatory conditions led to the conclusion that indicators of impairment were present and the carrying value for certain mines may not be fully recoverable. During the ARLP Partnership’s assessment of the recoverability of the carrying value of the ARLP Partnership’s operating segments, they determined that they would likely not recover the carrying value of the net assets at MC Mining within the Appalachia segment and Onton within the Illinois Basin segment. Accordingly, the ARLP Partnership estimated the fair values of the MC Mining and Onton net assets and then adjusted the carrying values to the fair values resulting in impairments of $19.5 million and $66.9 million respectively.
The fair value of the assets was determined using a market approach and represents a Level 3 fair value measurement under the fair value hierarchy. The fair value analysis was based on assumptions of marketability of coal properties in the current environment and the probability assessment of multiple sales scenarios based on observations of other recent mine sales.
During the fourth quarter of 2015, the ARLP Partnership determined that certain undeveloped coal reserves and related property in western Pennsylvania were no longer a core part of the ARLP Partnership’s foreseeable development plans and thus surrendered the lease for the properties in order to avoid the high holding costs of those reserves. The ARLP Partnership recorded an impairment charge of $3.0 million to the Appalachia segment during the quarter ended December 31, 2015 to remove advanced royalties associated with the lease from our consolidated balance sheet.
During the third quarter of 2015, the ARLP Partnership surrendered a lease agreement for certain undeveloped coal reserves and related property in western Kentucky. The ARLP Partnership determined that coal reserves held under this lease agreement were no longer a core part of the ARLP Partnership’s foreseeable development plans. As such, the ARLP Partnership surrendered the lease in order to avoid the high holding costs of those reserves. The ARLP Partnership recorded an impairment charge of $10.7 million to its Illinois Basin segment to remove certain assets associated with the lease, including mineral rights, advanced royalties and mining permits from our consolidated balance sheet.
In future periods, it is reasonably possible that a variety of circumstances could result in additional impairments of the ARLP Partnership’s long-lived assets.
5. INVENTORIES
Inventories consist of the following at December 31:
6. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following at December 31:
Equipment leased by the ARLP Partnership under lease agreements which are determined to be capital leases are stated at an amount equal to the present value of the minimum lease payments during the lease term, less accumulated amortization. Equipment under capital leases totaling $105.8 million included in mining equipment and processing facilities is amortized on the straight-line method over the shorter of its useful life or the related lease term. The provision for amortization of leased properties is included in depreciation, depletion and amortization expense. Accumulated amortization related to the ARLP Partnership’s capital leases was $7.1 million, $5.6 million and $5.8 million as of December 31, 2015, 2014 and 2013, respectively, and amortization expense was $5.7 million, $1.6 million and $2.0 million for the years ended December 31, 2015, 2014 and 2013, respectively. For information regarding long-lived asset impairments please see Note 4 - Long-Lived Asset Impairments.
7. LONG-TERM DEBT
Long-term debt consists of the following:
ARLP Credit Facility. On May 23, 2012, the Intermediate Partnership entered into a credit agreement (the “ARLP Credit Agreement”) with various financial institutions for a revolving credit facility (the “ARLP Revolving Credit Facility”) of $700.0 million and a term loan (the “ARLP Term Loan”) in the aggregate principal amount of $250.0 million (collectively, the ARLP Revolving Credit Facility and ARLP Term Loan are referred to as the “ARLP Credit Facility”). Borrowings under the ARLP Credit Agreement bear interest at a Base Rate or Eurodollar Rate, at the ARLP Partnership’s election, plus an applicable margin that fluctuates depending upon the ratio of Consolidated Debt to Consolidated Cash Flow (each as defined in the ARLP Credit Agreement). The ARLP Partnership has elected a Eurodollar Rate, which, with applicable margin, was 2.06% on borrowings outstanding as of December 31, 2015. The ARLP Credit Facility matures May 23, 2017, at which time all amounts then outstanding are required to be repaid. Interest is payable quarterly, with principal of the ARLP Term Loan due as follows: for each quarter commencing June 30, 2014 and ending March 31, 2016, quarterly principal payments in an amount per quarter equal to 2.50% of the aggregate amount of the ARLP Term Loan advances outstanding; for each quarter beginning June 30, 2016 through December 31, 2016, 20% of the aggregate amount of the ARLP Term Loan advances outstanding; and the remaining balance of the ARLP Term Loan advances at maturity. In June 2014, the ARLP Partnership began making quarterly principal payments on the ARLP Term Loan, leaving a balance of $206.3 million at December 31, 2015. The ARLP Partnership has the option to prepay the ARLP Term Loan at any time in whole or in part subject to terms and conditions described in the ARLP Credit Agreement. Upon a “change of control” (as defined in the ARLP Credit Agreement), the unpaid principal amount of the ARLP Credit Facility, all interest thereon and all other amounts payable under the ARLP Credit Agreement would become due and payable. On October 16, 2015 the ARLP Revolving Credit Facility was amended to increase the baskets for capital lease obligations from $10.0 million to $100.0 million and sale-leaseback arrangements from $10.0 million to $100.0 million per annum.
At December 31, 2015, the ARLP Partnership had borrowings of $385.0 million and $5.9 million of letters of credit outstanding with $309.1 million available for borrowing under the ARLP Revolving Credit Facility. The ARLP Partnership utilizes the ARLP Revolving Credit Facility, as appropriate, for working capital requirements, capital expenditures and investments in affiliates, scheduled debt payments and distribution payments. The ARLP Partnership incurs an annual commitment fee of 0.25% on the undrawn portion of the ARLP Revolving Credit Facility.
ARLP Series B Senior Notes. On June 26, 2008, the ARLP Partnership issued under the 2008 Note Purchase Agreement $145.0 million of Series B senior notes (“ARLP Series B Senior Notes”), which bear interest at 6.72% and mature on June 26, 2018 with interest payable semi-annually.
The ARLP Series B Senior Notes and the ARLP Credit Facility described above (collectively, “ARLP Debt Arrangements”) are guaranteed by all of the material direct and indirect subsidiaries of the Intermediate Partnership. The ARLP Debt Arrangements contain various covenants affecting the Intermediate Partnership and its subsidiaries restricting, among other things, the amount of distributions by the Intermediate Partnership, incurrence of additional indebtedness and liens, sale of assets, investments, mergers and consolidations and transactions with affiliates, in each case subject to various exceptions. The ARLP Debt Arrangements also require the Intermediate Partnership to remain in control of a certain amount of mineable coal reserves relative to its annual production. In addition, the ARLP Debt Arrangements require the Intermediate Partnership to maintain (a) debt to cash flow ratio of not more than 3.0 to 1.0 and (b) cash flow to interest expense ratio of not less than 3.0 to 1.0, in each case, during the four most recently ended fiscal
quarters. The debt to cash flow ratio and cash flow to interest expense ratio were 1.19 to 1.0 and 24.2 to 1.0, respectively, for the trailing twelve months ended December 31, 2015. The ARLP Partnership was in compliance with the covenants of the ARLP Debt Arrangements as of December 31, 2015.
ARLP Accounts Receivable Securitization. On December 5, 2014, certain direct and indirect wholly owned subsidiaries of the Intermediate Partnership entered into a $100.0 million accounts receivable securitization facility (“ARLP Securitization Facility”) providing additional liquidity and funding. Under the ARLP Securitization Facility, certain subsidiaries sell trade receivables on an ongoing basis to the Intermediate Partnership, which then sells the trade receivables to AROP Funding, a wholly owned bankruptcy-remote special purpose subsidiary of the Intermediate Partnership, which in turn borrows on a revolving basis up to $100.0 million secured by the trade receivables. After the sale, Alliance Coal, as servicer of the assets, collects the receivables on behalf of AROP Funding. The ARLP Securitization Facility bears interest based on a Eurodollar Rate. It was renewed in December 2015 and matures in December 2016. At December 31, 2015, the ARLP Partnership had $83.1 million outstanding under the ARLP Securitization Facility.
ARLP Hamilton Revolving Credit Facility and ARLP Hamilton Equipment Financing Agreement. In connection with the Hamilton Acquisition (see Note 3 - Acquisitions), the ARLP Partnership assumed a $10.0 million revolving credit facility (“ARLP Hamilton Revolving Credit Facility”). In November 2014, White Oak entered into the ARLP Hamilton Revolving Credit Facility allowing for periodic borrowings up to $10.0 million, collateralized by White Oak’s accounts receivable. Borrowings under the ARLP Hamilton Revolving Credit Facility carried interest at the prime rate plus 0.1%. On October 19, 2015, the outstanding balance of the ARLP Hamilton Revolving Credit Facility totaling $10.0 million was repaid.
Also in connection with the Hamilton Acquisition, the ARLP Partnership assumed an equipment financing agreement (“ARLP Hamilton Equipment Financing Agreement”). In 2012, White Oak acquired vendor financing totaling $100.0 million through the ARLP Hamilton Equipment Financing Agreement, which was secured by continuous mining, long-wall mining, and underground belt system equipment purchased from the vendor. The ARLP Hamilton Equipment Financing Agreement required repayment of principal and interest in equal monthly installments of $2.1 million from July 2014 until June 2019. On October 16, 2015, the outstanding balance of the ARLP Hamilton Equipment Financing Agreement totaling $80.6 million was repaid without penalty with funds drawn on the ARLP Revolving Credit Facility.
On October 29, 2015, the ARLP Partnership entered into a sale-leaseback transaction whereby it sold certain mining equipment for $100.0 million and concurrently entered into a lease agreement for that equipment. See Note 20 - Commitments and Contingencies for further information.
Cavalier Credit Agreement. On October 6, 2015, Cavalier Minerals (see Note 11 - Variable Interest Entity) entered into a credit agreement (the “Cavalier Credit Agreement”) with Mineral Lending, LLC (“Mineral Lending”) for a $100.0 million line of credit (the “Cavalier Credit Facility”). Mineral Lending is an entity owned by a) Alliance Resource Holdings II, Inc. (“ARH II,” the parent of ARH), b) an entity owned by an officer of ARH who is also a director of ARH II (“ARH Officer”) and c) foundations established by the President and Chief Executive Officer of MGP and Kathleen S. Craft. There is no commitment fee under the facility. Borrowings under the Cavalier Credit Facility bear interest at a one month LIBOR rate plus 6% with interest payable quarterly. Repayment of the principal balance will begin following the first fiscal quarter after the earlier of the date on which the aggregate amount borrowed exceeds $90.0 million or December 31, 2017, in quarterly payments of an amount equal to the greater of $1.3 million initially, escalated to $2.5 million after two years, or fifty percent of Cavalier Minerals’ excess cash flow. The Cavalier Credit Facility matures September 30, 2024, at which time all amounts then outstanding are required to be repaid. To secure payment of the facility, Cavalier Minerals pledged all of its partnership interests, then owned or later acquired, in AllDale Minerals, L.P. and AllDale Minerals II, L.P. Cavalier Minerals may prepay the Cavalier Credit Facility at any time in whole or in part subject to terms and conditions described in the Cavalier Credit Agreement. As of December 31, 2015, Cavalier Minerals’ had not drawn on the Cavalier Credit Facility.
Other. In addition to the letters of credit available under the Credit Facility discussed above, the ARLP Partnership also has agreements with two banks to provide additional letters of credit in an aggregate amount of $31.1 million to maintain surety bonds to secure certain asset retirement obligations and the ARLP Partnership’s obligations for workers’ compensation benefits. At December 31, 2015, the ARLP Partnership had $30.7 million in letters of credit outstanding under agreements with these two banks.
Aggregate maturities of long-term debt are payable as follows:
8. FAIR VALUE MEASUREMENTS
The following table summarizes the ARLP Partnership’s recurring fair value measurements within the hierarchy not included elsewhere in these notes:
See Note 2 - Summary of Significant Accounting Policies - Fair Value Measurements for more information regarding fair value hierarchy levels.
The carrying amounts for cash equivalents, accounts receivable, accounts payable, due from affiliates and due to affiliates approximate fair value due to the short maturity of those instruments.
The estimated fair value of the ARLP Partnership’s long-term debt, including current maturities, is based on interest rates that we believe are currently available to the ARLP Partnership in active markets for issuance of debt with similar terms and remaining maturities (See Note 7 - Long-Term Debt). The fair value of debt, which is based upon these interest rates, is classified as a Level 2 measurement under the fair value hierarchy.
As discussed in Note 3 - Acquisitions, the fair value of the contingent consideration on the Hamilton Acquisition Date was $14.8 million. This fair value decreased to $10.4 million as of December 31, 2015 due to changes in projected coal prices, changes in the estimated cost of debt in the coal industry, and a change in the discount rate. The fair value measurement is based on significant inputs not observable in active markets and thus represents a Level 3 fair value measurement under the fair value hierarchy.
9. DISTRIBUTIONS OF AVAILABLE CASH
We distribute 100% of our available cash (including any held by MGP) within 50 days after the end of each quarter to unitholders of record. Available cash is generally defined in the partnership agreement as all cash and cash equivalents of AHGP and its direct subsidiaries on hand at the end of each quarter less reserves established by AGP in its reasonable discretion for future cash requirements. These reserves are retained to provide for the conduct of our business, the payment of debt principal and interest and to provide funds for future distributions.
Our cash generating assets currently consist entirely of our partnership interests in ARLP, from which we receive quarterly cash distributions. At December 31, 2015, our assets consisted of the following partnership interests in ARLP: a 1.98% general partner interest in ARLP, which we hold through our 100% ownership interest in MGP; the IDR in ARLP, which we hold through our 100% ownership interest in MGP; 31,088,338 common units of ARLP, representing approximately 42.0% of the common units of ARLP; and a 0.001% managing interest in Alliance Coal which we hold through our 100% ownership interest in MGP.
The following table summarizes the quarterly per unit distribution paid during the respective quarter:
On January 26, 2016, we declared a quarterly distribution of $0.96 per unit, totaling approximately $57.5 million, which was paid on February 19, 2016, to all unitholders of record on February 12, 2016.
10. INCOME TAXES
ARLP’s indirect subsidiaries, ASI and Wildcat Insurance, are subject to federal and state income taxes. Wildcat Insurance’s income is due to insurance premiums provided by the ARLP Partnership’s other subsidiaries. ASI’s income is principally due to its subsidiary, Matrix Design. There are minor temporary differences between our taxable entities financial reporting basis and the tax basis of their assets and liabilities. Components of income tax expense (benefit) are as follows:
The ARLP Partnership has deferred tax assets due to net operating losses and research and development credits associated with ASI’s operations in the amount of $8.3 million, partially offset by liabilities of $1.6 million. State and federal valuation allowances have been established to reduce these deferred tax assets to an amount that will, more likely than not, be realized. During 2015, the federal and state valuation allowances increased to $5.2 million and $1.5 million, respectively, primarily due to the ongoing evaluation process of the losses and credits anticipated to be realized in future years.
Reconciliations from the provision for income taxes at the U.S. federal statutory tax rate to the effective tax rate for the provision for income taxes are as follows:
11. VARIABLE INTEREST ENTITIES
Cavalier Minerals
On November 10, 2014, the ARLP Partnership’s subsidiary, Alliance Minerals, and Bluegrass Minerals Management, LLC (“Bluegrass Minerals”) entered into a limited liability company agreement (the “Cavalier Agreement”) to create Cavalier Minerals, which was formed to indirectly acquire oil and gas mineral interests, initially through its 71.7% noncontrolling ownership interest in AllDale I and subsequently through its 72.8% noncontrolling ownership interest in AllDale II, collectively with AllDale I, AllDale Minerals) (see Note 13 - Equity Investments). Alliance Minerals and Bluegrass Minerals initially committed funding of $48.0 million and $2.0 million, respectively, to Cavalier Minerals, and Cavalier Minerals committed funding of $49.0 million to AllDale I. On October 6, 2015, Alliance Minerals and Bluegrass Minerals committed to fund an additional $96.0 million and $4.0 million, respectively, to Cavalier Minerals, and Cavalier Minerals committed to fund $100.0 million to AllDale II. Alliance Minerals’ contributions through December 31, 2014 to Cavalier Minerals totaled $11.5 million. During the year ended December 31, 2015, Alliance Minerals contributed an additional $51.6 million fulfilling the ARLP Partnership’s initial commitment and bringing its total investment in Cavalier Minerals to $63.1 million at December 31, 2015. The ARLP Partnership’s remaining commitment to Cavalier Minerals at December 31, 2015 was $80.9 million. Bluegrass Minerals, which is owned and controlled by the ARH Officer as discussed in Note 7 - Long-Term Debt and is Cavalier Minerals’ managing member, contributed $2.6 million as of December 31, 2015 and has a remaining commitment of $3.4 million. At Alliance Minerals’ election, Cavalier Minerals will meet its remaining funding commitment to AllDale Minerals through contributions from Alliance Minerals and Bluegrass Minerals or from borrowings under the Cavalier Credit Facility (see Note 7 - Long-Term Debt). The ARLP Partnership expects to fund its remaining commitments utilizing existing cash balances, future cash flows from operations, borrowings under credit and securitization facilities and cash provided from the issuance of debt or equity, or by requiring Cavalier Minerals to draw on the Cavalier Credit Facility.
In accordance with the Cavalier Agreement, Bluegrass Minerals is entitled to receive an incentive distribution from Cavalier Minerals equal to 25% of all distributions (including in liquidation) after return of members’ capital reduced by certain distributions received by Bluegrass Minerals or its owner from AllDale Minerals Management, LLC (“AllDale Minerals Management”), the managing member of AllDale Minerals. Alliance Minerals’ ownership interest in Cavalier Minerals at December 31, 2015 was 96%. The remainder of the equity ownership is held by Bluegrass Minerals. The ARLP Partnership has consolidated Cavalier Minerals’ financial results as it concluded that Cavalier Minerals is a VIE and the ARLP Partnership is the primary beneficiary because its consent is required for significant activities of Cavalier Minerals and due to Bluegrass Minerals’ relationship to the ARLP Partnership as described above. Bluegrass Minerals equity ownership of Cavalier Minerals is accounted for as noncontrolling ownership interest in the consolidated balance sheets. In addition, earnings attributable to Bluegrass Minerals are recognized as net loss attributable to noncontrolling interest in the consolidated statements of income. Furthermore, the ARLP Partnership has concluded that Cavalier Minerals has a variable interest in AllDale Minerals, which qualifies as a VIE. For more information on AllDale Minerals, see Note 13- Equity Investments.
WKY CoalPlay
On November 17, 2014, SGP Land, LLC (“SGP Land”) and two limited liability companies owned by irrevocable trusts established by the President and Chief Executive Officer of MGP (“Craft Companies”) entered into a limited liability company agreement to form WKY CoalPlay. WKY CoalPlay was formed, in part, to purchase and lease coal reserves. WKY CoalPlay is managed by the ARH Officer discussed in Note 7 - Long-term Debt, who is also an employee of SGP Land and trustee of the irrevocable trusts owning the Craft Companies. In December 2014 and February 2015, the ARLP Partnership entered into various coal reserve leases with WKY CoalPlay. See Note 19 - Related-Party Transactions for further information on the ARLP Partnership’s lease terms with WKY CoalPlay.
The ARLP Partnership has concluded that WKY CoalPlay is a VIE because of the ARLP Partnership’s ability to exercise options to acquire reserves under lease with WKY CoalPlay (Note 19 - Related-Party Transactions), which is not within the control of the equity holders and, if it occurs, could potentially limit the expected residual return to the owners of WKY CoalPlay. The ARLP Partnership does not have any economic or governance rights related to WKY CoalPlay and its options that provide the ARLP Partnership with a variable interest in WKY CoalPlay’s reserve assets do not give it any rights that constitute power to direct the primary activities that most significantly impact WKY CoalPlay’s economic performance. SGP Land has the sole ability to replace the manager of WKY CoalPlay at its discretion and therefore has power to direct the activities of WKY CoalPlay. Consequently, the ARLP Partnership concluded that SGP Land is the primary beneficiary of WKY CoalPlay.
White Oak
Prior to the ARLP Partnership’s acquisition of the remaining equity interests in White Oak as discussed in Note 3 - Acquisitions, White Oak was a variable interest entity of which the ARLP Partnership was not the primary beneficiary. The ARLP Partnership held a majority of the Series A Units that had certain distribution and liquidation preferences but only gave it a 40% voting interest in the primary activities of the company. The ARLP Partnership had protective rights and limited participating rights, such as minority representation on their board of directors, restrictions on indebtedness and other obligations, the ability to assume control of the board of directors in certain circumstances, such as an event of default, and the right to approve certain coal sales agreements.
These protective and participating rights did not provide the ARLP Partnership the ability to unilaterally direct any of the primary activities of White Oak that most significantly impacted its economic performance and thus, the ARLP Partnership was not the primary beneficiary for consolidation purposes. Consequentially, the ARLP Partnership accounted for its Series A Units investment as an equity investment. See Note 13 - Equity Method Investments for further information.
12. NONCONTROLLING INTERESTS
Our noncontrolling ownership interest in consolidated subsidiaries is presented in the consolidated balance sheet within partners’ capital as a separate component from the limited partners’ equity. In addition, consolidated net income includes earnings attributable to both the limited partners’ and the noncontrolling interests.
The noncontrolling interests balance is comprised of non-affiliate and affiliate ownership interests in the net assets of the ARLP Partnership that we consolidate (See Note 2 - Summary of Significant Accounting Policies) and an affiliate ownership interest in Cavalier Minerals.
The following table summarizes the components of noncontrolling interests recorded in Partners’ Capital for the periods indicated:
The noncontrolling interest designated as Affiliate (SGP) represents SGP’s 0.01% general partner interest in ARLP and 0.01% general partner interest in the Intermediate Partnership.
The noncontrolling interest designated as Non-Affiliates represents the limited partners’ interest in ARLP controlled through the common unit ownership, excluding the 31,088,338 common units of ARLP held by us. The total obligation associated with ARLP’s LTIP, SERP and the MGP Amended and Restated Deferred Compensation Plan for Directors (“MGP Deferred Compensation Plan”) is also included in the Non-Affiliates component of noncontrolling interest.
The following table summarizes net income attributable to each component of the noncontrolling interests for the periods indicated:
The following table summarizes cash distributions paid by ARLP to each component of the noncontrolling interests for the periods indicated:
(1) Distributions paid to noncontrolling interests, in the table above, represent ARLP’s quarterly distributions in accordance with the ARLP Partnership agreement.
The Affiliate (SGP) component of noncontrolling interests represents SGP’s cumulative investment basis in the net assets of the ARLP Partnership. After the consummation of the various transactions associated with the ARLP Partnership’s formation and initial public offering in 1999 (which included the contribution of net assets by SGP to the ARLP Partnership, the retention by SGP of debt borrowings assumed by ARLP and a distribution by ARLP to SGP), SGP’s investment basis in ARLP totaled $(303.9) million. SGP’s investment basis as of December 31, 2015 and 2014 also reflects the cumulative amount of nominal ARLP income allocations and distributions to SGP and nominal contributions by SGP to ARLP and the Intermediate Partnership to maintain its general partner interests.
13. EQUITY INVESTMENTS
AllDale Minerals
On November 10, 2014, Cavalier Minerals (see Note 11 - Variable Interest Entity) made an initial contribution of $7.4 million in return for a limited partner interest in AllDale Minerals, which was created to purchase oil and gas mineral interests in various geographic locations within producing basins in the continental U.S. As of December 31, 2014, Cavalier Minerals’ had contributed $11.6 million to AllDale Minerals. During the year ended December 31, 2015, Cavalier Minerals contributed an additional $54.3 million bringing the total investment in AllDale Minerals to $65.9 million as of December 31, 2015. The ARLP Partnership continually review all rights provided to Cavalier Minerals and the ARLP Partnership by various agreements and continue to conclude all such rights do not provide Cavalier Minerals or the ARLP Partnership the ability to unilaterally direct any of the activities of AllDale Minerals that most significantly impact its economic performance. As such, the ARLP Partnership accounts for Cavalier Minerals’ ownership interest in the income or loss of AllDale Minerals as an equity investment in the consolidated financial statements. The ARLP Partnership records equity income or loss based on AllDale Minerals’ distribution structure as described below. For the years ended December 31, 2015 and 2014, the ARLP Partnership has been allocated losses of $0.6 million and $0.4 million, respectively, from AllDale Minerals.
In accordance with AllDale Minerals’ partnership agreements, limited partners, such as Cavalier Minerals, will initially receive all distributions of proceeds from certain producing basins based upon the greater of the limited partner’s cumulative contributions plus 25.0% or an amount sufficient to cause the limited partner to receive an effective internal rate of return of 10.0%. Afterwards, 20.0% of all distributions will be allocated to AllDale Minerals Management, as an incentive distribution to the general partner, with the remaining 80.0% allocated to limited partners based upon ownership percentages. In addition, upon an event of liquidation, any proceeds will be distributed using the same methodology. AllDale Minerals distributed $0.4 million to Cavalier Minerals during 2015. AllDale Minerals did not make any distributions to its owners during 2014.
White Oak
On September 22, 2011, the ARLP Partnership entered into a series of transactions (“Initial Transactions”) with White Oak to support development of a longwall mining operation, which the ARLP Partnership assumed control of in July 2015 through the ARLP Partnership’s acquisition of the remaining equity interests in White Oak (see Note 3 - Acquisitions). The Initial Transactions featured several components, including an equity investment in White Oak, the acquisition and lease-back of certain coal reserves and surface rights, a loan and a coal handling and preparation agreement, pursuant to which the ARLP Partnership constructed and operated Hamilton’s preparation plant and other surface facilities. Prior to the Hamilton Acquisition the ARLP Partnership recorded its previous equity in income or losses of affiliates from White Oak under the hypothetical liquidation at book value method of accounting due to the preferences to which the ARLP Partnership were entitled with respect to distributions. See Note 11 - Variable Interest Entities regarding our determination to account for White Oak as an equity investment prior to the Hamilton Acquisition.
White Oak’s results prior to the Hamilton Acquisition for the period from January 1, 2015 to July 31, 2015 and for the years ended December 31, 2014 and 2013, are summarized as follows:
White Oak’s financial position as of December 31, 2015 and 2014 are summarized as follows:
(1) White Oak was not an equity method investee as of December 31, 2015 (see Note 3 - Acquisitions).
14. EMPLOYEE BENEFIT PLANS
Defined Contribution Plans-The ARLP Partnership’s eligible employees currently participate in a defined contribution profit sharing and savings plan (“PSSP”) that it sponsors. The PSSP covers substantially all regular full-time employees. PSSP participants may elect to make voluntary contributions to this plan up to a specified amount of their compensation. The ARLP Partnership makes matching contributions based on a percent of an employee’s eligible compensation and also makes an additional non-matching contribution. The ARLP Partnership’s contribution expense for the PSSP was approximately $22.6 million, $21.8 million and $20.4 million for the years ended December 31, 2015, 2014 and 2013, respectively.
Defined Benefit Plan-Eligible employees at certain of the ARLP Partnership’s mining operations participate in a defined benefit plan (the “Pension Plan”) that it sponsors. The Pension Plan is currently closed to new applicants; however, participants in the plan continue to accrue benefits. The benefit formula for the Pension Plan is a fixed-dollar unit based on years of service.
The following sets forth changes in benefit obligations and plan assets for the years ended December 31, 2015 and 2014 and the funded status of the Pension Plan reconciled with the amounts reported in our consolidated financial statements at December 31, 2015 and 2014, respectively:
The actuarial gain component of the change in benefit obligation in 2015 was primarily attributable to an increase in the discount rate compared to December 31, 2014 and the adoption of newly issued mortality tables reflecting improved life expectancies offset by updated retirement and withdrawal rate estimates. The actuarial loss component of the change in benefit obligation in 2014 was primarily attributable to a decrease in the discount rate and the actual rate of return on plan assets compared to December 31, 2013, adoption of newly issued mortality tables reflecting improved life expectancies and updated retirement and withdrawal rate estimates.
The expected long-term rate of return used to determine the pension liability was 8.0% for both December 31, 2015 and 2014 based on an asset allocation assumption of:
As of December 31, 2015
Asset allocation
assumption
Expected long-
term rate of
return
Domestic equity securities
70%
8.6%
Foreign equity securities
10%
5.3%
Fixed income securities/cash
20%
5.1%
100%
The actual return on plan assets was (2.0)% and 5.4% for the years ended December 31, 2015 and 2014, respectively.
Estimated future benefit payments as of December 31, 2015 are as follows:
The ARLP Partnership expects to contribute $2.6 million to the Pension Plan in 2016. The estimated net actuarial loss for the Pension Plan that will be amortized from AOCI into net periodic benefit cost during the 2016 fiscal year is $3.2 million.
The compensation committee of the MGP Board of Directors (“MGP Compensation Committee”) maintains a Funding and Investment Policy Statement (“Policy Statement”) for the Pension Plan. The Policy Statement provides that
the assets of the Pension Plan be invested in a prudent manner based on the stated purpose of the Pension Plan and diversified among a broad range of investments including domestic and international equity securities, domestic fixed income securities and cash equivalents. The Pension Plan allows for the utilization of options in a “collar strategy” to limit potential exposure to market fluctuations. The investment goal of the Pension Plan is to ensure that the assets provide sufficient resources to meet or exceed the benefit obligations as determined under terms and conditions of the Pension Plan. The Policy Statement provides that the Pension Plan shall be funded by employer contributions in amounts determined in accordance with generally accepted actuarial standards. The investment objectives as established by the Policy Statement are, first, to increase the value of the assets under the Pension Plan and, second, to control the level of risk or volatility of investment returns associated with Pension Plan investments.
In general, increases in benefit obligations will be offset by employer contributions and market returns. However, general market conditions may result in market losses. When the Pension Plan experiences market losses, significant variations in the funded status of the Pension Plan can, and often do, occur. Actuarial methods utilized in determining required future employer contributions take into account the long-term effect of market losses and result in increased future employer contributions, thus offsetting such market losses. Conversely, the long-term effect of market gains will result in decreased future employer contributions. Total account performance is reviewed at least annually, using a dynamic benchmark approach to track investment performance.
The MGP Compensation Committee has selected an investment manager to implement the selection and on-going evaluation of Pension Plan investments. The investments shall be selected from the following assets classes (which may include mutual funds, collective funds, or the direct investment in individual stocks, bonds or cash equivalent investments): (a) money market accounts, (b) U.S. Government bonds, (c) corporate bonds, (d) large, mid, and small capitalization stocks, and (e) international stocks. The Policy Statement provides the following guidelines and limitations, subject to exceptions authorized by the MGP Compensation Committee: (i) the maximum investment in any one stock should not exceed 10.0% of the total stock portfolio, (ii) the maximum investment in any one industry should not exceed 30.0% of the total stock portfolio, and (iii) the average credit quality of the bond portfolio should be at least AA with a maximum amount of non-investment grade debt of 10.0%.
The Policy Statement’s asset allocation guidelines are as follows:
Domestic equity securities primarily include investments in individual common stocks or registered investment companies that hold positions in companies that are based in the U.S. Foreign equity securities primarily include investments in individual common stocks or registered investment companies that hold positions in companies based outside the U.S. Fixed income securities primarily include individual bonds or registered investment companies that hold positions in U.S. Treasuries, U.S. government obligations, corporate bonds, mortgage-backed securities, and preferred stocks. Short-term market conditions may result in actual asset allocations that fall outside the minimum or maximum guidelines reflected in the Policy Statement.
Asset allocations as of December 31,
Domestic equity securities
70%
71%
Foreign equity securities
10%
8%
Fixed income securities/cash
20%
21%
100%
100%
The ARLP Partnership considers multiple factors in its investment strategy. The following factors have been taken into consideration with respect to the Pension Plan’s long-term investment goals and objectives and in the establishment of the Pension Plan’s target investment allocation:
· The long-term nature of providing retirement income benefits to Pension Plan participants;
· The projected annual funding requirements necessary to meet the benefit obligations;
· The current level of benefit payments to Pension Plan participants and beneficiaries; and
· Ongoing analysis of economic conditions and investment markets.
The following information discloses the fair values of the Pension Plan assets, by asset category, for the periods indicated:
(a) See Note 2 - Summary of Significant Accounting Policies - Fair Value Measurements for more information regarding the definitions of fair value hierarchy levels.
(b) Equity securities include investments in publicly traded common stock and preferred stock. Publicly-traded common stocks are traded on a national securities exchange and investments in common and preferred stocks are valued using quoted market prices multiplied by the number of shares owned.
(c) U.S. Treasury securities include agency and treasury debt. These investments are valued using dealer quotes in an active market.
(d) Bonds are valued utilizing a market approach that includes various valuation techniques and sources such as value generation models, broker quotes in active and non-active markets, benchmark yields and securities, reported trades, issuer spreads, and/or other applicable reference data. The corporate bonds and notes category is primarily comprised of U.S. dollar denominated, investment grade securities. Less than 5 percent of the securities have a rating below investment grade.
(e) Mutual funds are valued daily in actively traded markets by an independent custodian for the investment manager. For purposes of calculating the value, portfolio securities and other assets for which market quotes are readily available are valued at market value. Market value is generally determined on a basis of last reported sales prices, or if no sales are reported, based on quotes obtained from a quotation reporting system, established market makers, or pricing services. Investments initially valued in currencies other than the U.S. dollars are converted to the U.S. dollar using exchange rates obtained from pricing services.
(f) Options are valued utilizing quotes in active markets.
(g) Accrued income represents dividends declared, but not received, on equity securities owned at December 31, 2015 and 2014.
15. COMPENSATION PLANS
ARLP Partnership
The ARLP Partnership has established the ARLP LTIP for certain employees and officers of MGP and its affiliates who perform services for the ARLP Partnership. The ARLP LTIP awards are of non-vested “phantom” or notional units, which upon satisfaction of vesting requirements, entitle the ARLP LTIP participant to receive ARLP common units. Annual grant levels and vesting provisions for designated participants are recommended by the President and Chief Executive Officer of the MGP, subject to review and approval of the MGP Compensation Committee.
On January 22, 2016, the MGP Compensation Committee determined that the vesting requirements for the 2013 grants of 284,272 restricted units (which was net of 9,178 forfeitures) had been satisfied as of January 1, 2016. As a result of this vesting, on February 11, 2016, the ARLP Partnership issued 176,319 unrestricted common units to the ARLP LTIP participants. The remaining units were settled in cash to satisfy the individual statutory minimum tax obligations of the ARLP LTIP participants. On January 26, 2015, the MGP Compensation Committee determined that the vesting requirements for the 2012 grants of 202,778 restricted units (which was net of 11,450 forfeitures) had been satisfied as of January 1, 2015. As a result of this vesting, on February 11, 2015, the ARLP Partnership issued 128,150 unrestricted common units to the ARLP LTIP participants. The remaining units were settled in cash to satisfy the individual statutory minimum tax obligations of the ARLP LTIP participants.
On January 22, 2016, the MGP Compensation Committee authorized additional grants of 969,028 restricted units, of which 959,028 units were granted. During the years ended December 31, 2015 and 2014, the ARLP Partnership issued grants of 303,165 units and 356,154 units, respectively. Grants issued during the year ended December 31, 2015 vest on January 1, 2018. Grants issued during the year ended December 31, 2014 vest on January 1, 2017. Vesting of all grants is subject to the satisfaction of certain financial tests, which management currently believes is probable. As of December 31, 2015, 12,976 of these outstanding ARLP LTIP grants have been forfeited. After consideration of the January 1, 2016 vesting and subsequent issuance of 176,319 common units, 3.8 million units remain available for issuance in the future, assuming that all grants issued in 2015 and 2014 and currently outstanding are settled with common units, without reduction for tax withholding, and no future forfeitures occur.
For the years ended December 31, 2015, 2014 and 2013, ARLP LTIP expense was $11.2 million, $9.6 million and $7.4 million, respectively. The total obligation associated with the ARLP LTIP as of December 31, 2015 and 2014 was $21.4 million and $17.9 million, respectively, and is included in noncontrolling interests in our consolidated balance sheets.
The fair value of the 2015, 2014 and 2013 grants is based upon the intrinsic value at the date of grant, which was $37.18, $40.72 and $31.51 per restricted unit, respectively, on a weighted average basis. The ARLP Partnership expects to settle the non-vested ARLP LTIP grants by delivery of ARLP common units, except for the portion of the grants that will satisfy the minimum statutory tax withholding requirements. As provided under the distribution equivalent rights provision of the ARLP LTIP and the terms of the ARLP LTIP awards, all non-vested grants include contingent rights to receive quarterly cash distributions in an amount or, in the case of the 2016 grants, in the discretion of the MGP Compensation Committee, phantom units credited to a bookkeeping account with value, equal to the cash distribution the ARLP Partnership makes to unitholders during the vesting period.
A summary of non-vested ARLP LTIP grants as of and for the year ended December 31, 2015 is as follows:
Non-vested grants at January 1, 2015
843,340
Granted
303,165
Vested
(202,778)
Forfeited
(3,934)
Non-vested grants at December 31, 2015
939,793
As of December 31, 2015, there was $12.1 million in total unrecognized compensation expense related to the non-vested ARLP LTIP grants that are expected to vest. That expense is expected to be recognized over a weighted-average period of 1.5 years. As of December 31, 2015, the intrinsic value of the non-vested ARLP LTIP grants was $12.7 million.
AHGP Partnership
We have also adopted a Long-Term Incentive Plan (the “AHGP LTIP”) for employees, directors and consultants of our general partner and its affiliates, including the ARLP Partnership. Grants under the AHGP LTIP are to be made in AHGP restricted units, which are “phantom” units that entitle the grantee to receive either a common unit or equivalent amount of cash upon the vesting of the phantom unit. The aggregate number of common units reserved for issuance under the AHGP LTIP is 5,215,000. There have been no grants under the AHGP LTIP as of December 31, 2015.
SERP and Directors Deferred Compensation Plans
The ARLP Partnership has a SERP to provide deferred compensation benefits for certain officers and key employees. All allocations made to participants under the SERP are made in the form of “phantom” ARLP units. The SERP is administered by the MGP Compensation Committee.
Our directors participate in the AGP Deferred Compensation Plan, and the directors of MGP participate in the MGP Deferred Compensation Plan. Pursuant to the Deferred Compensation Plans, for amounts deferred either automatically or at the election of the director, a notional account is established and credited with notional common units of ARLP or AHGP, as appropriate, which are described in the Deferred Compensation Plans as “phantom” units.
For both the SERP and Deferred Compensation Plans, when quarterly cash distributions are made with respect to ARLP or AHGP common units, an amount equal to such quarterly distribution is credited to each participant’s notional account as additional phantom units. All grants of phantom units under the SERP and Deferred Compensation Plans vest immediately.
For the years ended December 31, 2015 and 2014, SERP and MGP Deferred Compensation Plan participant notional account balances were credited with a total of 60,160 and 27,577 phantom units, respectively, and the fair value of these phantom units was $21.38 and $44.56, respectively, on a weighted-average basis. For the years ended December 31, 2015 and 2014, AGP Deferred Compensation Plan participant notional account balances were credited with a total of 5,478 and 4,868 phantom units, respectively, and the fair value of these phantom units was $40.87 and $63.73, respectively, on a weighted-average basis. Total SERP and Deferred Compensation Plans expense was approximately $1.5 million for the years ended December 31, 2015, 2004 and 2013.
As of December 31, 2015, there were 450,828 total phantom units outstanding under the SERP and Deferred Compensation Plans and the total intrinsic value of the SERP and Deferred Compensation Plans phantom units was $6.2 million. As of December 31, 2015 and 2014, the total obligation associated with the SERP and MGP Deferred Compensation Plan was $13.8 million and $12.6 million, respectively, which was included in noncontrolling interests’ in our consolidated balance sheets. The total obligation associated with the AGP Deferred Compensation Plan as of December 31, 2015 and 2014 was $1.1 million and $1.0 million, respectively, and is included in partners’ capital-limited partners’ in our consolidated balance sheets.
16. SUPPLEMENTAL CASH FLOW INFORMATION
17. ASSET RETIREMENT OBLIGATIONS
The majority of the ARLP Partnership’s operations are governed by various state statutes and the Federal Surface Mining Control and Reclamation Act of 1977, which establish reclamation and mine closing standards. These regulations require, among other things, restoration of property in accordance with specified standards and an approved reclamation plan. The ARLP Partnership accounts for its asset retirement obligations by recognizing the fair value of the liability in the period in which it is incurred. The ARLP Partnership has estimated the costs and timing of future asset retirement obligations escalated for inflation, then discounted and recorded at the present value of those estimates. Federal and state laws require bonds to secure the ARLP Partnership’s obligations to reclaim lands used for mining and are typically renewable on a yearly basis. As of December 31, 2015 and 2014, the ARLP Partnership had approximately $153.5 million and $142.3 million, respectively, in surety bonds outstanding to secure the performance of its reclamation obligations.
The impact of discounting the ARLP Partnership’s estimated cash flows resulted in reducing the accrual for asset retirement obligations by $104.8 million and $88.8 million at December 31, 2015 and 2014, respectively. Estimated payments of asset retirement obligations as of December 31, 2015 are as follows:
The following table presents the activity affecting the asset retirement and mine closing liability:
For the year ended December 31, 2015, the increase in the total liability was primarily attributable to the acquisition of additional property with certain existing reclamation liabilities (See Note 3 - Acquisitions). The allocation of liability associated with mine development and change in assumptions was a net decrease of $3.5 million. This decrease was primarily attributable to decreased estimates of reclamation requirements at property of the ARLP Partnership’s subsidiary, Rough Creek Mining, LLC, offset by increased refuse site reclamation acreage and material required at Pattiki, along with updated estimates at all other operations, offset in part by the net impact of overall general changes in inflation and discount rates, current estimates of the costs and scope of remaining reclamation work, reclamation work completed and fluctuations in other projected mine life estimates.
For the year ended December 31, 2014, the allocation of liability associated with acquisition, mine development and change in assumptions was a net increase of $7.9 million. This increase was attributable to increased size of refuse sites primarily at the Onton, Gibson South, Tunnel Ridge, Dotiki and River View operations, offset in part by the net impact of overall general changes in inflation and discount rates, current estimates of the costs and scope of remaining reclamation work, reclamation work completed and fluctuations in other projected mine life estimates. The increase in the total liability was also attributed to the acquisition of additional property with certain existing reclamation liabilities (Note 3 - Acquisitions), offset in part by the sale of property associated with the Pontiki mine.
18. ACCRUED WORKERS’ COMPENSATION AND PNEUMOCONIOSIS BENEFITS
Certain of the ARLP Partnership’s mine operating entities are liable under state statutes and the Federal Coal Mine Health and Safety Act of 1969, as amended, to pay pneumoconiosis, or black lung, benefits to eligible employees and former employees and their dependents. In addition, the ARLP Partnership is liable for workers’ compensation benefits for traumatic injuries. Both black lung and traumatic claims are covered through the ARLP Partnership’s self-insured programs.
The ARLP Partnership’s black lung benefits liability is calculated using the service cost method that considers the calculation of the actuarial present value of the estimated black lung obligation. The ARLP Partnership’s actuarial calculations are based on numerous assumptions including disability incidence, medical costs, mortality, death benefits, dependents and interest rates. Actuarial gains or losses are amortized over the remaining service period of active miners.
The ARLP Partnership provides income replacement and medical treatment for work-related traumatic injury claims as required by applicable state laws. Workers’ compensation laws also compensate survivors of workers who suffer employment related deaths. The ARLP Partnership’s liability for traumatic injury claims is the estimated present value of current workers’ compensation benefits, based on its actuarial estimates. The ARLP Partnership’s actuarial calculations are based on a blend of actuarial projection methods and numerous assumptions including claim development patterns, mortality, medical costs and interest rates. The discount rate used to calculate the estimated present value of future obligations for black lung was 4.16%, 3.82% and 4.69% at December 31, 2015, 2014 and 2013, respectively, and for workers’ compensation was 3.63%, 3.41% and 4.11% at December 31, 2015, 2014 and 2013, respectively.
The black lung and workers’ compensation expense consists of the following components for the year ended December 31, 2015, 2014 and 2013:
The following is a reconciliation of the changes in the black lung benefit obligation recognized in AOCI for the years ended December 31, 2015, 2014 and 2013:
The following is a reconciliation of the changes in workers’ compensation liability (including current and long-term liability balances) at December 31, 2015 and 2014:
The valuation gain component of the change in benefit obligation in 2015 was primarily attributable to favorable changes in claims development and an increase in the discount rate used to calculate the estimated present value of future obligations. The 2014 valuation gain was primarily attributable to favorable reserve adjustments for claims incurred in prior years partially offset by a decrease in the discount rate used to calculate the estimated present value of future obligations.
The following is a reconciliation of the changes in black lung benefit obligations at December 31, 2015 and 2014:
The actuarial loss component of the change in benefit obligations in 2015 was primarily attributable to unfavorable changes in anticipated claims development and filing assumptions and higher expected claim benefit costs partially offset by an increase in the discount rate used to calculate the estimated present value of future obligations. The actuarial loss component of the change in benefit obligations in 2014 was primarily attributable to a decrease in the discount rate used to calculate the estimated present value of future obligations as well as unfavorable changes in claims development and disability incident rate assumptions.
Summarized below is information about the amounts recognized in the accompanying consolidated balance sheets for black lung and workers’ compensation benefits at December 31, 2015 and 2014:
Both the black lung and workers’ compensation obligations were unfunded at December 31, 2015 and 2014.
As of December 31, 2015 and 2014, the ARLP Partnership had $90.0 million and $79.3 million, respectively, in surety bonds and letters of credit outstanding to secure workers’ compensation obligations.
19. RELATED-PARTY TRANSACTIONS
ARLP Omnibus Agreement-Pursuant to the terms of an amended omnibus agreement, AHGP agreed, and caused its controlled affiliates to agree, for so long as management controls MGP through its ownership of AHGP, not to engage in the business of mining, marketing or transporting coal in the U.S., unless ARLP is first offered the opportunity to engage in the potential activity or acquire a potential business, and the board of directions of MGP (“MGP Board of Directors”) with the concurrence of the Conflicts Committee of MGP (“MGP Conflicts Committee”), elects to cause ARLP not to pursue such opportunity or acquisition. The amended omnibus agreement provides, among other things, that ARLP will be presumed to desire to acquire the assets until such time as it advises AHGP that it has abandoned the pursuit of such business opportunity, and AHGP may not pursue the acquisition of such assets prior to that time. This restriction does not apply to: any business owned or operated by AHGP and its affiliates at the closing of the IPO; any acquisition by AHGP or its affiliates, so long as the majority of the value of the acquisition does not derive from a restricted business and ARLP is offered the opportunity to purchase the restricted business following its acquisition; or
any business conducted by AHGP or our affiliates with the approval of the MGP Board of Directors or MGP Conflicts Committee.
Registration Rights-In connection with the Contribution Agreement, we agreed to register for sale under the Securities Act of 1933 (“Securities Act”) and applicable state securities laws, subject to certain limitations, any common units proposed to be sold by SGP and the former owners of MGP or any of their respective affiliates. These registration rights required us to file one registration statement for each of these groups. We also agreed to include any securities held by the owners of SGP and the former owners of MGP or any of their respective affiliates in any registration statement that we file to offer securities for cash, except an offering relating solely to an employee benefit plan and other similar exceptions. We satisfied our requirement by registering 47,363,000 outstanding common units on Form S-3 filed with the U.S. Securities and Exchange Commission (“SEC”) on June 1, 2007, declared effective on June 27, 2007. A prospectus supplement was filed with the SEC on December 18, 2007. These registration rights are in addition to the registration rights that we agreed to provide AGP and its affiliates pursuant to our limited partnership agreement.
The ARLP Partnership’s Related-Party Transactions
The MGP Board of Directors and MGP Conflicts Committee review the ARLP Partnership’s related-party transactions that involve a potential conflict of interest between a general partner and the ARLP Partnership or its subsidiaries or another partner to determine that such transactions reflect market-clearing terms and conditions customary in the coal industry. As a result of these reviews, the MGP Board of Directors and MGP Conflicts Committee approved each of the transactions described below that had such potential conflict of interest as fair and reasonable to us and our limited partners.
Affiliate Contributions-During December 2015, 2014 and 2013, an affiliated entity controlled by Mr. Craft contributed $1.5 million, $1.5 million and $2.2 million, respectively, to us for the purpose of funding certain of the ARLP Partnership’s general and administrative expenses. Upon our receipt of each contribution, we contributed the same to our subsidiary and ARLP’s managing general partner, MGP, which in turn contributed the same to Alliance Coal. The ARLP Partnership made special allocations to MGP of certain general and administrative expenses equal to the amount of the contributions, MGP made an identical expense allocation to us, and we then made the same expense allocation to the affiliated entity controlled by Mr. Craft.
White Oak-On September 22, 2011, the ARLP Partnership entered into the Initial Transactions (See Note 13 - Equity Investments) with White Oak and related entities to support development of a longwall mining operation. The Initial Transactions and subsequent transactions with White Oak involved several components, including an equity investment containing certain distribution and liquidation preferences, the acquisition and lease-back of certain reserves and surface rights which generated royalties of $11.4 million, $0.2 million and $15.0 thousand in 2015, 2014 and 2013, respectively, a coal handling and services agreement which generated throughput revenues of $28.2 million, $19.6 million and $2.1 million in 2015, 2014 and 2013, respectively, a coal supply agreement, export marketing and transportation agreements and certain debt agreements. On July 31, 2015 the ARLP Partnership purchased the remaining equity interests in White Oak. See Note 3 - Acquisitions for a detailed discussion of this acquisition.
In addition to the agreements discussed above, White Oak also had agreements with the ARLP Partnership’s subsidiaries for the purchase of various services and products, including for coal handling services provided by the Mt. Vernon transloading facility. For the years ended December 31, 2015, 2014 and 2013, the ARLP Partnership recorded revenues of $4.6 million, $3.9 million and $2.4 million, respectively, for services and products provided by Mt. Vernon and Matrix Design to White Oak, which are included in Other sales and operating revenues on our consolidated statements of income.
SGP Land-In 2001, SGP Land, as successor in interest to an unaffiliated third party, entered into an amended mineral lease with MC Mining. Under the terms of the lease, MC Mining has paid and will continue to pay an annual minimum royalty of $0.3 million until $6.0 million of cumulative annual minimum and/or earned royalty payments have been paid. As of December 31, 2015 the cumulative annual minimum was met. MC Mining paid royalties of $1.9 million, $0.9 million and $0.3 million for the years ended December 31, 2015, 2014 and 2013, respectively. As of December 31, 2015, all advanced minimum royalties paid under the lease have been recouped.
SGP-In January 2005, the ARLP Partnership acquired Tunnel Ridge from ARH. In connection with this acquisition, the ARLP Partnership assumed a coal lease with SGP. Under the terms of the lease, Tunnel Ridge has paid and will continue to pay an annual minimum royalty of $3.0 million until the earlier of January 1, 2033 or the exhaustion of the mineable and merchantable leased coal. Tunnel Ridge paid advance minimum royalties of $3.0 million during
each of the years ended December 31, 2015, 2014 and 2013. As of December 31, 2015, $5.5 million of advance minimum royalties paid under the lease is available for recoupment and management expects that it will be recouped against future production.
WKY CoalPlay-In February 2015, WKY CoalPlay entered into a coal lease agreement with Alliance Resource Properties regarding coal reserves located in Henderson and Union Counties, Kentucky. The lease has an initial term of 20 years and provides for earned royalty payments to WKY CoalPlay of 4.0% of the coal sales price and annual minimum royalty payments of $2.1 million. All annual minimum royalty payments are recoupable against earned royalty payments. Alliance Resource Properties also was granted an option to acquire the leased reserves at any time during a three-year period beginning in February 2018 for a purchase price that would provide WKY CoalPlay a 7.0% internal rate of return on its investment in these reserves taking into account payments previously made under the lease (See Note 11 - Variable Interest Entity). The ARLP Partnership paid WKY CoalPlay $2.1 million in February 2015 for the initial annual minimum royalty payment.
In December 2014, WKY CoalPlay’s subsidiary, Towhead Coal Reserves, LLC, entered into a coal lease agreement with Alliance Resource Properties regarding coal reserves located in Henderson and Union Counties, Kentucky. The lease has an initial term of 20 years and provides for earned royalty payments to WKY CoalPlay of 4.0% of the coal sales price and annual minimum royalty payments of $3.6 million. All annual minimum royalty payments are recoupable against earned royalty payments. Alliance Resource Properties also was granted an option to acquire the leased reserves at any time during a three-year period beginning in December 2017 for a purchase price that would provide WKY CoalPlay a 7.0% internal rate of return on its investment in these reserves taking into account payments previously made under the leases (See Note 11 - Variable Interest Entity). The ARLP Partnership paid WKY CoalPlay $3.6 million in January 2015 for the initial annual minimum royalty payment.
In December 2014, WKY CoalPlay’s subsidiary, Webster Coal Reserves, LLC, entered into a coal lease agreement with Alliance Resource Properties regarding coal reserves located in Webster County, Kentucky. The lease has an initial term of 7 years and provides for earned royalty payments to WKY CoalPlay of 4.0% of the coal sales price and annual minimum royalty payments of $2.6 million. All annual minimum royalty payments are recoupable against earned royalty payments. Alliance Resource Properties also was granted an option to acquire the leased reserves at any time during a three-year period beginning in December 2017 for a purchase price that would provide WKY CoalPlay a 7.0% internal rate of return on its investment in these reserves taking into account payments previously made under the leases (See Note 11 - Variable Interest Entities). The ARLP Partnership paid WKY CoalPlay $2.6 million in January 2015 for the initial annual minimum royalty payment.
In December 2014, WKY CoalPlay’s subsidiary, Henderson Coal Reserves, LLC, entered into a coal lease agreement with Alliance Resource Properties regarding coal reserves located in Henderson County, Kentucky. The lease has an initial term of 20 years and provides for earned royalty payments to WKY CoalPlay of 4.0% of the coal sales price and annual minimum royalty payments of $2.5 million. All annual minimum royalty payments are recoupable against earned royalty payments. Alliance Resource Properties also was granted an option to acquire the leased reserves at any time during a three-year period beginning in December 2017 for a purchase price that would provide WKY CoalPlay a 7.0% internal rate of return on its investment in these reserves taking into account payments previously made under the leases (See Note 11 - Variable Interest Entities). The ARLP Partnership paid WKY CoalPlay $2.5 million in January 2015 for the initial annual minimum royalty payment.
As of December 31, 2015, the ARLP Partnership had $10.8 million of advanced royalties outstanding with WKY CoalPlay which is reflected in the Advance royalties line item in our consolidated balance sheets.
Cavalier Minerals-As discussed in Note 11 - Variable Interest Entities, the ARLP Partnership consolidates Cavalier Minerals which holds limited partner interests in the AllDale Minerals entities, which were created to purchase oil and gas mineral interests in various geographical locations within producing basins in the continental U.S. As of December 31, 2014, Cavalier Minerals’ had contributed $11.6 million to AllDale Minerals. During the year ended December 31, 2015, Cavalier Minerals contributed an additional $54.3 million bringing the total investment in AllDale Minerals to $65.9 million as of December 31, 2015. See Note - 13 Equity Investments for further information.
Mineral Lending-See Note 7 - Long-Term Debt for discussion of the Cavalier Credit Agreement and Mineral Lending.
20. COMMITMENTS AND CONTINGENCIES
Commitments-The ARLP Partnership leases buildings and equipment under operating lease agreements that provide for the payment of both minimum and contingent rentals. The ARLP Partnership also has a noncancelable lease with SGP (See Note 19 - Related-Party Transactions) and a noncancelable lease for equipment under a capital lease obligation. In 2015, the ARLP Partnership acquired equipment and other assets under operating and capital lease agreements as a result of the Hamilton and Patriot acquisitions (See Note 3 - Acquisitions). Future minimum lease payments are as follows:
As a result of the idling of the Onton mine, the ARLP Partnership has removed certain rental payments currently under negotiation from the table above (See Note 4 - Long-Lived Asset Impairments). Rental expense (including rental expense incurred under operating lease agreements) was $11.7 million, $4.7 million and $5.1 million for the years ended December 31, 2015, 2014 and 2013, respectively.
Contractual Commitments-In connection with planned capital projects, the ARLP Partnership has contractual commitments of approximately $28.7 million at December 31, 2015. As of December 31, 2015, the ARLP Partnership had no material commitments to purchase coal from external production sources in 2016.
On November 10, 2014, Cavalier Minerals purchased equity interests in AllDale Minerals, an entity created to purchase oil and gas mineral interests in various geographic locations within producing basins in the continental U. S. Cavalier Minerals has an investment funding commitment to AllDale Minerals of $83.1 million at December 31, 2015, which it expects to fund over the next two years. For more information on Cavalier Minerals and AllDale Minerals, see Note 11 - Variable Interest Entities and Note 13 - Equity Investments.
On October 29, 2015, the ARLP Partnership entered into a sale-leaseback transaction whereby the ARLP Partnership sold certain mining equipment for $100.0 million and concurrently entered into a lease agreement for the sold equipment with a four-year term. Under the lease agreement, the ARLP Partnership will pay an initial monthly rent of $1.9 million. A balloon payment equal to 20% of the equipment cost is due at the end of the lease term. As a result of this transaction, the ARLP Partnership recognized a deferred gain of $5.0 million which will be amortized over the lease term. The ARLP Partnership has recognized this transaction as a capital lease and it is reflected in the future minimum lease payments presented above.
General Litigation-Various lawsuits, claims and regulatory proceedings incidental to the ARLP Partnership’s business are pending against the ARLP Partnership. The ARLP Partnership records an accrual for a potential loss related to these matters when, in management’s opinion, such loss is probable and reasonably estimable. Based on known facts and circumstances, the ARLP Partnership believes the ultimate outcome of these outstanding lawsuits, claims and regulatory proceedings will not have a material adverse effect on the ARLP Partnership’s financial condition, results of operations or liquidity. However, if the results of these matters were different from management’s current opinion and in amounts greater than the ARLP Partnership’s accruals, then they could have a material adverse effect.
Other-Effective October 1, 2015, the ARLP Partnership renewed its annual property and casualty insurance program. In an effort to reduce cost, the ARLP Partnership’s property insurance was procured from its wholly owned
captive insurance company, Wildcat Insurance. Wildcat Insurance charged certain of the ARLP Partnership’s subsidiaries for the premiums on this program and in return purchased reinsurance for the program in the standard market. The maximum limit in the commercial property program is $100.0 million per occurrence, excluding a $1.5 million deductible for property damage, a 75, 90 or 120 day waiting period for underground business interruption depending on the mining complex and an additional $10.0 million overall aggregate deductible. The ARLP Partnership can make no assurances that it will not experience significant insurance claims in the future that could have a material adverse effect on its business, financial condition, results of operations and ability to purchase property insurance in the future.
21. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS
The ARLP Partnership has significant long-term coal supply agreements, some of which contain prospective price adjustment provisions designed to reflect changes in market conditions, labor and other production costs and, in the infrequent circumstance when the coal is sold other than free on board the mine, changes in transportation rates. Total revenues from major customers, including transportation revenues, which are at least ten percent of total revenues, are as follows:
Trade accounts receivable from these customers totaled approximately $37.5 million and $43.5 million at December 31, 2015 and 2014, respectively. The ARLP Partnership’s bad debt experience has historically been insignificant. Financial conditions of the ARLP Partnership’s customers could result in a material change to its bad debt expense in future periods. The coal supply agreements expire in 2018 for customer A and 2016 for customer B.
22. SEGMENT INFORMATION
The ARLP Partnership operates in the eastern U.S. as a producer and marketer of coal to major utilities and industrial users. We aggregate multiple operating segments into two reportable segments: Illinois Basin and Appalachia and an “all other” category referred to as Other and Corporate. Our reportable segments correspond to major coal producing regions in the eastern U.S. Similar economic characteristics for the operating segments within each of these two reportable segments generally include coal quality, geology, coal marketing opportunities, mining and transportation methods and regulatory issues.
As a result of the ARLP Partnership acquiring the remaining equity interests in White Oak (the mining complex is now known as Hamilton Mine No. 1) (Note 3 - Acquisitions), the ARLP Partnership restructured its reportable segments to include Hamilton as part of the Illinois Basin segment due to the similarities in product, management, location, and operation with other mines included in the segment. This new organization reflects how the ARLP Partnership’s chief operating decision maker manages and allocates resources to the various operations. Prior periods have been recast to include White Oak in the Illinois Basin segment.
The Illinois Basin reportable segment is comprised of multiple operating segments, including Webster County Coal’s Dotiki mining complex, Gibson County Coal’s mining complex, which includes the Gibson North mine and Gibson South mine, Hopkins County Coal’s mining complex, which includes the Elk Creek mine, White County Coal’s Pattiki mining complex, Warrior’s mining complex, Sebree Mining’s mining complex, which includes the Onton mine, Steamport and certain Sebree Reserves, River View’s mining complex and the Hamilton mining complex. In April 2014, production began at the Gibson South mine. Illinois Basin reserves and other assets increased as a result of multiple acquisitions in 2014 and 2015 as discussed in Note 3 - Acquisitions. The Elk Creek mine is currently expected to cease production in early 2016. The Sebree Mining and Fies properties are held by the ARLP Partnership for future mine development. During the fourth quarter of 2015, the ARLP Partnership idled the Onton and Gibson North mines in response to market conditions and continued increases in coal inventories at the mines and customer locations.
The Appalachia reportable segment is comprised of multiple operating segments, including the Mettiki mining complex, the Tunnel Ridge mining complex and the MC Mining mining complex. The Mettiki mining complex includes Mettiki Coal (WV)’s Mountain View mine and Mettiki Coal’s preparation plant. During the fourth quarter of 2015, the
ARLP Partnership surrendered the Penn Ridge leases as they were no longer a core part of its foreseeable development plans. See Note 4 - Long-Lived Asset Impairment for further discussion of this surrender. In June 2013, Alliance Resource Properties acquired reserves that extended the life of the Mettiki (WV) Mountain View mine. For information regarding the reserves acquired, see Note 3 - Acquisitions.
Other and Corporate includes marketing and administrative expenses, ASI and its subsidiary, Matrix Design and its subsidiaries Matrix Design International, LLC and Matrix Design Africa (PTY) LTD, Alliance Design (collectively, the Matrix Design entities and Alliance Design are referred to as the “Matrix Group”), ASI’s ownership of aircraft, the Mt. Vernon dock activities, coal brokerage activity, MAC (Note 3 - Acquisitions), certain activities of Alliance Resource Properties, the Pontiki mining complex, which sold most of its assets in May 2014, Wildcat Insurance, Alliance Minerals, and its affiliate, Cavalier Minerals (Note 11 - Variable Interest Entity), which holds an equity investment in AllDale Minerals (Note 13 - Equity Investments), and AROP Funding (Note 7 - Long-Term Debt).
Reportable segment results as of and for the years ended December 31, 2015, 2014 and 2013 are presented below.
(1) The elimination column represents the elimination of intercompany transactions and is primarily comprised of sales from the Matrix Group and MAC to the ARLP Partnership’s mining operations, coal sales and purchases between operations within different segments, sales of receivables to AROP Funding and insurance premiums paid to Wildcat Insurance (2015 and 2014 only).
(2) Revenues included in Other and Corporate column are primarily attributable to the Matrix Group revenues, Mt. Vernon transloading revenues, administrative service revenues from affiliates, MAC revenues, Wildcat Insurance revenues, brokerage sales and Pontiki’s coal sales revenue (2013 only).
(3) Segment Adjusted EBITDA Expense includes operating expenses, outside coal purchases and other income. Transportation expenses are excluded as these expenses are passed through to the ARLP Partnership’s customers and consequently it does not realize any gain or loss on transportation revenues. We review Segment Adjusted EBITDA Expense per ton for cost trends.
The following is a reconciliation of consolidated Segment Adjusted EBITDA Expense to Operating expenses (excluding depreciation, depletion and amortization):
(4) Segment Adjusted EBITDA is defined as net income (prior to the allocation of noncontrolling interest) before net interest expense, income taxes, depreciation, depletion and amortization, asset impairment charge, acquisition gain, net and general and administrative expenses. Management therefore is able to focus solely on the evaluation of segment operating profitability as it relates to the ARLP Partnership’s revenues and operating expenses, which are primarily controlled by our segments. Consolidated Segment Adjusted EBITDA is reconciled to net income as follows:
(5) Includes equity in income (loss) of affiliates for the years ended December 31, 2015, 2014 and 2013 of $(48.5) million, $(16.6) million and $(25.3) million, respectively, for the Illinois Basin segment and $(0.5) million, $(3) thousand and $0.9 million, respectively, for Other and Corporate.
(6) Total assets at December 31, 2015, 2014 and 2013 include investments in affiliate of $64.5 million, $12.9 million and $1.7 million, respectively, within Other and Corporate. Total assets at December 31, 2014 and 2013 include investments in affiliate of $211.7 million and $128.7 million, respectively, for the Illinois Basin segment.
(7) Capital expenditures shown above include funding to White Oak of $4.1 million and $25.3 million, for the years ended December 31, 2014 and 2013, respectively, for the acquisition and development of coal reserves from White Oak, which is described as Payments to affiliate for acquisition and development of coal reserves in our consolidated statements of cash flow. Capital expenditures shown above exclude the Hamilton Acquisition on July 31, 2015, the Patriot acquisition on February 3, 2015, the MAC acquisition on January 1, 2015 and purchase of coal supply agreements from Patriot on December 31, 2014 (Note 3 - Acquisitions).
23. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
A summary of our consolidated quarterly operating results in 2015 and 2014 is as follows:
(1) The comparability of the December 31, 2015 quarterly results to other quarters presented was affected by $89.4 million of asset impairment charges relating to the Onton mine, MC Mining mine and a surrendered lease (Note 4 - Long-Lived Asset Impairments), which was partially offset by a $22.5 million net gain relating to final business combination accounting for the Hamilton Acquisition (Note 3 - Acquisitions). An impairment charge of $10.7 million impacted the comparability of the September 30, 2015 quarterly results to other quarters presented. The comparability of the June 30, 2014 quarterly results to other quarters presented was affected by a $7.0 million insurance settlement related to adverse geological events at the Onton mine in 2013 and a gain of $4.4 million recognized on the sale of Pontiki’s assets.
24. SUBSEQUENT EVENTS
Other than those events described in Notes 9 and 15, there were no subsequent events.
SCHEDULE II
ALLIANCE HOLDINGS GP, L.P. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2015, 2014 AND 2013
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANT ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. We maintain controls and procedures designed to provide reasonable assurance that information required to be disclosed in the reports we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosures. As required by Rule 13a-15(b) of the Exchange Act, we have evaluated, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) of the Exchange Act) as of December 31, 2015. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these controls and procedures are effective as of December 31, 2015.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal controls over financial reporting (“Internal Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the AHGP Partnership have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that simple errors or mistakes can occur. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our disclosure controls and internal controls and make modifications as necessary; our intent in this regard is that the disclosure controls and the internal controls will be maintained as systems change and conditions warrant.
Management’s Annual Report on Internal Control over Financial Reporting. Management of the AHGP Partnership is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rules 13a-15(f) under the Exchange Act. The AHGP Partnership’s internal control over financial reporting is designed to provide
reasonable assurance to our management and Board of Directors of our general partner regarding the preparation and fair presentation of published financial statements. Our controls are designed to provide reasonable assurance that the AHGP Partnership’s assets are protected from unauthorized use and that transactions are executed in accordance with established authorizations and properly recorded. The internal controls are supported by written policies and are complemented by a staff of competent business process owners and an internal auditor supported by competent and qualified external resources used to assist in testing the operating effectiveness of the AHGP Partnership’s internal control over financial reporting. Management concluded that the design and operations of our internal controls over financial reporting at December 31, 2015 are effective and provide reasonable assurance the books and records accurately reflect the transactions of the AHGP Partnership.
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2015. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). Based on our assessment, management concluded that, as of December 31, 2015, the AHGP Partnership’s internal control over financial reporting was effective based on those criteria, and management believes that we have no material internal control weaknesses in our financial reporting process.
Ernst & Young LLP, an independent registered public accounting firm, has made an independent assessment of the effectiveness of our internal control over financial reporting as of December 31, 2015, as stated in their report that is included herein.
As permitted by the SEC rules, we have excluded operations acquired on July 31, 2015 from White Oak from our evaluations of the effectiveness of internal control over financial reporting for the year ended December 31, 2015 due to the size and complexity and the limited time available to complete the evaluation. The operations excluded from our evaluation represent approximately 16.8% of our total assets at December 31, 2015 and approximately 3.4% of our total coal sales for the year ended December 31, 2015.
Changes in Internal Controls Over Financial Reporting. Other than changes that have resulted or may result from the ARLP Partnership’s purchase of the remaining equity of White Oak as described below, there has been no change in our internal controls over financial reporting (as defined in Rule 13a-15(f) or Rule 15d-15(f) of the Exchange Act) in the three months ended December 31, 2015 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
On July 31, 2015 (the “Hamilton Acquisition Date”), the ARLP Partnership acquired the remaining Series A and B Units, representing 60.0% of the voting interest in White Oak as described in “Item 8. Financial Statements and Supplementary Data-Note 3. Acquisitions” of this Annual Report on Form 10-K. As of the Hamilton Acquisition Date, the ARLP Partnership owned 100% of the equity interests in White Oak and assumed operating control of the Hamilton Mine No. 1 and began accounting for White Oak on a consolidated basis. At this time, the ARLP Partnership continues to evaluate the business and internal controls and processes of Hamilton and are making various changes to their operating and organizational structures based on its business plan. The ARLP Partnership is in the process of implementing its internal control structure over the acquired business. The ARLP Partnership expects to complete the evaluation and integration of the internal controls and processes of Hamilton in fiscal year 2016.
Report of Independent Registered Public Accounting Firm
The Board of Directors of Alliance GP, LLC
and the Partners of Alliance Holdings GP, L.P.
We have audited Alliance Holdings GP, L.P.’s and subsidiaries (the “Partnership”) internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). The Partnership’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Partnership’s internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As indicated in the accompanying Management’s Annual Report on Internal Control over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of White Oak Resources LLC (“White Oak”), which is included in the 2015 consolidated financial statements of the Partnership and constituted 16.8% and 31.4% of total and net assets, respectively, as of December 31, 2015 and 3.4% and 6.8% of revenues and net income, respectively, for the year then ended. Our audit of internal control over financial reporting of the Partnership also did not include an evaluation of the internal control over financial reporting of White Oak.
In our opinion, Alliance Holdings GP, L.P. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Alliance Holdings GP, L.P. and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, cash flows, and partners’ capital for each of the three years in the period ended December 31, 2015 and our report dated February 26, 2016 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Tulsa, Oklahoma
February 26, 2016
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE OF THE GENERAL PARTNER
As is commonly the case with publicly traded limited partnerships, we are managed and operated by our general partner. The following table shows information for executive officers and members of the Board of Directors of our general partner as of the date of the filing of this Annual Report on Form 10-K. Executive officers and directors are elected until death, resignation, retirement, disqualification, or removal.
Name
Age
Position With Our General Partner 1
Joseph W. Craft III
Chairman of the Board, President and Chief Executive Officer
Brian L. Cantrell
Senior Vice President and Chief Financial Officer
R. Eberley Davis
Senior Vice President, General Counsel and Secretary
Robert G. Sachse
Executive Vice President-Marketing
Charles R. Wesley
Executive Vice President
Thomas M. Wynne
Senior Vice President and Chief Operating Officer
Thomas M. Davidson, Sr.
Director and Member of Audit and Conflicts* Committees
Robert J. Druten
Director and Member of Audit and Conflicts Committees
Wilson M. Torrence
Director and Member of Audit* Committee
Michael J. Hall
Former Director and Member of Audit* Committee
* Indicates Chairman of Committee
1 Messrs. Sachse, Wesley and Wynne are officers of subsidiaries of our general partner as noted in their biographies below.
Joseph W. Craft III has been Chairman of the Board, President and Chief Executive Officer since November 2005. Mr. Craft has majority ownership of MGP, ARLP’s managing general partner, and owns indirectly ARLP’s special general partner and our general partner. Mr. Craft has served as President, Chief Executive Officer and a Director of MGP since 1999. Previously Mr. Craft served as President of MAPCO Coal Inc. since 1986. During that period, he also was Senior Vice President of MAPCO Inc. and had previously been that company’s General Counsel and Chief Financial Officer. He is a former Chairman and current Board member of the National Coal Council, a Board Member of the National Mining Association, and a Director and current Chairman of American Coalition for Clean Coal Electricity (“ACCCE”), and has been a Director of BOK Financial Corporation (NASDAQ: BOKF) since April of 2007 and became chairman of its compensation committee in 2014. Mr. Craft holds a Bachelor of Science degree in Accounting and a Juris Doctorate degree from the University of Kentucky. Mr. Craft also is a graduate of the Senior Executive Program of the Alfred P. Sloan School of Management at Massachusetts Institute of Technology. The specific experience, qualifications, attributes or skills that led to the conclusion Mr. Craft should serve as a Director include his long history of significant involvement in the coal industry, his demonstrated business acumen and his exceptional leadership of the Partnership since its inception.
Brian L. Cantrell has been Senior Vice President and Chief Financial Officer since November 2005. Mr. Cantrell also has served as Senior Vice President and Chief Financial Officer of MGP, the general partner of ARLP, since October 2003. Prior to his current position, Mr. Cantrell was President of AFN Communications, LLC from November 2001 to October 2003 where he had previously served as Executive Vice President and Chief Financial Officer after joining AFN in September 2000. Mr. Cantrell’s previous positions include Chief Financial Officer, Treasurer and Director with Brighton Energy, LLC from August 1997 to September 2000; Vice President-Finance of KCS Medallion Resources, Inc.; and Vice President-Finance, Secretary and Treasurer of Intercoast Oil and Gas Company. Mr. Cantrell is a Certified Public Accountant and holds Master of Accountancy and Bachelor of Accountancy degrees from the University of Oklahoma.
R. Eberley Davis has been Senior Vice President, General Counsel and Secretary since February 2007. Mr. Davis also serves as Senior Vice President, General Counsel and Secretary of MGP, the managing general partner of ARLP. From 2003 to February 2007, Mr. Davis practiced law in the Lexington, Kentucky office of Stoll Keenon Ogden PLLC. Prior to joining Stoll Keenon Ogden, Mr. Davis was Vice President, General Counsel and Secretary of Massey Energy Company for one year. Mr. Davis also served in various positions, including Vice President and General Counsel, for Lodestar Energy, Inc. from 1993 to 2002. Mr. Davis is an alumnus of the University of Kentucky, where he received a Bachelor of Arts degree in Economics and his Juris Doctorate degree. He also holds a Master of Business Administration degree from the University of Kentucky. Mr. Davis is a Trustee of the Energy and Mineral Law Foundation, and a member of the American and Kentucky Bar Associations.
Robert G. Sachse has been Executive Vice President of MGP since August 2000. Effective November 1, 2006, Mr. Sachse assumed responsibility for the ARLP Partnership’s coal marketing, sales and transportation functions. Mr. Sachse was also Vice Chairman of ARLP’s managing general partner from August 2000 to January 2007. Mr. Sachse was Executive Vice President and Chief Operating Officer of MAPCO Inc. from 1996 to 1998 when MAPCO merged with The Williams Companies. Following the merger, Mr. Sachse had a two year non-compete consulting agreement with The Williams Companies. Mr. Sachse held various positions while with MAPCO Coal Inc. from 1982 to 1991, and was promoted to President of MAPCO Natural Gas Liquids in 1992. Mr. Sachse holds a Bachelor of Science degree in Business Administration from Trinity University and a Juris Doctorate degree from the University of Tulsa.
Charles R. Wesley became a Director of MGP in January 2009 and has been Executive Vice President of MGP since March 2009. Mr. Wesley has served in a variety of capacities since joining the company in 1974, including as Senior Vice President-Operations from August 1996 through February 2009. Mr. Wesley is a former Chairman of the Board of Directors of the Kentucky Coal Association and also has served the industry as past President of the West Kentucky Mining Institute and National Mine Rescue Association Post 11, and as a director of the Kentucky Mining Institute. Mr. Wesley holds a Bachelor of Science degree in Mining Engineering from the University of Kentucky. The specific experience, qualifications, attributes or skills that led to the conclusion Mr. Wesley should serve as a Director of MGP include his long history of significant involvement in the coal industry, his successful leadership of the Partnership’s operations, and his knowledge and technical expertise in all aspects of producing and marketing coal.
Thomas M. Wynne has been Senior Vice President and Chief Operating Officer of MGP since March 2009. Mr. Wynne joined the company in 1981 as a mining engineer and has held a variety of positions with the company prior to his appointment in July 1998 as Vice President-Operations. Mr. Wynne has served the coal industry on the National Executive Committee for National Mine Rescue and previously as a member of the Coal Safety Committee for the National Mining Association. Mr. Wynne holds a Bachelor of Science degree in Mining Engineering from the University of Pittsburgh and a Master of Business Administration degree from West Virginia University.
Thomas M. Davidson, Sr. became a Director in March 2006. Mr. Davidson is Chairman of the Conflicts Committee and a member of the audit committee of AGP’s Board of Directors (“Audit Committee”). In 1999, Mr. Davidson founded Davidson Capital Group, a niche investment bank headquartered in the Washington, D.C. area and engaged primarily in assisting enterprises in merger and acquisition, financing, and other growth initiatives. Mr. Davidson is the President and Senior Managing Director of Davidson Capital Group and has served in such capacity since 1999. From 1986 to 1989, Mr. Davidson was Senior Vice President and General Counsel of The Peter Kiewit Companies, a coal mining and construction company headquartered in Omaha, Nebraska. From 1982 to 1985, Mr. Davidson was a senior law partner in the corporate group in Akin, Gump, Strauss, Hauer and Feld in Washington, D.C. From 1977 to 1982, Mr. Davidson was Senior Vice President and General Counsel of MAPCO Inc., a diversified oil and gas and coal company headquartered in Tulsa, Oklahoma, and a former parent of ARLP’s predecessors. From 1974 to 1977, Mr. Davidson was Senior Vice President and General Counsel of Mesa Petroleum Corporation, an oil and gas exploration company headquartered in Amarillo, Texas. Mr. Davidson holds a Bachelor degree in Political Science from Williams College and a Juris Doctorate degree from Duke University. The specific experience, qualifications, attributes or skills that led to the conclusion Mr. Davidson should serve as Director include his significant experience with both the legal and investment banking aspects of corporate financing and acquisition transactions and his previous service in a management role in the coal mining industry.
Robert J. Druten became a Director in January 2007. Mr. Druten is a member of the Audit and Conflicts Committees. From September 1994 until his retirement in August 2006, Mr. Druten served as Executive Vice President and Chief Financial Officer of Hallmark Cards, Inc. Mr. Druten holds a Bachelor of Science degree in Accounting from Kansas University as well as a Masters of Business Administration from Rockhurst University. Mr. Druten currently serves as Chairman of the Board of Directors of Kansas City Southern Industries, Inc. (NYSE: KSU), a transportation and financial services company, and is Chairman of its audit and finance committees, and is a member of its
compensation committee and nominating and governance committees. Mr. Druten is also a Trustee and Chairman of the Board of Entertainment Properties Trust (NYSE: EPR), a real estate investment trust focused on the acquisition of movie theatre complexes and other entertainment related properties, and is a member of its audit, compensation, finance and governance committees. Mr. Druten previously served as a director of American Italian Pasta, from 2007 until it was acquired by Ralcorp Holdings in July, 2010, where he was the Chair of the Audit Committee and also served on the Compensation Committee. The specific experience, qualifications, attributes or skills that led to the conclusion Mr. Druten should serve as Director are demonstrated by his lengthy and distinguished service as Chief Financial Officer of Hallmark, including direct oversight of a public company subsidiary, and his extensive experience serving as a director of public companies in multiple industries.
Wilson M. Torrence became a Director in April 2015. Mr. Torrence is Chairman of the Audit Committee. Since January 2007, Mr. Torrence has also been a Director of MGP, the managing general partner of ARLP. Mr. Torrence retired from Fluor Corporation in 2006 as a Senior Vice President of Project Development and Investments and since that time has performed investment and business consulting services for various clients. Mr. Torrence was employed at Fluor from 1989 to 2006 where, among other roles, he was responsible for the global Project Investment and Structured Finance Group and served as Chairman of Fluor’s Investment Committee. In that position, Mr. Torrence had executive responsibility for Fluor’s global activities in developing and arranging third-party financing for some of Fluor’s clients’ construction projects. Prior to joining Fluor in 1989, Mr. Torrence was President and CEO of Combustion Engineering Corporation’s Waste to Energy Division and, during that time, also served as Chairman of the Institute of Resource Recovery, a Washington-based industry advocacy organization. Mr. Torrence began his career at Mobil Oil Corporation, where he held several executive positions, including Assistant Treasurer of Mobil’s International Marketing and Refining Division and Chief Financial and Planning Officer of Mobil Land Development Company. From October 2006 to March 2007, Mr. Torrence served as Chief Financial Officer and as a Director of Cleantech America, LLC, a private company involved in development of central station solar generating plants. Mr. Torrence holds Bachelor and Master degrees in Business Administration from Virginia Tech University. The specific experience, qualifications, attributes or skills that led to the conclusion Mr. Torrence should serve as a Director include his extensive experience in the construction and energy businesses, his senior corporate finance-related and other leadership positions and his participation in numerous financing transactions.
Michael J. Hall became a Director in March 2006 and retired on April 23, 2015. Mr. Hall was Chairman of the Audit Committee. From March 2003 until retiring April 23, 2015, Mr. Hall also served as a Director of MGP, the managing general partner of ARLP. He was Chairman of MGP’s Audit Committee and a member of the Compensation Committee. Mr. Hall is Chairman of the Board of Directors of Matrix Service Company (“Matrix”) (NASDAQ: MTRX). Previously, Mr. Hall served as President and Chief Executive Officer of Matrix from March 2005 until he retired in November 2006. Mr. Hall also served as Vice President-Finance and Chief Financial Officer, Secretary and Treasurer of Matrix from September 1998 to May 2004. Mr. Hall became a Director of Matrix in October 1998, and was elected Chairman of its Board in November 2006. Matrix is a company that provides general industrial construction and repair and maintenance services principally to the petroleum, petrochemical, power, bulk storage terminal, pipeline and industrial gas industries. Prior to working for Matrix, Mr. Hall was Vice President and Chief Financial Officer of Pexco Holdings, Inc., Vice President-Finance and Chief Financial Officer for Worldwide Sports & Recreation, Inc., an affiliated company of Pexco, and worked for T.D. Williamson, Inc., as Senior Vice President, Chief Financial and Administrative Officer, and Director of Operations-Europe, Africa and Middle East Region. Mr. Hall was a member and Chairman of the Board of Directors of Integrated Electrical Services, Inc. (NASDAQ: IESC) and served in that capacity from May 2006 to February 2011, and was a member of its audit, compensation and nominating/governance committees. Mr. Hall served as Chairman of the Board of Directors of American Performance Funds, was a member of its audit and nominating committees and served as independent trustee from July 1990 to May 2008. Mr. Hall holds a Bachelor of Science degree in Accounting from Boston College and a Master of Business Administration from Stanford University. The specific experience, qualifications, attributes or skills that led to the conclusion Mr. Hall could serve as a Director include his long history of service in senior corporate leadership positions, his significant knowledge of the energy industry, and his extensive expertise and experience in financial reporting matters gained from his service as Chief Financial Officer of a public company.
Board of Directors
The leadership structure of our Board of Directors has been consistent since the Partnership’s inception. Mr. Craft, our President and Chief Executive Officer, is also the Chairman of our Board of Directors. We believe this structure is appropriate given Mr. Craft’s significant ownership position in and proven leadership of the Partnership.
Our Board of Directors generally administers its risk oversight function through the board as a whole. Our President and Chief Executive Officer, who reports to the Board of Directors, and the other executives named above, who report to
our President and Chief Executive Officer, have day-to-day risk management responsibilities. At the Board of Directors’ request, each of these executives attends the meetings of our Board of Directors, where the Board of Directors routinely receives reports on our financial results, the status of our operations and our safety performance, and other aspects of implementation of our business strategy, with ample opportunity for specific inquiries of management. Our Directors also regularly attend the meetings of the MGP Board of Directors where similar reports regarding the ARLP Partnership, as well as reports regarding the status of the ARLP Partnership’s operations and safety performance, are made. In addition, management provides periodic reports of the Partnership’s financial and operational performance to each member of the Board of Directors. The Audit Committee provides additional risk oversight through its quarterly meetings, where it receives a report from the Partnership’s internal auditor, who reports directly to the Audit Committee, and reviews the Partnership’s contingencies, significant transactions and subsequent events, among other matters, with management and our independent auditors. In addition, meetings of the Audit Committee typically are held concurrently with meetings of the audit committee of MGP (“MGP Audit Committee”).
The Board of Directors has selected as director nominees individuals with experience, skills and qualifications relevant to the business of the Partnership, such as experience in energy or related industries or with financial markets, expertise in mining, engineering or finance, and a history of service in senior leadership positions. The Board of Directors has not established a formal process for identifying director nominees, nor does it have a formal policy regarding consideration of diversity in identifying director nominees, but has endeavored to assemble a diverse group of individuals with the qualities and attributes required to provide effective oversight of the Partnership.
Audit Committee
The Audit Committee comprises three non-employee members of the Board of Directors (currently, Mr. Torrence, Mr. Davidson and Mr. Druten). After reviewing the qualifications of the current members of the Audit Committee, and any relationships they may have with us that might affect their independence, the Board of Directors has determined that all current Audit Committee members are “independent” as that concept is defined in Section 10A of the Exchange Act, all current Audit Committee members are “independent” as that concept is defined in the applicable rules of NASDAQ Stock Market, LLC, all current Audit Committee members are financially literate, and Mr. Torrence qualifies as an “audit committee financial expert” under the applicable rules promulgated pursuant to the Exchange Act.
Report of the Audit Committee
The Audit Committee oversees our financial reporting process on behalf of the Board of Directors. Management has primary responsibility for the financial statements and the reporting process including the systems of internal controls. The Audit Committee has responsibility for the appointment, compensation and oversight of the work of our independent registered public accounting firm and assists the Board of Directors by conducting its own review of our:
· filings with the SEC pursuant to the Securities Act of 1933 (the “Securities Act”) and the Exchange Act (i.e., Forms 10-K, 10-Q, and 8-K);
· press releases and other communications by us to the public, concerning earnings, financial condition and results of operations, including changes in distribution policies or practices affecting the holders of our units, if such review is not undertaken by the Board of Directors;
· systems of internal controls regarding finance and accounting that management and the Board of Directors have established; and
· auditing, accounting and financial reporting processes generally.
In fulfilling its oversight and other responsibilities, the Audit Committee met eight times during 2015. The Audit Committee’s activities included, but were not limited to: (a) selecting the independent registered public accounting firm, (b) meeting periodically in executive session with the independent registered public accounting firm, (c) reviewing the Quarterly Reports on Form 10-Q for the three months ended March 31, June 30, and September 30, 2015, (d) performing a self-assessment of the committee, (e) reviewing the Audit Committee charter, and (f) reviewing the overall scope, plans and findings of our internal auditor. Based on the results of the annual self-assessment, the Audit Committee believes that it satisfied the requirements of its charter. The Audit Committee also reviewed and discussed with management and the independent registered public accounting firm this Annual Report on Form 10-K, including the audited financial statements.
Our independent registered public accounting firm, Ernst & Young LLP, is responsible for expressing an opinion on the conformity of the audited financial statements with GAAP. The Audit Committee reviewed with Ernst & Young LLP its judgment as to the quality, not just the acceptability, of our accounting principles and such other matters as are required to be discussed with the Audit Committee under generally accepted auditing standards.
The Audit Committee discussed with Ernst & Young LLP the matters required to be discussed by the Statement of Auditing Standards (“SAS”) 114, The Auditor’s Communication with Those Charged with Governance, as may be modified or supplemented. The Audit Committee received written disclosures and the letter from Ernst & Young LLP required by applicable requirements of the Public Company Accounting Oversight Board regarding the independent accountant’s communication with the Audit Committee regarding independence, and has discussed with Ernst & Young LLP its independence from management and the ARLP Partnership.
Based on the reviews and discussions referred to above, the Audit Committee recommended to the Board of Directors that the audited financial statements be included in the Annual Report on Form 10-K for the year ended December 31, 2015 for filing with the SEC.
Members of the Audit Committee:
Wilson M. Torrence, Chairman
Thomas M. Davidson, Sr.
Robert J. Druten
Code of Ethics
We have adopted a code of ethics with which our President and Chief Executive Officer and our senior financial officers (including our principal financial officer and our principal accounting officer or controller) are expected to comply. The code of ethics is publicly available on our website under “Investor Information” at www.ahgp.com and is available in print without charge to any unitholder who requests it. Such requests should be directed to Investor Relations at (918) 295-1415. If any substantive amendments are made to the code of ethics or if there is a grant of a waiver, including any implicit waiver, from a provision of the code to our President and Chief Executive Officer, Chief Financial Officer, or Controller, we will disclose the nature of such amendment or waiver on our website or in a report on Form 8-K.
Communications with the Board
Unitholders or other interested parties can contact any director or committee of the Board of Directors by writing to them c/o Senior Vice President, General Counsel and Secretary, P. O. Box 22027, Tulsa, Oklahoma 74121-2027. Comments or complaints relating to our accounting, internal accounting controls or auditing matters will also be referred to members of the Audit Committee. The Audit Committee has procedures for (a) receipt, retention and treatment of complaints received by us regarding accounting, internal accounting controls, or auditing matters and (b) the confidential, anonymous submission by employees of concerns regarding questionable accounting or auditing matters.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act, as amended, requires directors, executive officers and persons who beneficially own more than ten percent of a registered class of our equity securities to file with the SEC initial reports of ownership and reports or changes in ownership of such equity securities. Such persons are also required to furnish us with copies of all Section 16(a) forms they file. Based upon a review of the copies of the forms furnished to us and written representations from certain reporting persons, we believe that during 2015 none of our officers and directors were delinquent with respect to any of the filing requirements under Rule 16(a).
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Compensation Discussion and Analysis
Introduction
The executive officers named in our Summary Compensation Table-(i) the President and Chief Executive Officer of our general partner, our principal executive officer, (ii) the Senior Vice President and Chief Financial Officer of our general partner, our principal financial officer, and (iii) our three most highly compensated executive officers for 2015 (collectively, the “Named Executive Officers”)-are also executive officers of MGP, ARLP’s managing general partner, of which we own 100% of the members interest. Our Named Executive Officers are also named in the Summary Compensation Table in Item 11 of the 2015 Form 10-K for ARLP. The compensation of our Named Executive Officers described below is their compensation as executive officers of MGP. We do not provide our Named Executive Officers any additional compensation.
Our Named Executive Officers spend the majority of their time managing the business of the ARLP Partnership, and the ARLP Partnership is responsible for the majority of their compensation. Therefore, our Board of Directors has delegated responsibility for decisions related to our Named Executive Officers’ compensation to the compensation committee of the MGP Board of Directors (“MGP Compensation Committee”). Accordingly, this Compensation Discussion and Analysis primarily addresses the ARLP Partnership’s compensation program as it relates to our Named Executive Officers.
We reimburse the ARLP Partnership for a portion of the compensation expense for certain of our Named Executive Officers pursuant to the Administrative Services Agreement. Based on the estimated time spent managing our affairs, the Board of Directors agreed that 5%, 4% and 8%, respectively, of the 2015 base salaries of Mr. Craft, the President and Chief Executive Officer of our general partner, Mr. Cantrell, the Senior Vice President and Chief Financial Officer of our general partner, and Mr. Davis, the Senior Vice President, General Counsel and Secretary of our general partner, would be allocated to us. None of the 2015 base salaries of Messrs. Sachse and Wynne were allocated to us. In addition, for 2015 we paid the ARLP Partnership a stipulated benefit burden equal to 40% of allocated base salary. We believe this percentage allocation is a reasonable estimation of the ARLP Partnership’s overall cost of cash compensation (i.e. compensation other than equity-based compensation) in excess of base salary, including, among other things, benefits, bonus and taxes. The Board of Directors reviews these allocations annually to determine whether they are appropriate. Please see “Item 13. -Certain Relationships and Related Transactions, and Director Independence-Administrative Services.”
The ARLP Partnership’s Compensation Objectives and Philosophy
The compensation of our Named Executive Officers is designed to achieve two key objectives: (i) provide a competitive compensation opportunity to allow the ARLP Partnership to recruit and retain key management talent, and (ii) motivate and reward the executive officers for creating sustainable, capital-efficient growth in available cash to maximize the ARLP Partnership’s distributions to its unitholders. In making decisions regarding executive compensation, the MGP Compensation Committee reviews current compensation levels of other companies in the coal industry and other peers, considers the assessment of each of the other executives by MGP’s President and Chief Executive Officer, and uses its discretion to determine an appropriate total compensation package of base salary and short-term and long-term incentives. The MGP Compensation Committee intends for each executive officer’s total compensation to be competitive in the marketplace and to effectively motivate the officer. Based upon its review of the ARLP Partnership’s overall executive compensation program, the Board of Directors believes the program is appropriately applied to our Named Executive Officers and is necessary to attract and retain the executive officers who are essential to our continued development and success, to compensate those executive officers for their contributions and to enhance unitholder value. Moreover, the Board of Directors believes the total compensation opportunities provided to our Named Executive Officers create alignment with our long-term interests and those of our unitholders. As a result, we do not maintain unit ownership requirements for our Named Executive Officers.
Setting Executive Compensation
Role of the MGP Compensation Committee
The MGP Compensation Committee discharges the MGP Board of Directors’ responsibilities relating to the ARLP Partnership’s executive compensation program. The MGP Compensation Committee oversees the ARLP Partnership’s
compensation and benefit plans and policies, administers its incentive bonus and equity participation plans, and reviews and approves annually all compensation decisions relating to its Named Executive Officers. The MGP Compensation Committee is empowered by the MGP Board of Directors and by the MGP Compensation Committee’s charter to make all decisions regarding compensation for the Named Executive Officers without ratification or other action by the MGP Board of Directors. The MGP Compensation Committee has the authority to secure services for executive compensation matters, legal advice, or other expert services, both from within and outside the company. While the MGP Compensation Committee is empowered to delegate all or a portion of its duties to a subcommittee, it has not done so.
The MGP Compensation Committee is composed of all directors of MGP who have been determined to be “independent” by the MGP Board of Directors in accordance with applicable NASDAQ Stock Market, LLC and SEC regulations.
Role of Executive Officers
Each year, the President and Chief Executive Officer of MGP submits recommendations to the MGP Compensation Committee for adjustments to the salary, bonuses and long-term equity incentive awards payable to the Named Executive Officers, excluding himself. The President and Chief Executive Officer bases his recommendations on his assessment of each executive’s performance, experience, demonstrated leadership, job knowledge and management skills. The MGP Compensation Committee considers the recommendations of the President and Chief Executive Officer of MGP as one factor in making compensation decisions regarding the Named Executive Officers. Historically, and in 2015, the MGP Compensation Committee and the President and Chief Executive Officer have been substantially aligned on decisions regarding compensation of the Named Executive Officers. As executive officers are promoted or hired during the year, the President and Chief Executive Officer makes compensation recommendations to the MGP Compensation Committee and works closely with the MGP Compensation Committee to ensure that all compensation arrangements for executive officers are consistent with our compensation philosophy and are approved by the MGP Compensation Committee. At the direction of the MGP Compensation Committee, the President and Chief Executive Officer and the Senior Vice President, General Counsel and Secretary of MGP attend certain meetings of the MGP Compensation Committee.
Use of Peer Group Comparisons
The MGP Compensation Committee believes that it is important to review and compare the ARLP Partnership’s performance with that of peer companies in the coal industry, and reviews the composition of the peer group annually. The peer group for 2015 included CONSOL, Arch Coal, Inc., Alpha Natural Resources Inc., Walter Energy, Inc., Westmoreland Resource Partners, L.P., Foresight Energy, L.P., and Natural Resource Partners L.P.. In assessing the competitiveness of the executive compensation program for 2015, the MGP Compensation Committee, with the assistance of the President and Chief Executive Officer, collected and analyzed peer group proxy information and developed a comparative analysis of base salaries, short-term incentives, total cash compensation, long-term incentives and total direct compensation. The MGP Compensation Committee uses the peer group data as a point of reference for comparative purposes, but it is not the determinative factor for the compensation of our Named Executive Officers. The MGP Compensation Committee exercises discretion in determining the nature and extent of the use of comparative pay data.
Consideration of Equity Ownership
Mr. Craft, the President and Chief Executive Officer, is evaluated and treated differently with respect to compensation than our other Named Executive Officers. Mr. Craft and related entities own significant equity positions in us, and therefore the interests of Mr. Craft are directly aligned with those of our unitholders. Mr. Craft has not received an increase in base salary since 2002, has not received a bonus under the ARLP Short-Term Incentive Plan (“ARLP STIP”) since 2005 and did not receive any grants of LTIP awards from 2005 through 2015. For 2016, at Mr. Craft’s request, his annual salary has been reduced to $1. On January 22, 2016 the compensation committee approved an ARLP LTIP award for Mr. Craft that will cliff vest on January 1, 2019 provided the vesting requirement for the 2016 awards, discussed below, is met.
Compensation Components
Overview
The principal components of compensation for our Named Executive Officers include:
· base salary;
· annual cash incentive bonus awards under the ARLP STIP; and
· awards of restricted units under the ARLP LTIP.
The relative amount of each component is not based on any formula, but rather is based on the recommendation of the President and Chief Executive Officer of MGP, subject to the discretion of the MGP Compensation Committee to make any modifications it deems appropriate.
Each of our Named Executive Officers also receives supplemental retirement benefits through the Supplemental Executive Retirement Plan (“SERP”). In addition, all executive officers are entitled to customary benefits available to the ARLP Partnership’s employees generally, including group medical, dental, and life insurance and participation in the ARLP Partnership’s profit sharing and savings plan (“PSSP”). The ARLP Partnership’s PSSP is a defined contribution plan and includes an employer matching contribution of 75% on the first 3% of eligible compensation contributed by the employee, an employer non-matching contribution of 0.75% of eligible compensation, and an employer supplemental contribution of 5% of eligible compensation. The PSSP provides an additional means of attracting and retaining qualified employees by providing tax-advantaged opportunities for employees to save for retirement.
Base Salary
When reviewing base salaries, the MGP Compensation Committee’s policy is to consider the individual’s experience, tenure and performance, the individual’s level of responsibility, the position’s complexity and its importance to the ARLP Partnership in relation to other executive positions, the ARLP Partnership’s financial performance, and competitive pay practices. The MGP Compensation Committee also considers comparative compensation data of companies in the ARLP Partnership’s peer group and the recommendation of the President and Chief Executive Officer of MGP. Base salaries are reviewed annually to ensure continuing consistency with market levels, and adjustments to base salaries are made as needed to reflect movement in the competitive market as well as individual performance.
Annual Cash Incentive Bonus Awards
The ARLP STIP is designed to assist the ARLP Partnership in attracting, retaining and motivating qualified personnel by rewarding management, including its Named Executive Officers, and selected other salaried employees with cash awards for the ARLP Partnership achievement of an annual financial performance target. The annual performance target is recommended by the President and Chief Executive Officer of MGP and approved by the MGP Compensation Committee, typically in January of each year. The performance measure is subject to equitable adjustment in the sole discretion of the MGP Compensation Committee to reflect the occurrence of any significant events during the year.
The performance target historically has been EBITDA-based, with items added or removed from the EBITDA calculation to ensure that the performance target reflects the operating results of the core mining business. (EBITDA for the ARLP Partnership is defined as net income of ARLP before net interest expense, income taxes, depreciation, depletion and amortization and net income attributable to noncontrolling interest.) The aggregate cash available for awards under the ARLP STIP each year is dependent on the ARLP Partnership’s actual financial results for the year compared to the annual performance target, and it increases in relationship to the ARLP Partnership’s EBITDA, as adjusted, exceeding the minimum threshold. The MGP Compensation Committee may determine satisfactory results and adjust the size of the pay-out pool in its sole discretion. In 2015, the MGP Compensation Committee approved a minimum financial performance target of $621.2 million in EBITDA from the ARLP Partnership’s current operations plus net cash flow from its White Oak investments, normalized by excluding any charges for unit-based and directors’ compensation and affiliate contributions, if any. The MGP Compensation Committee later amended the performance measure to remove the net cash flow from the ARLP Partnership’s White Oak investments component and exclude other results attributable to White Oak, and amended the target to $585.4 million as a result of the ARLP Partnership’s acquisition of the remaining equity interests and assumption of control of White Oak on July 31, 2015. For 2015, the ARLP Partnership exceeded the minimum performance target.
Awards to its Named Executive Officers each year are determined by and in the discretion of the MGP Compensation Committee. However, the MGP Compensation Committee does not establish individual target payout amounts for the Named Executive Officers’ ARLP STIP awards or otherwise communicate with the Named Executive Officers regarding their ARLP STIP awards or the payout amounts thereunder until the individual ARLP STIP awards are paid. As it does when reviewing base salaries, in determining individual awards under the ARLP STIP the MGP Compensation Committee considers its assessment of the individual’s performance, the ARLP Partnership’s financial performance, comparative compensation data of companies in our peer group and the recommendation of the President and Chief Executive Officer of MGP. The compensation expense associated with ARLP STIP awards is recognized by the ARLP Partnership in the year earned, with the cash awards payable in the first quarter of the following calendar year. Termination of employment of an executive officer for any reason prior to payment of a cash award will result in forfeiture of any right to the award, unless and to the extent waived by the MGP Compensation Committee in its discretion.
The performance measure for the ARLP STIP in 2016 will be EBITDA for current operations, excluding charges for unit-based and directors’ compensation and affiliate contributions, if any. As discussed above, the MGP Compensation Committee may, in its discretion, make equitable adjustments to the performance criteria under the ARLP STIP and adjust the amount of the aggregate pay-out. The MGP Compensation Committee believes the ARLP STIP performance criteria for 2016 will be reasonably difficult to achieve and therefore support the key compensation objectives discussed above.
Equity Awards under the ARLP LTIP
Equity compensation pursuant to the ARLP LTIP is a key component of the ARLP Partnership’s executive compensation program. The ARLP LTIP is sponsored by Alliance Coal. Under the ARLP LTIP, grants may be made of either (a) restricted ARLP units or (b) options to purchase ARLP common units, although to date, no grants of options have been made. The MGP Compensation Committee has authority to determine the participants to whom restricted units are granted, the number of restricted units to be granted to each such participant, and the conditions under which the restricted units may become vested, including the duration of any vesting period. Annual grant levels for designated participants (including the Named Executive Officers) are recommended by MGP’s President and Chief Executive Officer, subject to review and approval by the MGP Compensation Committee. Grant levels are intended to support the objectives of the comprehensive compensation package described above. The ARLP LTIP grants provide the Named Executive Officers with the opportunity to achieve a meaningful ownership stake in the ARLP Partnership, thereby assuring that their interests are aligned with its success. Even though Mr. Craft was not granted an award under the ARLP LTIP from 2005 through 2015, the MGP Compensation Committee believes Mr. Craft’s interests are directly aligned with the interests of ARLP’s unitholders as a result of his ownership positions. In addition, as noted above, Mr. Craft was granted an LTIP award for 2016. There is no formula for determining the size of awards to any individual recipient and, as it does when reviewing base salaries and individual ARLP STIP payments, the MGP Compensation Committee considers its assessment of the individual’s performance, the ARLP Partnership’s financial performance, compensation levels at peer companies in the coal industry and the recommendation of the President and Chief Executive Officer. Amounts realized from prior grants, including amounts realized due to changes in the value of ARLP’s common units, are not considered in setting grant levels or other compensation for its Named Executive Officers.
Restricted Units. Restricted units granted under the ARLP LTIP are “phantom” or notional units that upon vesting entitle the participant to receive an ARLP common unit. Restricted units granted under the ARLP LTIP vest at the end of a stated period from the grant date (which is currently approximately three years for all outstanding restricted units), provided the ARLP Partnership achieves an aggregate performance target for that period. However, if a grantee’s employment is terminated for any reason prior to the vesting of any restricted units, those restricted units will be automatically forfeited, unless the MGP Compensation Committee, in its sole discretion, determines otherwise. The number of units actually distributed upon satisfaction of the applicable vesting requirements is reduced to cover the minimum statutory income tax withholding requirement for each individual participant based upon the fair market value of the common units as of the date of distribution. At the MGP Compensation Committee’s discretion, grants of restricted units under the ARLP LTIP may include the contingent right to receive quarterly distributions in an amount equal to the cash distributions the ARLP Partnership makes to unitholders during the vesting period (“DERs”). DERs are payable, in the discretion of the MGP Compensation Committee, either in cash or in the form of additional Restricted Units credited to a book keeping account subject to the same vesting restrictions as the tandem award.
The performance target applicable to restricted unit awards under the ARLP LTIP is based on a normalized EBITDA measure, with that measure typically being similar to the ARLP STIP measure for the year of the grant. The target, however, requires achieving an aggregate performance level for the three-year period. The ARLP Partnership typically issues grants under the ARLP LTIP at the beginning of each year, with the exceptions of new employees who begin employment with the ARLP Partnership at some other time and job promotions that may occur at some other time. The compensation expense associated with ARLP LTIP grants is recognized by the ARLP Partnership over the vesting period in
accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 718, Compensation-Stock Compensation.
The policy of the MGP Compensation Committee is to grant restricted units pursuant to the ARLP LTIP to serve as a means of incentive compensation for performance. Therefore, no consideration will be payable by the ARLP LTIP participants upon receipt of the common units. Common units to be delivered upon the vesting of restricted units may be common units we already own, common units we acquire in the open market or from any other person, newly issued common units, or any combination of the foregoing. If we issue new common units upon payment of the restricted units instead of purchasing them, the total number of common units outstanding will increase.
Grants for 2015 under the ARLP LTIP, made January 26, 2015, will cliff vest on January 1, 2018, provided the ARLP Partnership achieves a target level of aggregate EBITDA for current operations plus net cash flow from our White Oak investments, excluding any charges for unit-based and directors’ compensation and affiliate contributions, if any, for the period January 1, 2015 through December 31, 2017. Grants for 2016 under the ARLP LTIP, made January 22, 2016, will cliff vest on January 1, 2019 provided the ARLP Partnership achieves a target level of aggregate EBITDA for current operations, excluding any charges for unit-based and directors’ compensation and affiliate contributions, if any, for the period January 1, 2016 through December 31, 2018. The ARLP LTIP provides the MGP Compensation Committee with discretion to determine the conditions for vesting (as well as all other terms and conditions) associated with any award under the plan, and to amend any of those conditions so long as an amendment does not materially reduce the benefit to the participant. The MGP Compensation Committee believes the performance-related vesting conditions of all outstanding awards under the ARLP LTIP will be reasonably difficult to satisfy and therefore support the key compensation objectives discussed above.
Unit Options. The ARLP Partnership has not made any grants of unit options. The MGP Compensation Committee, in the future, may decide to make unit option grants to employees and directors on terms determined by the MGP Compensation Committee.
Grant Timing. The MGP Compensation Committee does not time, nor has the MGP Compensation Committee in the past timed, the grant of ARLP LTIP awards in coordination with the release of material non-public information. Instead, ARLP LTIP awards are granted only at the time or times dictated by the ARLP Partnership’s normal compensation process as developed by the MGP Compensation Committee.
Effect of a Change in Control. Upon a “change in control” as defined in the ARLP LTIP, all awards outstanding under the ARLP LTIP will automatically vest and become payable or exercisable, as the case may be, in full. Please see “Item 11. Executive Compensation-Potential Payments Upon a Termination or Change of Control.”
Amendments and Termination. The MGP Board of Directors or the MGP Compensation Committee may, in its discretion, terminate the ARLP LTIP at any time with respect to any common units for which a grant has not previously been made. Except as required by the rules of the exchange on which the common units may be listed at that time, the MGP Board of Directors or the MGP Compensation Committee may alter or amend the ARLP LTIP in any manner from time to time; provided, however, that no change in any outstanding grant may be made that would materially impair the rights of the participant without the consent of the affected participant. In addition, the MGP Board of Directors or the MGP Compensation Committee may, in its discretion, establish such additional compensation and incentive arrangements as it deems appropriate to motivate and reward employees of the ARLP Partnership.
AHGP LTIP
We have also adopted the Long-Term Incentive Plan (“AHGP LTIP”) for employees, directors and consultants of our general partner and its affiliates, including the ARLP Partnership. Grants under the AHGP LTIP are to be made in AHGP restricted units, which are “phantom” units that entitle the grantee to receive either a common unit or equivalent amount of cash upon the vesting of the phantom unit. The aggregate number of common units reserved for issuance under the AHGP LTIP is 5,215,000. There have been no grants under the AHGP LTIP.
Supplemental Executive Retirement Plan
The ARLP Partnership maintains the SERP to help attract and motivate key employees, including its Named Executive Officers. The SERP is sponsored by Alliance Coal. Participation in the SERP aligns the interest of each Named Executive Officer with the interests of ARLP’s unitholders because all allocations made to participants under the SERP are made in the form of notional common units of ARLP, defined in the SERP as “phantom units.” The MGP Compensation Committee
approves the SERP participants and their percentage allocations, and can amend or terminate the SERP at any time. All of the Named Executive Officers currently participate in the SERP.
Under the terms of the SERP, a participant is entitled to receive on December 31 of each year an allocation of phantom units having a fair market value equal to his or her percentage allocation multiplied by the sum of the participant’s base salary and cash bonus received that year, then reduced by any supplemental contribution that was made to the ARLP Partnership’s defined contribution PSSP for the participant that year. A participant’s cumulative notional phantom unit account balance earns the equivalent of common unit distributions, which are added to the notional account balance in the form of additional phantom units. All amounts granted under the SERP vest immediately and are paid out upon the participant’s termination from employment in ARLP common units equal to the number of phantom units then credited to the participant’s account, less the number of units required to satisfy the ARLP Partnership’s tax withholding obligations. A participant in the SERP is not entitled to an allocation for the year in which his termination from employment occurs, except as described below.
A participant in the SERP, including any of the Named Executive Officers, is entitled to receive an allocation under the SERP for the year in which his employment is terminated only if such termination results from one of the following events:
(1) the participant’s employment is terminated other than for “cause”;
(2) the participant terminates employment for “good reason”;
(3) a change of control of the ARLP Partnership or MGP occurs and, as a result, the participant’s employment is terminated (whether voluntary or involuntary);
(4) death of the participant;
(5) the participant attains (or has attained) retirement age of 65 years; or
(6) the participant incurs a total and permanent disability, which shall be deemed to occur if the participant is eligible to receive benefits under the terms of the long-term disability program the ARLP Partnership maintains.
This allocation for the year in which a participant’s termination occurs shall equal the participant’s eligible compensation for such year (including any severance amount, if applicable) multiplied by his percentage allocation under the SERP, reduced by any supplemental contribution that was made to the ARLP Partnership’s defined contribution PSSP for the participant that year.
Other Compensation-Related Matters
Trading in Derivatives
It is MGP’s policy that directors and all officers, including the Named Executive Officers, may not purchase or sell options on ARLP’s common units. In addition, it is our general partner’s policy that directors and all officers, including our Named Executive Officers, may not purchase or sell options on AHGP’s common units absent approval by our general partner.
Tax Deductibility of Compensation
With respect to the deduction limitations imposed under Section 162(m) of the Internal Revenue Code, we and the ARLP Partnership are a limited partnership and do not meet the definition of a “corporation” within the meaning of Section 162(m). Accordingly, such limitations do not apply to compensation paid to the Named Executive Officers.
Perquisites and Personal Benefits
The ARLP Partnership provides a limited amount of perquisites and personal benefits to the Named Executive Officers in keeping with the MGP Compensation Committee’s objectives to provide competitive compensation to motivate and reward executive officers for creating sustainable, capital-efficient growth in available cash. These perquisites and personal benefits typically include amounts for items such as tax preparation fees and social club dues, and are reviewed annually by the MGP Compensation Committee.
Board of Directors Compensation Report
The Board of Directors has submitted the following report for inclusion in this Annual Report on Form 10-K:
Our Board of Directors has reviewed and discussed the Compensation Discussion and Analysis contained in this Annual Report on Form 10-K with management. Based on our Board of Directors’ review of and the discussions with management with respect to the Compensation Discussion and Analysis, our Board of Directors recommends that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K for the fiscal year ended December 31, 2015.
The foregoing report is provided by the following directors, who constitute all the members of the Board of Directors:
Members of the Board of Directors:
Joseph W. Craft III
Thomas M. Davidson, Sr.
Robert J. Druten
Wilson M. Torrence
Notwithstanding anything to the contrary set forth in any of our previous filings under the Securities Act or the Exchange Act, that incorporate future filings, including this Annual Report on Form 10-K, in whole or in part, the foregoing Board of Directors’ Compensation Report shall not be deemed to be filed with the SEC or incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate it by reference.
The comparative ARLP unit amounts and ARLP unit prices reflected in the following tables have been adjusted for the two-for-one split of the ARLP Partnership’s units completed on June 16, 2014.
Summary Compensation Table
(1) Column is not applicable.
(2) The table below reflects the portion of the Named Executive Officers’ total compensation expense for 2015 allocated to us by the ARLP Partnership. Based on the estimated time each Named Executive Officer spent managing our affairs in 2015, the Board of Directors agreed that 5%, 4% and 8%, respectively, of the beginning of the year base salaries of Messrs. Craft, Cantrell and Davis would be allocated to us. In addition, for 2015, we were billed by the ARLP Partnership a stipulated benefit burden of 40% of allocated base salary. We believe
this percentage allocation is a reasonable estimation of the ARLP Partnership’s overall cost of cash compensation (i.e. compensation other than equity-based compensation) in excess of base salary, including, among other things, benefits, bonus and taxes for the services provided by the Named Executive Officers to us. Pursuant to the Administrative Services Agreement, this percentage allocation is applied to the total allocated base salary cost of all employees of the ARLP Partnership who provide services to us, not just our Named Executive Officers, and is applied without regard to the amount of actual bonus, if any, received by any particular employee. Accordingly, the amounts shown are not indicative of the actual bonus, if any, received by Mr. Craft, Mr. Cantrell or Mr. Davis.
(3) The Unit Awards represent the aggregate grant date fair value of equity awards granted (computed in accordance with FASB ASC 718) to each Named Executive Officer under the LTIP in the respective year. Please see “Item 11. Compensation Discussion and Analysis-Compensation Program Components-Equity Awards under the ARLP LTIP.”
(4) Amounts represent the ARLP STIP bonus earned for the respective year. ARLP STIP payments are made in the first quarter of the year following the year in which they are earned. Other than this bonus, there were no other applicable bonuses earned or deferred associated with year 2015. Please see “Item 11. Compensation Discussion and Analysis-Compensation Program Components-Annual Cash Incentive Bonus Awards.”
(5) For all Named Executive Officers, the amounts represent the sum of the (a) SERP phantom unit contributions valued at the market closing price of ARLP’s common units on the date the phantom unit was granted, (b) profit sharing savings plan employer contribution and (c) perquisites in excess of $10,000. A reconciliation of the amounts shown is as follows:
a) For Mr. Craft, the 2015 amount includes perquisites and other personal benefits comprised of club dues of $11,473. For Mr. Cantrell, the 2015 amount includes perquisites and other personal benefits totaling $10,976 comprised of club dues of $9,701 and tax preparation fees of $1,275. For Mr. Sachse, the 2015 amount includes perquisites and other personal benefits comprised of club dues of $10,878.
Grants of Plan-Based Awards Table
(1) Column not applicable.
(2) These awards are grants of restricted units pursuant to the ARLP LTIP. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Equity Awards under the ARLP LTIP.”
(3) These awards are phantom units added to each Named Executive Officer’s SERP notional account balance. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Supplemental Executive Retirement Plan.”
(4) Grants of restricted units under the ARLP LTIP are not subject to minimum thresholds, targets or maximum payout conditions. However, the vesting of these grants is subject to the satisfaction of certain performance criteria. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Equity Awards under the ARLP LTIP.”
(5) The ARLP Partnership calculated the fair value of the ARLP LTIP awards using a value of $37.19 per unit, the unit price applicable for 2015 grants. The ARLP Partnership calculated the fair value of SERP phantom unit awards using the market closing price on the date the phantom unit award was granted. Phantom units granted under the SERP vest on the date granted.
(6) In accordance with the provisions of the SERP, a participant’s cumulative notional phantom unit account balance earns the equivalent of common unit distributions when the ARLP Partnership pays a distribution to our common unitholders, which is added to the account balance in the form of phantom units.
(7) These contributions are made in accordance with the SERP plan document that has been approved by the MGP Compensation Committee. Therefore, these contributions are not separately approved by the MGP Compensation Committee.
(8) These amounts represent awards pursuant to the ARLP STIP. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Annual Cash Incentive Bonus Awards” for additional information regarding the ARLP STIP awards.
(9) Awards under the ARLP STIP are subject to a minimum financial performance target each year. However, determination of individual awards under the ARLP STIP is based upon an assessment of the Named Executive Officer’s performance, comparative compensation data of companies in our peer group and recommendation of MGP’s President and Chief Executive Officer. The ARLP STIP does not specify any threshold or maximum payout amounts. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Annual Cash Incentive Bonus Awards” for additional information regarding the ARLP STIP awards.
Narrative Disclosure Relating to the Summary Compensation Table and Grants of Plan-Based Awards Table
Annual Cash Incentive Bonus Awards
Under the ARLP STIP, the Named Executive Officers are eligible for cash awards for the ARLP Partnership achieving an annual financial performance target. The annual performance target is recommended by the MGP’s President and Chief Executive Officer and approved by the MGP Compensation Committee, typically in January of each year. The performance target historically has been EBITDA-based, with items added or removed from the EBITDA calculation to ensure that the performance target reflects the pure operating results of the core mining business. (The ARLP Partnership’s EBITDA is calculated as net income of ARLP before net interest expense, income taxes, depreciation, depletion and amortization and net income attributable to noncontrolling interest.) The aggregate cash available for awards under the ARLP STIP each year is dependent on the ARLP Partnership’s actual financial results for the year compared to the annual performance target. The cash available generally increases in relationship to the ARLP Partnership’s EBITDA, as adjusted, exceeding the minimum financial performance target and is subject to adjustment by the MGP Compensation Committee in its discretion. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Annual Cash Incentive Bonus Awards.”
Long-Term Incentive Plan
Under the ARLP LTIP, grants may be made of either (a) restricted ARLP units or (b) options to purchase ARLP common units, although to date, no grants of options have been made. Annual grant levels for designated participants (including the Named Executive Officers) are recommended by MGP’s President and Chief Executive Officer, subject to the review and approval of the MGP Compensation Committee. Restricted units granted under the ARLP LTIP are “phantom” or notional units that upon vesting entitle the participant to receive an ARLP unit. Restricted units granted under the ARLP LTIP vest at the end of a stated period from the grant date (which is currently approximately three years for all outstanding restricted units), provided the ARLP Partnership achieves an aggregate performance target for that period. The performance target is based on a normalized EBITDA measure, with that measure typically being similar to the ARLP STIP measure for the year of the grant. The target, however, requires achieving an aggregate performance level for the three-year period. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Equity Awards under the ARLP LTIP.”
Supplemental Executive Retirement Plan
Under the terms of the SERP, participants are entitled to receive on December 31 of each year an allocation of phantom ARLP units having a fair market value equal to his or her percentage allocation multiplied by the sum of base salary and cash bonus received that year, then reduced by any supplemental contribution that was made to the ARLP Partnership’s defined contribution PSSP for the participant that year. A participant’s cumulative notional phantom unit account balance earns the equivalent of common unit distributions. The calculated distributions are added to the notional account balance in the form of additional phantom units. All amounts granted under the SERP vest immediately and are paid out upon the participant’s termination or death in ARLP common units equal to the number of phantom units then credited to the participant’s account, subject to reduction of the number of units distributed to cover withholding obligations. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Supplemental Executive Retirement Plan.”
Salary and Bonus in Proportion to Total Compensation
The following table shows the total of salary and bonus in proportion to total compensation from the Summary Compensation Table:
Outstanding ARLP Equity Awards at Fiscal Year-End Table
(1) Column is not applicable.
(2) Amounts represent restricted units awarded under the LTIP that were not vested as of December 31, 2015. Subject to the ARLP Partnership achieving financial performance targets, the units vested, or will vest, as follows: For Mr. Cantrell, 14,334 on January 1, 2016, 14,968 units on January 1, 2017 and 13,424 on January 1, 2018; Mr. Davis, 15,700 on January 1, 2016, 19,118 units on January 1, 2017 and 15,719 on January 1, 2018; for Mr. Sachse, 18,166 on January 1, 2016, 21,710 units on January 1, 2017 and 20,137 on January 1, 2018; and for Mr. Wynne, 20,666 on January 1, 2016, 21,118 units on January 1, 2017 and 19,038 on January 1, 2018. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Equity Awards under the ARLP LTIP.” All grants of restricted units under the ARLP LTIP include the contingent right to receive quarterly cash distributions in an amount equal to the cash distributions the ARLP Partnership makes to unitholders during the vesting period.
(3) Stated values are based on $13.49 per unit, the closing price of ARLP’s common units on December 31, 2015, the final market trading day of 2015.
Option Exercises and Units Vested Table
(1) Column is not applicable.
(2) Amounts represent the number and value of restricted units granted under the ARLP LTIP that vested in 2015. All of these units vested on January 1, 2015 and are valued at $43.18 per unit, the closing price on January 2, 2015, the first market trading date of 2015. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Equity Awards under the ARLP LTIP.”
Pension Benefits Table
(1) Column not applicable because no provision of the SERP is affected by years of service.
(2) Amounts represent the Named Executive Officer’s cumulative notional account balance of phantom units valued at $13.49, the closing price of ARLP’s common units on December 31, 2015, the final market trading day of 2015. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Supplemental Executive Retirement Plan.”
Narrative Discussion Relating to the Pension Benefits Table for 2015
Supplemental Executive Retirement Plan
Under the terms of the SERP, participants are entitled to receive on December 31 of each year an allocation of phantom units having a fair market value equal to their percentage allocation multiplied by the sum of base salary and cash bonus received that year, then reduced by any supplemental contribution that was made to the ARLP Partnership’s defined contribution PSSP for the participant that year. A participant’s cumulative notional phantom unit account balance earns the equivalent of common unit distributions. The calculated distributions are added to the notional account balance in the form of additional phantom units. All amounts granted under the SERP vest immediately and are paid out upon the participant’s termination or death in ARLP common units equal to the number of phantom units then credited to the participant’s account, subject to reduction of the number of units distributed to cover withholding obligations. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Supplemental Executive Retirement Plan.”
Potential Payments Upon a Termination or Change of Control
Each of our Named Executive Officers is eligible to receive accelerated vesting and payment under the ARLP LTIP and the SERP upon certain terminations of employment or upon our change in control. Upon a “change of control,” as defined in the ARLP LTIP, all awards outstanding under the ARLP LTIP will automatically vest and become payable or exercisable, as the case may be, in full. In this regard, all restricted periods shall terminate and all performance criteria, if any, shall be deemed to have been achieved at the maximum level. The ARLP LTIP defines a “change in control” as one of the following events: (1) any sale, lease, exchange or other transfer of all or substantially all of ARLP’s assets or Alliance Coal’s assets to any person other than a person who is ARLP’s affiliate; (2) the consolidation or merger of Alliance Coal with or into another person pursuant to a transaction in which the outstanding voting interests of Alliance Coal are changed into or exchanged for cash, securities or other property, other than any such transaction where (a) the outstanding voting interests of Alliance Coal are changed into or exchanged for voting stock or interests of the surviving corporation or its parent and (b) the holders of the voting interests of Alliance Coal immediately prior to such transaction own, directly or indirectly, not less than a majority of the voting stock or interests of the surviving corporation or its parent immediately after such transaction; or (3) a person or group being or becoming the beneficial owner of more than 50% of all voting interests of Alliance Coal then outstanding.
The amounts each of our Named Executive Officers could receive under the SERP have been previously disclosed in “Item 11. Pension Benefits Table for 2015” and the amounts each of the Named Executive Officers could receive under the ARLP LTIP have been previously disclosed in “Item 11. Outstanding ARLP Equity Awards at Fiscal Year-End 2015
Table”, in each case assuming the triggering event occurred on December 31, 2015. In addition, if a Named Executive Officer’s employment were terminated as a result of one of certain enumerated events, the Named Executive Officer would receive an amount based on an allocation for the year of termination. Please see “Item 11. Compensation Discussion and Analysis-Compensation Components-Supplemental Executive Retirement Plan” for additional information regarding the enumerated events and allocation determination. The exact amount that any Named Executive Officer would receive could only be determined with certainty upon an actual termination or change in control.
Director Compensation
The compensation of the directors of our general partner, AGP, is set by the Board of Directors. Mr. Craft, the only employee director, receives no director compensation. The directors of AGP devote 100% of their time as directors of AGP to the business of the AHGP Partnership.
Director Compensation Table for 2015
(1) Column is not applicable.
(2) Mr. Hall retired from the Board of Directors and Mr. Torrence was elected to the Board of Directors, in each case, in April 2015. Amounts reported in the “Fees earned or Paid in Cash” column represent (a) amounts earned by Mr. Hall for service from January 1, 2015 through his date of retirement and (b) amounts earned by Mr. Torrence from the date of his election through December 31, 2015.
(3) Amounts represent annual retainer paid in cash. Each non-employee director is eligible to defer all or part of the annual retainer pursuant to the AGP Amended and Restated Directors Annual Retainer and Deferred Compensation Plan (“AGP Deferred Compensation Plan”) that is administered by the Board of Directors. Please see Narrative to Directors Compensation Table, below.
(4) All Other Compensation for Mr. Druten includes matching charitable contributions made by us. We match individual contributions of $25 or more to educational institutions and not-for-profit organizations on a one-to-one basis up to $5,000 per individual, per calendar year.
(5) Amounts represent the grant date fair value of equity awards in 2015 related to deferrals of annual retainer and distributions earned on deferred units (computed in accordance with FASB ASC 718, using the same assumptions as used for financial reporting purposes). Please see Narrative to Director Compensation Table, below. At December 31, 2015, each director had the following number of “phantom” AHGP common units credited to his notional account under the AGP Deferred Compensation Plan:
Name
Deferred
Compensation
Plan (in Units)
Thomas M. Davidson
5,970
Robert J. Druten
9,168
Michael J. Hall
6,549
Wilson M. Torrence
-
Please see “Item 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED UNITHOLDER MATTERS
The following table sets forth certain information as of February 11, 2016, regarding the beneficial ownership of both our common units and the common units of ARLP by (a) each director of our general partner, (b) each executive officer identified in the Summary Compensation Table included in Item 11 above, (c) all such directors of our general partner and such executive officers as a group, and (d) each person or group known by our general partner to be the beneficial owner of more than 5% of our common units. Our general partner is owned by C-Holdings, LLC (“C-Holdings”), which is wholly owned by Mr. Craft. As of February 11, 2016, AHGP owns 41.8% of the outstanding common units of ARLP, and AHGP owns, directly or indirectly, all of the outstanding limited liability company interests of MGP, the managing general partner of ARLP. The address of each of ARLP, C-Holdings, AGP and, unless otherwise indicated in the footnotes to the table below, each of the directors and executive officers reflected in the table below is 1717 South Boulder Avenue, Suite 400, Tulsa, Oklahoma 74119. Unless otherwise indicated in the footnotes to the table below, our common units and the common units of ARLP reflected as being beneficially owned by the listed directors and executive officers are held directly by such directors and officers. The percentage of our common units beneficially owned is based on 59,863,000 common units outstanding as of February 11, 2016, and the percentage of common units of ARLP beneficially owned is based on 74,375,025 common units outstanding as of February 11, 2016.
* Less than one percent
Footnote related to AHGP Common Units Beneficial Ownership
(1) The AHGP common units attributed to Mr. Craft consist of (i) 2,463,449 AHGP common units held by the JWC III Rev Trust, of which Mr. Craft is trustee, (ii) 20,641,168 AHGP common units held by SGP (indirectly owned by Mr. Craft and Kathleen S. Craft), (iii) 315,941 AHGP common units held by Alliance Management Holdings III, LLC (“AMH III”), of which Mr. Craft may be deemed to be beneficial owner by virtue of his status as President and sole director of AMH III, and (iv) 17,647,950 AHGP common units held by the Management Group (some of whom are current or former members of management of ARLP) other than Mr. Craft with whom he may be deemed to comprise a group under Rule 13d-5(b) of the Exchange Act, as more fully described in footnote (4) below. The filing of this report shall not be deemed an admission that Mr. Craft beneficially owns the AHGP common units referenced in clauses (iii) and (iv) of this footnote.
(2) The AHGP common units attributed to Ms. Craft consist of (i) 1,998,250 AHGP common units held directly by the Kathleen S. Craft Revocable Trust, of which Ms. Craft is trustee and (ii) 20,641,168 AHGP common units held by SGP (indirectly owned by Mr. Craft and Kathleen S. Craft). 1,966,856 of the AHGP units referenced in clause (i) of this footnote are attributable to Mr. Craft as referenced in clause (iv) of footnote (1) above.
(3) Mr. Wynne is part of the Management Group with whom Mr. Craft may be deemed to comprise a group under Rule 13d-5(b) of the Exchange Act, as more fully described in clause (iv) of footnote (1) above and in footnote (4) below. Of the 684,525 AHGP common units collectively held, directly and through family trusts, by Mr. Wynne, 624,525 AHGP common units represent a portion of the 17,647,950 AHGP common units attributed to Mr. Craft as referenced in clause (iv) of footnote (1) above. Accordingly, in order to avoid double counting, those 624,525 AHGP common units were not included in the line item of the above table entitled “All directors and executive officers as a group (8 persons)” for the calculation of the aggregate number of AHGP common units beneficially owned by the listed officers and directors, and the corresponding percentage calculation.
(4) Members of the Management Group are parties to a Transfer Restrictions Agreement that contains certain provisions (e.g., drag-along rights granted to Mr. Craft) that, pursuant to Exchange Act Rule 13d-5(b), may cause the Management Group to be deemed to comprise a group under Exchange Act Rule 13d-5(b). Accordingly, without affirming the existence of an Exchange Act Rule 13d-5(b) group, the Management Group made a Schedule 13D filing pursuant to Exchange Act requirements. The Management Group’s 42,294,007 AHGP common units listed in the table above consist of (i) 23,420,558 AHGP common units owned, directly or indirectly, or attributed to Mr. Craft as described in clauses (i) through (iii) in footnote (1) above, and (ii) 18,873,449 AHGP common units held by the members of the Management Group other than Mr. Craft.
In addition to Mr. Craft, one other member of the Management Group, Thomas L. Pearson, individually holds more than 5% of AHGP’s common units. Mr. Pearson holds directly and through trusts 3,389,233 AHGP common units, representing 5.7% of the AHGP common units outstanding. The reference in clause (iv) of footnote (1) above to 17,647,950 AHGP common units beneficially held by Mr. Craft, includes 3,282,005 AHGP common units held by Mr. Pearson.
(5) Of the common units held by Mr. Sachse, 20,000 AHGP common units are subject to a pledge agreement in favor of JPMorgan Chase Bank, N.A.
Footnotes related to ARLP Common Units Beneficial Ownership
(6) The ARLP common units attributed to Mr. Craft consist of (i) 357,452 ARLP common units held directly by him, (ii) 2,000 ARLP common units held by his son, and (iii) 31,088,338 ARLP common units held by AHGP. Mr. Craft is Chairman of the Board of Directors and, through his ownership of C-Holdings, the indirect sole owner of AGP, the general partner of AHGP, and he holds, directly or indirectly, or may be deemed to be the beneficial owner of, a majority of the outstanding common units of AHGP (as described in footnote (1) above). As of February 11, 2016, AHGP owned 41.8% of ARLP’s common units. Mr. Craft disclaims beneficial ownership of the ARLP common units held by AHGP except to the extent of his pecuniary interest therein.
(7) Of the common units held by Mr. Sachse, 80,123 ARLP common units are subject to a pledge agreement in favor of JPMorgan Chase Bank, N.A.
Equity Compensation Plan Information
Plan Category
Number of units to be issued upon
exercise/vesting of outstanding
options, warrants and rights
as of December 31, 2015
Weighted-average exercise
price of outstanding
options, warrants and rights
Number of units remaining
available for future issuance
under equity compensation plans
as of December 31, 2015
Equity compensation plans approved by unitholders:
ARLP Long-Term Incentive Plan
939,793
N/A
3,683,627
AHGP Long-Term Incentive Plan
-
N/A
5,215,000
Equity compensation plans not approved by unitholders:
Supplemental Executive Retirement Plan
360,104
N/A
N/A
MGP Deferred Compensation Plan for Directors
69,037
N/A
N/A
AGP Deferred Compensation Plan for Directors
21,687
N/A
N/A
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
In addition to the related-party transactions discussed in “Item 8. Financial Statements and Supplementary Data-Note 19. Related-Party Transactions”, we have the following additional related-party transactions:
Certain Relationships
As of December 31, 2015, we owned 31,088,338 common units of ARLP, representing 41.9% of its outstanding common units. In addition, as of December 31, 2015 the Management Group owned approximately 36.3% of our outstanding common units, and ARLP’s special general partner owned approximately 34.5%.
Certain of the officers and directors of our general partner are also officers and/or directors of ARLP’s managing general partner, including Mr. Craft, the Chairman, President and Chief Executive Officer of our general partner, Mr. Torrence, a Director and Chairman of our general partner’s Audit Committee, Mr. Cantrell, the Senior Vice President and Chief Financial Officer of our general partner, and Mr. Davis, the Senior Vice President, General Counsel and Secretary of our general partner.
Omnibus Agreement
Pursuant to the terms of an amended omnibus agreement, we agreed, and caused our controlled affiliates to agree, for so long as management controls MGP through its ownership of our common units, not to engage in the business of mining, marketing or transporting coal in the U.S., unless ARLP is first offered the opportunity to engage in the potential activity or acquire a potential business, and the MGP Board of Directors with the concurrence of its conflicts committee, elects to cause ARLP not to pursue such opportunity or acquisition. The ARLP amended omnibus agreement provides, among other things, that ARLP will be presumed to desire to acquire the assets until such time as it advises us that it has abandoned the pursuit of such business opportunity, and we may not pursue the acquisition of such assets prior to that time. This restriction does not apply to: any business we or our affiliates owned or operated at the closing of our IPO; any acquisition by us or our affiliates so long as the majority of the value of the acquisition does not derive from a restricted business and ARLP is offered the opportunity to purchase the restricted business following its acquisition; or any business conducted by us or our affiliates with the approval of MGP Board of Directors or conflicts committee of MGP (“MGP Conflicts Committee”). Except as provided in the amended omnibus agreement, we and our affiliates are not prohibited from engaging in activities that directly compete with ARLP. In addition, our affiliates are not prohibited from engaging in activities that compete directly with us.
Related-Party Transactions
The Board of Directors of our general partner and its conflicts committee review our related-party transactions that involve a potential conflict of interest between a general partner and ARLP or its subsidiaries or another partner to determine that such transaction reflect market-clearing terms and conditions customary in the coal industry. As a result of these reviews, the Board of Directors and its conflicts committee approved each of the transactions described below that had such potential conflict of interest as fair and reasonable to us and our limited partners.
Administrative Services
On April 1, 2010, effective January 1, 2010, we entered into the Administrative Services Agreement with ARLP, MGP, the Intermediate Partnership, our general partner AGP, and ARH II, the indirect parent of SGP. The Administrative Services Agreement supersedes the administrative services agreement signed in connection with our IPO in 2006. Under the Administrative Services Agreement, certain employees of ARLP, including some executive officers, provide administrative services to AHGP and ARH II and their respective affiliates. The ARLP Partnership is reimbursed for services rendered by its employees on behalf of these affiliates as provided under the Administrative Services Agreement. We paid the ARLP Partnership $0.4 million under this agreement for the year ended December 31, 2014. The ARLP Partnership also billed and recognized administrative service revenue under this agreement of $0.1 million for the year ended December 31, 2014 from ARH II.
AGP
Our partnership agreement requires us to reimburse AGP for all direct and indirect expenses it incurs or payments it makes on our behalf and all other expenses allocable to us or otherwise incurred by our general partner in connection
with operating our business. The amounts billed by AGP to us totaled $0.9 million for the year ended December 31, 2015 for costs principally related to the AGP Deferred Compensation Plan.
The ARLP Partnership’s Related-Party Transactions
The MGP Board of Directors and its conflicts committee review the ARLP Partnership’s related-party transactions that involve a potential conflict of interest between a general partner and ARLP or its subsidiaries or another partner to determine that each such transaction reflects market-clearing terms and conditions customary in the coal industry. As a result of these reviews, the MGP Board of Directors and its conflicts committee approved each of the transactions described below that had such potential conflict of interest as fair and reasonable to the ARLP Partnership and its limited partners.
Affiliate Contribution
During December 2015, an affiliated entity controlled by Mr. Craft contributed to us $1.5 million for the purpose of funding certain of the ARLP Partnership’s general and administrative expenses. Upon our receipt of the contribution, we contributed the same to our subsidiary and ARLP’s managing general partner, MGP, which in turn contributed the same to Alliance Coal. The ARLP Partnership made a special allocation to MGP of certain general and administrative expenses equal to the amount of the contributions, MGP made an identical expense allocation to us, and we then made the same expense allocation to the affiliated entity controlled by Mr. Craft.
SGP
The ARLP Partnership has a noncancelable lease arrangement for the Gibson North mine’s coal preparation plant and ancillary facilities with SGP. The lease arrangement is considered a capital lease based on the terms of the arrangement. Lease payments for the year ended December 31, 2015 were $0.6 million. The lease term expires February 1, 2017, at which time the ARLP Partnership has the right to either purchase the facilities at fair market value or renew the lease for a mutually agreeable term at fair market rental value.
JC Land
The ARLP Partnership’s subsidiary, ASI, has a time-sharing agreement with Mr. Craft and Mr. Craft’s affiliate, JC Land, LLC (“JC Land”), concerning their use of aircraft owned by ASI for purposes other than the ARLP Partnership’s business. In accordance with the provisions of that agreement, Mr. Craft and JC Land paid ASI $0.1 million for the year ended December 31, 2015 for use of the aircraft. In addition, Alliance Coal has a time-sharing agreement with JC Land concerning Alliance Coal’s use of an airplane owned by JC Land. In accordance with the provisions of that agreement, Alliance Coal paid JC Land $0.2 million for the year ended December 31, 2015 for use of the aircraft.
Effective August 1, 2013, Alliance Coal entered into an expense reimbursement agreement with JC Land regarding pilots hired by Alliance Coal to operate aircraft owned by ASI and JC Land. In accordance with the expense reimbursement agreement, JC Land reimburses Alliance Coal for a portion of the compensation expense for its pilots. JC Land paid the ARLP Partnership $0.2 million in 2015 pursuant to this agreement.
Director Independence
As a publicly traded limited partnership listed on the NASDAQ Global Select Market, we are required to maintain a sufficient number of independent directors on the board of our general partner to satisfy the Audit Committee requirement set forth in NASDAQ Rule 4350(d)(2). Rule 4350(d)(2) requires us to maintain an Audit Committee of at least three members, each of whom must, among other requirements, be independent as defined under NASDAQ Rule 4200(a)(15) and meet the criteria for independence set forth in Rule 10A-3(b)(1) under the Exchange Act (subject to the exemptions provided in Rule 10A-3(c)).
All members of the Audit Committee of our general partner-Messrs. Torrence, Davidson and Druten-are independent directors as defined under applicable NASDAQ and Exchange Act rules. Please see “Item 10. Directors, Executive Officers and Corporate Governance of the Managing General Partner-Audit Committee.”
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The firm of Ernst & Young LLP is our independent registered public accounting firm. The following table sets forth fees paid to Ernst & Young LLP during the years ended December 31, 2015 and 2014:
(1) Audit fees consist primarily of the audit and quarterly reviews of the consolidated financial statements, but can also be related to statutory audits of subsidiaries required by governmental or regulatory bodies, attestation services required by statute or regulation, comfort letters, consents, assistance with and review of documents filed with the SEC, work performed by tax professionals in connection with the audit and quarterly reviews, and accounting and financial reporting consultations and research work necessary to comply with GAAP.
(2) Audit-related fees include fees related to acquisition due diligence and accounting consultations.
(3) Tax fees consist primarily of services rendered for tax compliance, tax advice, and tax planning.
In addition, ARLP paid audit, audit-related and tax fees of $1.3 million and $1.2 million for the years ended December 31, 2015 and 2014, respectively.
The charter of the Audit Committee provides that the committee is responsible for the pre-approval of all auditing services and permitted non-audit services to be performed for us by our independent registered public accounting firm, subject to the requirements of applicable law. In accordance with such charter, the Audit Committee may delegate the authority to grant such pre-approvals to the Audit Committee chairman or a sub-committee of the Audit Committee, which pre-approvals are then reviewed by the full Audit Committee at its next regular meeting. Typically, however, the Audit Committee itself reviews the matters to be approved. The Audit Committee periodically monitors the services rendered by and actual fees paid to the independent registered public accounting firm to ensure that such services are within the parameters approved by the Audit Committee.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1)
Financial Statements.
The response to this portion of Item 15 is submitted as a separate section herein under Item 8. Financial Statements and Supplementary Data.
(a)(2)
Financial Statement Schedule.
Schedule II-Valuation and Qualifying Accounts-Years ended December 31, 2015, 2014 and 2013, is set forth under Item 8. Financial Statements and Supplementary Data. All other schedules are omitted because they are not applicable or the information is shown in the financial statements or notes thereto.
(a)(3) and (c)
The exhibits listed below are filed as part of this annual report.
* Filed herewith (or furnished, in case of Exhibits 32.1 and 32.2).
(1) Denotes Alliance Resource Partners, L.P. filings.
(2) Denotes management contract or compensatory plan or arrangement.
(3) Portions of this exhibit have been omitted pursuant to a request for confidential treatment under Rule 24b-2 of the Exchange Act, as amended, and the omitted material has been separately filed with the SEC.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in Tulsa, Oklahoma, on February 26, 2016.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Joseph W. Craft III
Joseph W. Craft III
President, Chief Executive Officer,
and Director (Principal Executive Officer)
February 26, 2016
/s/ Brian L. Cantrell
Brian L. Cantrell
Senior Vice President and
Chief Financial Officer (Principal Financial and Accounting Officer)
February 26, 2016
/s/ Wilson M. Torrence
Wilson M. Torrence
Director
February 26, 2016
/s/ Thomas M. Davidson
Thomas M. Davidson
Director
February 26, 2016
/s/ Robert J. Druten
Robert J. Druten
Director
February 26, 2016