UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended September 30, 2004
or
For the transition period from to
Commission File Number: 001-14901
CONSOL ENERGY INC.
(Exact name of registrant as specified in its charter)
(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 ¨
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.
Class
Shares outstanding as of November 1, 2004
Common stock, $0.01 par value
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
ITEM 1.
ITEM 2.
ITEM 3.
ITEM 4.
PART II
OTHER INFORMATION
ITEM 6.
ITEM 1. CONDENSED FINANCIAL STATEMENTS
CONSOL ENERGY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands, except per share data)
Nine Months Ended
September 30,
Sales—Outside
Sales—Related Parties
Freight—Outside
Freight—Related Parties
Other Income
Total Revenue and Other Income
Cost of Goods Sold and Other Operating Charges
Freight Expense
Selling, General and Administrative Expense
Depreciation, Depletion and Amortization
Interest Expense
Taxes Other Than Income
Export Sales Excise Tax Resolution
Total Costs
Earnings (Loss) Before Income Taxes
Income Tax Benefit
Earnings (Loss) Before Cumulative Effect of Change in Accounting Principle
Cumulative Effect of Changes in Accounting for Mine Closing, Reclamation and Gas Well Closing Costs, net of Income Taxes of $3,035
Cumulative Effect of Changes in Accounting for Workers’ Compensation Liability, net of Income Taxes of $53,080
Net Income (Loss)
Basic Earnings Per Share
Dilutive Earnings Per Share
Weighted Average Number of Common Shares Outstanding:
Basic
Dilutive
Dividends Paid Per Share
The accompanying notes are an integral part of these financial statements.
1
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30,2004
Current Assets:
Cash and Cash Equivalents
Accounts and Notes Receivable:
Trade
Other Receivables
Inventories
Deferred Income Taxes
Recoverable Income Taxes
Prepaid Expenses
Total Current Assets
Property, Plant and Equipment:
Property, Plant and Equipment
Less—Accumulated Depreciation, Depletion and Amortization
Total Property, Plant and Equipment—Net
Other Assets:
Investment in Affiliates
Restricted Cash
Other
Total Other Assets
TOTAL ASSETS
Current Liabilities:
Accounts Payable
Short-Term Notes Payable
Current Portion of Long-Term Debt
Other Accrued Liabilities
Total Current Liabilities
Total Long-Term Debt
Deferred Credits and Other Liabilities:
Postretirement Benefits Other Than Pensions
Pneumoconiosis Benefits
Mine Closing
Workers’ Compensation
Deferred Revenue
Salary Retirement
Reclamation
Total Deferred Credits and Other Liabilities
Stockholders’ Equity:
Common Stock, $.01 par value; 500,000,000 Shares Authorized, 91,267,558 Issued; and 90,443,462 Outstanding at September 30, 2004, and 89,861,900 Outstanding at December 31, 2003
Preferred Stock, 15,000,000 Shares Authorized; None Issued and Outstanding
Capital in Excess of Par Value
Retained Earnings (Deficit)
Other Comprehensive Loss
Common Stock in Treasury, at Cost—824,096 Shares at September 30, 2004 and 1,405,658 Shares at December 31, 2003
Total Stockholders’ Equity
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
2
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
ComprehensiveIncome (Loss)
Balance—December 31, 2003
Net Income
Treasury Rate Lock (Net of $39 tax)
Interest Rate Swap Contract (Net of ($514) tax)
Gas Cash Flow Hedge (Net of $7,320 tax)
Comprehensive Income (Loss)
Issuance of Restricted Stock Units under the Equity Incentive Plan (195,377 units)
Stock-Based Compensation
Treasury Stock Issued (581,562 shares)
Dividends ($.42 per share)
Balance—September 30, 2004
3
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Operating Activities:
Adjustments to Reconcile Net Income (Loss) to Net Cash Provided by Operating Activities:
Cumulative Effect of Change in Accounting Principle, net of tax
Compensation from Restricted Stock Unit Grants
Gain on the Sale of Assets
Amortization of Mineral Leases
Equity in Earnings of Affiliates
Changes in Operating Assets:
Accounts Receivable Securitization
Accounts and Notes Receivable
Changes in Other Assets
Changes in Operating Liabilities:
Other Operating Liabilities
Changes in Other Liabilities
Net Cash Provided by Operating Activities
Investing Activities:
Capital Expenditures
Additions to Mineral Leases
Investment in Equity Affiliates
Proceeds from Sales of Assets
Net Cash Used in Investing Activities
Financing Activities:
Payments on Commercial Paper
(Payments on) Proceeds from Miscellaneous Borrowings
Payments on Revolver
Payments on Long Term Notes
Proceeds from Long Term Notes
Dividends Paid
Proceeds from Issuance of Common Stock
Withdrawal from (Deposit to) Restricted Cash
Issuance of Treasury Stock
Net Cash Provided by (Used in) Financing Activities
Net (Decrease) Increase in Cash and Cash Equivalents
Cash and Cash Equivalents at Beginning of Period
Cash and Cash Equivalents at End of Period
4
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
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, as well as the cumulative effect of changes in accounting for workers’ compensation and mine closing, reclamation and gas well closing) considered necessary for a fair presentation have been included. Operating results for the three-month period and nine-month period ended September 30, 2004 are not necessarily indicative of the results that may be expected for future periods.
The balance sheet at December 31, 2003 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, 2003 included in CONSOL Energy Inc.’s (CONSOL Energy) Form 10-K.
Certain reclassifications of the prior year’s data have been made to conform to the nine months ended September 30, 2004 classifications, with no effect on previously reported net income or stockholders’ equity. The reclassifications include classifying leased coal interest and advance mining royalties, previously reported separately on the balance sheet as intangible assets, as a component of property, plant and equipment in accordance with Emerging Issues Task Force Issue No. 04-02, “Whether Mineral Rights Are Tangible or Intangible Assets.”
Basic earnings per share are computed by dividing net earnings by the weighted average shares outstanding during the reporting period. Diluted earnings per share are computed similarly to basic earnings per share except that the weighted average shares outstanding are increased to include additional shares from the assumed exercise of stock options, if dilutive. The number of additional shares is calculated by assuming that outstanding stock options were exercised and that the proceeds from such exercises were used to acquire shares of common stock at the average market price during the reporting period. Options to purchase 1,104,283 shares of common stock were outstanding for the nine month period ended September 30, 2004, but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares and, therefore, the effect would be antidilutive. Options to purchase 1,730,205 shares of common stock were outstanding for the nine month period ended September 30, 2003, but were not included in the computation of diluted earnings per share because the options were antidilutive. Due to the net loss position for the three months ended September 30, 2004 and 2003, no options to purchase shares were included in the computation of diluted earnings per share because the effect would be antidilutive.
5
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The computations for basic and diluted earnings per share are as follows:
For the
Three Months
Ended September 30,
Nine Months
Earnings before cumulative effect of change in accounting
Cumulative effect of accounting change
Average shares of common stock Outstanding:
Effect of stock options
Diluted
Earnings per share:
Basic before cumulative effect
Basic after cumulative effect
Diluted before cumulative effect
Diluted after cumulative effect
NOTE 2—DISPOSITIONS:
In the nine months ended September 30, 2004, CONSOL Energy finalized working capital adjustment items and remaining liability transfers related to the sale of its Canadian coal assets and related port facilities. The sale was completed in February 2003. The finalization of these items resulted in CONSOL Energy making a cash payment to the buyer of $4,167 and recording a pre-tax gain of $3,561.
In February 2004, CONSOL Energy sold the stock of its wholly owned subsidiary CNX Australia Pty Limited to certain affiliates of AMCI, Inc. for $27,500 ($11,000 of cash and $16,500 of Notes Receivable). Certain affiliates of AMCI, Inc. also assumed $21,190 of credit facility debt and the associated interest rate swaps and foreign currency hedges that a subsidiary of CNX Australia Pty Limited had incurred in connection with the credit facility. CNX Australia Pty Limited, through its wholly owned subsidiary CONSOL Energy Australia Pty Limited, owned a 50% interest in the Glennies Creek Mine in New South Wales, Australia with its joint venture partner Maitland Main Collieries Pty Limited, an affiliate of AMCI, Inc. The sale resulted in a pre-tax gain of $14,374.
NOTE 3—STOCK-BASED COMPENSATION:
CONSOL Energy has implemented the disclosure-only provisions of Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure-an Amendment of SFAS 123” (SFAS No. 148). 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
6
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 and 148 to stock-based employee compensation:
Net income (loss), as reported
Add: Stock-based compensation expense for restricted stock units
Deduct: Total stock-based employee compensation expense determined under Black-Scholes option pricing model and stock-based compensation expense for restricted stock units
Pro forma net income (loss)
Basic—as reported
Basic—pro forma
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.
Restricted Stock Unit Awards are grants that entitle the holder to receive shares of common stock as the award vests. A total of 195,377 restricted stock units were granted during the nine months ended September 30, 2004, vesting over a weighted average period of 3.56 years. Each restricted stock unit represents one share of common stock. 194,807 of the shares represented by the restricted stock units had a market value of $30.78 per share (based upon the closing share price) at date of grant and 570 of the shares represented by these restricted stock units had a market value of $35.12 per share (based upon the closing share price) at date of grant. Compensation expense will be recognized over the vesting period of the units.
7
NOTE 4—COMPONENTS OF PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS NET PERIODIC BENEFIT COSTS:
Components of net periodic costs (benefits) for the three and nine months ended September 30 are as follows:
Ended
Service cost
Interest cost
Expected return on plan assets
Amortization costs
Curtailment gain
Net periodic benefit cost
CONSOL Energy previously disclosed in its financial statements for the year ended December 31, 2003, that it expected to contribute $57,414 to its pension plan in 2004. As of September 30, 2004, $56,092 of contributions has been made. CONSOL Energy presently anticipates contributing an additional $1,322 to fund its pension plan in 2004 for a total of $57,414.
CONSOL Energy has recognized the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) in the nine months ended September 30, 2004 in accordance with FASB Staff Position No. FAS 106-2, “Accounting and Disclosure Requirements related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.” Implementation of the Act resulted in a reduction of our postretirement benefit costs of $9,553 and $21,625 for the three and nine months ended September 30, 2004, and a reduction of $182,256 to our December 31, 2003 estimated other postretirement benefit obligation.
As previously disclosed in its financial statements for the year ended December 31, 2003, CONSOL Energy does not expect to contribute to the other post employment benefit plan in 2004. We intend to pay benefit claims as they become due. For the nine months ended September 30, 2004, $93,876 of other post employment benefits has been paid.
8
NOTE 5—COMPONENTS OF COAL WORKERS’ PNEUMOCONIOSIS (CWP) AND WORKERS’ COMPENSATION NET PERIODIC BENEFIT COSTS AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR WORKERS’ COMPENSATION:
Three MonthsEnded
Amortization of actuarial gain
Legal and administrative costs
Net periodic (benefit)cost
As previously disclosed in its financial statements for the year ended December 31, 2003, CONSOL Energy does not expect to contribute to the CWP plan in 2004. We intend to pay benefit claims as they become due. For the nine months ended September 30, 2004, $8,778 of CWP benefits have been paid.
CONSOL Energy’s workers’ compensation liabilities are unfunded, and benefit claims are paid as they become due. For the nine months ended September 30, 2004, $38,406 of workers’ compensation benefits have been paid.
CONSOL Energy also has expensed $10,596 related to workers’ compensation for the nine months ended September 30, 2004 for various state administrative fees and surety bond premiums. The state administrative fees are paid to various states for the right to self-insure workers’ compensation claims.
Effective January 1, 2004, CONSOL Energy changed its method of accounting for workers’ compensation. Under the new method, the undiscounted liability is actuarially calculated based on claims filed and an estimate of claims incurred but not yet reported. Additionally, the workers’ compensation liability is recorded on a discounted basis, which has been actuarially determined using various assumptions, including a discount rate of 6% and a future health care trend rate of 10% per annum, declining to 4.75% per annum in 2010. CONSOL Energy believes this change was preferable since it aligns the accounting with the Company’s accounting for its other long-term employee benefit obligations, which are recorded on a discounted basis. Additionally, it provides a better comparison with the Company’s industry peers, the majority of which record workers’ compensation liability on a discounted basis.
Effective January 1, 2004, as a result of the change, CONSOL Energy reduced its workers’ compensation liability by $136,453 and reduced its related deferred tax asset by $53,080. The cumulative effect adjustment recognized upon adoption was a gain of $83,373, net of a tax cost of approximately $53,080, and accordingly is reflected as a cumulative effect adjustment from a change in accounting. This cumulative effect adjustment is not included in the 2004 figures in the table above.
9
Prior to the change, CONSOL Energy recorded its workers’ compensation liability on an undiscounted basis. The liability represented the estimated liability for claims that had been filed with a third party administrator and an estimate representing an incurred but not reported claim liability. The total expense related to workers’ compensation for the three and nine months ended September 30, 2003 was $14,740 and $39,881, respectively. Pro forma net income for the three and nine months ended September 30, 2003 would have been a loss of $8,337 and income of $5,680, respectively, had the change in accounting for workers’ compensation costs occurred at the beginning of 2003, assuming total workers’ compensation expense of $2,442 and $7,141, respectively, for those periods. Pro forma net income per basic common share and pro forma net income per diluted common share for the three months and nine months ended September 30, 2003 would have been a loss of $0.10 and income of $0.07, respectively.
NOTE 6—CUMULATIVE EFFECT OF CHANGE 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.
NOTE 7—RESTRUCTURING COSTS:
In December 2003, CONSOL Energy reduced corporate overhead costs by eliminating approximately 100 selling, general and administrative and other positions within the Company. The restructuring of the corporate overhead was a result of developments in CONSOL Energy’s business, including operating fewer mines than have been operated in the past, the sale of non-core business assets and de-emphasizing coal exports. At that time, restructuring charges of $3,606 were recognized representing estimated severance costs related to the workforce reduction. At December 31, 2003, approximately 75%, or $2,720, of the employee termination benefits related to the program had been paid. The remaining restructuring obligation is recorded as Other Accrued Liabilities. Cash payments for the three and nine months ended September 30, 2004 were $60 and $886, respectively. There were no other adjustments made to the restructuring liability in the three or nine months ended September 30, 2004. The restructuring liability was fully paid at September 30, 2004.
10
NOTE 8—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 Nine Months Ended
Statutory U.S. federal income tax rate
Excess tax depletion
Effect from sale of foreign companies
Effect of Medicare Prescription Drug, Improvement and Modernization Act of 2003
Net Effect of state tax
Net Effect of foreign tax
Income Tax Benefit / Effective Rate
The effective tax rate for the nine months ended September 30, 2004 was calculated using the combination of an annual effective rate projection on recurring earnings and a discrete tax calculation for the impact of the sale of CONSOL Energy’s wholly owned foreign companies. The effective rate is sensitive to changes in annual profitability, percentage depletion and the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003. The 2003 income tax benefit was determined using a discrete tax calculation for the nine months ended September 30, 2003. An annual effective rate was not applied to the nine-month results due to the sensitivity of the rate to small changes in forecasted income. In addition, the provision for income taxes is adjusted at the time the tax returns are filed to reflect changes in previously estimated amounts. These adjustments decreased income tax expense by $3,011 and $1,128 for the nine months ended September 30, 2004 and 2003, respectively. These adjustments are included in Net Effect of foreign tax and Effect from sale of foreign companies for nine months ended September 30, 2004 and Other for the nine months ended September 30, 2003.
NOTE 9—INVENTORIES:
The components of inventories consist of the following:
Coal
Merchandise for resale
Supplies
Total Inventories
NOTE 10—ACCOUNTS RECEIVABLE SECURITIZATION
In April 2003, CONSOL Energy and certain of its U.S. subsidiaries entered into a trade accounts receivable facility with financial institutions for the sale on a continuous basis of eligible trade accounts receivable. CONSOL Energy formed CNX Funding Corporation, a wholly owned, special purpose, bankruptcy-remote subsidiary for the sole purpose of buying and selling eligible trade receivables generated by certain subsidiaries
11
of CONSOL Energy. Under the receivables facility, CONSOL Energy and certain subsidiaries, irrevocably and without recourse, sell all of their eligible trade accounts receivable to financial institutions and their affiliates, while maintaining a subordinated interest in a portion of the pool of trade receivables. CONSOL Energy will continue to service the sold trade receivables for the financial institutions for a fee based upon market rates for similar services.
The receivables facility allows CONSOL Energy to receive, on a revolving basis, up to $125,000. The cost of funds is based upon commercial paper rates, plus a charge for administrative services paid to the financial institutions. Costs associated with the receivables facility totaled $583 and $1,822 for the three and nine months ended September 30, 2004, respectively. Costs associated with the receivables facility totaled $428 and $691 for the three and nine months ended September 30, 2003, respectively. These costs have been recorded as financing fees, which are included in Cost of Goods Sold and Other Operating Charges in the consolidated statements of income. No servicing asset or liability has been recorded. The receivables facility expires in 2006.
At September 30, 2004 and December 31, 2003, eligible accounts receivable totaled approximately $122,400 and $108,600, respectively. The subordinated retained interest at September 30, 2004 and December 31, 2003 was approximately $20,100 and $600, respectively. Accounts receivable totaling $102,300 and $108,000 were removed from the consolidated balance sheet at September 30, 2004 and December 31, 2003, respectively. CONSOL Energy reduced its accounts receivable securitization program utilization by $5,700 in the nine months ended September 30, 2004. This reduction is included in cash flows from operating activities in the consolidated statement of cash flows.
The key economic assumptions used to measure the retained interest at the date of the securitization for all such sales completed in 2004 were a discount rate of 2.39% and an estimated life for eligible accounts receivable of 33 days. At September 30, 2004 an increase in the discount rate or estimated life of 10% and 20% would have reduced the fair value of the retained interest by $27 and $54, respectively. These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10% variation in assumption to the change in fair value may not be linear. Also, in this example, the effect of a variation in a particular assumption on the fair value of the subordinated retained interest is calculated without changing any other assumption. Changes in any one factor may result in changes in others.
NOTE 11—PROPERTY, PLANT AND EQUIPMENT:
Coal properties and surface lands
Mineral Interests
Plant & equipment
Mine development
Airshafts
Total Gross
Less: Accumulated depreciation, depletion and amortization
Total net property, plant and equipment
Leased coal interest and advance mining royalties, previously reported separately on the balance sheet as intangible assets, are reflected as mineral interests within property, plant and equipment in accordance with Emerging Issues Task Force Issue No. 04-02, “Whether Mineral Rights Are Tangible or Intangible Assets”.
12
NOTE 12—DEBT:
On June 30, 2004, CONSOL Energy completed a $600,000 senior secured credit facility to replace a previous facility of $266,750. The facility consists of a five-year $400,000 revolving credit facility and a six-year $200,000 Tranche B credit-linked deposit facility. Borrowings under the facility are secured by nearly all of the assets of the Company. Collateral has been provided to the banks and is shared equally and ratably with the holders of CONSOL Energy’s 7.875% bonds maturing in 2012 and CONSOL Energy’s subsidiary’s 8.25% medium-term notes maturing in 2007.
Funds may be borrowed under the revolving credit facility for periods of 1 to 180 days depending on the interest rate method chosen by CONSOL Energy. Interest is based, at its option, upon the Prime (Base) Rate or London Interbank Offered Rates (LIBOR) plus a spread, which is dependent on CONSOL Energy’s credit rating. Borrowings under the facilities will be used for general corporate purposes of CONSOL Energy and its subsidiaries, including working capital, capital expenditures and letter of credit needs. Cash collateralized letters of credit issued before the senior credit facility have been reissued under the Tranche B facility and $190,000 of restricted cash that previously served as collateral for the issuance of the letters of credit was released. The released cash was used to pay down short-term debt.
The $600,000 senior credit facility agreement has various covenants, including covenants that limit our ability to dispose of assets, make investments, purchase or redeem CONSOL Energy common stock and merge with another corporation. We are also required to maintain a ratio of financial covenant debt, as defined, 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 1.83 to 1.0 at September 30, 2004. In addition, we are required to maintain a ratio of twelve months trailing EBITDA to cash interest expense of no less than 4.5 to 1.0, measured quarterly. This ratio was 9.56 to 1.0 at September 30, 2004. The facility also has covenants restricting the level of annual capital expenditures to be made by CONSOL Energy. The capital expenditure limit is $450,000, $550,000 and $550,000 for the twelve months ended December 31, 2004, 2005 and 2006, respectively. For each fiscal year thereafter, the limit is $400,000. At September 30, 2004, the revolving credit facility had $45,000 of borrowings outstanding and $74,264 of letters of credit outstanding, leaving $280,736 of capacity available for borrowings and the issuance of letters of credit. At September 30, 2004, the Tranche B credit-linked deposit facility had $200,000 of letters of credit outstanding and CONSOL Energy has reached the Tranche B credit-linked deposit facility’s capacity for issuance of letters of credit.
NOTE 13—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 24,600 asbestos claims in state courts in Pennsylvania, Ohio, West Virginia, Maryland, New Jersey 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
13
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 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. In 1991, CONSOL Energy was named a potentially responsible party related to the Buckeye Landfill Superfund Site and accordingly recognized an estimated liability for remediation of this site of which $2,703 remained as of March 31, 2004. In April 2004, CONSOL Energy entered into an Environmental Liability Transfer and Indemnity Agreement that transferred our liability related to the Buckeye Landfill Superfund Site to another party. The transaction resulted in the reversal of the remaining liability and the recognition of $1,438 of income.
In January 2003, Mine 84, near Washington, Pennsylvania experienced a fire along several hundred feet of the conveyor belt 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, conveyor belt and steel framework on which the belt travels. Repairs took several weeks to complete and total estimated costs are approximately $7,000, net of expected insurance recovery of approximately $2,800. Costs incurred in the nine months ended September 30, 2003 were $6,500 and are primarily reflected in cost of goods sold and other charges, and the expected insurance recovery for damages is reflected in other receivables. Longwall coal production, which accounts for the majority of coal normally produced at the mine, resumed on February 10, 2003.
CONSOL Energy has filed insurance claims related to the damage incurred by this fire including claims under its business interruption policy. The claims process is lengthy and its outcome cannot be predicted with certainty. To date, no payments with respect to the Mine 84 fire have been received. No benefit for business interruption recovery have been recorded to date.
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 was estimated to be approximately $20,000, net of expected insurance recovery of approximately $25,000. Costs to the Company are primarily reflected in the 2003 cost of goods sold and other charges, $20,033 of which is included in the nine months ended September 30, 2003, and expected insurance recovery for damages was reflected in other receivables. Insurance payments for damages of $25,000 have been received by CONSOL Energy as of September 30, 2004. 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 delayed this installation until March 2004.
On October 21, 2003, a complaint was filed in the United States District Court for the Western District of Pennsylvania on behalf of Seth Moorhead against CONSOL Energy, J. Brett Harvey and William J. Lyons. The complaint alleges, among other things, that the defendants violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated under the Exchange Act and that during the period between January 24, 2002, and
14
July 18, 2002, the defendants issued false and misleading statements to the public that failed to disclose or misrepresented the following, among other things that: (a) CONSOL utilized an aggressive approach regarding its spot market sales by reserving 20% of its production to that market, and that by increasing its exposure to the spot market, CONSOL Energy was subjecting itself to increased risk and uncertainty as the price and demand for coal could be volatile; (b) CONSOL Energy was experiencing difficulty selling the production that it had allocated to the spot market, and, nonetheless, CONSOL Energy maintained its production levels which caused its coal inventory to increase; (c) CONSOL Energy’s increasing coal inventory was causing its expenses to rise dramatically, thereby weakening the company’s financial condition; and (d) based on the foregoing, defendants’ positive statements regarding CONSOL Energy’s earnings and prospects were lacking in a reasonable basis at all times and therefore were materially false and misleading. The complaint asks the court to (1) award unspecified damages to plaintiff and (2) award plaintiff reasonable costs and expenses incurred in connection with this action, including counsel fees and expert fees. Two other class action complaints have purportedly been filed in the United States District Court for the Western District of Pennsylvania against CONSOL Energy and certain officers and directors. CONSOL Energy has not yet been served with either purported complaint. CONSOL Energy management believes these claims are without merit, and, accordingly, the Company has not accrued any liability associated with these claims.
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 September 30, 2004.
15
Guarantee
Reclamation Surety Bonds (a)
Workers’ Compensation Surety Bonds (b)
1992 Benefit Plan Letter of Credit (c)
Gas Sales Agreements (d)
Ohio Power Company (e)
Longwall Lease Agreements (f)
Workers’ Compensation Letters of Credit (g)
Federal Black Lung Surety Bonds (h)
Ginger Hills Synfuels, LLC (i)
Ohio Valley Electric Corporation (j)
1992 Benefit Plan Surety Bond (k)
Gas Hedging Agreements (l)
Monongahela Power (m)
Travelers Casualty & Surety Co. (n)
West Penn Power Company (o)
Environmental Liabilities Letters of Credit (p)
Miscellaneous Surety Bonds (q)
Ontario Power Generation, Inc. (r)
Zurich American Insurance (s)
Duke Energy Corporation (t)
Key Corp Leasing (u)
Ontario Power Generation, Inc. (v)
The Cincinnati Gas & Electric Co. (w)
Court Bonds (x)
Ontario Power Generation, Inc. (y)
Hooks Industrial (z)
Reliant Energy (aa)
Centimark Corp. (bb)
Orion Power (cc)
Marathon Ashland Petroleum LLC (dd)
Ontario Power Generation, Inc. (ee)
Orion Power (ff)
Highmark Life & Casualty (gg)
Travelers Casualty & Surety Co. (hh)
Lumbermens Mutual (ii)
Allegheny Energy Supply Co. (jj)
LABAR Co. (kk)
Henry Berdine (ll)
Total Guarantees
16
1. CNX Gas Company LLC, a subsidiary of CONSOL Energy, has an agreement with CONOCO/Phillips Inc. that guarantees the physical delivery of CNX Gas Company LLC production through December 31, 2005. CONSOL Energy has guaranteed any unpaid obligations of CNX Gas Company LLC related to this sales agreement, up to $60,000.
2. CONSOL Energy has an agreement with Dominion Field Services to guarantee any unpaid obligations of CNX Gas Company LLC and Greene Energy, subsidiaries of CONSOL Energy, pursuant to their gas sales agreements with Dominion Field Services. The maximum undiscounted future payments required pursuant to the agreement to be made by these subsidiaries at September 30, 2004 are as follows: (a) CNX Gas Company LLC—$36,000, and (b) Greene Energy—$3,000.
3. CONSOL Energy has an agreement with AEP Energy Services to unconditionally guarantee the full and prompt payment of all obligations, up to $15,000, of CNX Gas Company LLC, a subsidiary of CONSOL Energy, arising from AEP Energy Services’ purchase, sale or exchange of energy services or energy related commodities with respect to the sales agreement between CNX Gas Company LLC and AEP Energy Services.
4. CONSOL Energy guarantees the delivery of specific quantities of gas by CNX Gas Company LLC through May 7, 2022. If our subsidiary fails to deliver the volume specified in the contract, CONSOL Energy is obligated to pay a deficiency charge, for each day delivery is not made, equal to the undelivered volumes times the daily price of gas.
5. CNX Gas Company LLC, a subsidiary of CONSOL Energy, has an agreement dated September 30, 2004 with Baltimore Gas and Electric Company (BGE) that guarantees the prompt and complete payment of all obligations and amounts owed to BGE related to the purchase and/or sale of natural gas. CONSOL Energy has guaranteed any unpaid obligations of CNX Gas Company LLC related to this agreement, up to $3,000. The guaranty will continue in force until thirty days prior written notice is given by CONSOL Energy.
6. CONSOL Energy is the guarantor of the agreement dated May 26, 2004 between CNX Gas Company LLC and Equitable Energy, LLC, relating to the purchases and/or trades of natural gas and/or natural gas products, electric energy or capacity, financial derivatives or related contracts. CONSOL Energy has guaranteed any unpaid obligations of CNX Gas Company LLC related to this agreement, up to $10,000. The guaranty will continue in force until thirty days prior written notice is given by CONSOL Energy.
7. CONSOL Energy is the guarantor of the agreement dated April 14, 2004 between CNX Gas Company LLC and Columbia Gas Transmission Corp., relating to the transportation of natural gas or
17
other services rendered and to be rendered on present or future orders on credit from Columbia Gas Transmission Corp. CONSOL Energy has guaranteed any unpaid obligations of CNX Gas Company LLC related to this agreement, in an amount of $535 per month from May 2004-October 2004, or approximately $3,213. The guaranty shall continue in full force and effect until April 14, 2005, and year-to-year thereafter unless terminated at any time by CONSOL Energy.
18
19
20
NOTE 14—FAIR VALUE OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used to estimate the fair values of financial instruments:
Cash and cash equivalents:The carrying amount reported in the balance sheets for cash and cash equivalents approximates its fair value due to the short maturity of these instruments.
Restricted Cash: The carrying amount reported in the December 31, 2003 balance sheet for restricted cash approximated its fair value. Restricted cash was invested in highly liquid securities to support requirements of long-term letters of credit.
Short-term notes payable: The carrying amount reported in the balance sheets for short-term notes payable approximates its fair value due to the short-term maturity of these instruments.
Current and Long-term debt: The fair values of long-term debt are estimated using discounted cash flow analyses, based on CONSOL Energy’s current incremental borrowing rates for similar types of borrowing arrangements.
Capital Leases: At December 31, 2003, the fair values of capital leases are estimated using discounted cash flow analyses, based on current incremental borrowing rates for similar types of borrowing arrangements. There were no outstanding balances owed under capital leases at September 30, 2004.
The carrying amounts and fair values of financial instruments, excluding derivative financial instruments disclosed in Item 3—Quantitative and Qualitative Disclosure About Market Risk, are as follows:
Cash and cash equivalents
Restricted cash
Short-term notes payable
Long-term debt
Capital Leases
NOTE 15—SEGMENT INFORMATION:
CONSOL Energy has two principal business units: Coal and Gas. The principal activities of the Coal unit are mining, preparation and marketing of steam coal, sold primarily to power generators, and metallurgical coal, sold to metal and coke producers. The Coal unit includes four reportable segments. These reportable segments
21
are Northern Appalachian, Central Appalachian, Metallurgical and Other Coal. Each of these reportable segments includes a number of operating segments (mines). For the three and nine months ended September 30, 2004, the Northern Appalachian aggregated segment includes the following mines: Shoemaker, Blacksville #2, Robinson Run, McElroy, Loveridge, Bailey, Enlow Fork and Mine 84. For the three and nine months ended September 30, 2004, the Central Appalachian aggregated segment includes the following mines: Jones Fork, Mill Creek and Wiley-Mill Creek. For the three and nine months ended September 30, 2004, the Metallurgical aggregated segment includes the following mines: Buchanan, Amonate and V.P. #8. The Other Coal segment includes the Company’s purchased coal activities, idled mine cost, coal segment business units not meeting aggregation criteria, as well as various other activities assigned to the coal segment but not allocated to individual mines. The principal activity of the Gas unit is to produce pipeline quality methane gas for sale primarily to gas wholesalers. CONSOL Energy’s All Other segment includes terminal services, river and dock services, industrial supply services and other business activities, including rentals of buildings and flight operations. The segment information presented for prior periods has been restated to be consistent with the information presented for the current period.
22
Industry segment results for the three months ended September 30, 2004:
Sales—outside
Freight—outside
Intersegment transfers
Total Sales and Freight
Segment asset
Depreciation, depletion and amortization
Industry segment results for the three months ended September 30, 2003:
23
Industry segment results for the nine months ended September 30, 2004:
24
Industry segment results for the nine months ended September 30, 2003:
Sales—related party
Freight—related party
25
Reconciliation of Segment Information to Consolidated Amounts:
Earnings (Loss) Before Income Taxes:
For the Three Months
Segment earnings (loss) before income taxes for total reportable business segments
Segment earnings (loss) before income taxes for all other businesses
Incentive compensation
Compensation from restricted stock unit grants
Other post employee benefit curtailment gain
Interest income (expense), net and other non-operating activity
Total Assets:
Segment assets for total reportable business segments
Segment assets for all other businesses
Items excluded from segment assets:
Cash and other investments
Deferred tax assets
Recoverable income taxes
Intangible asset—overfunded pension plan
Bond issuance costs
Total Consolidated Assets
NOTE 16—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 all 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.
26
Income Statement for the Three Months Ended September 30, 2004:
Other Income (including equity earnings)
Intercompany Activity
Income Tax Expense (Benefit)
27
Balance Sheet at September 30, 2004:
Assets:
Less-Accumulated Depreciation, Depletion and Amortization
Property, Plant and Equipment—Net
Total Assets
Liabilities and Stockholders’ Equity:
Accounts Payable (Recoverable)-Related Parties
Long-Term Debt:
Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
28
Condensed Statement of Cash Flows
For the Three Months Ended September 30, 2004:
Net Cash (Used in) Provided by Operating Activities
Cash Flows from Investing Activities:
Other Investing Activities
Net Cash (Used in) Provided by Investing Activities
Cash Flows from Financing Activities:
Payments on Short-Term Debt
Payments on Long-Term Notes
Withdrawal from Restricted Cash
Other Financing Activities
29
Income Statement for the Three Months Ended September 30, 2003:
30
Balance Sheet at December 31, 2003:
31
For the Three Months Ended September 30, 2003:
Payments on Short-Term Borrowings
Proceeds from Long-Term Notes
Deposit to Restricted Cash
Net Cash Provided by Financing Activities
32
Income Statement for the Nine Months Ended September 30, 2004:
Earnings (Loss) before Cumulative Effect of Change in Accounting Principle
33
For the Nine Months Ended September 30, 2004:
Net Cash Provided by (Used in) Investing Activities
34
Income Statement for the Nine Months Ended September 30, 2003:
Cumulative Effect of Changes in Accounting for Mine Closing, Reclamation, and Gas Well Closing Costs, Net of Income Taxes of $3,035
35
For the Nine Months Ended September 30, 2003:
Net Cash Provided by (Used in) Operating Activities
Net Cash (Used in) Provided by Financing Activities
NOTE 17—RECENT ACCOUNTING PRONOUNCEMENTS:
In March 2004, the FASB issued Emerging Issues Task Force Issue No. 04-2, “Whether Mineral Rights Are Tangible or Intangible Assets” (EITF 04-2). In this Issue, the Task Force reached the consensus that mineral rights are tangible assets. This consensus differs from the requirements of Statement of Financial Accounting Standards No. 141, “Business Combinations” and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” which classify mineral rights as intangible assets. Effective with the 2004 second quarter, CONSOL Energy has reclassified mineral rights as property, plant and equipment in accordance with EITF 04-2.
On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) was signed into law. The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. As permitted by recently issued accounting guidance, CONSOL Energy has recognized the benefits of the Act as of March 8, 2004 by adjusting the three months ended March 31, 2004 net income by approximately $2,200. The benefits of the Act are also recognized as a reduction of other postemployment benefit costs in the three months ended June 30, 2004 and September 30, 2004.
36
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. Interpretation No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entities activities, is entitled to receive a majority of the variable interest entities residual returns, or both. The interpretation also requires disclosures about variable interest entities that the company is not required to consolidate, but in which it has a significant variable interest. The consolidation requirements of Interpretation No. 46 applied immediately to variable interest entities created after January 31, 2003. Effective December 2003, the FASB elected to defer the effective date until the first fiscal year or interim period that begins after March 15, 2004 for variable interest entities in which an enterprise acquired before February 1, 2003. As of September 30, 2004, management believes that CONSOL Energy does not have any variable interest entities, therefore, there is no impact from the adoption of this standard.
37
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
CONSOL Energy had a net loss of $12 million for the three months ended September 30, 2004 compared to a net loss of $6 million for the three months ended September 30, 2003. Net income for the 2004 period was impaired from the 2003 period due to higher average unit costs, offset, in part, by higher average sales prices for both coal and gas. Higher cost per ton of coal produced was due to increased labor and supply cost per unit and increased Combined Fund premiums. These increases in cost per ton of coal produced were offset, in part, by a reduction in other post-employment benefits due to the recognition of the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 in the 2004 period. Higher cost of gas produced was due to the purchase of firm transportation capacity on the Columbia Gas Transmission Corporation’s interstate gas pipeline because of anticipated curtailments in the shipment capacity allocated to CONSOL Energy as a result of increased demand for pipeline use on the gas pipeline. CONSOL Energy purchased firm transportation capacity on the Columbia Gas Transmission Corporation’s interstate gas pipeline from the May 2004 through October 2004 period to assure pipeline capacity of our projected production. The increase in average cost per thousand cubic feet of gas sold was also attributable to an increase per thousand cubic feet in royalty expense. Royalty expense increased primarily due to the increase in average sales price per thousand cubic feet in the 2004 period compared to the 2003 period. Net income was also impaired due to the decrease in income tax benefits reflected in the 2004 period compared to the 2003 period.
Total coal sales for the three months ended September 30, 2004 were 15.7 million tons of which 15.1 million tons were produced by CONSOL Energy operations or sold from inventory of company produced coal. This compares with total coal sales of 15.8 million tons for the three months ended September 30, 2003, of which 15.2 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 lower production at Enlow Fork Mine, Bailey Mine, Buchanan Mine and Mine 84. Also, CONSOL Energy’s equity affiliate Australian mining operation, Glennies Creek Mine, was sold in February 2004. These decreases in tons sold were offset, in part, by the Loveridge Mine resuming production in March 2004 and increased production at the McElroy Mine. Company produced inventory was 1.0 million tons at September 30, 2004 and was 1.3 million tons at December 31, 2003. CONSOL Energy currently has obligations to deliver 96% of its projected 2004 production.
Sales volumes of coalbed methane gas, including a percentage of the sales of equity affiliates equal to our interest in these affiliates, increased 8.9% to 13.9 billion cubic feet in the three months ended September 30, 2004 compared with 12.8 billion cubic feet in the three months ended September 30, 2003 period. The increase in sales volumes 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, and including the effects of derivative transactions, increased 24.4% to $4.95 per thousand cubic feet in the 2004 period compared with $3.98 per thousand cubic feet in the 2003 period. Gas prices for the 2004 period were higher than levels during the 2003 period due to continued concerns about declining North American gas production, as well as increased oil prices and economic recovery increasing demand.
CONSOL Energy restated first quarter 2004 net income by approximately $2.2 million to reflect the recognition of the favorable effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 as of March 8, 2004 in accordance with recently issued accounting guidance.
On June 30, 2004, CONSOL Energy completed a $600 million senior secured credit facility to replace the existing $267 million facility. The new facility consists of a five-year $400 million revolving credit facility and a six-year $200 million Tranche B credit-linked deposit facility. The revolving credit and Tranche B letter of credit facility will be used for general corporate purposes of CONSOL Energy and its subsidiaries, including working
38
capital, capital expenditures and letter of credit needs. Cash collateralized letters of credit issued previously were transferred to the Tranche B facility and the associated $190 million of restricted cash was released. The released cash was used to pay down short-term debt.
In June 2004, Moody’s Investor Service upgraded CONSOL Energy’s 7.875% notes due 2012 to Ba2 (12th lowest out of 21 rating categories). Moody’s Investor Service also upgraded CONSOL Energy’s subsidiary’s medium term notes to Ba2. Moody’s Investor Service also affirmed the Ba3 senior implied rating and the Ba2 rating on CONSOL Energy’s $600 million secured bank facility, which replaced the Company’s previous secured $267 million bank facility. The rating outlook is stable. Obligations which are rated “Ba” are considered to have speculative elements; their future cannot be considered as well-assured. Often the protection of interest and principal payments may be very moderate, and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. The modifier 2 indicates that the obligation ranks in the mid-range of its generic rating category. The modifier 3 indicates that the obligation ranks in the lower end of its generic rating category.
In July 2004, Standard and Poor’s upgraded CONSOL Energy’s 7.875% notes due 2012 to BB (12th lowest out of 22 rating categories). Also, in July 2004, Standard and Poor’s affirmed CONSOL Energy’s BB- corporate credit rating and confirmed a BB rating (12th lowest out of 22 rating categories) with a recovery rate of ‘1’ to CONSOL Energy’s $600 million secured bank facility, which replaced the Company’s previous secured $267 million bank facility. The outlook is stable. Standard and Poor’s defines an obligation rated ‘BB’ as less vulnerable to nonpayment than other speculative issues. However, the rating indicates that an obligor faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions, which could lead to the obligor’s inadequate capacity to meet its financial commitment on the obligation. The rating of BB with a recovery rating of ‘1’ indicates a high expectation of full recovery of principal in the event of a default.
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.
39
Results of Operations
Three Months Ended September 30, 2004 Compared with Three Months Ended September 30, 2003
Net income changed primarily due to the following items (table in millions):
Coal Sales-Produced and Purchased
Produced Gas Sales
Purchased Gas Sales
Other Sales and Other Income
Coal Cost of Goods Sold—Produced and Purchased
Produced Gas Cost of Goods Sold
Purchased Gas Cost of Goods Sold
Other Cost of Goods Sold
Total Cost of Goods Sold
Earnings (Loss) before Income Taxes
Net loss for the three months ended September 30, 2004 (the 2004 period) was impaired from the three months ended September 30, 2003 (the 2003 period) due to higher average unit costs, offset, in part, by higher average sales prices for both coal and gas. Higher cost per ton of coal produced was due to increased labor and supply cost per unit and increased Combined Fund premiums. These increases in cost per ton of coal produced were offset, in part, by a reduction in other post-employment benefits due to the recognition of the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 in the 2004 period. Higher cost of gas produced was due to the purchase of firm transportation capacity on the Columbia Gas Transmission Corporation’s interstate gas pipeline because of anticipated curtailments in the shipment capacity allocated to CONSOL Energy as a result of increased demand for pipeline use on the gas pipeline. CONSOL Energy purchased firm transportation capacity on the Columbia Gas Transmission Corporation’s interstate gas pipeline for May 2004 through October 2004 to assure pipeline capacity of our projected production. The increase in average cost per thousand cubic feet of gas sold was also attributable to an increase per thousand cubic feet in royalty expense. Royalty expense increased primarily due to the increase in average sales price per thousand cubic feet in the 2004 period compared to the 2003 period. Net income was also impaired due to the decrease in income tax benefits reflected in the 2004 period compared to the 2003 period.
40
Revenue
Revenue and other income increased due to the following items:
Sales
Produced Coal
Purchased Coal
Produced Gas
Purchased Gas
Industrial Supplies
Total Sales
Freight Revenue
The increase in Company produced coal sales revenue was due to the increase in average sales price per ton during the 2004 period.
2004
Period
2003
Percentage
Change
Produced Tons Sold (in millions)
Average Sales Price Per Ton
The increase in average sales price in 2004 primarily reflects stronger prices negotiated in 2003 and an overall improvement in prices in the eastern coal market for domestic utility, export utility and metallurgical products. Tons sold remained constant in the period-to-period comparison. The Loveridge Mine resumed production in March 2004 and production at the McElroy Mine increased in 2004. Loveridge experienced a fire in February 2003 while it was in the process of developing a new underground area that would be mined with longwall mining equipment. The fire delayed completion of the development until March 2004. McElroy Mine production increase was due to the second longwall and plant expansion projects being completed during the 2004 period. The increased production at Loveridge and McElroy was offset by lower production at Enlow Fork Mine, Bailey Mine, Buchanan Mine and Mine 84.
The increase in Company purchased coal sales revenue was due to higher average sales price per ton of purchased coal.
Purchased Tons Sold (in millions)
The increased average sales price is primarily due to some of the purchased coal tons being sold in higher priced export and metallurgical markets. Increased revenue from higher average sales prices were offset slightly due to lower sales volumes in the 2004 period compared to the 2003 period.
The increase in gas sales revenue was primarily due to a higher average sales price per thousand cubic feet and increased volumes sold in the 2004 period compared to the 2003 period.
Produced Gas Sales Volumes (in billion gross cubic feet)
Average Sales Price Per thousand cubic feet (including effects of derivative transactions)
41
We believe that the 2004 gas market price increases were largely driven by continued concerns about declining North American gas production, as well as increased oil prices and the economic recovery which resulted in greater electricity use in our principal markets. CONSOL Energy enters into various physical gas supply transactions with both gas marketers and end users for terms varying in length from a single day to greater than a year. CONSOL Energy has also entered into various gas swap transactions that qualify as financial cash flow hedges. These gas swap transactions exist parallel to the underlying physical transactions. In the 2004 period, these cash flow hedges represented 26% of our produced sales volumes at an average price of $4.82 per thousand cubic feet. We intend these transactions to cover approximately 27% of our current 2004 estimated produced sales volumes at an average price of $5.02 per thousand cubic feet. CONSOL Energy sold 86% of its gas sales volumes in the three months ended September 30, 2004 under fixed price contracts at an average price of $4.85 per thousand cubic feet compared to 87% of its gas sales volumes under fixed price contracts in the three months ended September 30, 2003 at an average of $3.86 per thousand cubic feet. Higher sales volumes in the 2004 period were a result of wells coming on line from the ongoing drilling program, which allowed CONSOL Energy to take advantage of increased prices.
Due to the anticipated curtailment in the shipment capacity allocated to CONSOL Energy as a result of increased demand for pipeline use on the Columbia Gas Transmission Corporation’s interstate gas pipeline, CONSOL Energy purchased firm transportation capacity on the Columbia Gas Transmission Corporation’s interstate gas pipeline. The firm transportation arrangement covered the May 2004 through October 2004 period and assured pipeline capacity of our projected production. In addition, in order to satisfy obligations to certain customers, we purchased gas from and sold gas to other gas suppliers, which increased our revenues and our costs.
Purchased Gas Sales Volumes (in billion gross cubic feet)
Average Sales Price Per thousand cubic feet
CONSOL Energy believes that it will be necessary to purchase firm transportation guarantees of capacity in the future as a result of increased capacity demands on the Columbia pipeline.
The increase in revenues from the sale of industrial supplies was primarily due to increased sales volumes and increased average sales price.
Freight revenue, outside and related party, 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 consists of interest income, gain or loss on the disposition of assets, equity in earnings of affiliates, service income, royalty income, derivative gains and losses, rental income and miscellaneous income.
Dollar
Variance
Gain on sale of assets
Other miscellaneous
Total other income
The gain on sale of assets in the 2004 period is primarily related to the sale of coal leases, conveyance of associated surface property, the transfer of related mining permits and the related liabilities for a location in southern West Virginia that resulted in a pre-tax gain of approximately $7 million.
Other miscellaneous income increased $1 million due to various miscellaneous transactions that occurred throughout both periods, none of which were individually material.
42
Costs
Cost of Goods Sold and Other Charges
Closed and Idle Mines
Increased cost of goods sold and other charges for company produced coal was due mainly to an increase in cost per unit of produced coal sold.
Average Cost of Goods Sold and Other Charges Per Ton
Average cost of goods sold and other charges per ton for company produced coal increased in the 2004 period compared to the 2003 period. The increase in average cost per ton was due primarily to higher maintenance, labor and supply costs per unit. Increased supply costs were related to the impact of higher costs of materials, especially metal products, used in the mining process experienced in the 2004 period compared to the 2003 period. Increased labor and supply costs were also related to additional continuous miner shifts in the 2004 period. Continuous mining machines are used to mine the coal reserve in such a way that large, rectangular blocks of coal, called panels, are delineated underground in preparation for mining by larger more efficient longwall machines in mines equipped with these systems. Typically, mines attempt to delineate more than one panel in advance so that as the longwall machine completes the extraction of coal in one panel, it can move without delay to another prepared panel. Continuous mining machines are more labor intensive and use more supplies per ton of coal produced than longwall mining systems. Increased average cost per ton was also due to increased Combined Fund premiums related to a premium differential announced by the Social Security Administration for the past eleven plan years for beneficiaries assigned to CONSOL Energy. The increase is approximately $28 million for the plan year beginning October 1, 2003, of which all has been expensed from October 1, 2003 through September 30, 2004. Approximately $7 million of expense was recognized in the 2004 period. CONSOL estimates the additional costs for plan years subsequent to October 1, 2003 will be approximately $2 million per year. Costs for other post-employment benefits were reduced due to the recognition of the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 in the 2004 period.
Purchased coal cost of goods sold and other charges increased in the 2004 period compared to the 2003 period.
The increase in cost of goods sold and other charges for purchased coal was primarily due to higher average cost per ton of purchased coal sold in the 2004 period compared to the 2003 period. The increase in the average cost of purchased coal is primarily due to increased market price for export and metallurgical coal. The increase in cost of goods sold and other charges was offset, in part, due to a slight decrease in volume of purchased coal sold.
43
Gas cost of goods sold and other charges increased due to increased average cost per thousand cubic feet sold and increased volumes.
Gas Sales Volumes (in billion gross cubic feet)
Average Cost Per Thousand Cubic Feet
The increase in average cost per thousand cubic feet of gas sold was attributable to a $0.16 increase per thousand cubic feet in royalty expense. Royalty expense increased primarily due to the 24.7% increase in average sales price per thousand cubic feet in the 2004 period compared to the 2003 period. The increase in average cost per thousand cubic feet of gas sold was also attributable to approximately $0.11 increase per thousand cubic feet related to the purchase of firm transportation capacity on the Columbia Gas Transmission Corporation’s interstate gas pipeline because of anticipated curtailments in the shipment capacity allocated to CONSOL Energy as a result of increased demand for pipeline use on the gas pipeline. CONSOL Energy purchased firm transportation capacity on the Columbia Gas Transmission Corporation’s interstate gas pipeline from the May 2004 through October 2004 period to assure pipeline capacity of our projected production. Gas cost of goods sold and other charges also increased due to the increased volumes sold in the 2004 period as discussed previously.
In addition, in order to satisfy obligations to certain customers, we purchased from and sold to other gas suppliers, which increased our revenues and our costs.
Average Cost Per thousand cubic feet
CONSOL Energy believes that it will be necessary to purchase firm transportation capacity in the future as a result of increased capacity demands on the Columbia pipeline.
Industrial supplies cost of goods sold increased primarily due to higher sales volumes and increased average cost per item sold.
Closed and idle mine costs were $17 million in the 2004 period compared to $18 million in the 2003 period. The $1 million decrease in the 2004 period compared to the 2003 period was due to lower costs related to the idled Rend Lake mine. This decrease in cost was offset, in part, by an increase of approximately $1 million due to the interest component of workers’ compensation expense in the 2004 period. Effective January 1, 2004, CONSOL Energy changed its method of accounting for workers’ compensation. Under the new method, the undiscounted liability is actuarially calculated based on claims filed and an estimate of claims incurred but not yet reported. Additionally, the workers’ compensation liability is recorded on a discounted basis, which has been actuarially determined using various assumptions.
The decrease in miscellaneous cost of goods sold and other charges reflect the following items:
Loveridge fire loss
Supply Inventory Adjustment
Sales contract buy outs
Miscellaneous other
44
In February 2003, 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 costs of extinguishing the fire were adjusted in the 2003 period and an additional $11 million was recognized in the three months ended September 30, 2003 attributable to cost of goods sold and other charges. 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 delayed this installation until March 2004.
A $3 million supply inventory adjustment was recognized in the 2003 period.
In the 2004 period, an agreement was made with a customer to release tons committed under lower priced contracts for sale to other customers at higher pricing.
Incentive compensation expense increased in the 2004 period compared to the 2003 period due mainly to the level of earnings achieved in the 2004 period compared to expected 2004 annual results. The incentive compensation program is designed to increase compensation to eligible employees when CONSOL Energy reaches predetermined earnings targets and the employees reach predetermined performance targets.
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 billing equals the transportation expense.
Freight expense
Selling, general and administrative costs have decreased due to the following items:
Wages and salaries
Other post employment benefits
Commissions
Total Selling, General and Administrative
Wages and salaries for selling, general and administrative employees have decreased primarily due to the December 2003 reduction of approximately 100 positions. The reduction program was primarily a result of certain changes in CONSOL Energy’s business, including operating fewer mines than had been operated in the past, the sale of non-core businesses and de-emphasizing coal exports.
Costs related to other post employment benefits in the 2004 period have decreased from the 2003 period due to the recognition of the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 in the 2004 period.
Costs for coal commissions increased due to entering a new sales agreement in the 2004 period that requires commissions to be paid.
45
Depreciation, depletion and amortization has increased in the 2004 period from the 2003 period.
Gas:
Production
Gathering
Total Gas
Total depreciation, depletion and amortization
The increase in coal depreciation, depletion and amortization was primarily attributable to higher units-of-production financial depletion related to higher production volumes in the 2004 period compared to the 2003 period and additional depreciation on facilities and equipment placed in service after the 2003 period.
The decrease in gas production depreciation, depletion and amortization was primarily due to gob gas production. Gob wells generally produce for less than twelve months. As a result of the short production life, costs of the wells are generally expensed instead of capitalized and then amortized. Gathering depreciation, depletion and amortization is recorded on the straight-line method and remained consistent in both periods.
Interest expense has decreased in the 2004 period compared to the 2003 period.
Total Interest Expense
The decrease in interest expense related to long-term debt is attributable to the scheduled long-term debt payment of $45 million in June 2004.
Other interest expense was reduced primarily due to the increase in the amount of interest capitalized in the 2004 period as a result of the higher level of capital projects funded from operating cash flows in the 2004 period.
Taxes other than income increased primarily due to the following items:
Production taxes:
Gas
Total Production Taxes
Other taxes:
Total Taxes Other Than Income
46
Increased coal production taxes are primarily due to higher severance and black lung excise taxes attributable to higher average sales price and higher produced coal volumes.
Increased other taxes in the gas segment are due to various miscellaneous taxes, none of which are individually material.
Income Taxes
Tax Expense (Benefit)
Effective Income Tax Rate
CONSOL Energy’s effective tax rate is sensitive to changes in the relationship between pre-tax earnings and percentage depletion. The effective rate for the 2003 period was calculated using a discrete period tax calculation due to the projected annual pre-tax earnings being close to zero for the applicable period. See “Note 8—Income Taxes” in Item 1, Condensed Financial Statement of this Form 10-Q.
Nine Months Ended September 30, 2004 Compared with Nine Months Ended September 30, 2003
Gain on Sale of Glennies Creek
Earnings Before Cumulative Effect of Change in Accounting Principle
Cumulative Effect of Change in Accounting Principle
Net income for the 2004 period improved due to increased coal and gas production and increased average sales prices for both coal and gas. The higher net income was also due to the gain on sale of the stock of the Company’s wholly owned subsidiary, CNX Australia Pty Limited, to certain affiliates of AMCI, Inc. In addition,
47
net income for the 2004 period improved due to the cumulative effect of change in accounting related to workers’ compensation. Effective January 1, 2004, CONSOL Energy changed its method of accounting for workers’ compensation. Prior to the change, the Company recorded its workers’ compensation liability on an undiscounted basis. Under the new method, the Company recorded its liability on a discounted basis, which has been actuarially determined using various assumptions, including discount rate and projected future cost trends. The increase in net income was reduced, in part, by higher cost of goods sold attributable, in part, to higher sales volumes of coal and gas and to higher unit costs of tons of coal and gas produced. Higher cost per ton of coal produced was due mainly to increased Combined Fund premiums and increased maintenance, labor and supply cost per unit. A reduction of expenses was recognized in the 2004 period due to the recognition of the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 in the 2004 period. Higher cost of gas produced was due to the purchase of firm transportation capacity on the Columbia Gas Transmission Corporation’s interstate gas pipeline because of anticipated curtailments in the shipment capacity allocated to CONSOL Energy as a result of increased demand for pipeline use on the gas pipeline. CONSOL Energy purchased firm transportation capacity on the Columbia Gas Transmission Corporation’s interstate gas pipeline from the May 2004 through October 2004 period to assure pipeline capacity of our projected production. The increase in average cost per thousand cubic feet of gas sold was also attributable to an increase per thousand cubic feet in royalty expense. Royalty expense increased primarily due to the increase in average sales in the 2004 period compared to the 2003 period. Income tax benefits were reduced due mainly to having pre-tax income in the 2004 period compared to a pre-tax loss in the 2003 period.
Produced Coal—Related Party
Total Produced Coal
Freight Revenue—Related Party
Total Freight Revenue
The increase in Company produced coal sales revenue was due to the increase in volumes sold and the increase in average sales price per ton during the 2004 period.
The increase in tons sold is due primarily to the Loveridge Mine resuming production in March 2004 and improved production at McElroy and Robinson Run mines. Loveridge experienced a fire in February 2003 while
48
it was in the process of developing a new underground area that would be mined with longwall mining equipment. The fire delayed completion of the development until March 2004. McElroy production improved due to the completion of a second longwall and plant expansion projects in the 2004 period. The increased production at Loveridge, McElroy and Robinson Run was offset, in part, by lower production at Buchanan and Mine 84. Mine 84 has encountered adverse geological conditions throughout the 2004 period. The increase in average sales price in 2004 primarily reflects higher prices negotiated in 2003 and an overall improvement in prices in the eastern coal market for domestic utility, export utility and metallurgical products.
The increase in Company purchased coal sales revenue was due to higher average sales price per ton, slightly offset by lower volumes of purchased coal sold.
Increased sales revenue from Company purchased coal was primarily due to higher average sales price per ton of Company purchased coal sold. Higher average sales price per ton was attributable to some of the purchased coal tons being sold in higher priced export and metallurgical markets. Increased sales revenue from higher prices was slightly offset by decreased sales volume of purchased coal.
We believe that the 2004 gas market price increases were largely driven by continued concerns about declining North American gas production, as well as increased oil prices and greater electricity use in our principal markets. CONSOL Energy enters into various physical gas supply transactions with our gas marketers (gas sales transactions generally exceeding one year.) CONSOL Energy has also entered into various gas swap transactions. The gas swap transactions qualify as financial cash flow hedges. The swap transactions exist parallel to the underlying physical transactions. In the 2004 period, these cash flow hedges represented 26% of our produced sales volumes at an average price of $5.08 per thousand cubic feet. We intend these transactions to cover approximately 27% of our current 2004 estimated produced sales volumes at an average price of $5.02 per thousand cubic feet. CONSOL Energy sold 86% of its gas sales volumes in the nine months ended September 30, 2004 under fixed price contracts at an average price of $5.00 per thousand cubic feet compared to 90% of its gas sales volumes under fixed price sales contracts in the nine months ended September 30, 2003 at an average of $3.97 per thousand cubic feet. Higher sales volumes were a result of wells coming on line from the ongoing drilling program, which allowed CONSOL Energy to take advantage of increased prices.
49
CONSOL Energy believes this type of transaction will continue as a result of increased capacity demands on the Columbia pipeline.
The increase in revenues from the sale of industrial supplies was primarily due to increased sales volumes.
Equity in loss of affiliates
Harbor maintenance fees
The increase in gain on sale of assets is due mainly to CONSOL Energy’s sale of stock in its wholly owned subsidiary, CNX Australia Pty Limited, to certain affiliates of AMCI, Inc. for $27.5 million. Certain affiliates of AMCI, Inc. also assumed approximately $21.2 million of debt, and associated interest rate swaps and foreign currency hedges. CNX Australia Pty Limited, through its wholly owned subsidiary CONSOL Energy Australia Pty Limited, owned a 50% interest in the Glennies Creek Mine in New South Wales, Australia with its joint venture partner Maitland Main Collieries Pty Limited, an affiliate of AMCI, Inc. The sale was completed on February 25, 2004 and resulted in a pre-tax gain of approximately $14.4 million. The gain on sale of assets in the 2004 period is also related to the assignment of certain coal leases, conveyance of associated surface property, the transfer of related mining permits and the related liabilities for a location in southern West Virginia that resulted in a pre-tax gain of approximately $7 million. The additional gain on sale of assets in the 2004 period is related to the sale of several previously closed operations. The 2003 period gain on sale of assets is primarily related to the sale of surplus equipment and the expiration of a $5 million option granted to a third party to purchase property.
The equity losses of affiliates is due mainly to the equity losses related to Glennies Creek Mine operating results prior to the sale that occurred in February 2004.
CONSOL Energy received a refund in the 2003 period from the federal government for prior claims related to harbor maintenance fees imposed by Federal statue that was subsequently declared unconstitutional. These claims were pursued since 1991, and we do not expect other refunds related to these claims.
An additional $1 million increase in other miscellaneous income was due to various transactions that occurred throughout both periods, none of which were individually material.
50
Increased cost of goods sold and other charges for company produced coal was due mainly to an increase in cost per unit of produced coal sold and an increase in sales volumes.
Average cost of goods sold and other charges per ton for company produced coal increased in the 2004 period compared to the 2003 period. Cost per ton for produced coal increased due to higher maintenance, labor and supply costs per unit. Increased supply costs were related the higher costs of materials, especially metal products, used in the mining process experienced in the 2004 period compared to the 2003 period. Increased labor and supply costs are also increased due to additional continuous miner shifts in the 2004 period. Continuous mining machines are used to mine the coal reserve in such a way that large, rectangular blocks of coal, called panels, are delineated underground in preparation for mining by larger more efficient longwall machines in mines equipped with these systems. Typically, mines attempt to delineate more than one panel in advance so that as the longwall machine completes the extraction of coal in one panel, it can move without delay to another prepared panel. Continuous mining machines are more labor intensive and use more supplies per ton of coal produced than longwall mining systems. The increase in average cost per ton was also due to increased Combined Fund premiums related to a premium differential announced by the Social Security Administration for the past eleven plan years for beneficiaries assigned to CONSOL Energy. The increase is approximately $28 million for the plan year beginning October 1, 2003, all of which has been expensed from October 1, 2003 through September 30, 2004. Approximately $21 million of expense was recognized in the nine months ended September 30, 2004. CONSOL estimates the additional cost for plan years subsequent to October 1, 2003 will be approximately $2 million per year. Cost of goods sold and other charges also increased due to higher sales volumes of company produced coal in the 2004 period compared to the 2003 period. Costs for other post-employment benefits were reduced due to the recognition of the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 in the 2004 period.
51
Produced gas average cost per thousand cubic feet of gas sold increased in the 2004 period compared to the 2003 period. The increase in average cost per thousand cubic feet of gas sold was attributable to a $0.12 increase per thousand cubic feet in royalty expense. Royalty expense increased primarily due to the 22.5% increase in average sales price per thousand cubic feet in the 2004 period compared to the 2003 period. Average cost per thousand cubic feet of gas sold also increased approximately $0.06 related to the purchase of firm transportation capacity on the Columbia Gas Transmission Corporation’s interstate gas pipeline because of anticipated curtailments in the shipment capacity allocated to CONSOL Energy as a result of increased demand for pipeline use on the gas pipeline. CONSOL Energy purchased firm transportation capacity on the Columbia Gas Transmission Corporation’s interstate gas pipeline from the May 2004 through October 2004 period to assure pipeline capacity of our projected production. Produced gas cost of goods sold and other charges also increased due to the increased volumes sold in the 2004 period as discussed previously.
In addition, in order to satisfy obligations to certain customers, we purchased from and sold to other gas suppliers, which increased our revenues and our costs. CONSOL Energy believes this type of transaction will continue as a result of increased capacity demands on the Columbia pipeline.
Industrial supplies cost of goods sold increased primarily due to higher sales volumes.
Closed and idle mine cost was $53 million in the 2004 period compared to $49 million in the 2003 period. The increase in cost primarily reflects mine closing, perpetual care water treatment and reclamation liability adjustments as a result of updated engineering surveys. Survey adjustments resulted in $3 million of expense in the 2004 period for closed and idled locations. Closed and idle mine cost also increased approximately $3 million due to the interest component of workers’ compensation expense in the 2004 period. Effective January 1, 2004, CONSOL Energy changed its method of accounting for workers’ compensation. Under the new method, the undiscounted liability is actuarially calculated based on claims filed and an estimate of claims incurred but not yet reported. Additionally, the workers’ compensation liability is recorded on a discounted basis, which has been actuarially determined using various assumptions. Closed and idled mine costs also increased $1 million due to costs related to the Emery mine in the 2004 period. This mine was operating for most of the 2003 period. Emery mine resumed operations in August 2004. Closed and idled mine costs also increased $2 million for various miscellaneous transactions that occurred throughout both periods, none of which were individually material. These increases were offset, in part, by $5 million of lower costs related to the idled Rend Lake mine. Rend Lake mine has been idle since July 2002.
52
The decrease in miscellaneous cost of goods sold and other charges reflects the following items:
Loveridge fire
Mine Eighty-Four fire
Gas royalty dispute
Buckeye landfill superfund site liability transfer
In February 2003, 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 costs of extinguishing the fire were estimated to be approximately $17 million, net of expected insurance recovery, attributable to cost of goods sold and other charges as of September 30, 2003. In late December 2002, the mine had begun 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 delayed this installation until March 2004.
In January 2003, Eighty-Four Mine 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 were estimated to cost approximately $4 million, net of expected insurance recovery, attributable to cost of goods sold and other related charges. Longwall coal production, which accounts for the majority of coal normally produced at the mine resumed on February 10, 2003.
Miscellaneous cost of goods sold and other charges also decreased due to a $6 million payment made in the 2003 period of gas royalties in connection with a dispute between a subsidiary of CONSOL Energy and certain gas lessors.
Due to the restructuring that occurred in December 2003, a curtailment gain related to the other post employment benefit plan of approximately $3 million was recognized in the 2004 period. Due to CONSOL Energy’s measurement date being September 30, the gain was not able to be recognized in the financial statements until the quarter ended March 31, 2004.
In April 2004, CONSOL Energy entered into an Environmental Liability Transfer and Indemnity Agreement that transferred our liability related to the Buckeye Landfill Superfund Site to another party. In 1991, CONSOL Energy was named a potentially responsible party related to the Buckeye Landfill Superfund Site and accordingly recognized our estimated liability for remediation of this site. The Transfer and Indemnity transaction resulted in the reversal of the remaining liability and the recognition of approximately $1 million of income.
53
In the 2004 period, agreements were made with several customers in order to release tons committed under lower priced contracts for sale to other customers at higher pricing.
Other cost of goods sold decreased $5 million due to various transactions that occurred throughout both periods, none of which were individually material.
Selling, general and administrative costs have decreased in the 2004 period due to the following items:
Professional consulting and other purchased services
Insurance
Other post-employment benefits
Costs of professional consulting and other purchased services have increased in the 2004 period primarily due to services provided to complete procedures related to the special investigation into matters alleged in an anonymous letter and to services provided in relation to reviewing employee benefit plans and compensation packages provided by CONSOL Energy. These increases were offset, in part, by lower software support services.
Costs for insurance increased primarily due to director and officer insurance costs incurred in the 2004 period. CONSOL Energy officers and directors were previously insured under the RWE AG director and officer’s liability policy at lower fees. CONSOL Energy began to independently insure its directors in June 2003.
Wages and salaries for selling, general and administrative employees have decreased primarily due to the December 2003 reduction in workforce program. The reduction program was primarily focused on reducing the number of positions in the selling, general and administrative areas to better align with the Company’s current business strategy. The program reduced approximately 100 positions. These reductions were offset, in part, by the completion of the integrated information technology system provided by SAP AG in August 2003. Prior to the completion, wages and salaries for dedicated staff were capitalized as a component of the cost of the implementation project and are being amortized over seven years. The wages capitalized for the nine months ended September 30, 2003 were approximately $2 million.
Other selling, general and administrative costs decreased $1 million due to various transactions that occurred throughout both periods, none of which are individually material.
54
Depreciation, depletion and amortization reflects the following items:
Coal depreciation, depletion and amortization increased in the 2004 period compared to the 2003 period. Coal units-of-production financial depletion expense increased in the period-to-period comparison due to higher production and depreciation increased due to additional plant and equipment being placed in service after the 2003 period
Other depreciation, depletion and amortization increased primarily due to the depreciation related to the new integrated information technology system that is currently being used. All modules of the system have been implemented and are currently being amortized on a straight-line basis over seven years. All modules of the integrated information technology system were not completed in the 2003 period and therefore were not being amortized at that time.
Interest expense decreased in the 2004 period compared to the 2003 period.
Commercial paper and revolver
The decrease in interest expense related to long-term debt was due to a decrease in the amount outstanding due to the scheduled payment of $45 million in June 2004.
Other interest expense was reduced primarily due to the increase in the amount of interest capitalized in the 2004 period as a result of the higher level of capital projects funded from operating cash flows in the nine months ended September 30, 2004.
Interest expense decreases were offset, in part, by an interest expense related to commercial paper and the revolver. The increase was due to the weighted average interest rate of 2.4% per annum in the 2003 period compared to 5.2% per annum in the 2004 period. This increase was offset, in part, by a reduction of $31 million in the weighted average amount of outstanding borrowings in the 2004 period compared to the 2003 period. As of July 2003, CONSOL Energy was no longer able to participate as a seller of commercial paper due to Standard and Poor’s lowering its rating of our long-term debt.
55
Increased coal production taxes are primarily due to higher severance and black lung excise taxes attributable to higher average sales price and higher coal volumes produced. Increased gas production taxes are primarily due to higher severance taxes related to increased gas production volumes and higher average sales prices.
Increased other taxes in the coal segment are due to higher payroll taxes related to an increase in the 2004 period labor costs compared to the 2003 period. The increased labor costs are primarily related to the late March 2004 start up of the Loveridge Mine. This mine was idled in the 2003 period.
Increased other taxes were due to various miscellaneous taxes, none of which are individually material.
In the 2003 period, CONSOL Energy received refunds for claims and related interest for certain excise taxes on export sales. Upon receipt of these refunds, the estimate of interest receivable was adjusted to the actual amount received resulting in an additional $0.6 million of income. A $26 million receivable for the claims for the years 1991-1993 is still outstanding. There is no interest receivable related to the claims that are still outstanding.
CONSOL Energy’s effective tax rate is sensitive to changes to the relationship between pre-tax earnings and percentage depletion. The effective rate for the 2004 period was also impacted by the recognition of the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003. The effective rate for the 2003 period was calculated using a discrete period tax calculation due to the projected annual pre-tax earnings being close to zero for the applicable period. See “Note 8—Income Taxes” in Item 1, Condensed Financial Statement of this Form 10-Q.
Cumulative Effect of Change in Accounting
Effective January 1, 2004, CONSOL Energy changed its method of accounting for workers’ compensation. Under the new method, the undiscounted liability is actuarially calculated based on claims filed and an estimate of claims incurred but not yet reported. Additionally, the workers’ compensation liability is recorded on a discounted basis, which has been actuarially determined using various assumptions, including a discount rate of 6% and a future health care trend rate of 10%, declining to 4.75% in 2010. CONSOL Energy believes this change was preferable since it aligns the accounting with the Company’s other long-term employee benefit obligations, which are recorded on a discounted basis. Additionally, it provides a better comparison with the Company’s industry peers, the majority of which record the workers’ compensation liability on a discounted basis.
56
As a result of the change, CONSOL Energy reduced its workers’ compensation liability by $136 million and reduced its related deferred tax asset by $53 million. The cumulative effect adjustment recognized upon adoption was a gain of $83 million, net of a tax cost of approximately $53 million, and accordingly is reflected as a cumulative effect adjustment from a change in accounting.
Effective January 1, 2003, CONSOL Energy adopted SFAS No. 143, “Accounting for Asset Retirement Obligations”, 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 million. 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. On June 30, 2004, CONSOL Energy completed a $600 million Senior Secured Loan Agreement to replace the existing $267 million facility. The new agreement consists of a five-year $400 million revolving credit facility and a six-year $200 million Tranche B credit-linked deposit facility. The new facility is secured by nearly all of the assets of the company. CONSOL Energy’s 7.875 percent bonds that mature in 2012 and CONSOL Energy’s subsidiary’s 8.25 percent medium-term notes maturing in 2007 have been equally and ratably secured. The facility can be used for letters of credit and borrowings for general corporate purposes. In the three months ended June 30, 2004, cash collateralized letters of credit issued under a restricted cash arrangement have been transferred to the Tranche B facility and the $190 million of restricted cash has been released and was used to pay short-term debt. At our option, interest on borrowings under the new facility is based upon the Prime (Base) Rate or London Interbank Offered Rates (LIBOR) plus a spread that is dependent on our credit rating. The agreement has various covenants, including covenants that limit our ability to dispose of assets, make investments, purchase or redeem Consol Energy common stock and merge with another corporation. We are also required to maintain a ratio of financial covenant debt, as defined, 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 1.83 to 1.0 at September 30, 2004. In addition, we are required to maintain a ratio of twelve months trailing EBITDA to cash interest expense of no less than 4.5 to 1.0, measured quarterly. This ratio was 9.56 to 1.0 at September 30, 2004. The revolving credit facility also has covenants restricting the level of annual capital expenditures to be made by CONSOL Energy. The capital expenditure limit is $450.0 million for the twelve months ended December 31, 2004. At September 30, 2004, this facility had approximately $274.3 million letters of credit issued and had $45 million of borrowings outstanding, leaving approximately $280.7 million of unused capacity.
In June 2004, Moody’s Investor Service affirmed the rating of Ba2 (12th lowest out of 21 rating categories) to the $600 million secured bank facility, which replaced the Company’s secured $267 million bank facility. The rating outlook is stable. Obligations which are rated “Ba” are considered to have speculative elements; their future cannot be considered as well-assured. Often the protection of interest and principal payments may be very moderate, and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. The modifier 2 indicates that the obligation ranks in the middle of its generic rating category. In July 2004, Standard and Poor’s confirmed the BB rating (12th lowest out of 22 rating
57
categories) with a recovery rate of ‘1’ to CONSOL Energy’s $600 million secured bank facility, which replaced the Company’s secured $267 million bank facility. Standard and Poor’s defines an obligation rated ‘BB’ as less vulnerable to nonpayment than other speculative issues. However, the rating indicates that an obligor faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions, which could lead to the obligor’s inadequate capacity to meet its financial commitment on the obligation. The recovery rating of ‘1’ indicates a high expectation of full recovery of principal in the event of a default.
In April 2003, CONSOL Energy and certain of its Subsidiaries entered into a receivables facility with financial institutions for the sale on a continuous basis of eligible trade accounts receivable that will provide, on a revolving basis, up to $125 million of short-term funding. CONSOL Energy formed CNX Funding Corporation, a wholly owned, special purpose, bankruptcy-remote subsidiary, for the sole purpose of buying and selling eligible trade receivables generated by certain subsidiaries of CONSOL Energy. Under the receivables facility, CONSOL Energy and certain subsidiaries, irrevocably and without recourse, sell all of their eligible trade accounts receivable to CNX Funding Corporation. CNX Funding Corporation then sells, on a revolving basis, an undivided percentage interest in the pool of eligible trade accounts receivable to financial institutions and their affiliates, while maintaining a subordinated interest in a portion of the trade receivables. CONSOL Energy has agreed to continue servicing the sold receivables for the financial institutions for a fee based upon market rates for similar services. The cost of funds are consistent with commercial paper rates plus a charge for administrative services paid to the financial institution. The receivables facility expires in 2006. At September 30, 2004, eligible accounts receivable total approximately $122.4 million and the subordinated retained interest was approximately $20.1 million. Accounts receivable totaling $102.3 million were removed from the consolidated balance sheet at September 30, 2004. In accordance with the facility agreement, the Company is able to receive proceeds based upon total eligible accounts receivable at the previous month-end. Related repayments of $5.7 million are included in cash flows from operating activities in the consolidated statement of cash flows for the nine months ended September 30, 2004.
CONSOL Energy believes that cash generated from operations and its borrowing capacity under its new credit facility will be sufficient to meet its working capital requirements, anticipated capital expenditures (other than major acquisitions), scheduled debt payments, anticipated dividend payments in 2004 and to provide required letters of credit. Nevertheless, the ability of CONSOL Energy to satisfy its working capital requirements, 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 both gas marketers and end users for terms varying in length from a single day to greater than a year. CONSOL Energy has also entered into various gas swap transactions that qualify as financial cash flow hedges, which exist parallel to the underlying physical transactions. The fair value of these contracts was a loss of $16.9 million (net of $10.8 million of deferred tax) at September 30, 2004.
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.
58
Cash Flows (in millions) for the nine months ended September 30
Cash flows provided by operating activities
Cash used in investing activities
Cash provided by (used in) financing activities
Cash flows from operating activities changed due to the following items:
Net cash used in or provided by investing activities changed primarily due to the following items:
Net cash received from or used in financing activities changed primarily due to the following items;
59
The following is a summary of our significant contractual obligations at September 30, 2004 (in thousands):
Payments due by Year
Within
1 Year
After
5 Years
Short-term Notes Payable
Long-term Debt
Operating Lease Obligations
Total Contractual Obligations
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 estimate payments, net of any applicable trust reimbursements, related to these items at September 30, 2004 (in thousands) to be:
As discussed in “Critical Accounting Policies” and in the Notes to our Consolidated Financial Statements in Form 10-K, 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 2004 our estimates may change from the amounts included in the table, and may change significantly, if our assumptions change to reflect changing conditions.
Debt
At September 30, 2004, CONSOL Energy had total long-term debt of $428 million outstanding, including current portion of long-term debt of $4 million. This long-term debt consisted of:
On June 30, 2004, CONSOL Energy completed a $600 million Senior Secured Loan Agreement to replace the existing $267 million facility. The new agreement consists of a five-year $400 million revolving credit facility and a six-year $200 million Tranche B credit-linked deposit facility. The new facility is secured by nearly all of the assets of the company. Collateral has been provided to the banks and shared equally and ratably with
60
the holders of CONSOL Energy’s 7.875% bonds that mature in 2012 and CONSOL Energy’s subsidiary’s 8.25% medium-term notes maturing in 2007. The facility can be used for letters of credit and borrowings for general corporate purposes. As of September 30, 2004, cash collateralized letters of credit issued under a restricted cash arrangement have been transferred to the Tranche B facility and the $190 million of restricted cash was released. The released cash was used to paydown short-term debt. At our option, interest is based upon the Prime (Base) Rate or London Interbank Offered Rates (LIBOR) plus a spread that is dependent on our credit rating. The agreement has various covenants, including covenants that limit our ability to dispose of assets, make investments, purchase or redeem CONSOL Energy common stock and merge with another corporation. We are also required to maintain a ratio of financial covenant debt, as defined, 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 1.83 to 1.0 at September 30, 2004. In addition, we are required to maintain a ratio of twelve months trailing EBITDA to cash interest expense of no less than 4.5 to 1.0, measured quarterly. This ratio was 9.56 to 1.0 at September 30, 2004. The revolving credit facility also has covenants restricting the level of annual capital expenditures to be made by CONSOL Energy. The capital expenditure limit is $450.0 million and $550.0 million for the twelve months ended December 31, 2004 and 2005, respectively. At September 30, 2004, this facility had approximately $274.3 million letters of credit issued and had $45 million of borrowings outstanding, leaving approximately $280.7 million of unused capacity.
Stockholders’ Equity and Dividends
CONSOL Energy had stockholders’ equity of $385 million at September 30, 2004 and $291 million at December 31, 2003. The increase is primarily attributable to net income for the nine months ended September 30, 2004, offset, in part, by various cash flow hedges related to our gas business and the payment of dividends.
Dividend information for the current year to date is as follows:
The revolving credit facility does restrict CONSOL Energy’s ability to pay cash dividends. As long as CONSOL Energy has not achieved and maintained an Investment Grade rating, dividends payable on common stock cannot exceed $0.56 per share per fiscal year. Dividends may be paid only if the payment does not result in an event of default. The revolving credit facility also restricts CONSOL Energy’s common stock repurchases or redemptions.
Additional comprehensive losses, primarily related to gas hedging transactions, of approximately $11 million were recognized in the nine months ended September 30, 2004.
Off-Balance Sheet Transactions
CONSOL Energy does not maintain any off-balance sheet transactions, arrangements, obligations or other relationships with unconsolidated entities or others that are reasonably likely to have a material current or future effect on CONSOL Energy’s condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources which are not disclosed in the notes to the consolidated financial statements.
Recent Accounting Pronouncements
In March 2004, the FASB issued Emerging Issues Task Force Issue No. 04-2, “Whether Mineral Rights Are Tangible or Intangible Assets” (EITF 04-2). In this Issue, the Task Force reached the consensus that mineral rights are tangible assets. This consensus differs from the requirements of Statement of Financial Accounting Standards No. 141, “Business Combinations” and Statement of Financial Accounting Standards No. 142,
61
“Goodwill and Other Intangible Assets” which classify mineral rights as intangible assets. Effective with the 2004 second quarter, CONSOL Energy has reclassified mineral rights as property, plant and equipment in accordance with EITF 04-2.
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 and, in CONSOL Energy’s Form 10-K filed with the Securities and Exchange Commission on March 12, 2004, and other periodic reports filed, these risks, uncertainties and contingencies include, but are not limited to, the following:
62
63
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.
The use of derivative instruments could materially affect CONSOL Energy’s results of operations depending on market prices. 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. 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, 2003.
Sensitivity analyses of the incremental effects on pre-tax income for the nine months ended September 30, 2004 of a hypothetical 10 percent and 25 percent change in natural gas prices for open derivative instruments as of September 30, 2004 are provided in the following table:
Natural Gas (a)
CONSOL Energy remains at risk for possible changes in the market value of these derivative instruments; however, such risk should be mitigated by price changes in the underlying hedged item. The effect of this offset is not reflected in the sensitivity analyses. CONSOL Energy entered into derivative instruments to convert the market prices related to 2004 and 2005 anticipated sales of natural gas to fixed prices. The
64
sensitivity analysis reflects an inverse relationship between increases in commodity prices and a benefit to earnings. The fair value of these contracts was a loss of $16.9 million (net of $10.8 million of deferred tax) at September 30, 2004. We continually evaluate the portfolio of derivative commodity instruments and adjust the strategy to anticipated market conditions and risks accordingly.
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 September 30, 2004, CONSOL Energy had $428 million aggregate principal amount of debt outstanding under fixed-rate instruments. CONSOL Energy’s primary exposure to market risk for changes in interest rates relates to its revolving credit facility, under which there was $45.0 million of borrowings outstanding at September 30, 2004. On June 30, 2004, CONSOL Energy completed a $600 million senior secured loan facility to replace the existing $267 million facility. The new facility consists of a five-year $400 million revolving credit facility and a six-year $200 million Tranche B credit-linked deposit facility. CONSOL Energy’s revolving credit facility bore interest at a weighted average rate of 5.2% per annum during the nine months ended September 30, 2004. Due to the level of borrowings against this facility in the nine months ended September 30, 2004, a 100 basis-point increase in the average rate for CONSOL Energy’s revolving credit facility would not have significantly decreased net income for the period.
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
Disclosure controls and procedures. CONSOL Energy, under the supervision and with the participation of its management, including CONSOL Energy’s principal executive officer and principal financial officer, evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this quarterly report on Form 10-Q. Based on that evaluation, CONSOL Energy’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by CONSOL Energy in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by CONSOL Energy in such reports is accumulated and communicated to CONSOL Energy’s management, including CONSOL Energy’s principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in internal controls over financial reporting. There were no changes that occurred during the fiscal quarter covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
65
ITEM 6. EXHIBITS
66
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.
Date: November 8, 2004
By:
/s/ J. BRETTHARVEY
President Chief Executive Officer
(Duly Authorized Officer )
/s/ WILLIAM J. LYONS
Senior Vice President and Chief Financial Officer
(Duly Authorized Officer and Principal Financial and
Accounting Officer)
67
Exhibit Index
68