NRP

Business Context and Reporting Period

Natural Resource Partners L.P. (NRP) is a master limited partnership formed in April 2002 and commenced operations on October 17, 2002, following an initial public offering (IPO). The company owns and manages coal properties in Appalachia, the Illinois Basin, and the Western United States. NRP does not operate mines; instead, it leases coal reserves to third-party operators in exchange for royalty payments. As of December 31, 2002, NRP controlled approximately 1.23 billion tons of proven and probable coal reserves.

Reporting Period: The filing covers the fiscal year ended December 31, 2002. However, consolidated financial results for NRP are presented only for the period from the commencement of operations (October 17, 2002) through December 31, 2002 (approximately 2.5 months). Historical data for predecessor entities (WPP Group, Arch Coal Contributed Properties) is provided for full-year comparisons.

Key Financial Metrics

Predecessor Performance (Full Year 2002 vs 2001): For the properties contributed to NRP, coal royalty revenues increased 19% to $49.6 million in 2002 compared to $41.8 million in 2001. Production increased 5.2% to 30.5 million tons.

Material Changes

• Initial Public Offering: NRP completed its IPO on October 17, 2002, issuing 2,598,750 common units at $20.00 per unit, raising net proceeds of approximately $48.4 million. Arch Coal also sold 1,901,250 units.
• Major Acquisition: On December 4, 2002, NRP acquired mineral rights to approximately 120 million tons of coal reserves from El Paso Corporation for $57 million in cash. This acquisition was funded entirely by borrowings under a new revolving credit facility.
• Debt Assumption and Repayment: NRP assumed $46.5 million of debt from the WPP Group, which was repaid using IPO proceeds. Subsequently, NRP borrowed $57.5 million to fund the El Paso acquisition.
• Production Growth: Compared to the prior year, production from contributed properties increased primarily due to new mines coming online (e.g., West Fork, Welch/Wyoming) and increased activity at existing properties (e.g., Eunice, Dorothy), partially offset by declines at Western Energy and Rockhouse properties.

Guidance, Outlook, and Risks

Outlook and Management Commentary:

• Acquisition Strategy: NRP is actively pursuing additional property acquisitions and is in discussions to increase its $100 million revolving credit facility to fund these deals.
• Distributions: The partnership declared a cash distribution of $0.4234 per unit for the period from IPO to year-end, paid in February 2003. Management intends to increase distributions in the future assuming increased available cash from operations and acquisitions.
• Market Conditions: Management noted that spot coal prices increased about 10% recently due to colder weather and increased electricity demand, though much of the production is under long-term contracts.

Risks and Contingencies:

• Regulatory Litigation: Significant litigation regarding "mountaintop mining" and valley fills (e.g., Kentuckians for the Commonwealth v. Rivenburgh) poses a risk to lessees' ability to obtain permits. While a recent appellate ruling favored the lessees, further review is possible.
• Concentration Risk: NRP depends on a limited number of major lessees (Arch Coal, Massey Energy, Peabody Coal) for a significant portion of revenues. The loss of a major lessee could have a material adverse effect.
• Environmental Liability: While lessees are responsible for environmental compliance and reclamation, NRP could be held liable if lessees fail to meet obligations and bonding companies fail to cover costs.
• Interest Rate Risk: NRP has $57.5 million in variable-rate debt. A 100 basis point increase in LIBOR would increase annual interest expense by approximately $575,000.

Investor Verification Checklist

• Debt Covenants: Verify compliance with the revolving credit facility covenants, specifically the consolidated indebtedness to EBITDA ratio (max 2.5:1) and EBITDA to interest expense ratio (min 4.0:1).
• El Paso Acquisition Integration: Confirm the operational status and royalty generation of the 120 million tons of reserves acquired from El Paso in December 2002.
• Regulatory Status: Monitor the status of the Kentuckians for the Commonwealth litigation and any new environmental regulations affecting valley fill permits in West Virginia and Kentucky.
• Lessee Concentration: Review the financial health and production schedules of the top three lessees (Arch Coal, Massey Energy, Peabody Coal), which collectively account for a significant majority of revenue.
• Subordinated Unit Conversion: Track the conditions required for the conversion of subordinated units to common units, which depends on meeting minimum distribution targets over specific periods.