UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended March 31, 2003 or
For the transition period from to
Commission File Number: 001-14901
CONSOL Energy Inc.
(Exact name of registrant as specified in its charter)
Delaware
51-0337383
(State or other jurisdiction of
incorporation or organization)
(IRS Employer Identification No.)
1800 Washington Road, Pittsburgh, Pennsylvania 15241
(Address of principal executive offices, including zip code)
(412) 831-4000
(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 x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
As of April 30, 2003, there were 78,762,586 shares of Common Stock, $.01 par value, outstanding.
TABLE OF CONTENTS
Page
PART IFINANCIAL INFORMATION
ITEM 1.
CONDENSED FINANCIAL STATEMENTS
Consolidated Statements of Income for the three months ended March 31, 2003 and March 31, 2002
3
Consolidated Balance Sheets at March 31, 2003 and December 31, 2002
4
Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2003
6
Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and March 31, 2002
7
Notes to Consolidated Financial Statements
8
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
22
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
35
ITEM 4.
CONTROLS AND PROCEDURES
36
PART IIOTHER INFORMATION
ITEM 6.
EXHIBITS AND REPORTS ON FORM 8-K
2
PART I
FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS
CONSOL ENERGY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands, except per share data)
Three Months EndedMarch 31,
2003
2002
Sales—Outside
$
506,560
505,201
Sales—Related Parties
1,369
Freight—Outside
32,028
36,432
Freight—Related Parties
562
—
Other Income
19,290
8,371
Total Revenue and Other Income
559,809
550,008
Cost of Goods Sold and Other Operating Charges
407,871
362,909
Freight Expense
32,590
Selling, General and Administrative Expense
17,084
16,657
Depreciation, Depletion and Amortization
60,706
66,457
Interest Expense
9,476
10,137
Taxes Other Than Income
43,142
50,725
Total Costs
570,869
543,317
Earnings (Loss) Before Income Taxes
(11,060
)
6,691
Income Tax Expense (Benefit)
(14,449
1,190
Earnings before Cumulative Effect of Change in Accounting Principle
3,389
5,501
Cumulative Effect of Changes in Accounting for Mine Closing, Reclamation and Gas Well Closing Costs, net of Income Taxes of $3,035
4,768
Net Income
8,157
Basic Earnings Per Share
0.10
0.07
Dilutive Earnings Per Share
Weighted Average Number of Common Shares Outstanding:
Basic
78,749,180
78,707,070
Dilutive
78,845,356
78,912,296
Dividends Paid Per Share
0.14
0.28
The accompanying notes are an integral part of these financial statements.
CONSOLIDATED BALANCE SHEETS
MARCH 31,
DECEMBER 31,
ASSETS
Current Assets:
Cash and Cash Equivalents
19,944
11,517
Accounts and Notes Receivable:
Trade
219,687
205,891
Other Receivables
128,284
127,226
Inventories
127,360
135,621
Deferred Income Taxes
89,954
92,236
Recoverable Income Taxes
12,272
21,935
Prepaid Expenses
30,682
28,411
Total Current Assets
628,183
622,837
Property, Plant and Equipment:
Property, Plant and Equipment
5,766,545
5,697,724
Less—Accumulated Depreciation, Depletion and Amortization
2,830,578
2,793,700
Total Property, Plant and Equipment—Net
2,935,967
2,904,024
Other Assets:
444,907
420,718
Advance Mining Royalties
92,904
90,561
Investment in Affiliates
83,024
135,362
Other
120,730
119,658
Total Other Assets
741,565
766,299
TOTAL ASSETS
4,305,715
4,293,160
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts Payable
118,828
151,371
Short-Term Notes Payable
153,848
204,545
Current Portion of Long-Term Debt
8,256
8,615
Other Accrued Liabilities
495,771
449,902
Total Current Liabilities
776,703
814,433
Long-Term Debt:
Long-Term Debt
487,781
485,535
Capital Lease Obligations
2,420
2,896
Total Long-Term Debt
490,201
488,431
Deferred Credits and Other Liabilities:
Postretirement Benefits Other Than Pensions
1,457,342
1,437,987
Pneumoconiosis Benefits
450,473
455,436
Mine Closing
371,928
332,920
Workers’ Compensation
259,316
261,250
Deferred Revenue
91,655
102,400
Salary Retirement
93,523
91,474
Reclamation
6,933
5,812
150,548
140,970
Total Deferred Credits and Other Liabilities
2,881,718
2,828,249
Stockholders’ Equity:
Common Stock, $.01 par value; 500,000,000 Shares Authorized, 80,267,558 Issued; and 78,749,504 Outstanding at March 31, 2003 and 78,749,001 Outstanding at December 31, 2002
803
Preferred Stock, 15,000,000 Shares Authorized; None Issued and Outstanding
Capital in Excess of Par Value
643,790
643,787
Retained Earnings (Deficit)
(374,885
(372,017
Other Comprehensive Loss
(95,465
(93,370
Common Stock in Treasury, at Cost—1,518,054 Shares at March 31, 2003 and 1,518,557 Shares at December 31, 2002
(17,150
(17,156
Total Stockholders’ Equity
157,093
162,047
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
CommonStock
Capital inExcess ofPar Value
RetainedEarnings(Deficit)
OtherComprehensiveIncome(Loss)
TreasuryStock
TotalStockholders’Equity
Balance—December 31, 2002
Treasury Rate Lock (Net of $14 tax)
(21
Interest Rate Swap Contract (Net of $32 tax)
(49
Gas Cash Flow Hedge (Net of $1,289 tax)
(2,025
Comprehensive Income (Loss)
(2,095
6,062
Treasury Stock Issued (503 shares)
9
Dividends ($.14 per share)
(11,025
Balance—March 31, 2003
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Three Months Ended
March 31,
Operating Activities:
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Cumulative Effect of Change in Accounting Principle, net of tax
(4,768
Gain on the Sale of Assets
(8,900
(298
Amortization of Advance Mining Royalties
1,007
4,064
(23,607
657
Equity in Earnings of Affiliates
337
560
Changes in Operating Assets:
Accounts and Notes Receivable
(15,216
(9,666
3,042
(69,724
(5,490
(14,786
Changes in Other Assets
(966
3,066
Changes in Operating Liabilities:
(26,767
(29,210
Other Operating Liabilities
55,971
63,185
Changes in Other Liabilities
1,488
13,532
(1,634
(2,425
35,203
25,412
Net Cash Provided by Operating Activities
43,360
30,913
Investing Activities:
Capital Expenditures
(46,723
(70,360
Additions to Advance Mining Royalties
(2,588
(3,776
Investment in Equity Affiliates
(831
(5,411
Proceeds from Sales of Assets
76,878
949
Net Cash Provided by (Used in) Investing Activities
26,736
(78,598
Financing Activities:
Payments on Commercial Paper—Net
(52,281
(144,750
Proceeds from (Payment on) Miscellaneous Borrowings
621
(987
Payments on Long Term Notes
(23,000
Proceeds from Long Term Notes
246,310
Dividends Paid
(11,016
(22,025
Proceeds from Treasury Rate Lock
1,332
Payments for Bond Issuance Costs
(596
Issuance of Treasury Stock
117
Net Cash (Used in) Provided by Financing Activities
(61,669
56,401
Net Increase in Cash and Cash Equivalents
8,427
8,716
Cash and Cash Equivalents at Beginning of Period
15,582
Cash and Cash Equivalents at End of Period
24,298
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2003
NOTE 1—BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2003 are not necessarily indicative of the results that may be expected for future periods.
The balance sheet at December 31, 2002 has been derived from the audited financial statements at that date but does not include all the footnotes required by generally accepted accounting principles for complete financial statements.
For further information, refer to the consolidated financial statements and footnotes for the year ended December 31, 2002 included in CONSOL Energy Inc.’s (CONSOL Energy) Form 10-K, as amended.
Certain reclassifications of the prior year’s data have been made to conform to the three months ended March 31, 2003 classifications.
NOTE 2—STOCK-BASED COMPENSATION:
CONSOL Energy has implemented the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123). CONSOL Energy continues to measure compensation expense for its stock-based compensation plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” as amended. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of the grant. The following table illustrates the effect on net income and earnings per share if CONSOL Energy had applied the fair value recognition provisions of SFAS No. 123, to stock-based employee compensation:
Net income, as reported
Deduct: Total stock based employee compensation expense determined under Black-Scholes option pricing model
(648
(773
Pro forma net income
7,509
4,728
Earnings per share:
Basic—as reported
Basic—pro forma
0.06
Diluted—as reported
Diluted—pro forma
The pro forma adjustments in the current period are not necessarily indicative of future period pro forma adjustments as the assumptions used to determine fair value can vary significantly and the number of future shares to be issued under these plans is unknown.
NOTE 3—CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING FOR MINE CLOSING, RECLAMATION AND GAS WELL CLOSING COSTS:
Effective January 1, 2003, CONSOL Energy adopted Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (SFAS No. 143). As a result of this statement, CONSOL Energy recognized additional liabilities of $51,692 for asset retirement obligations associated with the costs of mine closing, reclamation and gas well closing. In addition, CONSOL Energy capitalized asset retirement costs by increasing the carrying amount of related long-lived assets, net of the associated accumulated depreciation, by $59,495.
The cumulative effect adjustment recognized upon adoption of this statement was a gain of $4,768, net of a tax cost of approximately $3,035. Net income for the three months ended March 31, 2002 and for the twelve months ended December 31, 2002 would not materially differ if this statement had been adopted January 1, 2002. The obligation for asset retirements is included in Mine Closing, Reclamation, Other Accrued Liabilities and Other Liabilities in the balance sheets.
The following table illustrates the pro forma impact on the carrying amounts of the obligations for the three months ended March 31, 2003 and the twelve months ended December 31, 2002 as if this statement had been adopted on January 1, 2002:
Three MonthsEndedMarch 31, 2003
Twelve MonthsEndedDecember 31, 2002
Balance at beginning of period
452,751
450,420
Accretion Expense
6,198
24,793
Payments
(6,408
(24,378
(5,025
1,916
Balance at end of period
447,516
NOTE 4—INCOME TAXES:
The following is a reconciliation, stated in dollars and as a percentage of pretax income, of the U. S. statutory federal income tax rate to CONSOL Energy’s effective tax rate:
For the Three Months Ended March 31,
Amount
Percent
Statutory U. S. federal income tax rate
(3,871
35.0
%
2,342
Excess tax depletion
(7,545
68.2
(1,987
(29.7
Net effect of state tax
(2,220
20.1
335
5.0
Net effect of foreign tax
(391
3.5
8.4
(422
3.8
(62
(0.9
Income Tax (Benefit) Expense Effective Rate
130.6
17.8
CONSOL Energy used a discrete tax calculation for the three months ended March 31, 2003. An annual effective rate was not applied to the quarterly results due to the sensitivity of the rate to small changes in forecasted income. The 2002 period rate was calculated using the annual effective rate projection available at that time. A small change in our estimated annual income was not projected to cause a disproportionately large change in the annual effective tax rate for the year ended December 31, 2002.
10
NOTE 5—INVENTORIES:
The components of inventories consist of the following:
March 31,2003
December 31,2002
Coal
59,505
67,119
Merchandise for resale
18,904
18,855
Supplies
48,951
49,647
Total Inventories
NOTE 6—COMMITMENTS AND CONTINGENCIES:
CONSOL Energy has various purchase commitments for materials, supplies and items of permanent investment incidental to the ordinary conduct of business. Such commitments are not at prices in excess of current market values.
One of our subsidiaries, Fairmont Supply Company, which distributes industrial supplies, currently is named as a defendant in approximately 21,900 asbestos claims in state courts in Pennsylvania, Ohio, West Virginia and Mississippi. Because a very small percentage of products manufactured by third parties and supplied by Fairmont in the past may have contained asbestos and many of the pending claims are part of mass complaints filed by hundreds of plaintiffs against a hundred or more defendants, it has been difficult for Fairmont to determine how many of the cases actually involve valid claims or plaintiffs who were actually exposed to asbestos-containing products supplied by Fairmont. In addition, while Fairmont may be entitled to indemnity or contribution in certain jurisdictions from manufacturers of identified products, the availability of such indemnity or contribution is unclear at this time and, in recent years, some of the manufacturers named as defendants in these actions have sought protection from these claims under bankruptcy laws. Fairmont has no insurance coverage with respect to these asbestos cases. To date, payments by Fairmont with respect to asbestos cases have not been material. However, there cannot be any assurance that payments in the future with respect to pending or future asbestos cases will not be material to the financial position, results of operations or cash flows of CONSOL Energy.
CONSOL Energy is subject to various lawsuits and claims with respect to such matters as personal injury, wrongful death, damage to property, exposure to hazardous substances, governmental regulations including environmental remediation, employment and contract disputes, and other claims and actions arising out of the normal course of business. In addition, CONSOL Energy has recognized a liability related to a waste disposal site and accrued $4,975 in Other Liabilities. CONSOL Energy has paid $2,092 to date related to the remediation of this waste disposal site and, accordingly, reduced the liability to $2,883 at March 31, 2003. In the opinion of management, the ultimate liabilities resulting from such pending lawsuits and claims will not materially affect the financial position, results of operations or cash flows of CONSOL Energy.
CONSOL Energy and certain of its subsidiaries have provided the following financial guarantees. CONSOL Energy Management believes that these guarantees will expire without being funded, and therefore, the commitments will not have a material adverse effect on financial condition. The fair values of all liabilities associated with these guarantees have been properly recorded and reported in the financial statements at March 31, 2003.
11
Guarantee
Term
Maximum Payments
Workers’ Compensation Surety Bonds(a)
Various
421,600
Reclamation Surety Bonds(b)
267,100
Gas Sales Agreements(c)
99,000
Ohio Power Company(d)
6/1993-6/2006
50,714
Ohio Valley Electric Corporation(e)
1/2000-12/2006
33,099
Miscellaneous Surety Bonds(f)
28,800
1992 Benefit Plan(g)
10/2002-10/2003
22,389
Orix Financial Services(h)
12/2002-12/2007
17,700
U.S. Bancorp(i)
7/2002-7/2007
15,311
Court Bonds(j)
11,000
Illinois Industrial Commission(k)
8,325
Old Republic Insurance(l)
6,777
Citibank ISDA Agreements(m)
6,300
U.S. Department of Energy(n)
4,900
GE Capital Finance(o)
2,449
Centimark Corp.(p)
8/2000-8/2008
1,581
Reliant Energy(q)
12/2002-12/2005
1,575
West Penn Power Company(r)
7/1967-12/2004
1,204
U.S. Department of Labor(s)
12/2002-12/2003
1,150
Orion Power(t)
635
Highmark Life & Casualty(u)
2/2002-5/2003
500
LABAR Co.(v)
4/1999-4/2005
346
Lumbermens Mutual(w)
7/2002-11/2003
253
Total Guarantees
1,002,708
12
13
and timely performance of all obligations of the subsidiary to Centimark, in relation to this lease agreement.
14
NOTE 7—SEGMENT INFORMATION:
Industry segment results for the three months ended March 31, 2003:
Reportable Business Segments
AllOther
Corporate,Adjustments& Eliminations
Consolidated
Gas
Total
Sales—outside
435,450
51,783
487,233
19,327
Sales—related parties
Freight—outside
31,907
121
Freight—related parties
Intersegment transfers
950
24,233
(25,183
Total Sales and Freight
469,288
52,733
522,021
43,681
540,519
Earnings (Loss) Before Income Taxes(A)
(12,599
16,084
3,485
(6,160
(8,385
Segment assets(B)
2,836,352
655,033
3,491,385
222,502
591,828
Depreciation, depletion and amortization
48,960
9,034
57,994
2,712
Capital expenditures
37,630
8,672
46,302
421
46,723
15
Industry segment results for the three months ended March 31, 2002:
Corporate, Adjustments & Eliminations
455,873
27,692
483,565
21,636
36,338
94
445
25,326
(25,771
492,215
28,137
520,352
47,056
541,637
Earnings (Loss) Before Income Taxes (C)
14,428
3,514
17,942
(1,139
(10,112
Segment assets (D)
2,948,015
602,673
3,550,688
208,562
533,574
4,292,824
55,493
8,162
63,655
2,359
443
51,227
18,662
69,889
471
70,360
Reconciliation of Segment Information to Consolidated Amounts:
Earnings (Loss) Before Income Taxes:
For the Three Months EndedMarch 31,
Segment earnings (loss) before income taxes for total reportable business segments
Segment (loss) before income taxes for all other businesses
Incentive compensation
(332
Interest income (expense), net and other non-operating activity
(8,393
(9,780
16
Total Assets:
Segment assets for total reportable business segments
Segment assets for all other businesses
Items excluded from segment assets:
Cash and other investments
20,269
24,695
Export sales excise tax resolution interest receivable
21,262
20,602
Deferred tax assets
534,861
400,595
Recoverable income taxes
84,572
Bond issuance costs
3,164
3,110
Total Consolidated Assets
NOTE 8—GUARANTOR SUBSIDIARIES FINANCIAL INFORMATION:
The payment obligations under the $250,000 7.875 percent Notes due 2012 issued by CONSOL Energy in 2002 are fully and unconditionally guaranteed by several subsidiaries of CONSOL Energy. In accordance with positions established by the Securities and Exchange Commission, the following financial information sets forth separate financial information with respect to the parent, the guarantor subsidiaries and the non-guarantor subsidiaries. The principal elimination entries eliminate investments in subsidiaries and certain intercompany balances and transactions. CONSOL Energy, the parent, and a guarantor subsidiary manage several assets and liabilities of their subsidiaries. For example, these include deferred tax assets, cash and other post-employment liabilities. These assets and liabilities are reflected as parent company or guarantor company amounts for purposes of this presentation.
17
Income Statement for Three Months Ended March 31, 2003:
Parent
Guarantors
Non- Guarantors
Elimination
404,930
101,630
25,543
6,485
Other Income (including equity earnings)
16,358
38,919
(10,021
(25,966
471,323
98,094
4,029
337,883
105,622
(39,663
Intercompany Activity
237
(12,093
(33,613
45,469
26,105
13,499
3,585
694
54,636
7,230
(1,854
5,900
3,290
286
1,223
34,294
7,625
12,083
457,614
97,220
3,952
4,275
13,709
874
(29,918
Income Taxes (Benefit)
(3,882
(10,629
62
Earnings (Loss) before Cumulative Effect
Effect of Change in Accounting Principle
24,338
812
Cumulative Effect of Changes in Accounting for Mine Closing, Reclamation, and Gas Well Closing Costs, Net of Income Taxes
(2,900
(1,868
Net Income (Loss)
27,238
2,680
18
Balance Sheet for March 31, 2003:
Non-Guarantors
Assets:
4,180
399
15,365
78,043
110,581
31,063
6,031
108,949
13,304
258
99,190
27,912
12,125
18,344
213
202,863
337,463
87,857
90,977
5,035,685
639,883
Less-Accumulated Depreciation, Depletion and Amortization
42,233
2,659,905
128,440
Property, Plant and Equipment—Net
48,744
2,375,780
511,443
Advanced Mining Royalties
85,191
7,713
1,320,428
647,873
120,099
(2,005,376
3,203
97,740
19,787
1,768,538
830,804
147,599
Total Assets
2,020,145
3,544,047
746,899
Liabilities and Stockholders’ Equity:
94,940
8,446
15,442
Accounts Payable (Recoverable)—Related Parties
1,141,651
(277,973
(863,678
150,825
3,023
7,772
484
66,756
361,735
67,280
1,454,172
99,980
(777,449
248,159
218,722
20,900
221,142
237,163
134,765
1,484
222,986
34,846
80,094
11,561
93,268
255
4,014
2,919
65,969
62,684
21,895
160,721
2,515,011
205,986
Stockholders’ Equity
707,914
1,297,462
Total Liabilities and Stockholders’ Equity
19
Condensed Statement of Cash Flows
For the Three Months Ended March 31, 2003:
Net Cash Provided by (Used in) Operating Activities
67,500
31,710
(55,850
Cash Flows from Investing Activities:
(2,575
(35,540
(8,608
(15
(816
Other Investing Activities
1
4,848
69,441
74,290
Net Cash (Used in) Provided by Investing Activities
(2,574
(30,707
60,017
Cash Flows from Financing Activities:
Payments on Short-Term Borrowings
Proceeds from Long-Term Notes
Other Financing Activities
(100
(897
1,618
(63,397
2,625
Income Statement for Three Months Ended March 31, 2002:
396,925
108,276
28,012
8,420
1,265
(1,265
8,278
12,324
(10,697
(1,534
437,263
107,266
(2,799
2,651
286,382
112,797
(38,921
(4,023
(2,255
(43,368
49,646
9,685
13,374
3,283
708
59,577
8,027
(1,855
3,552
5,928
1,116
39,050
10,559
4,004
430,068
101,640
7,605
4,274
7,195
5,626
(10,404
(1,227
692
1,725
6,503
3,901
20
Balance Sheet for December 31, 2002:
293
8,573
157,131
48,760
6,482
110,524
10,220
93,890
41,473
4,770
19,106
4,535
128,332
380,944
113,561
87,689
4,941,646
668,389
41,620
2,594,442
157,638
46,069
2,347,204
510,751
82,510
8,051
1,367,604
1,110,421
53,954
(2,396,617
2,509
95,901
21,248
1,790,831
1,288,832
83,253
1,965,232
4,016,980
707,565
110,120
16,334
24,917
1,023,380
(195,905
(827,475
203,139
1,406
100
8,032
483
62,606
322,743
64,553
1,399,345
151,204
(736,116
248,107
217,535
19,893
220,431
200,813
132,107
1,827
222,311
37,112
86,043
16,357
90,665
809
2,327
63,241
61,444
16,285
155,733
2,468,328
204,188
1,177,017
1,219,600
21
For the Three Months Ended March 31, 2002:
Net Cash (Used in) Provided by Operating Activities
(65,485
69,466
26,932
(2,507
(38,668
(29,185
(309
(50
(5,052
(1,070
(1,757
(2,827
Net Cash Used in Investing Activities
(2,816
(39,788
(35,994
Payments on Long-Term Notes
753
(887
(134
Net Cash Provided by (Used in) Financing Activities
80,288
(23,887
NOTE 9—RECENT ACCOUNTING PRONOUNCEMENTS:
In December 2002, Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” was issued and the disclosure requirements have been adopted by CONSOL Energy for the quarter ended March 31, 2003 and the year ended December 31, 2002. CONSOL Energy is currently evaluating the alternative methods of transition to determine if the Company will change to the fair value based method of accounting for stock-based employee compensation.
General
CONSOL Energy incurred a loss before income tax and cumulative effect of change in accounting principle of $11 million and recognized income tax benefits of $14 million, which resulted in earnings before cumulative effect of change in accounting principle of $3 million for the three months ended March 31, 2003. In this period, CONSOL Energy also recognized $5 million of income, net of $3 million of deferred tax expense, with respect to the cumulative effect of change in accounting principle related to the adoption of Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (SFAS No. 143). This statement requires that the fair value of an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The present value of the estimated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. Asset retirement obligations primarily relate to the closure of mines and gas wells and the reclamation of land upon exhaustion of coal and gas reserves. Under previous accounting standards, such obligations were recognized ratably over the life of the producing assets, primarily on a units-of-production basis. As a result, CONSOL Energy reported net income for the 2003 period of $8 million. Net income for the three months ended March 31, 2002 was $6 million.
Total coal sales for the three months ended March 31, 2003 were 16.2 million tons, including a portion of sales by equity affiliates, of which 15.6 million tons were produced by CONSOL Energy operations, by our equity affiliates or sold from inventory of company produced coal. This compares with total coal sales of 17.4 million tons for the three months ended March 31, 2002, of which 16.6 million tons were produced by CONSOL Energy operations, by our equity affiliates or sold from inventory of company produced coal. The decrease in tons sold was due primarily to the closure of the Dilworth, Windsor and Meigs mines due to economically depleted reserves. The decrease in tons sold was also attributable to the idling of the Rend Lake Mine. These closed and idled mines reduced overall company production. Production from CONSOL Energy operations, including our percentage of the production for equity affiliates, was 15.6 million tons during the three months ended March 31, 2003 and 19.9 million tons during the three months ended March 31, 2002. Company produced inventory, including our portion of inventory at equity affiliates, was 2.4 million tons at March 31, 2003 and was 3.0 million tons at December 31, 2002. CONSOL Energy currently has firm or committed coal sales for 98% of its projected 2003 production, subject to the deferral of acceptance of delivery by customers.
Sales volume of coalbed methane gas, including a percentage of the sales of equity affiliates equal to our interest in these affiliates, increased 8.9% to 12.0 billion cubic feet in the 2003 period compared with 11.0 billion cubic feet in the 2002 period. The increased sales volume is primarily due to higher production as a result of additional wells coming on line from the ongoing drilling program. Our average sales price for coalbed methane gas, including sales of equity affiliates, but excluding the effects of derivative transactions, increased 77.9% to $4.66 per million British thermal units in the 2003 period compared with $2.62 per million British thermal units in the 2002 period. Gas prices through the first quarter of 2003 were higher than levels during the first quarter of 2002 primarily as a result of the continued decline in U.S. gas production and reduced Canadian imported production. The decline in gas production has caused substantial declines in gas storage levels. CONSOL Energy enters into various physical gas supply transactions with our gas marketers (selling gas under short-term multi-month contract nominations generally not exceeding one year.) CONSOL Energy has also entered into four float-for-fixed gas swap transactions, which have resulted in a $2 million reduction of revenue and a $2 million increase in other comprehensive loss (net of a $1 million increase in deferred tax assets) in the three months ended March 31, 2003. These transactions qualify as financial cash flow hedges. The swap transactions exist parallel to the underlying physical transactions. The average sales price, including sales of equity affiliates and including the effects of derivative transactions, was $4.48 per million British thermal unit for the 2003 period, a 71.2%, or $1.86 increase compared to the average sales price of $2.62 per million British thermal unit for the 2002 period. CONSOL Energy locked in 90% of sales volumes in the 2003 period at an average of $4.30 per million British thermal unit compared to 64% of sales volumes in the 2002 period at $2.82 per million British thermal unit. CONSOL Energy currently has fixed gas prices for 44.8 billion cubic feet, or approximately 90%, of its projected 2003 production at $4.04 per million British thermal unit.
In February 2003, we sold our interests in Canadian coal assets and port facilities to Fording Inc. for a note and cash, including amounts to be adjusted through a working capital audit. The note was exchanged for 3.2 million units in the Fording Canadian Coal Trust, a newly organized publicly traded trust which acquired the assets of Fording Inc. We sold the units in the coal trust in March 2003. CONSOL Energy has received total proceeds of approximately $72 million pending finalization of the contract’s working capital audit, which resulted in a $1 million loss on the sale.
In February 2003, our Loveridge Mine experienced a fire near the bottom of the slope entry that is used to carry coal from the mine to the surface. The cost of extinguishing the fire is estimated to be approximately $8 million, net of expected insurance recovery. The Loveridge Mine was idle during 2002. In late December 2002, the mine began the process of developing a new underground area that would be mined with longwall mining equipment that was expected to be installed later in 2003. The fire will delay this installation.
In January 2003, an explosion occurred at an airshaft construction site at the McElroy Mine resulting in the deaths of three construction workers and the injury of three other construction workers. The workers were employees of the construction company installing the shaft. The airshaft is located in an area ahead of mining
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activity. The explosion did not affect the normal production schedule of the mine. We do not believe that this event will have a material adverse effect on our results of operations or financial condition.
In January 2003, Mine 84, near Washington, Pennsylvania experienced a fire along several hundred feet of the conveyor belt entry servicing the longwall section of the mine. The fire was extinguished approximately two weeks later. On January 20, 2003, the mine resumed production on a limited basis with continuous mining machines, while repairs continued on the belt entry. The fire caused damage to the roof support system, the conveyor belt and the steel framework on which the belt travels. Repairs took several weeks to complete and are estimated to cost approximately $7 million, net of expected insurance recovery. Longwall coal production, which accounts for the majority of coal normally produced at the mine resumed on February 10, 2003.
In January 2003, we announced that we had entered into a 17-year, 76.5 million ton coal supply agreement with FirstEnergy Generation Corp., a subsidiary of FirstEnergy Corp. The agreement provides for annual shipments of 4.5 million tons to FirstEnergy primarily from our McElroy Mine. The agreement includes a price re-opener provision every three years, beginning in 2005. If CONSOL Energy and FirstEnergy do not agree on price at that time, the contract can be terminated by either party.
In April 2003, Standard and Poor’s placed CONSOL Energy on CreditWatch with negative implications. Standard and Poor’s states this was due to CONSOL Energy’s exposure to unfunded postretirement benefit liabilities, including defined benefit pension and retiree medical liabilities. Standard and Poor’s stated that the benefit plan funding levels have suffered in the past three years, particularly in 2002, from the decline in the stock market and interest rates. In January 2003, Standard and Poor’s lowered its rating of CONSOL Energy’s long-term debt from BBB+ to BBB (9th lowest out of 22 rating categories) and raised the outlook to stable. An obligation rated ‘BBB’ exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation. Standard and Poor’s reaffirmed the Company’s A-2 rating (2nd lowest out of six rating categories) for short-term corporate debt. A short-term obligation rated ‘A-2’ is somewhat more susceptible to the adverse effects of changes to circumstances and economic conditions than obligations in higher rating categories. However, the rating means that the obligor’s capacity to meet its financial commitment of the obligation is satisfactory. A security rating is not a recommendation by a rating agency to buy, sell or hold securities. The security rating may be subject to change.
CONSOL Energy continues to convert to a new integrated information technology system provided by SAP AG to support business processes. The new technology is expected to provide cost-effective strategic software alternatives to meet future core business needs. The system will continue to be implemented in stages throughout 2003 at an estimated total cost of $53 million, of which $33 million has already been incurred.
CONSOL Energy has entered into an agreement to establish an Accounts Receivable Securitization facility that will provide up to $125 million of short term funding. Costs for drawing against this facility are based on commercial paper interest rates. This facility is expected to be operational in the quarter ended June 30, 2003.
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Results of Operations
Three Months Ended March 31, 2003 Compared with Three Months Ended March 31, 2002
CONSOL Energy’s net income was $8 million for the three months ended March 31, 2003 compared to $6 million for the three months ended March 31, 2002. The increase of $2 million primarily was due to a $14 million income tax benefit and $5 million of income, net of $3 million of deferred tax expense as a result of the cumulative effect of change in accounting principle related to the adoption of the Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (SFAS No. 143). This statement requires the fair value of an asset retirement obligation to be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The present value of the estimated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. Asset retirement obligations primarily relate to the closure of mines and gas wells and the reclamation of land upon exhaustion of coal and gas reserves. Under previous accounting standards, such obligations were recognized ratably over the life of the producing assets, primarily on a units-of-production basis. Losses before income taxes and the cumulative effect adjustment for the three months ended March 31, 2003 were $11 million compared to earnings of $7 million in the three months ended March 31, 2002. This decline is primarily due to increased costs related to long-term employee benefits such as Other Post Employment Benefits and Salaried Pension costs and the costs associated with two mine fires experienced in the 2003 period. The decline was offset, in part, by higher average sales prices for gas and coal in the 2003 period compared to the 2002 period as well as an increase in other income primarily due to an increase in gains on sales of assets.
Revenue
Sales increased $3 million, or 0.5%, to $508 million for the 2003 period from $505 million for the 2002 period.
Revenues from the sale of gas increased 86.9%, or $24 million, to $52 million in the 2003 period compared to $28 million in the 2002 period. The increase was primarily due to a higher average sales price in the 2003 period compared to the 2002 period. The average sales price, excluding the effects of derivative transactions, was $4.66 per million British thermal unit for the 2003 period, a 78.5%, or $2.05 increase compared to the average sales price of $2.61 per million British thermal unit for the 2002 period. The increase in average sales price was primarily due to decreasing gas inventory levels throughout the industry. CONSOL Energy enters into various physical gas supply transactions with our gas marketers (selling gas under short-term multi-month contract nominations generally not exceeding one year.) CONSOL Energy has also entered into four float-for-fixed gas swap transactions that qualify as financial cash flow hedges, which exist parallel to the underlying physical transactions. The average sales price, including the effects of derivative transactions, was $4.47 per million British thermal unit for the 2003 period, a 71.3%, or $1.86 increase compared to the average sales price of $2.61 per million British thermal unit for the 2002 period. CONSOL Energy locked in 90% of sales volumes in the 2003 period at an average price of $4.29 per million British thermal unit compared to 64% of sales volumes locked in for the 2002 period at an average price of $2.82 per British thermal unit. The increase in gas sales revenue was also due to higher volumes of gas sold. Sales volumes were 12.0 billion cubic feet, a 9.4%, or 1.0 billion cubic feet increase from the 2002 period. Higher sales volumes were a result of wells coming on line from the ongoing drilling program.
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The increase in sales revenue from the sale of gas was offset, in part, by decreases in company produced coal sales revenue. Company produced coal sales revenue decreased $12 million, or 2.7%, to $417 million in the 2003 period from $429 million in the 2002 period. The decrease in company produced coal revenue was due mainly to a decrease in the tons sold. Company produced tons sold were 15.4 million tons in the 2003 period, a 0.1 million ton, or 5.2%, decrease from the 2002 period. The decrease in tons sold was due primarily to the closure of the Dilworth, Windsor and Meigs mines due to economically depleted reserves. The decrease in tons sold was also attributable to the idling of the Rend Lake Mine. These closed and idled mines reduced overall company production. Although sales volumes have declined from the 2002 period, the average sales price per ton of company produced coal sold increased. Average sales price per ton of company-produced coal increased 2.6% to $27.14 per ton for the 2003 period from $26.44 per ton for the 2002 period. The increase in average sales price reflects higher prices negotiated in the second half of 2002.
Revenues from the sale of purchased coal decreased by $7 million, or 27.9%, to $20 million in the 2003 period from $27 million in the 2002 period. The decrease in purchased coal revenue was due mainly to a decrease in the tons sold. Purchased coal tons sold were 0.6 million tons in the 2003 period, a 0.2 million ton, or 27.7%, decrease from the 2002 period. The decrease in tons sold was due primarily to the termination of the synfuel agreement at the Dilworth Mine, which coincided with the closure of the mine. The average sales price per ton of purchased coal also declined slightly in the 2003 period. Average sales price per ton of purchased coal decreased $0.11 per ton, or 0.3%, to $33.64 in the 2003 period compared to $33.75 per ton in the 2002 period. The decrease in average sales price reflects a change in the overall product mix of purchased coal.
Revenues from the sale of industrial supplies decreased $3 million, or 13.7%, to $15 million in the 2003 period from $18 million in the 2002 period primarily due to reduced sales volumes. Sales volumes were reduced primarily due to decreased spending by our customer base.
Freight revenue, outside and related party, decreased 10.6% to $33 million for the 2003 period from $36 million in the 2002 period. Freight revenue is based on weight of coal shipped, negotiated freight rates and method of transportation (i.e., rail, barge, truck, etc.) used for the customers to which CONSOL Energy contractually provides transportation services. Freight revenue is the amount billed to customers for transportation costs incurred.
Other income, which consists of interest income, gain or loss on the disposition of assets, equity in earnings of affiliates, service income, royalty income, rental income and miscellaneous income, was $19 million in the 2003 period compared to $8 million in the 2002 period. The increase of $11 million, or 130.4% was primarily due to $9 million additional gain on sale of assets in the 2003 period. The gain on sale of assets in the 2003 period principally relates to the sale of surplus equipment. The increased revenue was also due to a $1 million gain on a foreign currency derivative. The foreign currency hedge contracts were executed on July 10, 2002 to permit CONSOL Energy Australia Pty (CEA) to purchase Australian dollars at a fixed exchange rate. CEA entered into these hedges in order to minimize exposure to foreign exchange rate fluctuations. Future hedge contracts will be made in order to satisfy the requirement to provide protection of the forecasted currency exposure for a rolling two-year period. Other income also increased $2 million as a result of various transactions that occurred throughout both periods, none of which was individually material. These increases in other income were reduced by a $1 million loss on the sale of our interest in Canadian coal assets and port facilities to Fording Inc. for a note and cash in February 2003. The note was exchanged for 3.2 million units in the Fording Canadian Coal Trust, a newly organized publicly traded trust which acquired the assets of Fording Inc. We subsequently sold the coal trust units in March 2003. CONSOL Energy has received total proceeds of approximately $72 million pending finalization of the contract’s working capital audit.
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Costs
Cost of Goods Sold and Other Operating Charges increased $45 million, or 12.4%, to $408 million in the 2003 period compared to $363 million in the 2002 period.
Gas operations cost of goods sold increased 32.2% to $18 million in the 2003 period from $14 million in the 2002 period. The increase of $4 million was due mainly to a 20.8% increase in the average cost per million British thermal unit sold. The average cost per million British thermal unit was $1.57 in the 2003 period compared to $1.30 in the 2002 period. Average cost per million British thermal unit increased in the 2003 period primarily due to an increase in royalty expense. Royalty expense increased primarily due to a 78.1% increase in average sales price per British thermal unit in the 2003 period compared to the 2002 period. The increase in cost per unit also increased due to a 9.4% increase in the volume sold. Volumes in the 2003 period were 12.0 million cubic feet compared to 10.9 million cubic feet in the 2002 period. The increased volumes sold were due mainly to additional production from wells coming on line.
Cost of goods sold and other charges for company produced coal was $304 million in the 2003 period, an increase of $19 million, or 6.7%, from $285 million in the 2002 period. The increase in cost of goods sold and other charges for company-produced coal was due to a $34 million, or 12.5%, increase in the cost per ton sold. Costs per ton of coal sold are higher primarily due to increased medical costs for active and retired employees and increased salaried pension costs. These increases in cost per ton of company-produced coal were offset, in part, by $15 million due to the decrease in the volume of company-produced coal sold. Sales tons of company-produced coal decreased 0.8 tons, or 5.2%, to 15.4 million tons in the 2003 period compared to 16.2 million tons in the 2002 period.
Cost of goods sold and other charges for closed and idle mine costs have increased $4 million, or 31.3%, to $16 million in the 2003 period from $12 million in the 2002 period. The increase is primarily due to approximately $6 million of expenses related to mines that were closed or idled for the entire 2003 period that were operating in the 2002 period. These mines include Humphrey, Dilworth, Rend Lake, Windsor and Meigs 2. These increased costs were offset, in part, by approximately $2 million due to the reversal of a mine closing liability that was transferred to a third party.
Miscellaneous cost of goods sold and other operating charges increased $26 million to $34 million in the 2003 period from $8 million in the 2002 period. An increase of $15 million was primarily due to two mine fires in the 2003 period. In January 2003, Mine 84 experienced a fire along several hundred feet of the conveyor belt entry servicing the longwall section of the mine. The fire was extinguished approximately two weeks later. On January 20, 2003, the mine resumed production on a limited basis with continuous mining machines, while repairs continued on the belt entry. The fire caused damage to the roof support system, the conveyor belt and the steel framework on which the belt travels. Repairs took several weeks to complete and are estimated to cost approximately $7 million, net of expected insurance recovery. Longwall coal production, which accounts for the majority of coal normally produced at the mine resumed on February 10, 2003. In February 2003, our Loveridge Mine experienced a fire near the bottom of the slope entry that is used to carry coal from the mine to the surface. The cost of extinguishing the fire is estimated to be approximately $8 million, net of expected insurance recovery. The Loveridge Mine was idle during 2002. In late December 2002, the mine began the process of developing a new underground area that would be mined with longwall mining equipment that was expected to be installed later in 2003. The fire will delay this installation. Miscellaneous cost of goods sold and other operating charges also increased $6 million due to the payment of gas royalties in connection with a dispute between a subsidiary of CONSOL Energy and certain gas lessors. The remaining $5 million increase in miscellaneous cost of goods sold and other operating charges were due to various miscellaneous transactions that occurred throughout both periods, none of which were individually material.
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These increases in cost of goods sold and other charges were offset, in part, by decreased costs for purchased coal. Purchased coal cost of goods sold and other charges decreased 25.1% to $19 million in the 2003 period from $26 million in the 2002 period. The $7 million decrease was due mainly to a 27.7% decrease in the volume of purchased coal sold. The decrease in tons sold was due primarily to the termination of the synfuel agreement at the Dilworth Mine, which coincided with the closure of the mine.
Industrial supplies cost of goods sold also decreased $1 million, or 8.1%, to $17 million in the 2003 period compared to $18 million in the 2002 period. The decrease was due to reduced sales volumes.
Freight expense increased 10.6% to $33 million in the 2003 period from $36 million in the 2002 period. Freight expense is based on weight of coal shipped, negotiated freight rates and method of transportation (i.e., rail, barge, truck, etc.) used for the customers to whom CONSOL Energy contractually provides transportation. Freight expense is billed to customers and the revenue from such billings equals the transportation expense.
Selling, general and administrative expenses remained stable at $17 million in the 2003 period compared to the 2002 period.
Depreciation, depletion and amortization expense decreased 8.7% to $61 million in the 2003 period compared to $66 million in the 2002 period. The decrease of $5 million is primarily due to equipment at the Dilworth mine and related preparation plant becoming fully depreciated to coincide with the closure of the mine due to economically depleted reserves.
Interest expense decreased 6.5% to $9 million for the 2003 period compared to $10 million for the 2002 period. The decrease of $1 million was due to several changes in the period-to-period comparison. Interest expense on commercial paper decreased $1 million in the 2003 period compared to the 2002 period. This was due primarily to a $96 million reduction in commercial paper outstanding and a 0.8% per annum reduction in the average interest rate in the 2003 period from the 2002 period. Interest expense also decreased $1 million due to the reduction of long-term debt through scheduled payments. An additional $2 million decrease in interest expense was due to the implementation of Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (SFAS No. 143). Under this statement, the interest accretion related to the discounted portions of mine closing, reclamation and gas well closing liabilities, previously reported as interest expense, are now reported as operating expenses. These decreases in interest expense were offset, in part, by a $3 million increase in interest expense related to the March 7, 2002 issuance of $250 million of 7.875% Notes due in 2012.
Taxes other than income decreased 15.0% to $43 million for the 2003 period compared to $51 million for the 2002 period. The decrease of $8 million was due primarily to decreased production taxes and decreased payroll taxes. Production taxes decreased $5 million primarily due to lower production volumes in the 2003 period compared to the 2002 period. Coal production was 15 million tons in the 2003 period compared to 20 million tons in the 2002 period. Payroll taxes were reduced by $2 million primarily due to the closure or idling of several mines in the period-to-period comparison. Dilworth, Rend Lake and Humphrey mines were not operating in the 2003 period and, therefore, the number of employees was lower in the 2003 period compared to the 2002 period. The remaining $1 million decrease was due to changes in various other taxes (such as sales and use tax, federal excise taxes and property taxes) throughout both periods, none of which were individually material.
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Income Taxes
Income taxes were a benefit of $14 million in the 2003 period compared to expense of $1 million in the 2002 period. The change of $15 million was due mainly to a pre-tax loss in the 2003 period compared to pre-tax income in the 2002 period with little loss of percentage depletion tax benefits. Our effective tax rate for the quarter was 130.6%, which was determined using a discrete period tax calculation for the quarterly results. The annual effective rate method was not applied to the quarterly results due to the sensitivity of the rate to small changes in forecasted income. The effective tax rate for the 2002 period was 17.8%. The 2002 period rate was calculated using the annual effective rate projection available at that time. A small change in our estimated annual income was not projected to cause a disproportionately large change in the annual effective tax rate for the year ended December 31, 2002.
Cumulative Effect of Changes in Accounting for Mine Closing, Reclamation and Gas Well Closing Costs
Effective January 1, 2003, CONSOL Energy adopted SFAS No. 143, as required. CONSOL Energy reflected a gain of approximately $5 million, net of a tax cost of approximately $3 million. At the time of adoption, total assets, net of accumulated depreciation, increased approximately $59 million and total liabilities increased approximately $51. The amounts recorded upon adoption are dependent upon a number of variables, including the estimated future retirement costs, estimated proved reserves, assumptions involving profit margins, inflation rates and the assumed credit-adjusted risk-free interest rate.
Previous accounting standards generally used the units of production method to match estimated retirement costs with the revenues generated by the producing assets. In contrast, SFAS No. 143 requires depreciation of the capitalized asset retirement cost and accretion of the asset retirement obligation over time. The depreciation will generally be determined on a units-of-production basis, whereas the accretion to be recognized will escalate over the life of the producing assets, typically as production declines. Because of the long lives of the underlying producing assets, the impact on net income in the near term is not expected to be material.
Liquidity and Capital Resources
CONSOL Energy generally has satisfied its working capital requirements and funded its capital expenditures and debt service obligations from cash generated from operations and proceeds from borrowings. A principal source of borrowing is the issuance of commercial paper. At March 31, 2003, CONSOL Energy had an aggregate principal amount outstanding of $151 million of commercial paper. In September 2002, CONSOL Energy entered into a new Senior Credit Facility that provides for an aggregate $485 million that may be used for commercial paper maturities, letters of credit and borrowings for other corporate purposes. This facility replaced a $400 million credit facility, which expired in September 2002. The current agreement consists of a 364-day $218 million credit facility which expires in September 2003, and a three year $267 million credit facility which expires in September 2005. Interest is based at our option, upon the Prime (Base) Rate or London Interbank Offered Rates (LIBOR) plus a spread, which is dependent on our credit rating. The agreement has various covenants, including covenants that limit our ability to dispose of assets and merge with another corporation. We are also required to maintain a ratio of total consolidated indebtedness to twelve month trailing earnings before interest, taxes, depreciation, depletion and amortization (EBITDA) of not more than 3.0 to 1.0, measured quarterly. This ratio was 2.63 to 1.0 at March 31, 2003. In addition, we are required to maintain a ratio of twelve months trailing EBITDA to interest expense and amortization of debt of no less than 4.5 to 1.0 measured quarterly. This ratio was 5.22 to 1.0 at March 31, 2003. At March 31, 2003, this facility had $299 million of additional capacity. At April 30, 2003, this facility has $290 million of additional capacity.
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CONSOL Energy believes that cash generated from operations and its borrowing capacity will be sufficient to meet its working capital requirements, anticipated capital expenditures (other than major acquisitions), scheduled debt payments and anticipated dividend payments in 2003. Nevertheless, the ability of CONSOL Energy to satisfy its debt service obligations, to fund planned capital expenditures or pay dividends will depend upon its future operating performance, which will be affected by prevailing economic conditions in the coal and gas industries and other financial and business factors, some of which are beyond CONSOL Energy’s control.
In order to manage the market risk exposure of volatile natural gas prices in the future, CONSOL Energy enters into various physical gas supply transactions with our gas marketers (selling gas under short-term multi-month contract nominations generally not exceeding one year.) CONSOL Energy has also entered into four float-for-fixed gas swap transactions that qualify as financial cash flow hedges, which exist parallel to the underlying physical transactions. These transactions resulted in other comprehensive loss of $2.0 million (net of $1.3 million of deferred tax) in the three months ended March 31, 2003.
CONSOL Energy frequently evaluates potential acquisitions. CONSOL Energy has funded acquisitions primarily with cash generated from operations and a variety of other sources, depending on the size of the transaction, including debt financing. There can be no assurance that additional capital resources, including debt financing, will be available to CONSOL Energy on terms which CONSOL Energy finds acceptable, or at all.
Stockholders’ Equity and Dividends
CONSOL Energy had stockholders’ equity of $157 million at March 31, 2003 and $162 million at December 31, 2002. Stockholders’ equity was reduced by $56 million in the twelve months ended December 31, 2002 due to Other Comprehensive Losses. These losses relate primarily to minimum pension liability as a result of the negative return on plan assets for non-contributory defined benefit retirement plans. Comprehensive losses are calculated annually and reflect a number of factors including conditions in the stock markets and interest rates. See Consolidated Statements of Stockholders’ Equity and Note 20 of the Notes to Consolidated Financial Statements included in our 2002 Form 10-K, as amended.
A quarterly dividend of $0.14 per share was declared on January 27, 2003, payable to shareholders of record on February 10, 2003. This dividend was paid on February 28, 2003. A quarterly dividend of $0.14 per share was declared on April 25, 2003, payable to shareholders of record on May 9, 2003. This dividend will be paid on May 30, 2003. Under our $485 million Senior Revolving Credit facility, payment of dividends must be suspended in the event of a default under the facility.
Cash Flows
Net cash provided by operating activities was $43 million for the three months ended March 31, 2003 compared to $31 million for the three months ended March 31, 2002. The change in net cash provided by operating activities is primarily due to the decreases in coal inventories. Coal inventories decreased 0.3 million tons in the three month period ended March 31, 2003 compared to an increase of 3.3 million tons in the three month period ended March 31, 2002. The decreases in inventories also resulted in a decrease of prepaid expenses related to deferred freight charges that are accumulated in proportion to the amount of coal inventory carried. These decreases in operating cash flow were offset, in part, by increases in employee related long-term liabilities. Increased employee related long-term liabilities were primarily due to increases in the actuarially determined provisions related to certain assumption changes used in the calculation offset, in part, by increased cash payments. Cash payments increased due to the projected exhaustion of trust funds related to Other Post Employment Benefits that were used to make benefit payments in the 2002 period. Changes in net income also contributed to the change in operating cash flow. Net income for the three month period ended March 31, 2003 increased $2 million, although this increase included non-cash changes such as the cumulative effect of the
30
change in accounting principles related to the adoption of Statement of Financial Accounting Standard No. 143, “Accounting for Asset Retirement Obligations” (SFAS No. 143), decreases in depreciation, depletion and amortization and additional gains on the sale of assets.
Net cash provided by investing activities was $27 million in the 2003 period compared to net cash used in investing activities of $79 million in the 2002 period. The change in net cash provided by (used in) investing activities was primarily due to increased proceeds from the sale of assets and reduced capital expenditures. Proceeds from the sales of assets were $77 million in the 2003 period compared to $1 million in the 2002 period. The increase was due mainly to the $70 million of cash proceeds received in the sale of our interests in Canadian coal assets and port facilities to Fording Inc. for a note and cash in February 2003. The note was exchanged for 3.2 million units in the Fording Canadian Coal Trust, a newly organized publicly traded trust which acquired the assets of Fording Inc. We sold the coal trust units in March 2003. CONSOL Energy still has a $2 million receivable related to this transaction due to monies being held in escrow until the deal is finalized. Capital expenditures were $47 million in the 2003 period compared to $70 million in the 2002 period. Capital expenditures were higher in the 2002 period due mainly to monies being spent for the expansion of the McElroy Preparation Plant, which was completed and placed in service in 2002. Capital expenditures were also higher in the 2002 period due to the additional gas wells being drilled in the 2002 period compared to the 2003 period.
Net cash used in financing activities was $62 million in the 2003 period compared with net cash provided by financing activities of $56 million in the 2002 period. The change in net cash used in or provided by financing activities primarily reflects the cash received in the 2002 period of approximately $246 million related to the issuance on March 7, 2002 of 7.875% notes due 2012. This receipt of cash was offset, in part by additional payments made to reduce the outstanding principal balance of commercial paper in the 2002 period compared to the 2003 period. Also, a scheduled payment of $23 million was made in the 2002 period on unsecured notes.
The following is a summary of our significant obligations at March 31, 2003 (in thousands):
Payments due by Year
Within 1
Year
2-3
Years
4-5
After 5
Short-term Notes Payable
Long-term Debt
3,382
52,181
56,960
378,640
491,163
4,874
7,294
Operating Lease Obligations
12,935
21,773
16,178
7,384
58,270
Total Obligations
175,039
76,374
73,138
386,024
710,575
Additionally, we have long-term liabilities relating to other post employment benefits, work-related injuries and illnesses, defined benefit pension plans, mine reclamation and closure, and other long-term liability costs. We estimated the payments, net of any applicable trust reimbursements, related to these items at March 31, 2003 (in thousands) to be:
$275,278
$562,788
$536,919
$1,374,985
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As discussed in “Critical Accounting Policies” and in the Notes to our Consolidated Financial Statements on our Form 10-K, as amended, to which we refer you, our determination of these long-term liabilities is calculated annually and is based on several assumptions, including then prevailing conditions, which may change from year to year. In any year, if our assumptions are inaccurate, we could be required to expend greater amounts than anticipated. Moreover, in particular, for periods after 2003 our estimates may change from the amounts included in the table, and may change significantly, if our assumptions change to reflect changing conditions. For example, the payments due in years 2-3 include an estimate of approximately $50 million related to a final payout under a long-term coal contract which was entered into in 1984. Under this agreement, CONSOL Energy was reimbursed for estimated post closure reclamation costs plus a contingency over coal shipments made to the customer. Upon final bond release of the affected areas, reclamation costs versus monies received for reclamation over the life of the contract would be actualized.
Debt
At March 31, 2003, CONSOL Energy had total long-term debt of $498 million, including the current portion of long-term debt of $8 million. Such long-term debt consisted of:
At March 31, 2003, CONSOL Energy had an aggregate principal amount of $151 million of commercial paper outstanding that had maturities remaining ranging from 1 to 31 days with interest at varying rates ranging from 1.46% per annum to 1.55% per annum. A subsidiary of CONSOL Energy also had $3 million aggregate principal amount of short-term debt outstanding under a working capital bank facility utilized by the joint venture operations at the Glennies Creek Mine in Australia. Drawings against this facility are made in Australian Dollars and interest is based on the Australian Bank Bills Rate reset monthly.
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CONSOL Energy’s commercial paper program has been backed by a Senior Revolving Credit facility provided by a bank syndicate. The facility provides for an aggregate of $485 million that may be used for commercial paper maturities, letters of credit and borrowings for other corporate purposes. The agreement consists of a 364-day $218 million credit facility which expires in September 2003, and a three year $267 million credit facility which expires in September 2005. Interest is payable based, at our option, upon the Prime (Base) Rate or London Interbank Offered Rates (LIBOR) plus a spread, which is dependent on our credit rating. The agreement has various covenants, including covenants that limit our ability to dispose of assets and merge with another corporation. We are also required to maintain a ratio of total consolidated indebtedness to twelve month trailing earnings before interest, taxes, depreciation, depletion and amortization (EBITDA) of not more than 3.0 to 1.0 measured quarterly. This ratio was 2.63 to 1.0 at March 31, 2003. In addition, we are required to maintain a ratio of twelve months trailing EBITDA to interest expense and amortization of debt of no less than 4.5 to 1.0 measured quarterly. This ratio was 5.22 to 1.0 at March 31, 2003. At March 31, 2003 this facility had $299 million of additional capacity remaining. At April 30, 2003, this facility has $290 million of additional capacity.
At March 31, 2003, five letters of credit have been issued that are supported by the Senior Revolving Credit facility. The letters of credit total $35 million and were issued to the United Mine Workers of America 1992 Benefit Fund, the Illinois Industrial Commission for self insuring workers’ compensation, Old Republic Insurance for self insuring workers’ compensation, the General Electric Capital Corp. for a guarantee of note payable related to equipment purchased by a 50% joint-venture and the U. S. Department of Labor for self insuring Longshore and Harborworkers’ compensation.
Recent Accounting Pronouncements
In December 2002, Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” was issued and the disclosure requirements have been adopted by CONSOL Energy for the year ended December 31, 2002. CONSOL Energy is currently evaluating the alternative methods of transition to determine if the Company will change to the fair value based method of accounting for stock-based employee compensation.
Forward-Looking Statements
We are including the following cautionary statement in this Report on Form 10-Q to make applicable and to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by, or on behalf of us. With the exception of historical matters, the matters discussed in this Report on Form 10-Q are forward-looking statements (as defined in Section 21E of the Exchange Act) that involve risks and uncertainties that could cause actual results to differ materially from projected results. In addition to other factors and matters discussed elsewhere in this Report on Form 10-Q, these risks, uncertainties and contingencies include, but are not limited to, the following:
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In addition to the risks inherent in operations, CONSOL Energy is exposed to financial, market, political and economic risks. The following discussion provides additional detail regarding CONSOL Energy’s exposure to the risks of changing natural gas prices, interest rates and foreign exchange rates.
CONSOL Energy is exposed to market price risk in the normal course of selling natural gas production and to a lesser extent in the sale of coal. CONSOL Energy sells coal under both short-term and long-term contracts with fixed price and/or indexed price contracts that reflect market value. CONSOL Energy uses fixed-price contracts, collar-price contracts and derivative commodity instruments that qualify as cash-flow hedges under Statement of Financial Accounting Standards No. 133 to minimize exposure to market price volatility in the sale of natural gas. Our risk management policy strictly prohibits the use of derivatives for speculative positions.
CONSOL Energy has established risk management policies and procedures to strengthen the internal control environment of the marketing of commodities produced from its asset base. All of the derivative instruments are held for purposes other than trading. They are used primarily to mitigate uncertainty and volatility and cover underlying exposures. CONSOL Energy’s market risk strategy incorporates fundamental risk management tools to assess market price risk and establish a framework in which management can maintain a portfolio of transactions within pre-defined risk parameters.
CONSOL Energy believes that the use of derivative instruments along with the risk assessment procedures and internal controls does not expose CONSOL Energy to material risk. The use of derivative instruments could materially affect CONSOL Energy’s results of operations depending on interest rates, exchange rates or market prices. However, we believe that use of these instruments will not have a material adverse effect on our financial position or liquidity.
For a summary of accounting policies related to derivative instruments, see Note 1 of the Notes to the Consolidated Financial Statements in our Annual Report Form 10-K for the year ended December 31, 2002, as amended.
Sensitivity analyses of the incremental effects on pre-tax income for the three months ended March 31, 2003 of a hypothetical 10 percent and 25 percent change in natural gas prices, foreign exchange and interest rates for open derivative instruments as of March 31, 2003 are provided in the following table:
Incremental Decrease in Pre-tax Income Assuming a Hypothetical Price,
Exchange Rate or Interest Rate Change of:
10%
25%
(in millions)
Natural Gas(a)
10.7
17.9
Foreign Currency(b)
1.0
2.2
Interest Rates(c)
0.4
CONSOL Energy is exposed to credit risk in the event of nonperformance by counterparties. The credit worthiness of counterparties is subject to continuing review.
CONSOL Energy’s interest expense is sensitive to changes in the general level of interest rates in the United States. At March 31, 2003, CONSOL Energy had $499 million aggregate principal amount of debt outstanding under fixed-rate instruments and $154 million aggregate principal amount of debt outstanding under variable-rate instruments. CONSOL Energy’s primary exposure to market risk for changes in interest rates relates to its commercial paper program. At March 31, 2003, CONSOL Energy had an aggregate of $151 million in commercial paper outstanding. CONSOL Energy’s commercial paper bore interest at a weighted average rate of 1.6% during the three months ended March 31, 2003. A 100 basis-point increase in the average rate for CONSOL Energy’s commercial paper would have decreased net income for the three months ended March 31, 2003 by approximately $0.3 million.
Almost all of CONSOL Energy’s transactions are denominated in U.S. dollars, and, as a result, it does not have material exposure to currency exchange-rate risks.
ITEM 4. CONTROLS AND PROCEDURES
Based on their evaluation of the Company’s disclosure controls and procedures as of a date within 90 days of the filing of this Report, the Chief Executive Officer and Chief Financial Officer have concluded that such controls and procedures are effective.
There were no significant changes in the Company’s internal controls or in other factors that could significantly affect such controls subsequent to the date of their evaluation.
PART II
OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
99.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
CONSOL ENERGY INC.
Date: May 9, 2003
By:
/s/ WILLIAM J. LYONS
William J. LyonsSenior Vice President andChief Financial Officer(Duly Authorized Officer and Principal Financial and Accounting Officer)
CERTIFICATIONS
I, J. Brett Harvey, certify that:
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/s/ J. BRETTHARVEY
J. Brett HarveyPresident, Chief Executive Officer and Director
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I, William J. Lyons, certify that:
/s/ WILLIAM. J. LYONS
William. J. LyonsSenior Vice President and Chief Financial Officer
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