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EX-95 - Royal Energy Resources, Inc.ex95.htm
EX-32.2 - Royal Energy Resources, Inc.ex32-2.htm
EX-32.1 - Royal Energy Resources, Inc.ex32-1.htm
EX-31.2 - Royal Energy Resources, Inc.ex31-2.htm
EX-31.1 - Royal Energy Resources, Inc.ex31-1.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended: September 30, 2017

 

or

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from:

 

Royal Energy Resources, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   000-52547   11-3480036
(State or Other Jurisdiction of   (Commission   (I.R.S. Employer
Incorporation or Organization)   File Number)   Identification No.)

 

56 Broad Street, Suite 2, Charleston, SC 29401

(Address of Principal Executive Offices) (Zip Code)

 

843-900-7693

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [  ] No [X]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, emerging growth company or a smaller reporting company.

 

  Large accelerated filer [  ] Accelerated filer [X] Non-accelerated filer [  ] Smaller reporting company [  ]
         
  Emerging growth company [  ]    

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Securities Act. [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [  ] No [X]

 

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 18,079,293 shares of common stock issued and outstanding as of November 8, 2017.

 

 

 

   

 

 

TABLE OF CONTENTS

 

  Page
PART I – FINANCIAL INFORMATION 4
     
ITEM 1: Financial Statements 4
     
ITEM 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations 31
     
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk 60
     
ITEM 4: Controls and Procedures 60
     
PART II - OTHER INFORMATION 61
     
Item 1: Legal Proceedings 61
     
ITEM 1A: Risk Factors 61
     
ITEM 2: Unregistered Sales of Equity Securities and Use of Proceeds 61
     
ITEM 3: Defaults upon Senior Securities. 61
     
ITEM 4: Mine Safety Disclosures. 62
     
ITEM 5: Other Information. 62
     
ITEM 6: Exhibits 62
     
SIGNATURES 63

 

2

 

 

Cautionary Note Regarding Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains certain “forward-looking statements.” Statements included in this report that are not historical facts, that address activities, events or developments that we expect or anticipate will or may occur in the future, including things such as statements regarding our future financial position, expectations with respect to our liquidity, capital resources and ability to continue as a going concern, plans for growth of the business, future capital expenditures, references to future goals or intentions or other such references are forward-looking statements. These statements can be identified by the use of forward-looking terminology, including “may,” “believe,” “expect,” “anticipate,” “estimate,” “continue,” or similar words. These statements are made by us based on our experience and our perception of historical trends, current conditions and expected future developments as well as other considerations we believe are reasonable as and when made. Whether actual results and developments in the future will conform to our expectations is subject to numerous risks and uncertainties, many of which are beyond our control. Therefore, actual outcomes and results could materially differ from what is expressed, implied or forecasted in these statements.

 

Any differences could be caused by a number of factors, including, but not limited to: our ability to maintain adequate cash flow and to obtain financing necessary to fund our capital expenditures, meet working capital needs and maintain and grow our operations or our ability to obtain alternative financing upon the expiration of our amended and restated senior secured credit facility and our related ability to continue as a going concern; our future levels of indebtedness and compliance with debt covenants; sustained depressed levels of or further decline in coal prices, which depend upon several factors such as the supply of domestic and foreign coal, the demand for domestic and foreign coal, governmental regulations, price and availability of alternative fuels for electricity generation and prevailing economic conditions; declines in demand for electricity and coal; current and future environmental laws and regulations, which could materially increase operating costs or limit our ability to produce and sell coal; extensive government regulation of mine operations, especially with respect to mine safety and health, which imposes significant actual and potential costs; difficulties in obtaining and/or renewing permits necessary for operations; a variety of operating risks, such as unfavorable geologic conditions, adverse weather conditions and natural disasters, mining and processing equipment unavailability, failures and unexpected maintenance problems and accidents, including fire and explosions from methane; poor mining conditions resulting from the effects of prior mining; the availability and costs of key supplies and commodities such as steel, diesel fuel and explosives; fluctuations in transportation costs or disruptions in transportation services, which could increase competition or impair our ability to supply coal; a shortage of skilled labor, increased labor costs or work stoppages; our ability to secure or acquire new or replacement high-quality coal reserves that are economically recoverable; material inaccuracies in our estimates of coal reserves and non-reserve coal deposits; existing and future laws and regulations regulating the emission of sulfur dioxide and other compounds, which could affect coal consumers and reduce demand for coal; federal and state laws restricting the emissions of greenhouse gases; our ability to acquire or failure to maintain, obtain or renew surety bonds used to secure obligations to reclaim mined property; our dependence on a few customers and our ability to find and retain customers under favorable supply contracts; changes in consumption patterns by utilities away from the use of coal, such as changes resulting from low natural gas prices; changes in governmental regulation of the electric utility industry; defects in title in properties that we own or losses of any of our leasehold interests; our ability to retain and attract senior management and other key personnel; material inaccuracy of assumptions underlying reclamation and mine closure obligations; and weakness in global economic conditions. Other factors that could cause our actual results to differ from our projected results are described elsewhere in (1) this Form 10-Q, (2) our Annual Report on Form 10-K for the year ended December 31, 2016, (3) our reports and registration statements filed from time to time with the Securities and Exchange Commission and (4) other announcements we make from time to time. In addition, we may be subject to unforeseen risks that may have a materially adverse effect on us. Accordingly, no assurances can be given that the actual events and results will not be materially different from the anticipated results described in the forward-looking statements.

 

The forward-looking statements speak only as of the date made, and, other than as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

3

 

 

PART I.—FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

ROYAL ENERGY RESOURCES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

(in thousands)

 

   September 30, 2017   December 31, 2016 
   (Unaudited)   (Audited) 
ASSETS          
CURRENT ASSETS:          
Cash and cash equivalents  $1,416   $86 
Accounts receivable, less allowance for bad debts of $0 as of September 30, 2017 and December 31, 2016   18,467    13,893 
Inventories   11,334    8,050 
Advance royalties, current portion   653    898 
Investment in available for sale securities   9,590    3,532 
Prepaid expenses and other   4,653    4,929 
Total current assets   46,113    31,388 
PROPERTY, PLANT AND EQUIPMENT:          
At cost, including coal properties, mine development and construction costs   247,789    69,684 
Less accumulated depreciation, depletion and amortization   (41,030)   (4,572)
Net property, plant and equipment   206,759    65,112 
Advance royalties, net of current portion   7,847    7,652 
Investment in unconsolidated affiliates   130    5,121 
Intangible purchase option   21,750    21,750 
Goodwill   -    7,594 
Intangible assets, less accumulated amortization of $101 and $67, respectively   -    34 
Other non-current assets   27,694    27,591 
TOTAL  $310,293   $166,242 
LIABILITIES AND EQUITY          
CURRENT LIABILITIES:          
Accounts payable   11,954    10,447 
Accrued expenses and other   12,435    11,405 
Accrued preferred distributions   4,118    - 
Notes payable-related party   504    504 
Current portion of long-term debt   9,940    12,040 
Current portion of asset retirement obligations   917    917 
Related party advance and accrued interest payable   42    71 
Total current liabilities   39,910    35,384 
NON-CURRENT LIABILITIES:          
Deferred tax liability   43,396    - 
Long-term debt, net of current portion   2,500    - 
Asset retirement obligations, net of current portion   20,497    26,503 
Other non-current liabilities   40,319    39,073 
Total non-current liabilities   106,712    65,576 
Total liabilities   146,622    100,960 
COMMITMENTS AND CONTINGENCIES (NOTE 16)          
STOCKHOLDERS’ EQUITY          
Preferred stock: $0.00001 par value; authorized 5,000,000 shares; 51,000 issued and outstanding at September 30, 2017 and authorized 10,000,000 shares; 51,000 issued and outstanding at December 31, 2016.          
Common stock: $0.00001 par value; authorized 25,000,000 shares; 18,079,293 shares issued and outstanding at September 30, 2017 and authorized 500,000,000; 17,212,278 shares issued and outstanding at December 31, 2016.   1    1 
Additional paid-in capital   46,861    47,295 
Stock subscription receivable   -    (213)
Accumulated other comprehensive income   1,440    874 
Treasury Stock   (4,126)   - 
Retained earnings (accumulated deficit)    90,415    (20,579)
Total stockholders’ equity owned by common shareholders   134,591    27,378 
Non-controlling interest   29,080    37,904 
Total stockholders’ equity owned by common shareholders   163,671    65,282 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $310,293   $166,242 

 

See notes to unaudited condensed consolidated financial statements.

 

4

 

 

ROYAL ENERGY RESOURCES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND

COMPREHENSIVE INCOME

(in thousands, except per unit data)

 

   Three Months   Nine Months 
   Ended September 30,   Ended September 30, 
   2017   2016   2017   2016 
REVENUES:                    
Coal sales  $56,460   $40,992   $162,951   $86,675 
Freight and handling revenues   220    424    537    1,106 
Other revenues   1,666    1,999    4,944    3,406 
Total revenues   58,346    43,415    168,432    91,187 
COSTS AND EXPENSES:                    
Cost of operations (exclusive of depreciation, depletion and amortization shown separately below)   46,376    35,249    137,898    72,648 
Freight and handling costs   1,518    385    2,516    988 
Depreciation, depletion and amortization   6,954    1,639    37,071    3,029 
Selling, general and administrative (exclusive of depreciation, depletion and amortization shown separately above)   3,133    4,717    9,804    11,520 
Loss on sale/disposal of assets—net   (45)   (100)   25    (125)
Total costs and expenses   57,936    41,890    187,314    88,060 
INCOME/(LOSS) FROM OPERATIONS   410    1,525    (18,882)   3,127 
INTEREST AND OTHER INCOME/(EXPENSE):                    
Interest income                    
Other   86    (54)   87    (17)
Related party   -    2    0    5 
Interest expense                    
Other   (1,079)   (1,958)   (3,307)   (4,054)
Related Party   (89)   (3)   (95)   (9)
Gain on extinguishment of debt   -    1,663    -    1,663 
Equity in net (loss)/income of unconsolidated affiliates   -    (27)   35    (92)
Gain on bargain purchase   -    -    171,151    - 
Total interest and other (expense)/income   (1,082)   (377)   167,871    (2,504)
NET (LOSS)/INCOME BEFORE INCOME TAXES FROM CONTINUING OPERATIONS   (672)   1,148    148,989    623 
INCOME TAXES   (635)   -    43,396    - 
NET (LOSS)/INCOME FROM CONTINUING OPERATIONS   (37)   1,148    105,593    623 
DISCONTINUED OPERATIONS (NOTE 4)                    
(Loss)/Income from discontinued operations   -    (70)   -    650 
NET (LOSS)/INCOME BEFORE NON-CONTROLLING INTEREST   (37)   1,078    105,593    1,273 
Less net (loss)/income attributable to non-controlling interest   (15)   166    (9,288)   196 
NET (LOSS)/INCOME ATTRIBUTABLE TO COMPANY’S STOCKHOLDERS   (22)   912    114,881    1,077 
Other comprehensive income:                    
Fair market value adjustment for available-for-sale investment   (990)   -    1,030    - 
Less comprehensive income attributable to non-controlling interest   (451)   -    464    - 
COMPREHENSIVE (LOSS)/INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS  $(561)  $912   $115,447   $1,077 
                     
Net (loss)/income per share, basic and diluted                    
Continuing operations  $(0.00)  $0.06   $6.63   $0.03 
Discontinued operations   -    (0.00)   -    0.04 
   $(0.00)  $0.05   $6.63   $0.07 
                     
Weighted average shares outstanding, basic and diluted   17,725,230    16,699,036    17,325,596    15,624,438 

 

See notes to unaudited condensed consolidated financial statements.

 

5

 

 

ROYAL ENERGY RESOURCES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

   Nine Months Ended September 30, 
   2017   2016 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $105,593   $1,273 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation, depletion and amortization   37,071    3,754 
Accretion on asset retirement obligations   1,255    760 
Amortization of deferred revenue   -    (1,174)
Amortization of advance royalties   876    554 
Amortization of debt issuance costs   1,098    1,413 
Amortization of actuarial gain        (1)
Loss on retirement of advance royalties   136    31 
(Gain) on sale/disposal of assets—net   25    (125)
(Gain) on bargain purchase   (171,151)   - 
Loss on impairment of asset   -    2,000 
Equity in net loss of unconsolidated affiliates   (36)   53 
Equity-based compensation   260    489 
Value of common shares issued for services   250    - 
Accrued interest income-related party   -    5 
Accrued interest expense-related party   9    9 
Changes in assets and liabilities:          
Accounts receivable   (4,820)   (2,202)
Inventories   (3,284)   (3,366)
Advance royalties   (962)   (682)
Prepaid expenses and other assets   (1,784)   (829)
Accounts payable   1,211    332 
Accounts payable-related party   -    9 
Accrued expenses and other liabilities   2,916    960 
Deferred income taxes   43,396    - 
Asset retirement obligations   (34)   (91)
Net cash provided by operating activities   12,025    3,172 
CASH FLOWS FROM INVESTING ACTIVITIES:          
Investment in Rhino Resource Partners, LP   -    (4,500)
Investment in Blaze Mining royalty   -    150 
Note receivable-related party   -    (9)
Cash acquired in acquisitions   -    619 
Sale of Rhino preferred and common units   2,300    - 
Proceeds from sale of Elk Horn   890    10,650 
Additions to property, plant, and equipment   (14,306)   (3,385)
Proceeds from sales of property, plant, and equipment   404    7 
Net cash (used in)/provided by investing activities   (10,712)   3,532 
CASH FLOWS FROM FINANCING ACTIVITIES:          
Borrowings on line of credit   98,350    80,150 
Repayments on line of credit   (98,450)   (91,300)
Payments on debt issuance costs   (227)   (1,148)
Proceeds from related party loans   85    50 
NP Rhino converted to Royal Shares   -    - 
Repayments on loan   -    55 
Repayments of loans from related party   (2,000)   - 
Gain on extinguishment of debt   -    (1,663)
Restricted cash from Royal   -    (2,000)
Proceeds from issuance of common stock   120    1,183 
Repayment of notes payable and long-term debt   -    (1,210)
Proceeds from loan -Cedarview   2,150    - 
Proceeds from issuance of convertible notes   -    2,150 
Net cash provided by/(used in) financing activities   28    (13,733)
NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS   1,341    (7,029)
CASH AND CASH EQUIVALENTS—Beginning of period   75    7,104 
CASH AND CASH EQUIVALENTS—End of period  $1,416   $75 

 

See notes to unaudited condensed consolidated financial statements.

 

6

 

 

ROYAL ENERGY RESOURCES, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

September 30, 2017

 

(Unaudited)

 

1 BASIS OF PRESENTATION, ORGANIZATION AND GOING CONCERN

 

Basis of presentation

 

The accompanying unaudited condensed consolidated financial statements include the accounts of Royal Energy Resources, Inc. (the “Company,” “Royal,”) and its wholly owned subsidiaries Rhino GP LLC (“Rhino GP” or (“General Partner”), Blaze Minerals, LLC (“Blaze”), a West Virginia limited liability company, and Blue Grove Coal, LLC (“Blue Grove”), a West Virginia limited liability company (transferred to previous owners on July 1, 2017), and its majority owned subsidiary Rhino Resource Partners, LP (“Rhino” or the “Partnership”)(OTCQB:RHNO), a Delaware limited partnership. Rhino GP is the General Partner of Rhino. All significant intercompany balances and transactions have been eliminated in consolidation.

 

Unaudited Interim Financial Information—The accompanying unaudited interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. The condensed consolidated statement of financial position as of September 30, 2017, condensed consolidated statements of operations and comprehensive income for the three and nine months ended September 30, 2017 and 2016 and the condensed consolidated statements of cash flows for the nine months ended September 30, 2017 and 2016 include all adjustments (consisting of normal recurring adjustments) which the Company considers necessary for a fair presentation of the financial position, operating results and cash flows for the periods presented. The condensed consolidated statement of financial position as of December 31, 2016 was derived from audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S.”). These unaudited interim financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report for the year ended December 31, 2016 filed with the SEC on April 3, 2017.

 

The results of operations for the three and nine months ended September 30, 2017 are not necessarily indicative of the results to be expected for the entire year.

 

Organization and nature of business

 

Royal is a Delaware corporation which was incorporated on March 22, 1999, under the name Webmarketing, Inc. On July 7, 2004, the Company revived its charter and changed its name to World Marketing, Inc. In December 2007, the Company changed its name to Royal Energy Resources, Inc. Since 2007, the Company pursued gold, silver, copper and rare earth metal mining concessions in Romania and mining leases in the United States. Commencing in January 2015, the Company began a series of transactions to sell all of its existing assets, undergo a change in ownership control and management and repurpose itself as a North American energy recovery company, planning to purchase a group of synergistic, long-lived energy assets, but taking advantage of favorable valuations for mergers and acquisitions in the current energy markets. On April 13, 2015, the Company executed an agreement for the first acquisition in furtherance of its change in principal operations.

 

Blaze Minerals is the owner of 40,976 net acres of coal and coalbed methane mineral interest in 22 counties across West Virginia.

 

Blue Grove is a licensed mine operator based in McDowell County, West Virginia and is currently under contract to operate a mine owned by GS Energy, LLC.

 

7

 

 

As discussed further below, Royal obtained control of, and a majority limited partner interest, in Rhino on March 17, 2016. Rhino was formed on April 19, 2010 to acquire Rhino Energy LLC (the “Operating Company”). The Operating Company and its wholly owned subsidiaries produce and market coal from surface and underground mines in Illinois, Kentucky, Ohio, West Virginia, and Utah. The majority of Rhino’s sales are made to domestic utilities and other coal-related organizations in the United States.

 

Royal Energy Resources, Inc. Acquisition of Rhino

 

On January 21, 2016, a definitive agreement (“Definitive Agreement”) was completed between Royal and Wexford Capital LP and certain of its affiliates (collectively, “Wexford”) whereby Royal acquired 676,912 issued and outstanding common units of Rhino previously owned by Wexford for $3.5 million. The Definitive Agreement also included a commitment by Royal to acquire within sixty days from the date of the Definitive Agreement all of the issued and outstanding membership interests of Rhino GP, the General Partner of Rhino, as well as 945,526 issued and outstanding subordinated units of the Partnership owned by Wexford for $1.0 million.

 

On March 17, 2016, Royal completed the acquisition of all of the issued and outstanding membership interests of the General Partner, as well as 945,526 issued and outstanding subordinated units from Wexford. Royal obtained control of, and a majority limited partner interest, in the Partnership with the completion of this transaction.

 

On March 21, 2016, Royal and the Partnership entered into a securities purchase agreement (the “Securities Purchase Agreement”) pursuant to which the Partnership issued 6,000,000 common units to Royal in a private placement at $1.50 per common unit for an aggregate purchase price of $9.0 million. Royal paid the Partnership $2.0 million in cash and delivered a promissory note payable to Rhino in the amount of $7.0 million (the “Rhino Promissory Note”). The promissory note was payable in three installments: (i) $3.0 million on July 31, 2016; (ii) $2.0 million on or before September 30, 2016 and (iii) $2.0 million on or before December 31, 2016. On December 30, 2016, the Partnership modified the Rhino Promissory Note with Royal for the final $2.0 million payment due on or before December 31, 2016 to extend the due date to December 31, 2018 and to provide that it would be convertible into shares of Royal common stock at Royal’s election. On September 1, 2017, Royal elected to convert the Rhino Promissory Note to shares of Royal common stock. Please read “—Letter Agreement Regarding Rhino Promissory Note and Weston Promissory Note.”

 

As a result of these transactions, Rhino became a majority-owned subsidiary of Royal.

 

Option Agreement-Armstrong Energy

 

On December 30, 2016, the Partnership entered into an option agreement (the “Option Agreement”) with Royal, Rhino Resources Partners Holdings, LLC (“Rhino Holdings”), an entity wholly owned by certain investment partnerships managed by Yorktown Partners LLC (“Yorktown”), and the General Partner. Upon execution of the Option Agreement, the Partnership received an option (the “Call Option”) from Rhino Holdings to acquire substantially all of the outstanding common stock of Armstrong Energy, Inc. (“Armstrong Energy”) that is currently owned by investment partnerships managed by Yorktown, which currently represent approximately 97% of the outstanding common stock of Armstrong Energy. The Option Agreement stipulates that the Partnership can exercise the Call Option no earlier than January 1, 2018 and no later than December 31, 2019. In exchange for Rhino Holdings granting the Partnership the Call Option, the Partnership issued 5.0 million common units, representing limited partner interests in the Partnership (the “Call Option Premium Units”) to Rhino Holdings upon the execution of the Option Agreement. The Option Agreement stipulates the Partnership can exercise the Call Option and purchase the common stock of Armstrong Energy in exchange for a number of common units to be issued to Rhino Holdings, which when added with the Call Option Premium Units, will result in Rhino Holdings owning 51% of the fully diluted common units of the Partnership. The purchase of Armstrong Energy through the exercise of the Call Option would also require Royal to transfer a 51% ownership interest in the General Partner to Rhino Holdings. The Partnership’s ability to exercise the Call Option is conditioned upon (i) sixty (60) days having passed since the entry by Armstrong Energy into an agreement with its bondholders to restructure its bonds and (ii) the amendment of the Partnership’s revolving credit facility to permit the acquisition of Armstrong Energy. The percentage ownership of Armstrong Energy represented by the Armstrong shares as of the date the Call Option is exercised is subject to dilution based upon the terms under which Armstrong Energy restructures its indebtedness, the terms of which have not been determined yet.

 

8

 

 

The Option Agreement also contains an option (the “Put Option”) granted by the Partnership to Rhino Holdings whereby Rhino Holdings has the right, but not the obligation, to cause the Partnership to purchase substantially all of the outstanding common stock of Armstrong Energy from Rhino Holdings under the same terms and conditions discussed above for the Call Option. The exercise of the Put Option is dependent upon (i) the entry by Armstrong Energy into an agreement with its bondholders to restructure its bonds and (ii) the termination and repayment of any outstanding balance under the Partnership’s revolving credit facility. In the event either the Partnership or Rhino GP fail to perform their obligations in the event Rhino Holdings exercises the Put Option, then Rhino Holdings and the Partnership each have the right to terminate the Option Agreement, in which event no party thereto shall have any liability to any other party under the Option Agreement, although Rhino Holdings shall be allowed to retain the Call Option Premium Units.

 

The Option Agreement contains customary covenants, representations and warranties and indemnification obligations for losses arising from the inaccuracy of representations or warranties or breaches of covenants contained in the Option Agreement, the Seventh Amendment and the GP Amendment. Upon the request by Rhino Holdings, Rhino will also enter into a registration rights agreement that provides Rhino Holdings with the right to demand two shelf registration statements and registration statements on Form S-1, as well as piggyback registration rights for as long as Rhino Holdings owns at least 10% of the outstanding common units.

 

Pursuant to the Option Agreement, the Second Amended and Restated Limited Liability Company Agreement of our General Partner was amended (“GP Amendment”). Pursuant to the GP Amendment, Mr. Bryan H. Lawrence was appointed to the board of directors of the General Partner as a designee of Rhino Holdings and Rhino Holdings has the right to appoint an additional independent director. Rhino Holdings has the right to appoint two members to the board of directors of the General Partner for as long as it continues to own 20% of the common units on an undiluted basis. The GP Amendment also provided Rhino Holdings with the authority to consent to any delegation of authority to any committee of the board of the General Partner. Upon the exercise of the Call Option or the Put Option, the Second Amended and Restated Limited Liability Company Agreement of the General Partner, as amended, will be further amended to provide that Royal and Rhino Holdings will each have the ability to appoint three directors and that the remaining director will be the chief executive officer of the General Partner unless agreed otherwise.

 

On October 31, 2017, Armstrong Energy and its subsidiaries filed Chapter 11 petitions in the Eastern District of Missouri’s United States Bankruptcy Court. Per the Chapter 11 petitions, Armstrong Energy will file a detailed restructuring plan as part of the Chapter 11 proceedings. The Partnership is evaluating the Armstrong Energy Chapter 11 filing and any effect it may have on the Option Agreement. See Note 7 for further information on the Partnership’s assessment of the Call Option.

 

Series A Preferred Unit Purchase Agreement

 

On December 30, 2016, the Partnership entered into a Series A Preferred Unit Purchase Agreement (the “Preferred Unit Agreement”) with Weston Energy LLC (“Weston”), an entity wholly owned by certain investment partnerships managed by Yorktown, and Royal. Under the Preferred Unit Agreement, Weston and Royal agreed to purchase 1,300,000 and 200,000, respectively, of Series A preferred units representing limited partner interests in the Partnership (“Series A Preferred Units”) at a price of $10.00 per Series A preferred unit. The Series A preferred units have the preferences, rights and obligations set forth in the Fourth Amended and Restated Agreement of Limited Partnership of the Partnership, Weston and Royal paid cash of $11.0 million and $2.0 million, respectively, to the Partnership and Weston assigned to the Partnership a $2.0 million note receivable from Royal originally dated September 30, 2016 (the “Weston Promissory Note”). Please read “—Letter Agreement Regarding Rhino Promissory Note and Weston Promissory Note.”

 

The Preferred Unit Agreement contains customary representations, warrants and covenants, which include among other things, that, for as long as the Series A preferred units are outstanding, the Partnership will cause CAM Mining, LLC (“CAM Mining”), which comprises the Partnership’s Central Appalachia segment, to conduct its business in the ordinary course consistent with past practice and use reasonable best efforts to maintain and preserve intact its current organization, business and franchise and to preserve the rights, franchises, goodwill and relationships of its employees, customers, lenders, suppliers, regulators and others having business relationships with CAM Mining.

 

9

 

 

The Preferred Unit Agreement stipulates that upon the request of the holder of the majority of the Partnership’s common units following their conversion from Series A preferred units, as outlined in the Amended and Restated Partnership Agreement, the Partnership will enter into a registration rights agreement with such holder. Such majority holder has the right to demand two shelf registration statements and registration statements on Form S-1, as well as piggyback registration rights.

 

Letter Agreement Regarding Rhino Promissory Note and Weston Promissory Note

 

On December 30, 2016, the Partnership and Royal entered into a letter agreement whereby they extended the maturity dates of the Weston Promissory Note and the final installment payment of the Rhino Promissory Note to December 31, 2018. The letter agreement further provides that the aggregate $4.0 million balance of the Weston Promissory Note and Rhino Promissory Note may be converted at Royal’s option into a number of shares of Royal’s common stock equal to the outstanding balance multiplied by seventy-five percent (75%) of the volume-weighted average closing price of Royal’s common stock for the 90 days preceding the date of conversion (“Royal VWAP”), subject to a minimum Royal VWAP of $3.50 and a maximum Royal VWAP of $7.50. On September 1, 2017, Royal elected to convert the Rhino Promissory Note and the Weston Promissory Note into shares of Royal common stock. Royal issued 914,797 shares of its common stock to Rhino at a conversion price of $4.51 per share. See Note 12 for further discussion.

 

Fourth Amended and Restated Agreement of Limited Partnership of Rhino Resource Partners LP

 

On December 30, 2016, Rhino GP entered into the Fourth Amended and Restated Agreement of Limited Partnership of the Partnership (“Amended and Restated Partnership Agreement”) to create, authorize and issue the Series A Preferred Units.

 

The Series A preferred units are a new class of equity security that rank senior to all classes or series of equity securities of the Partnership with respect to distribution rights and rights upon liquidation. The holders of the Series A preferred units shall be entitled to receive annual distributions equal to the greater of (i) 50% of the CAM Mining free cash flow (as defined below) and (ii) an amount equal to the number of outstanding Series A preferred units multiplied by $0.80. “CAM Mining free cash flow” is defined in the Amended and Restated Partnership Agreement as (i) the total revenue of the Partnership’s Central Appalachia business segment, minus (ii) the cost of operations (exclusive of depreciation, depletion and amortization) for the Partnership’s Central Appalachia business segment, minus (iii) an amount equal to $6.50, multiplied by the aggregate number of met coal and steam coal tons sold by the Partnership from its Central Appalachia business segment. If the Partnership fails to pay any or all of the distributions in respect of the Series A preferred units, such deficiency will accrue until paid in full and the Partnership will not be permitted to pay any distributions on its Partnership interests that rank junior to the Series A preferred units, including its common units. The Series A preferred units will be liquidated in accordance with their capital accounts and upon liquidation will be entitled to distributions of property and cash in accordance with the balances of their capital accounts prior to such distributions to equity securities that rank junior to the Series A preferred units.

 

The Series A preferred units will vote on an as-converted basis with the common units, and the Partnership will be restricted from taking certain actions without the consent of the holders of a majority of the Series A preferred units, including: (i) the issuance of additional Series A preferred units, or securities that rank senior or equal to the Series A preferred units; (ii) the sale or transfer of CAM Mining or a material portion of its assets; (iii) the repurchase of common units, or the issuance of rights or warrants to holders of common units entitling them to purchase common units at less than fair market value; (iv) consummation of a spin off; (v) the incurrence, assumption or guaranty of indebtedness for borrowed money in excess of $50.0 million except indebtedness relating to entities or assets that are acquired by the Partnership or its affiliates that is in existence at the time of such acquisition or (vi) the modification of CAM Mining’s accounting principles or the financial or operational reporting principles of the Partnership’s Central Appalachia business segment, subject to certain exceptions.

 

The Partnership will have the option to convert the outstanding Series A preferred units at any time on or after the time at which the amount of aggregate distributions paid in respect of each Series A preferred unit exceeds $10.00 per unit. Each Series A preferred unit will convert into a number of common units equal to the quotient (the “Series A Conversion Ratio”) of (i) the sum of $10.00 and any unpaid distributions in respect of such Series A Preferred Unit divided by (ii) 75% of the volume-weighted average closing price of the common units for the preceding 90 trading days (the “VWAP”); provided however, that the VWAP will be capped at a minimum of $2.00 and a maximum of $10.00. On December 31, 2021, all outstanding Series A preferred units will convert into common units of the Partnership at the then applicable Series A Conversion Ratio.

 

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Debt Classification— Rhino evaluated its amended and restated senior secured credit facility at September 30, 2017 to determine whether this debt liability should be classified as a long-term or current liability. As of December 31, 2016, Rhino had met the requirements to extend the maturity date of the credit facility to December 31, 2017. Since the credit facility has an expiration date of December 2017, the Company determined that its credit facility debt liability at September 30, 2017 of $9.9 million, should be classified as a current liability on its unaudited condensed consolidated statements of financial position. The classification of the credit facility balance as a current liability raises substantial doubt of the Rhino’s, and thus the Company’s ability to continue as a going concern for the next twelve months. Rhino is considering alternative financing options that could result in a new long-term credit facility. The financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount of and classification of liabilities that may result should the Company be unable to continue as a going concern.

 

Reclassifications— Certain prior year amounts have been reclassified to discontinued operations on the unaudited condensed consolidated statements of operations and comprehensive income related to the disposal of an operating component of Rhino, the Elk Horn coal leasing business, during 2016. See Note 4 for further information on the Elk Horn disposal.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND GENERAL

 

Investments in Unconsolidated Affiliates. Investments in other entities are accounted for using the consolidation, equity method or cost basis depending upon the level of ownership, Royal’s or its subsidiaries’ ability to exercise significant influence over the operating and financial policies of the investee and whether Royal or its subsidiaries are determined to be the primary beneficiary of a variable interest entity. Equity investments are recorded at original cost and adjusted periodically to recognize Royal’s or its subsidiaries’ proportionate share of the investees’ net income or losses after the date of investment. Any losses from the equity method investments are absorbed by Royal or its subsidiaries based upon its proportionate ownership percentage. Investments are written down only when there is clear evidence that a decline in value that is other than temporary has occurred.

 

In December 2012, the Partnership made an initial investment in a new joint venture, Muskie Proppant LLC (“Muskie”), with affiliates of Wexford Capital. In November 2014, the Partnership contributed its investment interest in Muskie to Mammoth Energy Partners LP (“Mammoth”) in return for a limited partner interest in Mammoth. In October 2016, the Partnership contributed its limited partner interests in Mammoth to Mammoth Energy Services, Inc. (NASDAQ: TUSK) (“Mammoth Inc.”) in exchange for 234,300 shares of common stock of Mammoth, Inc.

 

In September 2014, the Partnership made an initial investment of $5.0 million in a new joint venture, Sturgeon Acquisitions LLC (“Sturgeon”), with affiliates of Wexford Capital and Gulfport Energy Corporation (NASDAQ: GPOR) (“Gulfport”). The Partnership accounts for the investment in this joint venture and results of operations under the equity method based upon its ownership percentage. The Partnership recorded its proportionate share of the operating income for this investment for the three and nine months ended September 30, 2017 of approximately $0 and $36,000, respectively. The Partnership recorded its proportionate share of the operating (loss) for Sturgeon for the three and nine months ended September 30, 2016 of approximately ($26,000) and ($0.1) million, respectively. In June 2017, the Partnership contributed its limited partner interests in Sturgeon to Mammoth Inc. in exchange for 336,447 shares of common stock of Mammoth Inc. As of September 30, 2017, the Partnership owned 568,794 shares of Mammoth Inc.

 

As of September 30, 2017 and December 31, 2016, the Partnership recorded a fair market value adjustment of $1.0 million and $1.6 million, respectively, for its available-for-sale investment in Mammoth Inc. based on the market value of the shares at September 30, 2017 and December 31, 2016, respectively, which was recorded in Other Comprehensive Income. As of September 30, 2017 and December 31, 2016, the Partnership has recorded its investment in Mammoth Inc. as a short-term asset, which the Partnership has classified as available-for-sale. The Partnership has included its investment in Mammoth and its prior investment in Muskie and Sturgeon in its Other category for segment reporting purposes.

 

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Recently Issued Accounting Standards. In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). ASU 2014-09 clarifies the principles for recognizing revenue and establishes a common revenue standard for U.S. financial reporting purposes. The guidance in ASU 2014-09 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). ASU 2014-09 supersedes the revenue recognition requirements in Accounting Standards Codification (“ASC”) 605, Revenue Recognition, and most industry-specific accounting guidance. Additionally, ASU 2014-09 supersedes some cost guidance included in ASC 605-35, Revenue Recognition—Construction-Type and Production-Type Contracts. In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer (for example, assets within the scope of ASC 360, Property, Plant, and Equipment, and intangible assets within the scope of ASC 350, Intangibles—Goodwill and Other) are amended to be consistent with the guidance on recognition and measurement (including the constraint on revenue) in ASU 2014-09. In July 2015, the FASB approved to defer the effective date of ASU 2014-09 by one year. Accordingly, ASU 2014-09 will be effective for public entities for annual reporting periods beginning after December 15, 2017 and interim periods therein. The Company is evaluating the requirements of this new accounting guidance and currently believes the new guidance will not have a material impact on its financial results when adopted, but will require additional disclosures in its financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 requires that lessees recognize all leases (other than leases with a term of twelve months or less) on the balance sheet as lease liabilities, based upon the present value of the lease payments, with corresponding right of use assets. ASU 2016-02 also makes targeted changes to other aspects of current guidance, including identifying a lease and lease classification criteria as well as the lessor accounting model, including guidance on separating components of a contract and consideration in the contract. The amendments in ASU 2016-02 will be effective for the Company on January 1, 2019 and will require modified retrospective application as of the beginning of the earliest period presented in the financial statements. Early application is permitted. The Company is currently evaluating this guidance and currently believes this new guidance will not have a material impact on its financial results when adopted, but will require additional assets and liabilities to be recognized for certain agreements where the Company has the rights to use assets.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 provides guidance on eight cash flow issues, including debt prepayment or debt extinguishment costs. ASU 2016-15 requires that cash payments related to debt prepayments or debt extinguishments, excluding accrued interest, be classified as a financing activity rather than an operating activity even when the effects enter into the determination of net income. The amendments in ASU 2016-15 will be effective on January 1, 2018 and must be applied retrospectively. Early application is permitted. The Company is currently evaluating this guidance.

 

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805). ASU 2017-01 clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating this guidance.

 

3 ACQUISITIONS

 

Acquisition of Rhino GP, LLC and Rhino Resource Partners, LP

 

As discussed in Note 1, the Company acquired Rhino GP and obtained control of, and became a majority limited partner, in Rhino on March 17, 2016. Rhino GP is the General Partner of Rhino.

 

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Rhino is a diversified energy limited partnership formed in Delaware that is focused on coal and energy related assets and activities, including energy infrastructure investments. Rhino produces, processes and sells high quality coal of various steam and metallurgical grades. Rhino markets its steam coal primarily to electric utility companies as fuel for their steam powered generators. Customers for its metallurgical coal are primarily steel and coke producers who use its coal to produce coke, which is used as a raw material in the steel manufacturing process. Rhino’s business includes investments in oilfield services for independent oil and natural gas producers and land-based drilling contractors in North America. The investments provide completion and production services, including pressure pumping, pressure control, flowback and equipment rental services, and also produce and sell natural sand for hydraulic fracturing.

 

Rhino has a geographically diverse asset base with coal reserves located in Central Appalachia, Northern Appalachia, the Illinois Basin and the Western Bituminous region. As of December 31, 2016, Rhino controlled an estimated 256.9 million tons of proven and probable coal reserves, consisting of an estimated 203.5 million tons of steam coal and an estimated 53.4 million tons of metallurgical coal. In addition, as of December 31, 2016, Rhino controlled an estimated 196.5 million tons of non-reserve coal deposits.

 

At September 30, 2017, the Company’s investment in Rhino consists of $11,250,213 in cash. The acquisition was completed in three steps as described in Note 1. The fair value of Rhino’s property, plant and equipment was determined by an independent, third-party appraiser that completed their report during the first quarter of 2017. The fair value of the Partnership’s coal properties were based on observable inputs from market transactions that closely related to the nature of Rhino’s coal properties. The asset retirement obligations of the Partnership were adjusted to fair value based upon current risk adjusted discount rates. The original provisional assets and liabilities were adjusted as of March 31, 2017 within the one year measurement period. The total income statement impact of these adjustments was recognized during the three months ended March 31, 2017. The table below reflects the value the assets acquired and the liabilities assumed for the acquisition of Rhino.

 

   Final Amounts   Provisional Amounts 
   March 17, 2016   December 31, 2016 
   (thousands) 
Assets:          
Current Assets  $25,851   $23,117 
Property, plant and equipment   229,950    66,812 
Other non-current assets   37,673    40,047 
Total identifiable assets   293,474    129,976 
Liabilities:          
Current liabilities   60,211    62,810 
Non-current liabilities          
Long-term debt, net of current portion   2,536    2,536 
Asset retirement obligations, net of current portion   17,986    27,108 
Other non-current liabilities   37,090    37,092 
Total non-current liabilities   57,612    66,736 
Total liabilities   117,823    129,546 
Net identifiable assets   175,651    430 
Goodwill   -    7,594 
subtotal   175,651    8,024 
Non-controlling shareholders   -    3,524 
Bargain purchase gain   171,151    - 
Total consideration paid  $4,500   $4,500 

 

Note: Final amounts were determined in the quarter ending March 31, 2017 as discussed above, which resulted in the differences to the provisional amounts.

 

13

 

 

Operating results for Rhino for the three and nine months ended September 30, 2017 and 2016 are as follows.

 

   Three months ended September 30,   Nine months ended September 30, 
   2017   2016   2017   2016 
   (in thousands)   (in thousands) 
Revenues  $58,346   $43,415   $168,432   $124,358 
                     
Comprehensive income (loss)   682    (3,785)   963    (126,960)
                     
Net loss per unit, basic and fully diluted  $-   $(0.41)  $0.29   $(20.43)

 

The first quarter’s remeasurement of the acquired net assets of Rhino resulted in the recognition of a deferred income tax liability of $55,529 as of the acquisition date. The recognition of this deferred tax liability has been included in the first quarter’s provision for income taxes. The recognition of the deferred tax liability also reflects future taxable income through the reversals of temporary differences; therefore, the first quarter’s tax provision also includes the reversal of a valuation allowance of $7,415 which had been applied to deferred tax assets at December 31, 2016. The remaining components of the provision consists of the deferred tax effects arising from other net income and expense items for the period, including the effects of acquisition remeasurements recognized in the first quarter. The Company had a reduction in income tax expense in the three months ended September 30, 2017.

 

Blaze Mining Company, LLC Option Termination and Royalty Agreement

 

On May 29, 2015, the Company entered into an Option Agreement with Blaze Energy Corp. (“Blaze Energy”) to acquire all of the membership units of Blaze Mining Company, LLC (“Blaze Mining”), which is a wholly-owned subsidiary of Blaze Energy. Under the Option Agreement, as amended, the Company had the right to complete the purchase through March 31, 2016 by the issuance of 1,272,858 shares of the Company’s common stock and payment of $250,000 in cash. Blaze Mining controlled operations for and had the right to acquire 100% ownership of Alpheus Coal Impoundment reclamation site in McDowell County, West Virginia under a contract with Gary Partners, LLC, which owned the property. On February 22, 2016, the Company facilitated a series of transactions wherein: (i) Blaze Mining and Blaze Energy entered into an Asset Purchase Agreement to acquire substantially all of the assets of Gary Partners, LLC; (ii) Blaze Mining entered into an Assignment Agreement to assign its rights under the Asset Purchase Agreement to a third party; and (iii) the Company and Blaze Energy entered into an Option Termination Agreement, as amended, whereby the following royalties granted to Blaze Mining under the Assignment Agreement were assigned to the Company: a $1.25 per ton royalty on raw coal or coal refuse mined or removed from the property, and a $1.75 per ton royalty on processed or refined coal or coal refuse mined or removed from the property (the “Royalties”). Pursuant to the Option Termination Agreement, the parties thereby agreed to terminate the Option Agreement by the issuance of 1,750,000 shares of the Company’s common stock to Blaze Energy in consideration for the payment by Blaze Energy of $350,000 to the Company and the assignment by Blaze Mining of the Royalties to the Company. The transactions closed on March 22, 2016.

 

Pursuant to an Advisory Agreement with East Coast Management Group, LLC (“ECMG”), the Company agreed to compensate ECMG $200,000 in cash; $0.175 of the $1.25 royalty on raw coal or coal refuse; and $0.25 of the $1.75 royalty on processed or refined coal for its services in facilitating the Option Termination Agreement.

 

The transaction was initially valued based on the trading price of the Company’s common stock on March 22, 2016 as follows.

 

   (thousands) 
Royalty interests  $21,113 
Cash received   350 
Cash paid   (200)
Common stock issued  $21,263 

 

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The Company performed a comprehensive review of its current coal mining operations as well as potential future development projects for the year ended December 31, 2016 to ascertain any potential impairment losses. Since production from this property had not begun at December 31, 2016, the Company engaged a third-party engineer to provide an estimate of fair value. The specialist valued the royalty interests at $4.4 million. Accordingly, the Company recorded an asset impairment loss of $16.7 million in the fourth quarter of 2016.

 

Blue Grove Coal, LLC (“Blue Grove”).

 

On June 10, 2015, the Company entered into a Securities Purchase Agreement (the “Blue Grove Agreement”) under which it acquired all of the membership interests in Blue Grove Coal, LLC (“Blue Grove”) from Ian Ganzer and Gary Ganzer (the “Ganzers”) for 350,000 shares of common stock. The Blue Grove Amendment was amended on December 23, 2015 to reduce the purchase price for Blue Grove to 10,000 shares of common stock. Blue Grove was the operator of a surface coal mine owned by G.S. Energy, LLC, a company also owned by the Ganzers, but ceased operations in the third quarter of 2015 when the buyer of coal from the mine filed for bankruptcy. On July 1, 2017, the Company entered into a Call Option Agreement with the Ganzers, under which the Company exercised its right to put its membership interests in Blue Grove to the Ganzers. Under the agreement, the Company conveyed all of the its ownership in Blue Grove to the Ganzers, and the Ganzers returned 10,000 shares of the Company’s common stock which they had received on consideration for the Blue Grove membership interests. Under the Call Option Agreement, the Ganzers agreed to release the Company from any liability, and to indemnify and hold the Company harmless against any liability arising out of its relationship with Blue Grove. Under the Call Option Agreement, Ian Ganzer also released the Company of any liability under his employment agreement with the Company, although Mr. Ganzer was allowed to retain 15,998 shares of common stock issued to him as a signing bonus under his employment agreement, which had vested as of the date of his resignation in September 2016.

 

4. DISCONTINUED OPERATIONS

 

Elk Horn Coal Leasing

 

In August 2016, the Partnership entered into an agreement to sell its Elk Horn coal leasing company (“Elk Horn”) to a third party for total cash consideration of $12.0 million. The Partnership received $10.5 million in cash consideration upon the closing of the Elk Horn transaction and the remaining $1.5 million of consideration was paid in ten equal monthly installments of $150,000 on the 20th of each calendar month beginning on September 20, 2016. The previous operating results of Elk Horn have been reclassified and reported on the (Gain)/loss from discontinued operations line on the Company’s unaudited condensed consolidated statement of operations and comprehensive income for the three and nine months ended September 30, 2016.

 

Major components of net income from discontinued operations for the three and nine months ended September 30, 2017 and 2016 are summarized as follows:

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2017   2016   2017   2016 
   (in thousands) 
Major line items constituting (loss)/income from discontinued operations for the Elk Horn disposal:                    
Other revenues  $-   $442   $-   $1,707 
Total revenues   -    442         1,707 
                     
Cost of operations (exclusive of depreciation, depletion and amortization shown separately below)   -    345    -    650 
Depreciation, depletion and amortization   -    86    -    237 
Selling, general and administrative (exclusive of depreciation, depletion and amortization shown separately above)   -    78    -    161 
Interest expense and other   -    3    -    9 
Total costs and expenses   -    512    -    1,057 
(Loss)/Income from discontinued operations before income taxes for the Elk Horn disposal   -    (70)   -    650 
Income taxes   -    -    -    - 
Net (loss)/ income from discontinued operations  $-   $(70)  $-   $650 

 

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5 PREPAID EXPENSES AND OTHER CURRENT ASSETS

 

Prepaid expenses and other current assets as of September 30, 2017 and December 31, 2016 consisted of the following:

 

   September 30, 2017   December 31, 2016 
   (in thousands) 
Other prepaid expenses  $1,731   $761 
Debt issuance costs—net   110    981 
Escrow deposit   263    - 
Prepaid insurance   1,922    1,432 
Prepaid leases   123    77 
Supply inventory   504    614 
Deposits   -    164 
Note receivable-current portion   -    900 
Total Prepaid expenses and other  $4,653   $4,929 

 

Debt issuance costs were included in Prepaid expenses and other current assets as of September 30, 2017 and December 31, 2016 since Rhino’s credit facility balance was classified as a current liability. See Note 10 for further information on the amendments to Rhino’s amended and restated senior secured credit facility.

 

As of December 31, 2016, the note receivable balance of $0.9 million related to the $1.5 million of consideration to be paid in ten equal monthly installments of $150,000 for the Elk Horn sale discussed earlier. The note receivable was paid in full as of September 30, 2017.

 

6 PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment, including coal properties and mine development and construction costs, as of September 30, 2017 and December 31, 2016 are summarized by major classification as follows:

 

   Useful Lives  September 30, 2017   December 31, 2016 
      (in thousands) 
            
Coal properties, including mining and other equipment  1 - 20 Years  $-   $69,684 
Land      10,986     n/a 
Mining and other equipment and related facilities  2 - 20 Years   201,792     n/a 
Mine development costs  1 - 15 Years   762     n/a 
Coal properties  1 - 15 Years   31,141     n/a 
Construction work in process      3,108     n/a 
Total      247,789    69,684 
Less accumulated depreciation, depletion and amortization      (41,030)   (4,572)
Net     $206,759   $65,112 

 

Depreciation expense for mining and other equipment and related facilities, depletion expense for coal properties and oil and natural gas properties, amortization expense for mine development costs, amortization expense for intangible assets and amortization expense for asset retirement costs for the three and nine months ended September 30, 2017 and 2016 were as follows:

 

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   Three Months Ended September 30,   Nine Months Ended September 30, 
   2017   2016   2017   2016 
   (in thousands)   (in thousands) 
Depreciation expense-mining and other equipment and related facilities  $6,784   $1,662   $36,219   $3,074 
Depletion expense for coal properties and oil and natural gas properties   160    -    878    - 
Amortization of mine development costs   10    -    39    - 
Amortization expense for intangible assets   -    -    34    - 
Amortization expense for asset retirement costs   -    (23)   (99)   (45)
Total depreciation, depletion and amortization  $6,954   $1,639   $37,071   $3,029 

 

As discussed in Notes 1 and 3, the Company acquired and became a majority limited partner in Rhino on March 17, 2016. The Company completed its purchase accounting fair value adjustments in the first quarter of 2017 and adjusted the previous provisional amounts the Company had recorded for the Rhino acquisition. The fair value purchase adjustments resulted in a bargain purchase gain of $171 million recorded in the first quarter of 2017 that related to the prior 2016 reporting period as well as $16.1 million of additional depreciation, depletion and amortization expense recorded in the first quarter of 2017 that related to the prior 2016 reporting period.

 

7 INTANGIBLE AND OTHER NON-CURRENT ASSETS

 

Other non-current assets as of September 30, 2017 and December 31, 2016 consisted of the following:

 

   September 30, 2017   December 31, 2016 
   (in thousands) 
Deposits and other  $343   $218 
Non-current receivable   27,157    27,157 
Deferred expenses   194    216 
Total  $27,694   $27,591 

 

Non-current receivable. The non-current receivable balance of $27.2 million as of September 30, 2017 and December 31, 2016 consisted of the amount due from the Partnership’s workers’ compensation insurance providers for potential claims against the Partnership that are the primary responsibility of the Partnership, which are covered under the Partnership’s insurance policies. The $27.2 million is also included in the accrued workers’ compensation benefits liability balance, which is included in non-current liabilities. The Company presents this amount on a gross asset and liability basis since a right of setoff does not exist per the accounting guidance in ASC Topic 210, Balance Sheet. This presentation has no impact on the results of operations or cash flows.

 

Call Option-Armstrong Energy. As discussed in Note 1, the Partnership and Rhino Holdings executed an Option Agreement in December 2016 where the Partnership received a Call Option from Rhino Holdings to acquire substantially all of the outstanding common stock of Armstrong Energy. In exchange for Rhino Holdings granting the Partnership the Call Option, the Partnership issued 5.0 million common units to Rhino Holdings upon the execution of the Option Agreement. The Partnership valued the Call Option at $21.8 million based upon the closing price of the Partnership’s publicly traded common units on the date the Option Agreement was executed. The Partnership has determined the value of the common units issued at December 30, 2016 of $21.8 million constituted an amount that would be applied to the potential acquisition of Armstrong Energy, as discussed in Note 1.

 

As discussed in Note 1, on October 31, 2017, Armstrong Energy filed Chapter 11 petitions in the Eastern District of Missouri’s United States Bankruptcy Court. The Partnership is evaluating the Chapter 11 petitions filed by Armstrong Energy and the Partnership will further evaluate the detailed restructuring plan when it is submitted by Armstrong Energy to determine what, if any, effect the ultimate outcome of the Chapter 11 proceedings will have on the Call Option. Because of the uncertain facts and circumstances surrounding the current state of the Armstrong Energy Chapter 11 proceedings, which includes the possibility that the Partnership will still exercise the Call Option as outlined in Note 1, the Partnership concluded that the value of the Call Option was not impaired as of September 30, 2017. However, management expects that further information, including the progression of Armstrong’s restructuring plan and bankruptcy proceedings, will become available in the next quarter; such information may have a material effect on the carrying value of the Option Agreement.

 

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8 ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

 

Accrued expenses and other current liabilities as of September 30, 2017 and December 31, 2016 consisted of the following:

 

   September 30, 2017   December 31, 2016 
   (in thousands) 
Payroll, bonus and vacation expense  $1,786   $1,721 
Non income taxes   3,393    2,669 
Royalty expenses   2,077    1,617 
Accrued interest   601    601 
Health claims   803    630 
Workers’ compensation & pneumoconiosis   2,450    2,450 
Other   1,325    1,717 
Total  $12,435   $11,405 

 

9 NOTES PAYABLE – RELATED PARTY

 

Related party notes payable consist of the following at September 30, 2017 and December 31, 2016.

 

   September 30, 2017   December 31, 2016 
   (thousands) 
Demand note payable dated March 6, 2015; owed E-Starts Money Co., a related party; interest at 6% per annum  $204   $204 
Demand note payable dated June 11, 2015; owed E-Starts Money Co., a related party; non-interest bearing   200    200 
Demand note payable dated September 22, 2016; owed E-Starts Co., a related party; non-interest bearing   50    50 
Demand note payable dated December 8, 2016; owed to E-Starts Money Co., a related party; non-interest bearing   50    50 
           
Total related party notes payable  $504   $504 

 

The related party notes payable have accrued interest of $31,509 at September 30, 2017 and $22,372 at December 31, 2016. For the three and nine months ended September 30, 2017, the Company expensed $3,046 and $9,137, respectively, in interest from the related party loans.

 

10 DEBT

 

Debt as of September 30, 2017 and December 31, 2016 consisted of the following:

 

   September 30, 2017   December 31, 2016 
   (in thousands) 
Senior secured credit facility with PNC Bank, N.A.  $9,940   $10,040 
Note payable to Weston Energy dated December 30, 2016; interest at 8% per annum; due January 15, 2017   -    2,000 
Note payable to Cedarview Opportunities Master Fund, L.P. dated May 31, 2017; interest at 14% annum; due May 31, 2019   2,500    - 
Total   12,440    12,040 
Less current portion   (9,940)   (12,040)
Long-term debt  $2,500   $- 

 

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Secured Promissory Note – On June 12, 2017, Company entered into a Secured Promissory Note dated May 31, 2017 with Cedarview Opportunities Master Fund, L.P. (the “Lender”), under which the Company borrowed $2,500,000 from the Lender. The loan bears non-default interest at the rate of 14%, and default interest at the rate of 17% per annum. The Company and the Lender simultaneously entered into a Pledge and Security Agreement dated May 31, 2017, under which the Company pledged 5,000,000 Common Units in Rhino as collateral for the loan. The loan is payable through quarterly payments of interest only until May 31, 2019, when the loan matures, at which time all principal and interest is due and payable. The Company deposited $350,000 of the loan proceeds into an escrow account, from which interest payments for the first year will be paid. After the first year, the Company is obligated to maintain at least one quarter of interest on the loan in the escrow account at all times. In consideration for the Lender’s agreement to make the loan, the Company transferred 25,000 Common Units of Rhino to the Lender as a fee. The Company intends to use the proceeds to repay in full all loans made to the Company by E-Starts Money Co. in the principal amount of $503,593, and to use the balance for general corporate overhead, as well as costs associated with potential acquisitions of mineral resource companies, including legal and engineering due diligence, deposits, and down payments.

 

Senior Secured Credit Facility with PNC Bank, N.A.— On July 29, 2011, the Partnership executed the amended and restated credit agreement (as amended, the “Amended and Restated Credit Agreement”). The maximum availability under the amended and restated credit facility was $300.0 million, with a one-time option to increase the availability by an amount not to exceed $50.0 million. Of the $300.0 million, $75.0 million was available for letters of credit. In April 2015, the amended and restated credit agreement was amended and the borrowing commitment under the facility was reduced to $100.0 million and the amount available for letters of credit was reduced to $50.0 million. As described below, in March 2016 and May 2016, the borrowing commitment under the facility was further reduced to $80.0 million and $75.0 million, respectively, and the amount available for letters of credit was reduced to $30.0 million. In addition, as described below, the borrowing commitment under the facility was further reduced by amendments in July 2016 and December 2016 to $44.3 million as of September 30, 2017. The amount available for letters of credit was unchanged from these amendments.

 

On March 17, 2016, the Partnership entered into a fourth amendment (the “Fourth Amendment”) of the amended and restated credit agreement. The Fourth Amendment amended the definition of change of control in the amended and restated credit agreement to permit Royal to purchase the membership interests of the General Partner. The Fourth Amendment also eliminated the option to borrow funds utilizing the LIBOR rate plus an applicable margin and establishes the borrowing rate for all borrowings under the facility to be based upon the current PRIME rate plus an applicable margin of 3.50%.

 

On May 13, 2016, the Partnership entered into the Fifth Amendment of the amended and restated credit agreement, which extended the term to July 31, 2017.

 

In July 2016, the Partnership entered into a sixth amendment (the “Sixth Amendment”) of its amended and restated senior secured credit agreement that permitted the sale of Elk Horn that was discussed earlier. The Sixth Amendment further reduced the maximum commitment amount allowed under the credit facility by $375,000 each quarterly period beginning September 30, 2016 through June 30, 2017 for the additional $1.5 million that was received from the Elk Horn sale.

 

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In December 2016, the Partnership entered into a seventh amendment of its amended and restated credit agreement (the “Seventh Amendment”). The Seventh Amendment allows for the issuance of the Series A preferred units as outlined in the Amended and Restated Partnership Agreement. The Seventh Amendment immediately reduced the revolving credit commitments by $11.0 million and provides for additional revolving credit commitment reductions of $2.0 million each on June 30, 2017 and September 30, 2017. The Seventh Amendment further reduces the revolving credit commitments over time on a dollar-for-dollar basis for the net cash proceeds received from any asset sales after the Seventh Amendment date once the aggregate net cash proceeds received exceeds $2.0 million. The Seventh Amendment alters the maximum leverage ratio to 4.0 to 1.0 effective December 31, 2016 through May 31, 2017 and 3.5 to 1.0 from June 30, 2017 through December 31, 2017. The maximum leverage ratio shall be reduced by 0.50 to 1.0 for every $10.0 million of net cash proceeds, in the aggregate, received after the Seventh Amendment date from (i) the issuance of any equity by the Partnership and/or (ii) the disposition of any assets in excess of $2.0 million in the aggregate, provided, however, that in no event will the maximum leverage ratio be reduced below 3.0 to 1.0.

 

The Seventh Amendment alters the minimum consolidated EBITDA, as calculated on a rolling twelve months basis, to $12.5 million from December 31, 2016 through May 31, 2017 and $15.0 million from June 30, 2017 through December 31, 2017. The Seventh Amendment alters the maximum capital expenditures allowed, as calculated on a rolling twelve months basis, to $20.0 million through the expiration of the credit facility. A condition precedent to the effectiveness of the Seventh Amendment is the receipt of the $13.0 million of cash proceeds received by the Partnership from the issuance of the Series A preferred units pursuant to the Preferred Unit Agreement, which was used to repay outstanding borrowings under the revolving credit facility. Per the Seventh Amendment, the receipt of $13.0 million cash proceeds fulfills the required Royal equity contribution, which was a requirement of prior amendments to the credit agreement.

 

On March 23, 2017, the Partnership entered into an eighth amendment (the “Eighth Amendment”) of its amended and restated credit agreement that allows the annual auditor’s report for the years ended December 31, 2016 and 2015 to contain a qualification with respect to the short-term classification of the Partnership’s credit facility balance without creating a default under the credit agreement.

 

On June 9, 2017, the Partnership entered into a ninth amendment (the “Ninth Amendment”) of its amended and restated credit agreement that permitted outstanding letters of credit to be replaced with different counterparties without affecting the revolving credit commitments under the credit agreement. The Ninth Amendment also permits certain lease and sale leaseback transactions under the credit agreement that do not affect the revolving credit commitments under the credit agreement for asset dispositions and also do not factor in the calculation of the maximum capital expenditures allowed under the credit agreement.

 

At September 30, 2017, the Partnership had borrowed $9.9 million at a variable interest rate of PRIME plus 3.50% (7.75% at September 30, 2017). In addition, the Partnership had outstanding letters of credit of $26.1 million at a fixed interest rate of 5.00% at September 30, 2017. Based upon a maximum borrowing capacity of 3.50 times a trailing twelve-month EBITDA calculation (as defined in the credit agreement), the Partnership had not used $8.2 million of the borrowing availability at September 30, 2017. As of September 30, 2017 and December 31, 2016, the Partnership was in compliance with respect to all covenants contained in its credit agreement.

 

11 ASSET RETIREMENT OBLIGATIONS

 

The changes in asset retirement obligations for the nine months ended September 30, 2017 and the year ended December 31, 2016 are as follows:

 

   Nine months ended   Year ended 
   September 30, 2017   December 31, 2016 
   (in thousands) 
Balance at beginning of period (including current portion)  $27,420   $- 
Acquired   -    28,200 
Accretion expense   1,255    1,105 
Adjustment resulting from annual recosting and other   -    (1,685)
Adjustments to the liability resulting from final purchase allocation   (7,228)   - 
Liabilities settled   (33)   (200)
Balance at end of period   21,414    27,420 
Less current portion of asset retirement obligation   (917)   (917)
Long-term portion of asset retirement obligation  $20,497   $26,503 

 

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12 STOCKHOLDERS’ EQUITY

 

In October 2012 the Company amended its charter to authorize issuance of up to 500,000,000 shares of common stock with a par value of $0.00001. In March 2017, the Company filed an amendment to its Certificate of Incorporation to reduce the authorized shares of Common Stock to 25,000,000 and to reduce the authorized shares of Preferred Stock to 5,000,000 from 10,000,000.

 

Series A preferred stock

 

The Board has authorized one series of Preferred Stock, which is known as the “Series A Preferred Stock,” for 100,000 shares. The certificate of designation of the Series A Preferred Stock provides: the holders of Series A preferred stock shall be entitled to receive dividends when, as and if declared by the board of directors of the Company; participates with common stock upon liquidation; convertible into one share of common stock; and has voting rights such that the Series A preferred stock shall have an aggregate voting right for 54% of the total shares entitled to vote.

 

Stock subscription receivable

 

On October 4, 2016, the Company entered into a securities purchase agreement with East Hill Investments, Ltd. (“East Hill”), a British Virgin Islands company. The agreement provided that the Company would sell 1,000,000 shares of its common stock, par value $0.00001, to East Hill for an aggregate purchase price of $4,250,000. The transaction was to be completed in a series of transactions for 25,000 to 50,000 shares each. The initial transaction was on October 4, 2016 in the amount of $212,500 for which the Company received a note originally due October 19, 2016 and extended to November 30, 2016. During the first quarter of 2017, both parties agreed to cancel the transaction and the shares were returned to the Company to be cancelled.

 

Issuance of shares in private placement

 

In the first quarter of 2017, the Company issued 21,817 shares to three investors in a private placement at $5.50 per share.

 

Conversion of the Weston Promissory Note and the Rhino Promissory Note

 

On September 1, 2017, Royal elected to convert the Weston Promissory Note of $2.1 million (including accrued interest) and the Rhino Promissory Note of $2.0 million to shares of Royal common stock. Royal issued 914,797 shares of its common stock to the Partnership at a conversion price of $4.51 per share. Please read “Note 1. Basis of Presentation, Organization and Going Concern – Organization and Nature of Business —Letter Agreement Regarding Rhino Promissory Note and Weston Promissory Note.” The Company recorded the $4.1 million conversion of the Weston Promissory Note and Rhino Promissory Note as Treasury Stock in the Company’s stockholders’ equity section of the Company’s unaudited condensed consolidated statements of financial position.

 

13 RELATED PARTY TRANSACTIONS

 

On March 6, 2015, the Company borrowed $203,593 from E-Starts Money Co. (“E-Starts”) pursuant to a 6% demand promissory note. (See Note 9) The proceeds were used to repay all of Royal’s indebtedness at the time. E-Starts is owned by William L. Tuorto, our Chairman and Chief Executive Officer. On June 11, 2015, the Company borrowed an additional $200,000 from E-Starts pursuant to a non-interest bearing demand promissory note. On September 22, 2016, the Company borrowed $50,000 from E-Starts pursuant to a non-bearing demand promissory note. On December 8, 2016, the Company borrowed $50,000 from E-Starts pursuant to a non-interest bearing demand promissory note. On March 3, 2017, the Company borrowed $50,000 from E-Starts pursuant to a non-interest bearing demand promissory note which was repaid by Royal on June 28, 2017. On March 16, 2017, the Company borrowed $25,000 from E-Starts pursuant to a non-interest bearing demand promissory note which was repaid by Royal on June 28, 2017. On April 26, 2017, the Company borrowed $10,000 from E-Starts pursuant to a non-interest bearing promissory note which was repaid by Royal on June 6, 2017. The total amount owed to E-Starts at September 30, 2017 and December 31, 2016 was $503,593, plus accrued interest.

 

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E-Starts, in addition to the promissory notes listed above, advanced money to the Company for use in paying certain obligations of the Company.

 

The details of the due to related party account are summarized as follows:

 

   September 30, 2017   December 31, 2016 
   (thousands) 
Due to E-Starts Money Co          
Expense advances  $10   $11 
Accrued interest   32    22 
    42    33 
Due to GS Energy, LLC   -    18 
Due to Ian Ganzer   -    10 
Due to Gary Ganzer   -    10 
   $42   $71 

 

On May 14, 2015, the Company entered into an Option Agreement to acquire substantially all of the assets of Wellston Coal, LLC (“Wellston”) for 500,000 shares of the Company’s common stock. The Option Agreement originally terminated on September 1, 2015, but was later extended to December 31, 2016. Wellston owns approximately 1,600 acres of surface and 2,200 acres of mineral rights in McDowell County, West Virginia (the “Wellston Property”). Pursuant to the Option Agreement, pending the closing of the Wellston Property, the Company agreed to loan Wellston up to $500,000 from time to time. The loan was evidenced by a Promissory Note bearing interest at 12% per annum, due and payable at the expiration of the Option Agreement, and was secured by a Deed of Trust on the Wellston Property. The Company ultimately loaned Wellston $53,000. Royal’s President and Secretary, Ronald Phillips, owns a minority interest in Wellston, and is the manager of Wellston. On September 13, 2016, Wellston sold its assets to an unrelated third party. As part of the sale, the Company cancelled the Option Agreement and received a royalty of $1 per ton on the first 250,000 tons of coal mined from the property in consideration for a release of its lien on the Wellston Property and the cancellation of its debt from Wellston.

 

Blue Grove Coal, LLC). On June 10, 2015, the Company acquired Blue Grove in exchange for 350,000 shares of its common stock. Blue Grove was owned 50% by Ian Ganzer, who became our chief operating officer simultaneous with the acquisition, and 50% by Gary Ganzer, Ian Ganzer’s father (the “Members”). Simultaneous with the Company’s acquisition of Blue Grove, Blue Grove entered into an operator agreement with GS Energy, LLC, (“GS Energy”), under which Blue Grove has an exclusive right to mine the coal properties of GS Energy for a two year period. Simultaneous with the acquisition of Blue Grove, Blue Grove also entered into a Management Agreement with Black Oak Resources, LLC (“Black Oak”), a company owned by the Members. Under the Management Agreement, Blue Grove subcontracted all of its responsibilities under the Management Agreement with GS Energy to Black Oak. In consideration, Black Oak was entitled to 75% of all net profits generated by the mining of the coal properties of GS Energy. Subsequently, the agreement with Black Oak was amended to provide that Black Oak was entitled to 100% of the first $400,000 and 50% of the next $1,000,000, for a maximum of $900,000 of net profits generated by the mining of the coal properties of GS Energy.

 

On December 23, 2015, the Company and the Members entered into an Amendment to Securities Exchange Agreement (“Amendment”) originally entered into on June 8, 2015. Pursuant to the Amendment, the consideration for the acquisition of Blue Grove was reduced from 350,000 shares of the Company’s common stock to 10,000 shares.

 

On July 1, 2017, the Company entered into an agreement with Ian and Gary Ganzer, under which the Company transferred its interest in Blue Grove to the Ganzers in consideration for the Ganzers’ return of 10,000 shares of the Company’s common stock, which was the purchase price for Blue Grove. In the same agreement, Ian Ganzer returned 9,599 shares of common stock for cancellation. The shares represented the unvested portion of a stock bonus issued to Mr. Ganzer when he was employed as chief operating officer of the Company. The parties executed mutual releases of liability. In addition, the Ganzers’ agreed to hold the Company harmless against any liability arising out its former ownership of Blue Grove.

 

14 EMPLOYEE BENEFITS

 

401(k) Plans— The Partnership and certain subsidiaries sponsor defined contribution savings plans for all employees. Under one defined contribution savings plan, the Operating Company matches voluntary contributions of participants up to a maximum contribution based upon a percentage of a participant’s salary with an additional matching contribution possible at the Operating Company’s discretion. The expense under these plans for the three and nine months ended September 30, 2017 and 2016 is included in Cost of operations and Selling, general and administrative expense in the unaudited condensed consolidated statements of operations and comprehensive income and was as follows:

 

   Three months ended September 30,   Nine months ended September 30, 
   2017   2016   2017   2016 
   (in thousands) 
401(k) plan expense  $387   $406   $1,107   $1,113 

 

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15 EQUITY-BASED COMPENSATION

 

Stock option plan - The Royal Energy Resources, Inc. 2015 Stock Option Plan and the Royal Energy Resources, Inc. 2015 Employee, Consultant and Advisor Stock Compensation Plan (“Plans”) were approved by the Company’s board on July 31, 2015. Each Plan reserves 1,000,000 shares for awards. The Company’s Board of Directors is designated to administer the Plan. No options are outstanding under the Plans at September 30, 2017. As of September 30, 2017, there were 114,092 shares issued from the Employee, Consultant and Advisor Stock Compensation Plan. As of September 30, 2017, there are 1,000,000 shares available under the Stock Option Plan and 885,908 shares available under the Employee, Consultant and Advisor Stock Compensation Plan. The shares issued under the Employee, Consultant and Advisor Stock Compensation Plan were expensed at their market value on the date of issuance.

 

In October 2010, the General Partner established the Rhino Long-Term Incentive Plan (the “Plan” or “LTIP”). The Plan is intended to promote the interests of the Partnership by providing to employees, consultants and directors of the General Partner, the Partnership or affiliates of either, incentive compensation awards to encourage superior performance. The LTIP provides for grants of restricted units, unit options, unit appreciation rights, phantom units, unit awards, and other unit-based awards.

 

16 COMMITMENTS AND CONTINGENCIES

 

Coal Sales Contracts and Contingencies—As of September 30, 2017, the Partnership had commitments under sales contracts to deliver annually scheduled base quantities of coal as follows:

 

Year  Tons (in thousands)   Number of customers 
2017-Q4   1,329    14 
2018   1,825    6 
2019   700    2 

 

Some of the contracts have sales price adjustment provisions, subject to certain limitations and adjustments, based on a variety of factors and indices.

 

Purchase Commitments— The Partnership has a commitment to purchase approximately 1.0 million gallons of diesel fuel at fixed prices from January 2017 through December 2017 for approximately $2.0 million.

 

Purchased Coal Expenses—The Partnership incurs purchased coal expense from time to time related to coal purchase contracts. In addition, the Partnership incurs expense from time to time related to coal purchased on the over-the-counter market (“OTC”). The Partnership had no expense for purchased coal from coal purchase contracts or expense from OTC purchases for the three and nine months ended September 30, 2017 and 2016.

 

Leases—The Partnership leases various mining, transportation and other equipment under operating leases. The Partnership also leases coal reserves under agreements that call for royalties to be paid as the coal is mined. Lease and royalty expense for the three and nine months ended September 30, 2017 and 2016 are included in Cost of operations in the unaudited condensed consolidated statements of operations for the period owned by the Company were as follows:

 

   Three months ended September 30,   Nine months ended September 30, 
   2017   2016   2017   2016 
   (in thousands)         
Lease expense  $726   $1,438   $3,217   $3,517 
Royalty expense  $3,636   $2,409   $10,963   $7,350 

 

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17 MAJOR CUSTOMERS

 

The Partnership had revenues or receivables from the following major customers that in each period equaled or exceeded 10% of revenues:

 

   September 30   December 31   Nine months   Nine months 
   2017   2016   ended   ended 
   Receivable   Receivable   September 30   September 30 
   Balance   Balance   2017 Sales   2016 Sales 
   (in thousands) 
LG&E and KU (PPL)  $1,749   $1,496   $30,971   $31,333 
Big Rivers Electric Corporation   1,133    -    18,387    14,045 
Integrity Coal Sales   2,125    1,975    18,152    2,532 
Dominion Energy   1,826    -    17,148    4,673 

 

18 FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The Company determines the fair value of assets and liabilities based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. The fair values are based on assumptions that market participants would use when pricing an asset or liability, including assumptions about risk and the risks inherent in valuation techniques and the inputs to valuations. The fair value hierarchy is based on whether the inputs to valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s assumptions of what market participants would use.

 

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The fair value hierarchy includes three levels of inputs that may be used to measure fair value as described below:

 

Level One - Quoted prices for identical instruments in active markets.

 

Level Two - The fair value of the assets and liabilities included in Level 2 are based on standard industry income approach models that use significant observable inputs.

 

Level Three - Unobservable inputs significant to the fair value measurement supported by little or no market activity.

 

In those cases when the inputs used to measure fair value meet the definition of more than one level of the fair value hierarchy, the lowest level input that is significant to the fair value measurement in its totality determines the applicable level in the fair value hierarchy.

 

The book values of cash and cash equivalents, accounts receivable and accounts payable are considered to be representative of their respective fair values because of the immediate short-term maturity of these financial instruments. The fair value of the Partnership’s amended and restated senior secured credit facility was based upon a Level 2 measurement utilizing a market approach, which incorporated market-based interest rate information with credit risks similar to the Partnership. The fair value of the Partnership’s amended and restated senior secured credit facility approximates the carrying value at September 30, 2017. The book value of the Company’s secured promissory note is considered to be representative of its fair value as of September 30, 2017 since only a brief time period has elapsed since the note was entered on May 31, 2017.

 

As of September 30, 2017 and December 31, 2016, the Partnership had a recurring fair value measurement relating to its investment in Mammoth, Inc. As discussed in Note 2, in October 2016, the Partnership contributed its limited partner interests in Mammoth to Mammoth, Inc. in exchange for 234,300 shares of common stock of Mammoth, Inc. The common stock of Mammoth, Inc. began trading on the NASDAQ Global Select Market in October 2016 under the ticker symbol TUSK and the Partnership sold 1,953 shares during the initial public offering of Mammoth, Inc. and received proceeds of approximately $27,000. In June 2017, the Partnership contributed its limited partner interests in Sturgeon to Mammoth Inc. in exchange for 336,447 shares of common stock of Mammoth, Inc. As of September 30, 2017, the Partnership owned 568,794 shares of Mammoth, Inc. The Partnership’s shares of Mammoth, Inc. are classified as an available-for-sale investment on the unaudited condensed consolidated statements of financial position. Based on the availability of a quoted price, the recurring fair value measurement of the Mammoth, Inc. shares is a Level 1 measurement.

 

19 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

 

The unaudited condensed consolidated statement of cash flows for the nine months ended September 30, 2017 and 2016 excludes approximately $1.3 million and $0.2 million, respectively, of property additions, which are recorded in accounts payable. The unaudited condensed consolidated statement of cash flows for the nine months ended September 30, 2017 excludes the debt conversion as discussed in Note 12.

 

20 SEGMENT INFORMATION

 

The Company produces and markets coal from surface and underground mines in Kentucky, West Virginia, Ohio and Utah. The Company sells primarily to electric utilities in the United States. For the three months ended September 30, 2017, the Company had four reportable segments: Central Appalachia (comprised of both surface and underground mines located in Eastern Kentucky and Southern West Virginia), Northern Appalachia (comprised of both surface and underground mines located in Ohio), Rhino Western (comprised of an underground mine in Utah) and Illinois Basin (comprised of an underground mine in western Kentucky).

 

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The Company’s other category is comprised of the Company’s ancillary businesses, its remaining oil and natural gas activities and its corporate overhead. The Company has not provided disclosure of total expenditures by segment for long-lived assets, as the Company does not maintain discrete financial information concerning segment expenditures for long lived assets, and accordingly such information is not provided to the Company’s chief operating decision maker. The information provided in the following tables represents the primary measures used to assess segment performance by the Company’s chief operating decision maker. For the 2017 reporting period, the Partnership changed its methodology for allocating interest expense to its reportable segments where interest expense is no longer allocated to the reportable segments and is reported in the Other category. All prior periods have been recast to reflect this allocation methodology change.

 

Reportable segment results of operations for the three months ended September 30, 2017 are as follows (Note: “DD&A” refers to depreciation, depletion and amortization):

 

   Central   Northern   Rhino   Illinois       Total 
   Appalachia   Appalachia   Western   Basin   Other   Consolidated 
   (in thousands) 
Total revenues  $27,891   $6,398   $9,080   $14,965   $12   $58,346 
DD&A   2,533    508    1,448    2,352    113    6,954 
Interest expense *   -    -    -    -    1,168    1,168 
Net(loss) from continuing operations  $(321)  $(74)  $(105)  $(172)  $635   $(37)

 

Reportable segment results of operations for the three months ended September 30, 2016 are as follows (Note: “DD&A” refers to depreciation, depletion and amortization) (Rhino is only included from its date of acquisition of March 17, 2016):

 

   Central   Northern   Rhino   Illinois       Total 
   Appalachia   Appalachia   Western   Basin   Other   Consolidated 
   (in thousands) 
Total revenues  $10,432   $10,974   $7,219   $14,576   $214   $43,415 
DD&A   415    196    326    666    36    1,639 
Interest expense *   552    59    119    310    921    1,961 
Net (loss)/income from continuing operations  $(276)  $2,296   $-   $(505)  $(367)  $1,148 

 

Reportable segment results of operations for the nine months ended September 30, 2017 are as follows (Note: “DD&A” refers to depreciation, depletion and amortization):

 

   Central   Northern   Rhino   Illinois       Total 
   Appalachia   Appalachia   Western   Basin   Other   Consolidated 
   (in thousands) 
Total revenues  $76,880   $17,014   $25,141   $49,377   $20   $168,432 
DD&A   13,062    2,908    7,632    12,828    641    37,071 
Interest expense *   -    -    -    -    3,402    3,402 
Net income from continuing operations  $(10,116)  $(2,239)  $(3,308)  $(6,500)  $127,756   $105,593 

 

Reportable segment results of operations for the nine months ended September 30, 2016 are as follows (Note: “DD&A” refers to depreciation, depletion and amortization) (Rhino is only included from its date of acquisition of March 17, 2016):

 

   Central   Northern   Rhino   Illinois       Total 
   Appalachia   Appalachia   Western   Basin   Other   Consolidated 
   (in thousands) 
Total revenues  $15,892   $23,250   $18,434   $33,331   $280   $91,187 
DD&A   818    420    678    1,044    69    3,029 
Interest expense *   1,404    224    238    596    1,601    4,063 
Net (loss)/income from continuing operations  $(349)  $1,246   $(19)  $(150)  $(105)  $623 

 

*For the 2017 reporting period, the Partnership changed its methodology for allocating interest expense to its reportable segments where interest expense is no longer allocated to the reportable segments and is reported in the Other category. All prior periods have been recast to reflect this allocation methodology change.

 

21 PARENT COMPANY FINANCIAL STATEMENTS

 

The Company’s Rhino subsidiary has certain restrictions on its assets and funds that are available to be transferred outside of Rhino based upon its Amended and Restated Credit Agreement as discussed in Note 10. Due to the restrictions on the assets and funds available for remittance to the Company, the following tables present the financial statements of the parent Company for all periods presented.

 

26

 

 

Item 1. Financial Statements (Unaudited)

 

PART I.—FINANCIAL INFORMATION

 

ROYAL ENERGY RESOURCES, INC.

UNAUDITED CONDENSED STATEMENTS OF FINANCIAL POSITION

(in thousands)

 

   September 30, 2017   December 31, 2016 
ASSETS          
CURRENT ASSETS:          
Cash and cash equivalents  $1,389   $39 
Prepaid expenses and other   264    54 
Total current assets   1,653    93 
PROPERTY, PLANT AND EQUIPMENT:          
At cost, including coal properties, mine development and construction costs   11,432    11,432 
Less accumulated depreciation, depletion and amortization   -    - 
Net property, plant and equipment   11,432    11,432 
Investment in Rhino, net   197,714    61,136 
Intangible assets, less accumulated amortization of $-0- and $67, respectively   -    34 
TOTAL  $210,799   $72,695 
LIABILITIES AND EQUITY          
CURRENT LIABILITIES:          
Accounts payable   -    29 
Accrued expenses and other   686    769 
Note payable-related parties   504    2,504 
Note payable-Rhino   -    4,040 
Related party advance and accrued interest payable   42    71 
Total current liabilities   1,232    7,413 
NON-CURRENT LIABILITIES:          
Deferred tax liability   43,396    - 
Long-term debt, net of current portion   2,500    - 
Total non-current liabilities   45,896    - 
Total liabilities   47,128    7,413 
           
STOCKHOLDERS’ EQUITY          
Preferred stock: $0.00001 par value; authorized 5,000,000 shares; 51,000 issued and outstanding at September 30, 2017 and authorized 10,000,000 shares; 51,000 issued and outstanding at December 31, 2016          
Common stock: $0.00001 par value; authorized 25,000,000 shares; 18,079,293 shares issued and outstanding at September 30, 2017 and authorized 500,000,000; 18,079,293 shares issued and outstanding at December 31, 2016.   1    1 
Additional paid-in capital   46,861    47,295 
Stock subscription receivable   -    (213)
Accumulated other comprehensive income   1,440    874 
Treasury stock   (4,126)   - 
Retained earnings (accumulated deficit)   90,415    (20,579)
Total stockholders’ equity owned by common shareholders   134,591    27,378 
Total non-controlling interest   29,080    37,904 
Total stockholders’ equity   163,671    65,282 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $210,799   $72,695 

 

27

 

 

ROYAL ENERGY RESOURCES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND

COMPREHENSIVE INCOME

(in thousands, except per unit data)

 

   Three Months   Nine Months 
   Ended September 30,   Ended September 30, 
   2017   2016   2017   2016 
REVENUES:                    
Revenues  $-   $-   $-   $- 
Total revenues   -    -    -    - 
COSTS AND EXPENSES:                    
Depreciation, depletion and amortization   -    17    34    50 
Selling, general and administrative (exclusive of depreciation, depletion and amortization shown separately above)   463    436    1,350    1,488 
Total costs and expenses   463    453    1,384    1,538 
(LOSS)/INCOME FROM OPERATIONS   (463)   (453)   (1,384)   (1,538)
INTEREST AND OTHER (EXPENSE)/INCOME:                    
Interest income                    
Other   1    -    1    1 
Related party   -    2    -    5 
Interest expense                    
Other   (88)   (54)   (146)   (93)
Related Party   (89)   (3)   (95)   (9)
Gain on bargain purchase   -    -    171,151    - 
Equity in net income from Rhino   (33)   1,586    (20,538)   2,907 
Total interest and other (expense)/income   (209)   1,531    150,373    2,811 
NET (LOSS)/INCOME FROM OPERATIONS BEFORE INCOME TAXES   (672)   1,078    148,989    1,273 
INCOME TAXES   (635)   -    43,396    - 
NET (LOSS)/INCOME FROM OPERATIONS   (37)   1,078    105,593    1,273 
NET (LOSS/ INCOME BEFORE NON-CONTROLLING INTEREST   (37)   1,078    105,593    1,273 
Less net (loss)/income attributable to non-controlling interest   (15)   166    (9,288)   196 
NET (LOSS)/INCOME ATTRIBUTABLE TO COMPANY’S STOCKHOLDERS  $(22)  $912   $114,881   $1,077 
                     
Net(loss)/income per share, basic and diluted  $(0.00)  $0.05   $6.63   $0.07 
                     
Weighted average shares outstanding, basic and diluted   18,079,293    16,699,036    17,325,596    15,624,438 

 

28

 

 

ROYAL ENERGY RESOURCES, INC.

UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

 

   Nine Months Ended September 30, 
   2017   2016 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $105,593   $1,273 
Adjustments to reconcile net income to net cash used in operating activities: