NRP (GP) LP
REPORT OF INDEPENDENT AUDITORS
To NRP (GP) LP
We have audited the accompanying consolidated balance sheet of NRP (GP) LP
as of December 31, 2002. This financial statement is the responsibility of NRP
(GP) LP's management. Our responsibility is to express an opinion on this
financial statement based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the balance sheet is free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statement. 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 audit provides a reasonable basis for our
opinion.
In our opinion, the balance sheet referred to above presents fairly, in all
material respects, the financial position of NRP (GP) LP as of December 31, 2002
in conformity with accounting principles generally accepted in the United
States.
ERNST & YOUNG LLP
March 13, 2003
Houston, Texas
NRP (GP) LP
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
DECEMBER 31, 2002
<Table>
<Caption>
ASSETS
Current assets:
Cash and cash equivalents ................................... $ 7,754
Accounts receivable ......................................... 7,593
Accounts receivable - affiliate ............................. 1,450
Other ....................................................... 511
---------
Total current assets ...................................... 17,308
Property and equipment, at cost ................................. 433,430
Less accumulated depreciation and depletion ................. (59,243)
---------
Net property and equipment .................................. 374,187
Loan financing costs, net ....................................... 1,225
---------
Total assets .......................................... $ 392,720
=========
LIABILITIES AND PARTNERS' CAPITAL
Current liabilities:
Accounts payable ............................................ $ 735
Accounts payable - affiliate ................................ 667
Property and franchise taxes payable ........................ 1,731
Accrued interest ............................................ 200
---------
Total current liabilities ............................. 3,333
Deferred revenue ................................................ 13,252
Long-term debt .................................................. 57,500
Minority Interest ............................................... 311,968
Partners' capital:
Limited Partners' Capital ................................... 6,666
General partner's interest .................................. 1
---------
Total partners' capital ............................... 6,667
---------
Total liabilities and partners' capital ............... $ 392,720
=========
</Table>
The accompanying notes are an integral part of these financial statements.
NRP (GP) LP
NOTES TO CONSOLIDATED BALANCE SHEET
1. BASIS OF PRESENTATION AND ORGANIZATION
NRP (GP) LP (the "Partnership") is a Delaware limited partnership formed on
April 9, 2002 by GP Natural Resource Partners LLC, as the general partner, and
by Western Pocahontas Properties Limited Partnership ("WPP"), Great Northern
Properties Limited Partnership ("GNP"), New Gauley Coal Corporation ("NGCC"),
and Ark Land Company, an affiliate of Arch Coal, Inc., as limited partners, to
be the general partner of Natural Resource Partners L.P ("NRP").
On April 15, 2002 GP Natural Resource Partners LLC contributed $1, and the
limited partners contributed a total of $999 to the Partnership in exchange for
0.001% general partner interest and an aggregate 99.999% limited partner
interest respectively.
Natural Resource Partners L.P., a Delaware limited partnership, was formed
in April 2002 to own and manage certain coal royalty producing properties
contributed to the Partnership by WPP, GNP, NGCC and Arch Coal, Inc.
(collectively "predecessors" or "predecessors companies"). The predecessor
companies contributed assets to NRP on October 17, 2002.
The chief executive officer of the Partnership's general partner controls
the general partners of WPP and GNP and is the controlling shareholder of NGCC.
He also controls the Partnership. In accordance with EITF 87-19, "Change of
Accounting Basis in Master Limited Partnership Transactions," the assets of WPP,
GNP and NGCC were contributed to NRP at historical costs. The assets contributed
by Arch Coal, Inc., which consisted solely of land and coal reserves, were
recorded at their fair values.
As the general partner of NRP, the Partnership engages principally in the
business of owning and managing coal properties in the three major
coal-producing regions of the United States: Appalachia, the Illinois Basin and
the Western United States. As of December 31, 2002, NRP controlled approximately
1.23 billion tons of proven and probable coal reserves in eight states. NRP does
not operate any mines. NRP leases coal reserves, through its wholly owned
subsidiary, NRP (Operating) LLC, to experienced mine operators under long-term
leases that grant the operators the right to mine NRP's coal reserves in
exchange for royalty payments. NRP's lessees are generally required to make
payments to NRP based on the higher of a percentage of the gross sales price or
a fixed price per ton of coal sold, in addition to a minimum payment.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The financial statements include the accounts of the Partnership and
consolidated accounts of NRP due to the Partnership's control over NRP.
Intercompany transactions and balances have been eliminated.
USE OF ESTIMATES
Preparation of the accompanying balance sheet in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities in the balance sheet. Actual results could differ from those
estimates.
PROPERTY AND EQUIPMENT
Land and coal property are carried at historical cost for properties
contributed to NRP by WPP, GNP and NGCC. The coal properties contributed by Arch
Coal Inc. have been accounted for using purchase accounting based on their
estimated fair value.
ASSET IMPAIRMENT
If facts and circumstances suggest that a long-lived asset may be impaired,
the carrying value is reviewed. If this review indicates that the value of the
asset will not be recoverable, as determined based on projected undiscounted
cash flows related to the asset over its remaining life, then the carrying value
of the asset is reduced to its estimated fair value.
CONCENTRATION OF CREDIT RISK
Substantially all of the Partnership's accounts receivable result from
amounts due from third-party companies in the coal industry. This concentration
of customers may affect the Partnership's overall credit risk, either positively
or negatively, in that these entities may be similarly affected by changes in
economic or other conditions. Receivables are generally not collateralized.
Historical credit losses incurred by the Partnership on receivables have not
been significant.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Partnership's financial instruments consist of cash and cash
equivalents, accounts receivable, accounts payable and long-term debt. The
carrying value of these financial instruments approximate fair value, due to
their short-term nature or variable interest rates that reflect market rates.
DEFERRED FINANCING COSTS
Deferred financing costs consists of legal and other costs related to the
issuance of the Partnership's revolving credit facility. These costs are
amortized over the term of the facility.
NEW ACCOUNTING STANDARDS
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 requires that the fair value of a liability for an
asset retirement obligation be recognized in the period in which it is incurred
with the associated asset retirement cost being capitalized as a part of the
carrying amount of the long-lived asset. SFAS No. 143 also includes disclosure
requirements that provide a description of asset retirement obligations and a
reconciliation of changes in the components of those obligations. Adoption of
SFAS No. 143 on January 1, 2003 did not have a material impact on the
Partnership's financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." SFAS No. 144 addresses the accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" and APB Opinion No. 30, "Reporting the
Results of Operations -- Reporting the Effects of the Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." The objective of SFAS No. 144 is to establish one accounting
model for long-lived assets to be disposed of by sale as well as resolve
implementation issues related to SFAS No. 121. The adoption of SFAS No. 144,
effective January 1, 2002, did not have a material impact on the Partnership's
financial position or results of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which supersedes EITF No. 94-3, "Liability
Recognition for Certain Employment Termination Benefits and Other Costs to Exit
an Activity." SFAS No. 146 requires companies to record liabilities for costs
associated with exit or disposal activities to be recognized only when the
liability is incurred instead of at the date of commitment to an exit or
disposal activity. Adoption of this standard is effective for exit or disposal
activities that are initiated after December 31, 2002. The adoption of this
standard is not expected to have a significant impact on the Partnership's
financial statements.
3. ACQUISITION
On December 4, 2002, NRP purchased the land and mineral rights to
approximately 120 million tons of coal and 25,000 acres of surface land for
$57.5 million, including transaction costs, from certain subsidiaries of El Paso
Corporation. El Paso Corporation retained an overriding royalty interest in
certain assets. The acquisition was funded with NRP's revolving credit facility.
The factors used in determining the fair market value of the assets
included, but were not limited to, discounted future net cash flows, the quality
of the reserves, the probability of continued coal mining on the property, and
marketability of the coal.
The results of operations of this transaction were included in the
Partnership's consolidated financial statements since December 4, 2002.
4. PROPERTY AND EQUIPMENT
Property and equipment includes:
<Table>
<Caption>
DECEMBER 31,
2002
(IN THOUSANDS)
--------------
Land.................................................... $ 13,532
Coal properties......................................... 411,434
Other................................................... 8,464
---------
$ 433,430
=========
</Table>
5. REVOLVING CREDIT FACILITY
At December 31, 2002, NRP had borrowed $57.5 million on its $100 million
revolving credit facility. NRP has a $100 million unsecured revolving credit
facility, which matures in October 2005, when all principal payments are due in
full. The revolving credit facility allows NRP to elect the interest rate at (i)
LIBOR plus an applicable margin ranging from 1.25% to 1.75%, based on certain
financial data or (ii) the higher of the federal funds rate plus 0.50% or the
prime rate as announced by the agent bank. The revolving credit facility bore
interest at a rate of 2.72% at December 31, 2002. The revolving credit facility
includes a $12 million distribution loan sub-limit that can be used for
quarterly distributions. The financial covenants require NRP to maintain a ratio
of consolidated total indebtedness to consolidated EBITDA (as defined in the
credit agreement) that does not exceed 2.5 to 1.0 and a ratio of consolidated
EBITDA to consolidated interest expense of at least 4.0 to 1.0. NRP is currently
in compliance with all of the covenants of the revolving credit facility.
6. RELATED PARTY TRANSACTIONS
Quintana Mineral Resources Corporation, a company controlled by Corbin J.
Robertson, Jr., Chairman and CEO of the Partnership's general partner, provided
certain administrative services to NRP and charged it for direct costs related
to the administrative services. Additionally, WPP provides certain
administrative services for NRP and allocated a portion of its overhead to NRP
in 2002.
At December 31, 2002, NRP had accounts receivable from affiliates of $1.4
million due from Arch Coal, Inc. which is primarily made up of $436,000 in
minimum royalty payments received by Arch Coal, Inc. that were due to NRP and a
$839,000 advance rental payment from the Pardee lease. NRP also had accounts
payable to affiliates of $667,000, which includes overhead reimbursements to
Quintana Minerals Corporation and Western Pocahontas Properties of $135,000 and
$256,000, respectively, as well as $276,000 for coal royalties received by NRP
from lessees that were due to Western Pocahontas Properties.
7. COMMITMENTS AND CONTINGENCIES
LEGAL
The Partnership is involved, from time to time, in various legal proceedings
arising in the ordinary course of business. While the ultimate results of these
proceedings cannot be predicted with certainty, Partnership management believes
these claims will not have a material effect on the Partnership's financial
position, liquidity or operations.
Environmental Compliance
The operations conducted on NRP's properties by its lessees are subject to
environmental laws and regulations adopted by various governmental authorities
in the jurisdictions in which these operations are conducted. As owner of
surface interests in some properties, NRP and the Partnership may be liable for
certain environmental conditions occurring at the surface properties. The terms
of substantially all of the NRP's coal leases require the lessee to comply with
all applicable laws and regulations, including environmental laws and
regulations. Lessees post reclamation bonds assuring that reclamation will be
completed as required by the relevant permit, and substantially all of the
leases require the lessee to indemnify NRP against, among other things,
environmental liabilities. Some of these indemnifications survive the
termination of the lease. Because NRP has no employees, Western Pocahontas
employees make regular visits to the mines to ensure compliance with lease
terms, but the duty to comply with all regulations rests with the lessees.
Management believes that NRP's lessees will be able to comply with existing
regulations and does not expect any lessee's failure to comply with
environmental laws and regulations to have a material impact on the
Partnership's financial condition or results of operations. Neither the
Partnership nor NRP has incurred, or is aware of, any material environmental
charges imposed on it related to NRP's properties for the period ended December
31, 2002. NRP is not associated with any environmental contamination that may
require remediation costs. However, lessees do, from time to time, conduct
reclamation work on the properties under lease to them. Because NRP is not the
permittee of the mines being reclaimed, it is not responsible for the costs
associated with these reclamation operations. However, in the event any of NRP's
lessees are unable to complete its reclamation obligations and their bonding
company likewise fails to meet the obligations or provide money to the state to
perform the reclamation, NRP could be held liable for these costs. NRP is also
indemnified by WPP, GNP, NGCC and Arch Coal Inc., jointly and severally, for
three years after the closing of the initial public offering against
environmental and tax liabilities attributable to the ownership and operation of
the assets contributed to NRP prior to the closing. The environmental indemnity
is limited to a maximum of $10.0 million.
8. MAJOR LESSEES
The Partnership depends on a few lessees of NRP for a significant portion of
its revenues. Revenues from major lessees that exceed ten percent of total
revenues are as follows:
<Table>
<Caption>
COMMENCEMENT OF
OPERATIONS (OCTOBER
17, 2002) THROUGH
DECEMBER 31, 2002
REVENUES PERCENT
-------- -------
(DOLLARS IN
THOUSANDS)
Lessee A.................................. $1,815 13.1%
Lessee B.................................. $2,120 15.3%
Lessee C.................................. $1,994 14.4%
</Table>
9. INCENTIVE PLAN
Prior to NRP's initial public offering, GP Natural Resource Partners LLC,
the general partner of the Partnership, adopted the Natural Resource Partners
Long-Term Incentive Plan (the "Plan") for employees and directors of GP Natural
Resource Partners LLC and its affiliates who perform services for NRP. The Plan
provides for the granting of restricted units and unit options. The Plan permits
the granting of awards covering a number of common units equal to three percent
of the number of common units outstanding immediately following NRP's initial
public offering of common units. The Plan is administered by the compensation
committee of GP Natural Resource Partners LLC's board of directors. Subject to
the rules of the exchange upon which the common units are listed at the time, GP
Natural Resource Partners LLC's board of directors or the compensation committee
also has the right to alter or amend the Plan or any part of the Plan from time
to time, including increasing the number of units that may be granted. Except
upon the occurrence of unusual or nonrecurring events, no change in any
outstanding grant may be made that would materially reduce the benefit intended
to be made available to a participant without the consent of the participant.
A restricted unit is a "phantom" unit that entitles the grantee to receive
a common unit upon the vesting of the phantom unit or, in the discretion of the
compensation committee, its fair market value in cash. The compensation
committee may make grants under the Plan to employees and directors containing
such terms as the compensation committee shall determine. The compensation
committee will determine the period over which the restricted units granted to
employees and directors will vest. The committee may provide for an acceleration
of vesting based upon the achievement of specified financial objectives. In
addition, the restricted units will vest upon a change in control of the
Partnership, NRP, or GP Natural Resource Partners LLC.
If a grantee's employment or membership on the board of directors
terminates for any reason, the grantee's restricted units will be automatically
forfeited unless, and to the extent, the compensation committee provides
otherwise. Common units to be delivered upon the vesting of restricted units may
be common units acquired by GP Natural Resource Partners LLC in the open market,
common units already owned by GP Natural Resource Partners LLC, common units
acquired by GP Natural Resource Partners LLC directly from NRP, from another
affiliate or any other person or entity or any combination thereof. GP Natural
Resource Partners LLC will be entitled to reimbursement by NRP for the cost
incurred in acquiring common units.
Unit options under the Plan will have an exercise price that may not be
less than the fair market value of the units on the date of grant. In general,
units will become exercisable over a period determined by the compensation
committee. The compensation committee may provide for an acceleration of vesting
based upon the achievement of specified financial objectives. In addition, the
units will become exercisable upon a change in control as described for
restricted units above. If a grantee's employment or membership on the board of
directors terminates for any reason, the grantee's options will be automatically
forfeited unless, and to the extent, the compensation committee provides
otherwise. Upon exercise of a unit option, GP Natural Resource Partners LLC will
acquire common units as describe above for restricted units.
The Natural Resource Partners Annual Incentive Compensation Plan (the
"Compensation Plan") was adopted in October 2002. The Compensation Plan is
designed to enhance the performance of GP Natural Resource Partners LLC and its
affiliates' key employees by rewarding them with cash awards for achieving
annual financial and operational performance objectives. The compensation
committee in its discretion may determine individual participants and payments,
if any, for each year. The board of directors of GP Natural Resource Partners
LLC may amend or change the Compensation Plan at any time. NRP will reimburse GP
Natural Resource Partners LLC for payments and costs incurred under the
Compensation Plan.
10. SUBSEQUENT EVENT
Cash Distributions
On January 21, 2003, NRP declared a cash distribution of $0.4234 per unit.
Total distributions of $9.8 million were paid on February 14, 2003.