UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended June 30, 2005
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)
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).
Yesx 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 July 26, 2005
Common stock, $0.01 par value
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
ITEM 1.
CONDENSED FINANCIAL STATEMENTS
Consolidated Statements of Income for the three and six months ended June 30, 2005 and June 30, 2004
Consolidated Balance Sheets at June 30, 2005 and December 31, 2004
Consolidated Statements of Stockholders’ Equity for the six months ended June 30, 2005
Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and June 30, 2004
Notes to Consolidated Financial Statements
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4.
CONTROLS AND PROCEDURES
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 6.
EXHIBITS
CONSOL ENERGY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands, except per share data)
Sales - Outside
Sales - Related Parties
Freight - Outside
Other Income
Total Revenue and Other Income
Cost of Goods Sold and Other Operating Charges (exclusive of depreciation, depletion and amortization shown below)
Freight Expense
Selling, General and Administrative Expense
Depreciation, Depletion and Amortization
Interest Expense
Taxes Other Than Income
Total Costs
Earnings Before Income Taxes
Income Taxes
Earnings Before Cumulative Effect of Change in Accounting Principle
Cumulative Effect of Change in Accounting for Workers’ Compensation Liability, net of Income Taxes of $53,080
Net Income
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
ASSETS
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
Other
Total Other Assets
TOTAL ASSETS
2
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts Payable
Short-Term Notes Payable
Current Portion of Long-Term Debt
Accrued Income Taxes
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, 91,681,615 Issued and Outstanding at June 30, 2005; 91,267,558 Issued and 90,642,939 Outstanding at December 31, 2004
Preferred Stock, 15,000,000 Shares Authorized; None Issued and Outstanding
Capital in Excess of Par Value
Retained Earnings (Deficit)
Other Comprehensive Loss
Unearned Compensation on Restricted Stock Units
Common Stock in Treasury, at Cost - 0 Shares at June 30, 2005, 624,619 Shares at December 31, 2004
Total Stockholders’ Equity
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
3
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Balance - December 31, 2004
Treasury Rate Lock (Net of $26 tax)
Gas Cash Flow Hedge (Net of $2,440 tax)
Comprehensive Income (Loss)
Dividend Equivalents on Restricted Stock Units (3,338 units)
Issuance of Restricted Stock Under the Equity Incentive Plan (93,508 shares)
Stock Options Exercised (1,038,407 shares)
Stock-Based Compensation from Accelerated Vesting
Common Stock Issued (4,946 shares)
Amortization of Restricted Stock Unit Grants
Dividends ($.28 per share)
Balance at June 30, 2005
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Operating Activities:
Adjustments to Reconcile Net Income 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) Losses 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 Miscellaneous Borrowings
Payments on Revolver
Payments on Long Term Notes
Dividends Paid
Withdrawal from Restricted Cash
Stock Options Exercised
Net Cash (Used in) Provided by 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
5
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
NOTE 1 - BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month and six-month periods ended June 30, 2005 are not necessarily indicative of the results that may be expected for future periods.
The balance sheet at December 31, 2004 has been derived from the audited consolidated financial statements at that date but does not include all the notes required by generally accepted accounting principles for complete financial statements.
For further information, refer to the consolidated financial statements and related notes for the year ended December 31, 2004 included in CONSOL Energy’s Form 10-K.
Certain reclassifications of 2004 data have been made to conform to the six months ended June 30, 2005 classifications.
In the three months ended March 31, 2005, there was a settlement related to the Harmar Environmental Trust (the Trust). The Trust Settlement was due to the court’s decision to terminate a Trust Agreement among CONSOL Energy Inc. (CONSOL Energy) and other parties. The Trust was established in 1988 to provide funding for water treatment related to the now closed Harmar Mine. Other parties funded the trust. CONSOL Energy was responsible for completing water treatment activities, but all costs associated with these activities were funded by the Trust. Any excess funding upon completion of water treatment or a specified date in the future were to be distributed to the parties that originally funded the trust. In the decision, all previously funded, but unused, amounts remaining in the Trust were distributed. CONSOL Energy’s portion of the distributed funds, $15,000, was placed into an escrow account, pending provision of financial assurance supporting CONSOL Energy water treatment obligations. In the quarter ended June 30, 2005, CONSOL Energy has provided the financial assurance for this obligation and the funds have been released from escrow. CONSOL Energy is responsible for the on-going water treatment at this facility. CONSOL Energy recorded the funding and $8,517 for present value of the water treatment liability, resulting in $6,483 of income in the six months ended June 30, 2005.
CONSOL Energy restated first quarter 2004 net income by approximately $2,164, or $0.02 per share, to reflect the recognition of favorable effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 as of March 8, 2004 in accordance with
6
authoritative accounting implementation guidance. The restatement reduced cost of goods sold by $2,347 and selling, general and administrative expenses by $82. Income tax expense was increased by $265 due to this adjustment.
In February 2005, CONSOL Energy’s Buchanan Mine, located near Keen Mountain, Virginia, experienced a cave-in behind the longwall mining machinery and an ignition of methane gas that started a fire. The mine was evacuated safely and was sealed on February 16, 2005 in order to extinguish any fire by cutting off oxygen to the mine’s underground atmosphere. Costs related to the fire of approximately $23,291 and $36,858, net of expected insurance recovery, have been incurred for the three and six months ended June 30, 2005, respectively. Costs to CONSOL Energy are primarily reflected in Cost of Goods Sold and Other Charges and Depreciation, Depletion and Amortization on the consolidated statement of income. Expected insurance recovery for the fire related costs are reflected in Other Receivables. The fire has been extinguished and the mine was restarted on June 16, 2005.
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. Expected insurance recovery for damages of approximately $1,034 and $2,819 were reflected in Other Receivables at June 30, 2005 and December 31, 2004, respectively. CONSOL Energy received $1,785 of this receivable in the three months ended June 30, 2005.
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. There were no options to purchase shares of common stock outstanding for the three or six month periods ended June 30, 2005 that were not included in the computation of diluted earnings per share because the exercise prices of all options were less than the average market price of the common shares. Options to purchase 1,120,553 shares and 1,124,553 shares of common stock were outstanding for the three and six month period ended June 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.
7
The computations for basic and diluted earnings per share from continuing operations are as follows:
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 - ACQUISITIONS AND DISPOSITIONS:
In June 2005, CONSOL Energy completed a sale/lease-back transaction for its headquarters building and certain surrounding land located in Upper Saint Clair, Pennsylvania. Cash proceeds from the sale were $14,000 and resulted in a pretax gain of $8,365, which has been deferred and will be recognized over the initial lease term of 13 years. The lease agreement includes an option to extend the lease term for two five-year periods. The lease is accounted for as an operating lease. Annual rental payments are $1,176 and are payable in equal quarterly installments of $294. The agreement provides for a possible Consumer Price Index adjustment to the annual rental payments at the beginning of the fourth lease year and every four years thereafter.
In March 2005, CONSOL Energy through its subsidiary, CONSOL of West Virginia, LLC, acquired a 49% interest in Southern West Virginia Energy, LLC for a cash payment of $6,200. In addition, CONSOL Energy agreed to assume the perpetual care liability after certain bond release work is completed by Southern West Virginia Energy, LLC. The discounted liability assumed by CONSOL Energy is estimated to be $10,159. Southern West Virginia Energy, LLC through its subsidiary will mine low sulfur bituminous coal. The acquisition has been accounted for under the equity method of accounting. The transaction is still under review in relation to Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities”. A final determination will be made in the quarter ended September 30, 2005
8
after all agreements are finalized and analyzed. If it is determined that this entity should be consolidated, the impact on the 2005 first and second quarter financial statements would have been immaterial.
In February 2004, CONSOL Energy sold the stock in 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), the assumption of $21,190 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 resulted in a pre-tax gain of $14,374.
9
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 No. 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 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 as reported
Add: Stock-based compensation due to change in vesting period
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
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.
10
NOTE 4 – COMPONENTS OF PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS NET PERIODIC BENEFIT COSTS:
Components of net periodic costs (benefits) for the three and six months ended June 30 are as follows:
Service cost
Interest cost
Expected return on plan assets
Amortization costs
Curtailment gain
Net periodic benefit cost
CONSOL Energy previously disclosed in the notes to its audited consolidated financial statements for the year ended December 31, 2004, that it expected to contribute $66,133 to its pension plan in 2005. For the three and six months ended June 30, 2005, $16 and $277 of contributions have been made, respectively. CONSOL Energy presently anticipates contributing an additional $70,856 to fund its pension plan in 2005 for a total of $71,133.
CONSOL Energy restated first quarter 2004 net periodic benefit cost for its postretirement benefit plans by $2,520 to reflect the recognition of favorable effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003, as of March 8, 2004, in accordance with authoritative accounting implementation guidance.
As previously disclosed in the notes to its audited consolidated financial statements for the year ended December 31, 2004, CONSOL Energy does not expect to contribute to the other post employment benefit plan in 2005. We intend to pay benefit claims as they become due. For the three and six months ended June 30, 2005, $30,849 and $63,111 of other post employment benefits have been paid, respectively.
11
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:
Six Months Ended
June 30,
Amortization of actuarial gain
Legal and administrative costs
Net periodic (benefit)cost
As previously disclosed in the notes to its audited consolidated financial statements for the year ended December 31, 2004, CONSOL Energy does not expect to contribute to the CWP plan in 2005. We intend to pay benefit claims as they become due. For the three and six months ended June 30, 2005, $3,953 and $8,179 of CWP benefits have been paid, respectively.
As previously disclosed in the notes to its audited consolidated financial statements for the year ended December 31, 2004, CONSOL Energy does not expect to contribute to the workers’ compensation plan in 2005. We intend to pay benefit claims as they become due. For the three and six months ended June 30, 2005, $13,897 and $28,849 of workers’ compensation benefits, state administrative fees and surety bond premiums have been paid, respectively.
CONSOL Energy also has expensed $4,598 and $10,505 related to workers’ compensation for the three and six months ended June 30, 2005, respectively, 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, we recorded our liability on a discounted basis, which has been actuarially determined using various assumptions, including discount rate and future cost trends. CONSOL Energy believes this change was preferable since it aligns the accounting with our other long-term employee benefit obligations, which are recorded on a discounted basis. Additionally, it provides a better comparison with our industry peers, the majority of which record the workers’ compensation liability on a discounted basis.
As a result of the change, as of January 1, 2004, CONSOL Energy reduced its workers’ compensation liability by $136,453 and reduced its related deferred tax asset by $53,080. The
12
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 amounts for 2004 in the table above.
NOTE 6 - 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:
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 Expense / Effective Rate
The effective tax rate for the six-month period ended June 30, 2005 was calculated using the annual effective rate projection on recurring earnings. The effective tax rate for the six month period ended June 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 our wholly owned subsidiary CNX Australia Pty Limited.
13
NOTE 7 - INVENTORIES:
Inventory components consist of the following:
Coal
Merchandise for resale
Supplies
Total Inventories
NOTE 8 – 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 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 consistent with commercial paper rates, plus a charge for administrative services paid to the financial institutions. Costs associated with the receivables facility totaled $1,022 and $2,114 for the three and six months ended June 30, 2005, respectively. Costs associated with the receivables facility totaled $721 and $1,239 for the three and six months ended June 30, 2004, 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 June 30, 2005 and December 31, 2004, eligible accounts receivable totaled approximately $124,300 and $141,100, respectively. The subordinated retained interest at June 30, 2005 and December 31, 2004 was approximately $109,300 and $16,100, respectively. Accounts receivable totaling $15,000 and $125,000 were removed from the consolidated balance sheet at June 30, 2005 and December 31, 2004, respectively. CONSOL Energy’s $110,000 reduction in the accounts receivable securitization program for the six months ended June 30, 2005 is reflected in cash flows from operating activities in the consolidated statement of cash flows. The $17,000 of proceeds, net of reductions, from the accounts receivable securitization program for the six months ended June 30, 2004 is also reflected in operating activities in the consolidated statement of cash flows.
The key economic assumptions used to measure the retained interest at the date of securitization for all such sales completed in 2005 were a discount rate of 3.59% and an estimated life for eligible accounts receivables of 32 days. At June 30, 2005, an increase in the discount rate or
14
estimated life of 10% and 20% would have reduced the fair value of the retained interest by $53 and $94, 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 9 – PROPERTY, PLANT AND EQUIPMENT:
The components of property, plant and equipment are as follows:
Plant & equipment
Coal properties and surface lands
Airshafts
Mine development
Leased Coal Lands
Advance Mining Royalties
Total Gross
Less: Accumulated depreciation, depletion and amortization
Total net property, plant and equipment
NOTE 10 - DEBT:
On April 1, 2005, CONSOL Energy amended the existing credit facility to increase the borrowing capacity, reduce cost and extend the term. The amended facility features a five-year, $750,000 revolving credit facility, replacing the previous $600,000 credit facility, which included the Tranche B credit-linked deposit facility of $200,000. The amended facility is collateralized by nearly all of the assets of CONSOL Energy. Collateral is shared equally and ratably with 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. Fees and interest rate spreads are based on a ratio of financial covenant debt to twelve month trailing earnings before interest, taxes, depreciation, depletion and amortization (EBITDA), measured quarterly. Covenants in the amended facility limit our ability to dispose of assets, make investments, purchase or redeem CONSOL Energy common stock and merge with another corporation. The amended facility includes a leverage ratio covenant of not more than 3.25 to 1.00, measured quarterly. The leverage ratio was 0.86 to 1.00 at June 30, 2005. The facility also includes an interest coverage ratio of no less than 4.50 to 1.00, measured quarterly. The interest coverage ratio was 17.70 to 1.00 at June 30, 2005. There are no covenants in the amended facility restricting the level of annual capital expenditures.
15
NOTE 11 - 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 26,200 asbestos claims in state courts in Pennsylvania, Ohio, West Virginia, Maryland, New Jersey, Michigan and Mississippi. Because a very small percentage of products manufactured by third parties and supplied by Fairmont in the past may have contained asbestos and many of the pending claims are part of mass complaints filed by hundreds of plaintiffs against a hundred or more defendants, it has been difficult for Fairmont to determine how many of the cases actually involve valid claims or plaintiffs who were actually exposed to asbestos-containing products supplied by Fairmont. In addition, while Fairmont may be entitled to indemnity or contribution in certain jurisdictions from manufacturers of identified products, the availability of such indemnity or contribution is unclear at this time and, in recent years, some of the manufacturers named as defendants in these actions have sought protection from these claims under bankruptcy laws. Fairmont has no insurance coverage with respect to these asbestos cases. To date, payments by Fairmont with respect to asbestos cases have not been material. However, there cannot be any assurance that payments in the future with respect to pending or future asbestos cases will not be material to the financial position, results of operations or cash flows of CONSOL Energy.
CONSOL Energy is subject to various lawsuits and claims with respect to such matters as personal injury, wrongful death, damage to property, exposure to hazardous substances, governmental regulations including environmental remediation, employment and contract disputes, and other claims and actions arising out of the normal course of business. CONSOL Energy was notified in November 2004 by the United States Environmental Protection Agency (EPA) that it is a potentially responsible party (PRP) under Superfund legislation with respect to the Ward Transformer site in Wake County, North Carolina. The EPA has also identified other PRPs. No agreement on an allocation of costs between the PRPs has been reached to date. The estimated total remediation cost for all responsible parties, based on preliminary information, is approximately $7,000 with CONSOL Energy’s portion estimated to be 40%-45% of total. Accordingly, a $3,000 liability is included in other accrued liabilities, of which $1,500 was recorded in the three months and six months ended June 30, 2005. CONSOL Energy has made no payments to date related to the remediation of this site.
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.
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 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
16
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. CONSOL Energy management believes these claims are without merit and, accordingly, has not accrued any liability associated with these claims.
At June 30, 2005, 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.
Less Than
1 Year
Letters of Credit:
Employee-Related
Environmental
Total Letters of Credit
Surety Bonds:
Total Surety Bonds
Guarantees:
Gas
Total Guarantees
Total Commitments
Employee-related letters of credit and surety bonds have primarily been extended to support the United Mine Workers’ of America’s 1992 Benefit Plan and various state workers’ compensation self-insurance programs. Environmental letters of credit and surety bonds have primarily been extended to support various performance bonds related to reclamation and other environmental issues. Other letters of credit and surety bonds have been extended to support insurance policies, legal matters and various other items necessary in the normal course of business.
CONSOL Energy and certain of its subsidiaries have also provided guarantees for the delivery of specific quantities of coal and gas to various customers. These guarantees are several or joint and several. Other guarantees have also been provided to promise the full and timely payments to lessors of mining equipment and to support various other items necessary in the normal course of business.
17
NOTE 12- 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.
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.
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
Short-term notes payable
Long-term debt
NOTE 13- 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 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 six months ended June 30, 2005, the Northern Appalachian aggregated segment includes the following mines: Shoemaker, Blacksville #2, Robinson Run, McElroy, Loveridge, Bailey, Enlow Fork, Mine 84 and Mahoning Valley. For the three and six months ended June 30, 2005, Central Appalachian aggregated segment includes the following mines: Jones Fork, Mill Creek and Wiley-Mill Creek. For the three and six months ended June 30, 2005, the Metallurgical aggregated segment includes the following mines: Buchanan, Amonate, Miles Branch and V.P. #8. The Other Coal segment
18
includes our 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 each individual mine. 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 classification is made up of the Company’s terminal services, river and dock services, industrial supply services and other business activities, including rentals of buildings and flight operations. The 2004 segment information was reclassified to conform to the 2005 presentation. Royalty income, miscellaneous revenues and Buchanan Generation assets previously reported within Coal and All Other segments are now included in the gas segment. Additionally, the segment information presented has been restated to reflect the restated earnings before income taxes for the three months ended March 31, 2004 due to the favorable effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 as of March 8, 2004, in accordance with authoritative accounting implementation guidance.
Industry segment results for the three months ended June 30, 2005:
Sales—outside
Sales—related parties
Freight—outside
Intersegment transfers
Total Sales and Freight
Earnings (Loss) Before Income Taxes
Segment asset
Depreciation, depletion and amortization
19
Industry segment results for the three months ended June 30, 2004:
Industry segment results for the six months ended June 30, 2005:
20
Industry segment results for the six months ended June 30, 2004:
Reconciliation of Segment Information to Consolidated Amounts:
Earnings (Loss) Before Income Taxes:
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
21
Total Assets:
Segment assets for total reportable business segments
Segment assets for all other businesses
Items excluded from segment assets:
Cash and other investments
Restricted cash
Deferred tax assets
Recoverable income taxes
Intangible asset - overfunded pension plan
Bond issuance costs
Total Consolidated Assets
NOTE 14 - 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.
22
Income statement three months ended June 30, 2005:
Sales - Related Party
Other Income (including equity earnings)
Cost of Goods Sold and Other Operating Charges
Intercompany Activity
Income Tax Expense (Benefit)
Net Income (Loss)
23
Balance sheet at June 30, 2005:
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
24
Income Statement Three Months Ended June 30, 2004:
25
Balance Sheet December 31, 2004:
Accounts Payable (Recoverable)-Related Parties
26
Income Statement for the Six Months Ended June 30, 2005:
Cash Flow for the Six Months Ended June 30, 2005:
Net Cash (Used in) Provided by Operating Activities
Cash Flows from Investing Activities:
Other Investing Activities
Net Cash Provided by (Used in) Investing Activities
Cash Flows from Financing Activities:
Payments on Short-Term Debt
Other Financing Activities
Net Cash (Used in) Financing Activities
27
Income Statement for the Six Months Ended June 30, 2004:
Earnings (Loss) before Cumulative Effect of Change in Accounting Principle
Cumulative Effect of Changes in Accounting for Workers’ Compensation Liability, net of Income Taxes of $53,080
Cash Flow for the Six Months Ended June 30, 2004:
Payments on Long-Term Notes
Net Cash Provided by (Used in) Financing Activities
28
NOTE 15 – RECENT ACCOUNTING PRONOUNCEMENTS:
In June 2005, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 154, Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3. This Statement provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. This Statement also provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The correction of an error in previously issued financial statements is not an accounting change. However, the reporting of an error correction involves adjustments to previously issued financial statements similar to those generally applicable to reporting an accounting change retrospectively. Therefore, the reporting of a correction of an error by restating previously issued financial statements is also addressed by this Statement. This Statement shall be effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005. We do not expect this guidance to have a significant impact on CONSOL Energy.
In April 2005, the FASB issued FSP No. FAS 19-1 “Accounting for Suspended Well Costs” (FSP 19-1). This position concluded that exploratory well costs should continue to be capitalized beyond twelve months when the well has found a sufficient quantity of reserves to justify its completion as a producing well, and the enterprise is making sufficient progress assessing the reserves and the economic and operating viability of the project. This guidance requires management to exercise more judgment than was previously required and also requires additional disclosure. Management does not believe this statement of position will have a significant effect on the financial statements.
In March 2005, the Financial Accounting Standards Board (FASB) issued FASB Interpretation (FIN) 47, Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143. This interpretation clarifies that the term, conditional asset retirement obligation, as used in FASB Statement No. 143, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. Thus, the timing and/or method of settlement may be conditional on a future event. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The fair value of a liability for the conditional asset retirement obligation should be recognized when incurred, generally upon acquisition, construction, or development and/or through the normal operation of the asset. Uncertainty about the timing and/or method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. SFAS No. 143 acknowledges that, in some cases, sufficient information may not be available to reasonably estimate the fair value of an asset retirement obligation. We do not expect this guidance to have a significant impact on CONSOL Energy.
On December 15, 2004, the FASB released its final revised standard entitled FASB Statement No. 123R, “Share-Based Payment” (SFAS No. 123R). This Statement requires that all public entities
29
measure the cost of equity-based service awards based on the grant-date fair value. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award or the requisite service period, which usually is the vesting period. Compensation cost is not recognized for equity instruments for which employees do not render the requisite service. In addition, the SEC Staff issued Staff Accounting Bulletin (SAB) 107 on SFAS No. 123R in March 2005. The SAB was issued to assist preparers by simplifying some of the implementation challenges of SFAS No. 123R while enhancing information that investors receive. This SAB provides guidance related to, among other relevant items, share-based payment transactions with non-employees, valuation methods, the classification of compensation expense, non-GAAP financial measures, first-time adoptions of SFAS No. 123R in an interim period, capitalization of compensation cost related to share-based payment arrangements, the accounting for income tax effects, the modification of employee share options prior to adoption of SFAS No. 123R, and disclosures in Management’s Discussion and Analysis subsequent to adoption of SFAS No. 123R. SFAS No. 123R is to be effective for public companies as of the beginning of the first annual reporting period that begins after June 15, 2005. CONSOL Energy is currently evaluating the impact of unvested stock options outstanding and plans to adopt the provisions of this statement January 1, 2006.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs: An Amendment of ARB 43, Chapter 4” (SFAS No. 151). This statement amends the guidance in ARB No. 43 Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB No. 43, Chapter 4, previously stated that “under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and re-handling costs may be so abnormal as to require treatment as current period charges.” SFAS No. 151 requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this Statement are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We do not expect this guidance to have a significant impact on CONSOL Energy.
In October 2004, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 04-10, “Applying Paragraph 19 of FASB Statement No. 131, ‘Disclosure about Segments of an Enterprise and Related Information,’ in Determining Whether to Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds” (EITF 04-10). FASB Statement No. 131 requires that a public business enterprise report financial and descriptive information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. EITF 04-10 clarifies how an enterprise should evaluate the aggregation criteria in paragraph 17 of FAS No. 131 when determining whether operating segments that do not meet the quantitative thresholds may be aggregated in accordance with paragraph 19 of FAS No. 131. In addition, the FASB Task Force has requested that the FASB staff propose a FASB Staff Position (FSP) to provide guidance in determining whether two or more operating segments have similar economic characteristics. The Task Force has agreed that since the two issues are interrelated, the effective date of EITF 04-10 should coincide with the future undetermined effective date of the anticipated FSP. We are currently evaluating the positions addressed in EITF 04-10, and foresee no significant changes in the reporting practices currently used to report segment information.
NOTE 16–SUBSEQUENT EVENTS:
In July 2005, CONSOL Energy announced that it had created CNX Gas Corporation (CNX Gas), a wholly owned subsidiary of CONSOL Energy, to conduct its gas exploration and production activities. CONSOL Energy contributed substantially all of the assets of its gas business, including all of CONSOL Energy’s rights to coalbed methane associated with 4.5 billion tons of coal reserves owned or controlled by CONSOL Energy as well as all of CONSOL Energy’s rights to conventional gas. CONSOL Energy entered into various agreements with CNX Gas that will define various operating and service relationships between the two companies.
Subsequently, CNX Gas, entered into an agreement to sell approximately 24.3 million shares in a private transaction and granted a 30 day option to purchase an additional 3.6 million shares. The shares are being sold to qualified institutional and accredited investors in a private transaction exempt form registration under Rule 144A, Regulation S and Regulation D. The shares have not been registered under the Securities Act of 1933 and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. Following the close of the transaction, CNX Gas expects to receive approximately $365,400 in net proceeds (approximately $420,200 if the option is exercised) that it will use to pay a special dividend to CONSOL Energy. CONSOL Energy intends to use the proceeds of the special dividend to accelerate efficiency projects in its coal segment and to make acquisitions. In addition, CONSOL Energy has agreed to pay approximately $6,000 in expenses related to this transaction.
Following the close of the transaction, CONSOL Energy will hold approximately 122.9 million shares, or approximately 83.5 percent (81.5 percent if the option is exercised), of the then outstanding shares of CNX Gas’ common stock (before issuance of any shares under CNX Gas’ 2.5 million share equity incentive plan).
30
General
CONSOL Energy had net income of $41 million for the three months ended June 30, 2005 compared to $26 million for the three months ended June 30, 2004. Net income for the 2005 period was improved primarily due to increased average sales prices for coal. This increase was offset, in part, by costs related to the Buchanan fire and higher cost per units sold for both coal and gas. Higher coal unit costs were primarily due to increased expenses related to supplies, labor, contractor mining fees and other post employment benefits. Higher gas unit costs were primarily due to increased well maintenance expenses, enhanced stimulation on existing frac wells (wells drilled into the coal seam) expenses and firm transportation expenses. Increased revenues were offset by costs related to the Buchanan Mine fire. Net income in the 2005 period included additional income tax expense due primarily to higher pre-tax earnings.
Total coal sales for the three months ended June 30, 2005 were 17.4 million tons, of which 17.0 million tons were produced by CONSOL Energy operations or sold from inventory of company-produced coal. This compares with total coal sales of 17.3 million tons for the three months ended June 30, 2004, of which 16.7 million tons were produced by CONSOL Energy operations or sold from inventory of company-produced coal. Overall, production of 16.5 million tons remained consistent in the period-to-period comparison. McElroy Mine production increased 0.9 million tons related to running two longwall mining units in the 2005 period compared to running one longwall mining unit in the 2004 period. Production also increased due to the reactivation of Emery Mine, which was idled in the 2004 period and the opening of the Miller Creek complex in October 2004. These increases in production were offset by a 0.9 million tons reduction at Buchanan Mine in the 2005 period. Buchanan Mine experienced a fire that developed in the mine after a large rock fall behind its longwall mining section on February 14, 2005. The mine was temporarily sealed in order to extinguish the fire. Coal production resumed on June 16, 2005. As of June 30, 2005, total costs related to extinguishment efforts at the Buchanan Mine were approximately $36.9 million, net of expected insurance recovery. However, we also expect to file a claim for a business interruption insurance recovery at some point, none of which has been recorded at June 30, 2005. Total insurance recoveries for the Buchanan fire are limited to $75 million. Production decreases in the period-to-period comparison were also due to Enlow Fork Mine experiencing more challenging mining conditions in the 2005 period.
Our gas production was also impacted by the Buchanan Mine fire. Gross gas production of 2.2 billion cubic feet for the three months ended June 30, 2005 and 3.6 billion cubic feet for the six months ended June 30, 2005 is estimated to have been impaired due to the shutdown of the Buchanan longwall. Before the mine fire, approximately 20% of CONSOL Energy’s total gas production was associated with mining activity at the Buchanan Mine. These Buchanan impacts are in addition to an estimated 3 billion cubic feet curtailment for the year ended December 31, 2005, previously disclosed, related to congestion on the interstate pipeline that transports our Virginia gas that we expect could reduce gas production. Of the 3 billion cubic feet projected curtailment for the year, 0.9 billion cubic feet has already been curtailed in the six months ended June 30, 2005.
Sales volumes of coalbed methane gas, including a percentage of the sales of equity affiliates equal to our interest in these affiliates, decreased 5.1% to 12.9 billion cubic feet in the three months ended June 30, 2005 period compared with 13.6 billion cubic feet in the three months
31
ended June 30, 2004 period. The decrease in sales volumes is primarily due to the loss in production from the Buchanan Mine fire and pipeline curtailments, offset, in part, by an increase in production as a result of additional wells coming on line from the ongoing drilling program and results of the enhanced stimulation of existing frac wells (wells drilled into the coal seam). Our average sales price for coalbed methane gas, including sales of equity affiliates increased 0.8% to $5.02 per thousand cubic feet in the 2005 period compared with $4.98 per thousand cubic feet in the 2004 period.
CONSOL Energy restated first quarter 2004 net income by approximately $2.2 million to reflect the recognition of favorable effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 as of March 8, 2004 in accordance with authoritative accounting implementation guidance.
In April 2005, CONSOL Energy completed a $750 million Senior Secured Loan Agreement to replace an existing facility of $600 million. The new agreement is a five-year revolving credit facility.
In May 2005, CONSOL Energy announced that it planned to expand the Enlow Fork Mine in southwestern Pennsylvania. The expansion project, which is subject to final approval by the CONSOL Energy Board of Directors, is expected to add approximately seven million tons of additional capacity and be running by 2010.
In July 2005, CONSOL Energy announced that it had created CNX Gas Corporation, a wholly owned subsidiary of CONSOL Energy, to conduct its gas exploration and production activities. CONSOL Energy contributed substantially all of the assets of its gas business, including all of CONSOL Energy’s rights to coalbed methane associated with 4.5 billion tons of coal reserves owned or controlled by CONSOL Energy as well as all of CONSOL Energy’s rights to conventional gas. CONSOL Energy entered into various agreements with CNX Gas that will define various operating and service relationships between the two companies.
In conjunction with the creation of the new company, several CONSOL Energy executives will resign their positions with CONSOL Energy to become employees of the new company. They include: Ronald Smith, Executive Vice-President; Nicholas DeIuliis, Senior Vice President; and Gary Bench, Vice President. In addition, a separate Board of Directors has been created to govern CNX Gas. CONSOL Energy Director Phillip Baxter will resign from the Board to become Chairman of the Board of CNX Gas. In addition, CONSOL Energy Board of Director members J. Brett Harvey, James Altmeyer, Sr., and Raj Gupta will serve on both boards.
Subsequently, CNX Gas, entered into an agreement to sell approximately 24.3 million shares in a private transaction and granted a 30 day option to purchase an additional 3.6 million shares. The shares are being sold to qualified institutional and accredited investors in a private transaction exempt from registration under Rule 144A, Regulation S and Regulation D. The shares have not been registered under the Securities Act of 1933 and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. Following the close of the transaction, CNX Gas expects to receive approximately $365.4 million in net proceeds (approximately $420.2 million if the option is exercised) that it will use to pay a special dividend to CONSOL Energy. CONSOL Energy intends to use the proceeds of the special dividend to accelerate efficiency projects in its coal segment and to make acquisitions. In addition, CONSOL Energy has agreed to pay approximately $6.0 million in expenses related to this transaction.
Following the close of the transaction, CONSOL Energy will hold approximately 122.9 million shares, or approximately 83.5 percent (81.5 percent if the option is exercised), of the then outstanding shares of CNX Gas common stock (before issuance of any shares under CNX Gas’ 2.5 million share equity incentive plan). At the price paid in the transaction, CONSOL Energy’s shares of CNX Gas would be valued at approximately $1.966 billion.
In July 2005, Standard & Poor’s Rating Services affirmed its “BB-” (12th lowest out of 22 rating categories) corporate credit and its other ratings on CONSOL Energy and upgraded the outlook from stable to positive. Standard & 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.
32
Results of Operations
Three Months Ended June 30, 2005 Compared with Three Months Ended June 30, 2004
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
Income Tax Expense
Net income for the 2005 period was improved primarily due to increased average sales prices for coal. This increase was offset, in part, by costs related to the Buchanan Mine fire and higher cost per units sold for both coal and gas. Higher coal unit costs were primarily due to increased expenses related to supplies, labor, contractor mining fees and other post employment benefits. Higher gas unit costs were primarily due to increased well maintenance expense, enhanced stimulation on existing frac wells (wells drilled into the coal seam) expenses and firm transportation expenses. Net income in the 2005 period included additional income tax expense due primarily to higher pre-tax earnings.
33
Revenue
Revenue and other income increased due to the following items:
Sales
Produced Coal (including related party)
Purchased Coal
Produced Gas
Purchased Gas
Industrial Supplies
Total Sales
Freight Revenue
The increase in company produced coal sales revenue, including related party, during the 2005 period was due mainly to the increase in average sales price per ton.
2005
Period
2004
Percentage
Change
Produced Tons Sold (in millions)
Average Sales Price Per Ton
The increase in average sales price primarily reflects stronger prices negotiated in 2004 and early 2005 resulting from an overall improvement in prices in the eastern coal market for domestic and foreign power generators and steel producers. The increase was also attributable to pricing premiums due to improved quality on coal shipments. Sales tons in the 2005 period increased slightly over the 2004 period. Overall production of 16.5 million tons remained consistent in the period-to-period comparison. McElroy Mine production increased 0.9 million tons related to running two longwall mining units in the 2005 period compared to running one longwall mining unit in the 2004 period. Production also increased due to the reactivation of Emery Mine, which was idled in the 2004 period and the opening of the Miller Creek complex in October 2004. These increases in production were offset by a 0.9 million tons reduction at Buchanan Mine in the 2005 period. Buchanan Mine experienced a fire that developed in the mine after a large rock fall behind its longwall mining section on February 14, 2005. The mine was temporarily sealed in order to extinguish the fire. Coal production resumed on June 16, 2005. Production decreases in the period-to-period comparison were also due to Enlow Fork Mine experiencing more challenging mining conditions in the 2005 period.
34
The increase in company-purchased coal sales revenue was due to an increase in average sales price per ton of purchased coal.
Purchased Tons Sold (in millions)
The increased average sales price is primarily due to sales of purchased coal tons being sold in higher priced export and metallurgical markets. Increased revenue from higher average sales prices were offset, in part, by lower sales volumes of purchased coal in the 2005 period compared to the 2004 period.
The decrease in produced gas sales revenue was primarily due to decreased volumes sold in the 2005 period compared to the 2004 period, offset, in part, by an increase in average sales price per unit sold.
Produced Gas Sales Volumes (in billion gross cubic feet)
Average Sales Price Per thousand cubic feet (including effects of derivative transactions)
Lower sales volumes in the 2005 period were primarily related to the Buchanan Mine fire and curtailments on CONSOL Energy shipment capacity on the Columbia interstate pipeline. The Buchanan Mine fire developed after a large rock fall behind its longwall mining section on February 14, 2005. The mine was temporarily sealed in order to extinguish the fire. Gas production associated with mining activity was reduced because of the idling of the mine and because of the temporary shutdown of certain active gob gas wells. Our gas production was impaired by approximately 2.2 Bcf (gross) for the three months ended June 30, 2005 because of the shutdown of Buchanan Mine. Gas production gradually began to resume in May 2005, when mine fans began to ventilate the mine and mine rescue teams entered the mine to begin a thorough investigation of the working areas of the mine. As a result of increased demand for pipeline use on the Columbia interstate pipeline, CONSOL Energy shipments of gas were curtailed in the 2005 period. This curtailment resulted in a 0.9 billion cubic feet reduction. These reductions in sales volumes were offset, in part, by the results of wells coming on line from the on-going drilling program and the results of the enhanced stimulation of existing frac wells (wells drilled into the coal seam). 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 2005 period, these financial cash flow hedges represented 19% of
35
our produced gas sales volumes at an average price of $4.88 per thousand cubic feet. These financial cash flow hedges currently are expected to represent 18% of our estimated total 2005 produced sales volumes at an average price of $5.48 per thousand cubic feet. CONSOL Energy sold 58% of our produced gas sales volumes in the 2005 period under fixed price contracts at an average price of $4.54 per thousand cubic feet.
Due to the potential curtailment on portions of the shipment capacity allocated to CONSOL Energy, as a result of increased demand for capacity on the Columbia interstate pipeline, CONSOL Energy purchased firm transportation capacity on the pipeline during 2005. This arrangement is expected to offset a portion of the expected impact from periodic curtailments. As of June 30, 2005, the purchased firm transportation capacity on the pipeline for the third quarter represents approximately 72% of our projected production for the same period. In April 2005 due to routine maintenance and construction activities, CONSOL Energy was given notice by Columbia regarding reductions in allowable gas flows. Interruptible gas was completely shut in and our contractual flows were reduced by 60%. These reductions resulted in a second quarter impact of approximately $6.8 million of reduced revenues. Although scheduled reductions have been lifted, CONSOL Energy anticipates that the pipeline constraints will be an on-going issue for the foreseeable future requiring the procurement of firm capacity.
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. Sales of purchased gas volumes have primarily increased due to CONSOL Energy purchasing firm transportation on a regular basis throughout the 2005 period that required us to purchase from and sell to other gas suppliers. CONSOL Energy began to enter into this type of transaction in May of 2004.
Purchased Gas Sales Volumes (in billion gross cubic feet)
The $2 million increase in revenues from the sale of industrial supplies was primarily due to increased sales volumes.
The $3 million increase in other sales was primarily attributable to revenues from river barge towing. Under the Jones Act Bowater exemption, because CONSOL Energy was more than 25% owned by a foreign company, it was prohibited from providing river barge towing to third parties. CONSOL Energy began third party river barge towing shortly after RWE AG divested its ownership interest in the 2004 period.
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.
36
Other income consists of interest income, gain or loss on the disposition of assets, equity in earnings of affiliates, service income, royalty income, rental income and miscellaneous income. Other income remained consistent in the period-to-period comparison.
Dollar
Variance
Gain on sale of assets
Other miscellaneous
Total other income
Costs
Cost of Goods Sold and Other Charges
Produced Coal
Closed and Idle Mines
Increased cost of goods sold and other charges for company-produced coal was due mainly to a 8.3% increase in cost per ton of produced coal sold and a 1.8% increase in sales volumes.
Average Cost of Goods Sold and Other Charges Per Ton
Average cost of goods sold and other charges for produced coal increased due mainly to increased unit costs. This increase is attributable to higher supply costs, higher labor cost, higher contract mining fee costs and higher other post employment benefits per unit sold. Higher supply costs were attributable to increased maintenance costs and increased cost for steel, petroleum products and chemicals, such as magnetite, used in the mining and coal
37
preparation process. Higher supply costs were also related to difficult mining conditions in certain locations which increase costs on a per unit of output basis. Increased labor costs were attributable to increased employee counts and increased wages at certain mining operations. Mancounts have been increased in certain locations to maintain development rates ahead of the longwall mining units. Labor rates were increased in order to stay competitive in certain labor markets. Increased contract mining fees were attributable to increased fees negotiated with the contractors used primarily in our central Appalachian operations. Increased other post employment benefits were primarily due to the impact of the cost increases for medical and drug benefits. Increased produced coal costs of goods sold was also due to slightly higher sales volumes in the 2005 period compared to the 2004 period. These increases in costs were offset, in part, by reduced Combined Fund premiums related to a premium differential that was paid in the 2004 period. CONSOL Energy currently anticipates that the 1992 Fund premiums will increase approximately $5-$10 million for the plan year beginning January 1, 2006. CONSOL Energy also anticipates property insurance and business interruption insurance expenses to increase approximately 32%, or $5 million based on a renewed one-year policy effective July 1, 2005.
Purchased coal cost of goods sold and other charges increased in the 2005 period compared to the 2004 period.
The higher average cost of purchased coal is primarily due to overall increases in prices for domestic coals.
Gas cost of goods sold and other charges increased due primarily to increased unit costs, offset, in part, by a decrease in volumes sold.
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 primarily attributable to increases in well and pipeline maintenance per unit cost. Gas well maintenance expenses increased due to 45 additional wells being serviced in the 2005 period compared to the 2004. Gas well maintenance expenses were also increased due to the initiation of an enhancement program on frac wells (wells drilled into the coal seam) in an attempt to stimulate additional production during the shutdown of the Buchanan Mine. Pipeline maintenance expenses have increased in the period-to-period comparison due to accelerated maintenance that was
38
re-scheduled to coincide with the curtailment on the Columbia Gas Transmission Corporation’s interstate pipeline. Additionally, the average cost per thousand cubic feet of gas sold increased due to a $0.05 increase per thousand cubic feet of gas sold related to the purchase of firm transportation capacity on the Columbia Gas Transmission Corporation’s interstate pipeline because of potential curtailments on portions of shipment capacity allocated to CONSOL Energy as a result of increased demand for pipeline access in the 2005 period. CONSOL Energy began to purchase firm transportation capacity on the pipeline in May 2004. The purchased fixed capacity on the pipeline for the third quarter 2005 represents approximately 72% of our projected production for the same period. The increase in average costs per unit sold was offset, in part, by a reduction of royalty expense. Although average gas sales prices increased 0.6%, CONSOL Energy royalty expense decreased approximately $0.03 per thousand cubic feet. The decrease was due to the finalization of several agreements with lessors that resulted in lower royalty rates.
In connection with the purchase of firm transportation capacity on the Columbia pipeline, we purchased from and sold to other gas suppliers, which increased our revenues and our costs. CONSOL Energy believes this type of transaction may continue as a result of increased demands on the Columbia pipeline.
Purchased gas volumes have increased primarily due to CONSOL Energy purchasing firm transportation on a regular basis throughout the 2005 period that required us to purchase from and sell to other gas suppliers. CONSOL Energy began to enter into this type of transaction in May of 2004. Average costs of purchased gas have increased reflecting the average increase in market price of gas.
Industrial supplies cost of goods sold increased primarily due to higher sales volumes and unit cost increases.
Although closed and idle mine cost of goods sold and other charges were consistent in the 2005 period compared to the 2004 period, workers’ compensation expense related to closed and idled locations has decreased $2 million. This decrease was primarily due to the actuarial effects of several law changes in the state of West Virginia related to workers’ compensation. Lower closed and idle mine cost of goods sold were also due to Emery mine being inactive for most of the 2004 period. Emery was in active production status throughout the 2005 period. These improvements were offset by higher expenses related to mine closing, perpetual care water treatment and reclamation liability adjustments that were a result of updated engineering surveys. Survey adjustments resulted in $3 million of additional expense in the 2005 period for closed and idled locations compared to the results of the survey adjustments in the 2004 period.
39
Miscellaneous cost of goods sold and other charges increased due to the following items:
Buchanan Mine fire
Bank fees
Buckeye landfill superfund site liability transfer
Stock-based compensation expense
Miscellaneous transactions
Total Miscellaneous Cost of Goods Sold and Other Charges
CONSOL Energy’s Buchanan Mine, located near Keen Mountain, Virginia, experienced a large rock fall behind its longwall mining section on February 14, 2005. While caving behind the longwall is a normal part of the mining process, the size of this cave-in created a large air pressure wave that disrupted ventilation and also caused an ignition of methane gas in the area. CONSOL Energy temporarily sealed the mine in order to extinguish the fire that developed after the ignition. Various materials, including nitrogen foam and water were pumped into the mine in order to accelerate the process of creating an inert environment within the mine to extinguish the fire. Coal production resumed on June 16, 2005. Costs of goods sold incurred for the Buchanan Mine fire, net of expected insurance recovery, for the quarter ended June 30, 2005 were $20 million.
The increase in bank fees in the 2005 period is primarily related to the expense of previously unamortized bank fees related to amending the existing credit facility on April 1, 2005. The new facility increased the borrowing capacity and extend the terms of the previous facility.
Incentive compensation expense increased due to an increase in the projected amount expected to be paid out to employees in the 2005 period compared to the 2004 period and differences in the level of earnings achieved compared to the projected annual earnings in the period to period comparison. 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.
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 an 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 provision reductions.
In April 2004, CONSOL Energy began to issue restricted stock units as part of its equity incentive plan. Compensation cost for the restricted stock units is based upon the closing share
40
price at the date of grant and is recognized over the vesting period of the units. The increase in stock-based compensation expense in the 2005 period is due to additional compensation costs for restricted stock unit grants that occurred in the 2005 period.
Miscellaneous cost of goods sold and other charges increased $4 million due to various miscellaneous transactions that occurred throughout both periods, none of which were individually material.
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 increased due to the following items:
Professional consulting and other purchased services
Wages and salaries
Total Selling, General and Administrative
Costs of professional consulting and other purchased services were higher in the 2005 period compared to the 2004 period primarily due to services provided that were related to various corporate initiatives.
Wages and salaries have increased in the quarter-to-quarter comparison due to the annual performance increases and salary restructuring as a result of the completion of compensation studies that were completed.
41
Depreciation, depletion and amortization increased due to the following items:
Gas:
Production
Gathering
Total Gas
Total Depreciation, Depletion and Amortization
The increase in coal depreciation, depletion and amortization was primarily attributable to assets placed in service after the 2004 period. Equipment and airshafts have been placed in service at McElroy, Bailey and Enlow mines that have increased depreciation, depletion and amortization approximately $5 million in the 2005 period compared to the 2004 period. Increases are also attributable to the expansion projects, such as McElroy and Bailey refuse area and plant expansion, that were completed and in service in the 2005 period.
Gas production and gathering depreciation, depletion and amortization was consistent in the period-to-period comparison.
Interest expense decreased in the 2005 period compared to the 2004 period.
Short-term borrowings
12 year and 15 year secured notes
Total Interest Expense
Interest expense decreased primarily due to a reduction in the weighted average outstanding balance under short-term borrowings in the 2005 period compared to the 2004 period. The weighted average outstanding balance was approximately $5 million in the 2005 period compared to the $107 million in the 2004 period.
The decrease in interest expense related to the 12-year and 15- year secured notes is attributable to the scheduled long-term debt payment of $45 million for the 12-year secured note in June 2004.
42
Other interest expense increased due to reduced amounts of interest capitalized in the 2005 period compared to the 2004 period. The reduced capitalized interest was attributable to the lower level of capital projects funded from operating cash flow, primarily due to the completion of the McElroy expansion project.
Taxes other than income increased primarily due to the following items:
Production taxes:
Total Production Taxes
Other taxes:
Total Taxes Other Than Income
Increased coal production taxes are primarily due to higher severance taxes and higher black lung excise taxes attributable to higher average sales price for coal.
Other coal taxes have increased primarily due to higher payroll taxes attributable to additional labor expense. Additional labor expenses were attributable to a 5% increase in employee-counts at June 2005 compared to June 2004.
Tax Expense
Effective Income Tax Rate
CONSOL Energy’s effective tax rate is sensitive to changes to the relationship between pre-tax earnings and percentage depletion. See “Note 6 - Income Taxes” in Item 1, Condensed Financial Statement of this Form 10-Q.
43
Six Months Ended June 30, 2005 Compared with Six Months Ended June 30, 2004
Coal Sales-Produced and Purchased (Outside and Related Party)
Earnings (Loss) before Income Taxes
Cumulative Effect of Change in Accounting Principle
Earnings before cumulative effect of change in accounting for the 2005 period were improved primarily due to increased average sales prices for both coal and gas and increased volume of produced coal sold. These increases were offset, in part, by costs related to the Buchanan Mine fire and by higher cost per units sold for both coal and gas. Higher coal unit costs were primarily due to increased supply costs, higher labor costs, higher contractor mining fees and higher other post-employment benefits. Higher gas unit costs were primarily due to higher gas well maintenance expenses, enhanced stimulation on existing frac wells (wells drilled into the
44
coal seam) expenses and firm transportation expenses. Net income in the 2004 period included a 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, CONSOL Energy recorded its workers’ compensation liability on an undiscounted basis. Under the new method, CONSOL Energy records its liability on a discounted basis, which has been actuarially determined using various assumptions, including discount rate and future cost trends. Net income in the 2005 period included additional income tax expense due primarily to higher pre-tax earnings.
Produced Coal-Outside and Related Party
45
The increase in company produced coal sales revenue, including related party, during the 2005 period was due mainly to the increase in average sales price per ton and increased sales volumes.
The increase in average sales price primarily reflects stronger prices negotiated in 2004 and early 2005 resulting from an overall improvement in prices in the eastern coal market for domestic and foreign power generators and steel producers. The increase was also attributable to pricing premiums due to improved quality on coal shipments. The increase in tons sold was due primarily to increased production at Loveridge, McElroy, the reactivation of Emery Mine and the opening of the Miller Creek complex in October 2004, offset, in part, by a decrease in tons sold due to lower production at Buchanan and Enlow Fork. The Loveridge production increase is due to the mine operating for the full six months of the 2005 period compared to only a portion of the 2004 period due to the fire at this location in 2003. The McElroy production increase is related to running two longwall mining units in the 2005 period compared to running one longwall mining unit in the 2004 period. Buchanan production has decreased in the 2005 period due to a fire that developed in the mine after a large rock fall behind its longwall mining section on February 14, 2005. The mine was temporarily sealed in order to extinguish the fire. Buchanan resumed production on June 16, 2005. Enlow Fork production has decreased due to experiencing more challenging mining conditions in the 2005 period.
The increase in company-purchased coal sales revenue was due to an increase in average sales price per ton of purchased coal, offset, in part, by reduced sales volumes.
46
The increase in gas sales revenue was due to a higher average sales price per thousand cubic feet sold in the 2005 period compared to the 2004 period.
We believe the 2005 gas market price increases were largely driven by continued concerns over levels of North American gas production, as well as increased oil prices and favorable economic conditions in the United States that encourage demand for natural gas. 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 2005 period, these financial cash flow hedges represented approximately 20% of our produced gas sales volumes at an average price of $5.98 per thousand cubic feet. These financial cash flow hedges currently are expected to represent 18% of our estimated total 2005 produced sales volumes at an average price of $5.48 per thousand cubic feet. CONSOL Energy sold 52% of our produced gas sales volumes in the 2005 period under fixed price contracts at an average price of $4.52 per thousand cubic feet. Sales volumes remained consistent in the 2005 period due to the reduction of 3.6 billion cubic feet caused by the Buchanan Mine fire and the 0.9 reduction related to curtailments in CONSOL Energy’s shipment capacity on the Columbia interstate pipeline. These reductions were offset by the results of wells coming on line from the on-going drilling program and the results of the enhanced stimulation of existing frac wells (wells drilled into the coal seam).
Due to the potential curtailment on portions of the shipment capacity allocated to CONSOL Energy, as a result of increased demand for capacity on the Columbia interstate pipeline, CONSOL Energy purchased firm transportation capacity on the pipeline during 2005. This arrangement is expected to offset a portion of the expected impact from periodic curtailments. As of June 30, 2005, the purchased firm transportation capacity on the pipeline for the third quarter represents approximately 72% of our projected production for the same period. However, in April 2005 due to routine maintenance and construction activities, CONSOL Energy was given notice by Columbia regarding reductions in allowable gas flows. Interruptible gas was completely shut in and our contractual flows were reduced by approximately 60%. These reductions resulted in a year to date impact of approximately $6.8 million of reduced revenues. Even after these scheduled reductions were lifted, CONSOL Energy anticipates that the pipeline constraints will be an on-going issue for the foreseeable future requiring the procurement of firm capacity.
47
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. Sales of purchased gas volumes have increased primarily due to CONSOL Energy purchasing firm transportation on a regular basis throughout the 2005 period that required us to purchase from and sell to other gas suppliers. CONSOL Energy began to enter into this type of transaction in May of 2004.
The $6 million increase in revenues from the sale of industrial supplies was primarily due to increased sales volumes.
The $5 million increase in other sales was attributable to revenues from river barge towing. Under the Jones Act Bowater exemption, because CONSOL Energy was more than 25% owned by a foreign company, it was prohibited from providing river barge towing to third parties. CONSOL Energy began third party river barge towing shortly after RWE AG divested its ownership interest in the 2004 period.
Freight revenue is based on weight of coal shipped, negotiated freight rates and method of transportation (i.e., rail, barge, truck, etc.) used for the customers to which CONSOL Energy contractually provides transportation services. Freight revenue is the amount billed to customers for transportation costs incurred.
48
Other income consists of interest income, gain or loss on the disposition of assets, equity in earnings of affiliates, service income, royalty income, rental income and miscellaneous income.
Harmar Trust Settlement
Equity in income (loss) of affiliates
The decrease in gain on sale of assets in the 2005 period reflects 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, the assumption of approximately $21.3 million of debt, and associated interest rate swaps and foreign currency hedges in the 2004 period. The sale resulted in a pre-tax gain of approximately $14.4 million. The additional gain on sale of assets in the 2004 period is primarily related to the sale of several previously closed operations. The 2005 period gain on sale of assets is primarily related to the sale of several previously closed operations.
Other income from the Harmar Environmental Trust (the Trust) Settlement was attributable to the Civil Division of the Court of Common Pleas of Allegheny County’s decision to terminate a Trust among CONSOL Energy and other parties. The Trust was established in 1988 to provide funding for water treatment related to the now closed Harmar Mine. Other parties funded the trust. CONSOL Energy was responsible to complete water treatment activities, but all costs associated with these activities were funded by the Trust Agreement. Any excess funding upon completion of water treatment or a specified date in the future was to be distributed to parties that originally funded the trust. In the decision, all previously funded, but unused, amounts remaining in the Trust were distributed. CONSOL Energy’s portion of the distributed funds, $15 million, was placed into an escrow account pending provision of financial assurance supporting CONSOL Energy’s water treatment obligations. CONSOL Energy has provided the financial assurance for this obligation and the funds have been released from escrow. CONSOL Energy is responsible for the ongoing water treatment at this facility. CONSOL Energy recorded the funds and the present value of the water treatment liability resulting in $6 million of income in the 2005 period.
The equity income of affiliates in the 2005 period is attributable to CONSOL Energy’s portion of a gain on sale of land by the affiliate. The equity losses of affiliates in the 2004 period is due mainly to the equity losses related to Glennies Creek Mine operating results prior to the sale that occurred in February 2004.
An additional $4 million increase in other income was due to various transactions that occurred throughout both periods, none of which were individually material.
49
Increased cost of goods sold and other charges for company-produced coal was due mainly to a 8.0% increase in cost per ton of produced coal sold and a 2.7% increase in sales volumes.
Average cost of goods sold and other charges for produced coal increased due mainly to increased unit costs. This increase is attributable to higher supply costs, higher labor cost, higher contract mining fee costs and higher other post employment benefits per unit sold. Higher supply costs were attributable to increased maintenance costs and increased cost for steel, petroleum products and chemicals, such as magnetite, used in the mining and coal preparation process. Higher supply costs were also related to certain locations being in difficult mining conditions which increase costs on a per unit of output basis. Increased labor costs were attributable to increased employee counts and increased wages at certain mining operations. Mancounts have been increased in certain locations to maintain development rates ahead of the longwall mining units. Labor rates were increased in order to stay competitive in certain labor markets. Increased contract mining fees were attributable to increased fees negotiated with the contractors used primarily in our central Appalachian operations. Increased other post
50
employment benefits were primarily due to the impact of cost increases for medical and drug benefits. Increased produced coal costs of goods sold was also due to higher sales volumes in the 2005 period compared to the 2004 period. These increases in costs were offset, in part, by reduced Combined Fund premiums related to a premium differential that was paid in the 2004 period. CONSOL Energy currently anticipates that the 1992 Fund premiums will increase approximately $5-$10 million for the plan year beginning January 1, 2006. CONSOL Energy also anticipates property insurance and business interruption insurance expenses to increase approximately 32%, or $5 million based on a renewed one-year policy effective July 1, 2005.
Gas cost of goods sold and other charges increased due primarily to increased unit costs.
The increase in average cost per thousand cubic feet of gas sold was primarily attributable to higher gas well and pipeline maintenance expenses. Gas well maintenance increased due to 124 additional wells being serviced in the 2005 period compared to the 2004. Gas well maintenance expenses were also increased due to the initiation of an enhancement program on frac wells (wells drilled into the coal seam) in an attempt to stimulate additional production during the shutdown of Buchanan. Pipeline maintenance expenses have increased in the period-to-period comparison due to accelerated maintenance that was re-scheduled to coincide with the curtailment on the Columbia interstate pipeline. Increased unit costs were also attributable to a $0.06 increase per thousand cubic feet related to the purchase of firm transportation capacity on
51
the Columbia Gas Transmission Corporation’s interstate pipeline because of potential curtailments on portions of shipment capacity allocated to CONSOL Energy as a result of increased demand for pipeline access in the 2005 period. CONSOL Energy began to purchase firm transportation capacity on the pipeline in May 2004. The purchased fixed capacity on the pipeline for the third quarter 2005 represents approximately 72% of our projected production for the same period. A $0.04 increase in average cost per thousand cubic feet of gas was also attributable to gas imbalance on the pipeline. Because contracted quantities of gas delivered to the pipeline rarely equal physical deliveries to customers, CONSOL Energy is responsible for monitoring this imbalance and requesting adjustments to contracted volumes as circumstances warrant. The gas imbalance has shifted from an over-delivered position to an under-delivered position in the 2005 period compared to the 2004 period. The increase in imbalance cost per unit sold was offset by corresponding increases in gas sales revenue. Increased unit costs were offset, in part, by decreased royalty expense. Although average gas sales prices increased 4.1%, CONSOL Energy royalty expense decreased approximately $0.07 per thousand cubic feet. The decrease was due to finalization of several agreements with lessors that resulted in lower royalty rates.
In connection with the purchase of firm transportation capacity on the Columbia pipeline, we purchased from and sold to other gas suppliers, which increased our revenues and our costs. CONSOL Energy believes this type of transaction may continue as a result of increased capacity demands on the Columbia pipeline.
Purchased gas volumes have primarily increased due to CONSOL Energy purchasing firm transportation on a regular basis throughout the 2005 period that required us to purchase from and sell to other gas suppliers. CONSOL Energy began to enter into this type of transaction in May of 2004. Average costs of purchased gas have increased reflecting the average increase in market price of gas.
Industrial supplies cost of goods sold increased primarily due to higher sales volumes and higher unit costs.
Closed and idle mine cost of goods sold was $2 million lower in the 2005 period compared to the 2004 period primarily due to lower workers’ compensation expense. Workers’ compensation expense related to closed and idled locations has decreased $4 million primarily due to the actuarial effects of several law changes in the state of West Virginia related to workers’ compensation. Lower expenses were also due to Emery and Loveridge mines being inactive for most of the 2004 period. These mines were in active production status throughout the 2005 period. These improvements were offset, in part, by higher expenses related to mine
52
closing, perpetual care water treatment and reclamation liability adjustments that were a result of updated engineering surveys. Survey adjustments resulted in $4 million of additional expense in the 2005 period for closed and idled locations compared to the results of the survey adjustments in the 2004 period.
Sales contract buy outs
Accounts receivable securitization fees
CONSOL Energy’s Buchanan Mine, located near Keen Mountain, Virginia, experienced a large rock fall behind its longwall mining section on February 14, 2005. While caving behind the longwall is a normal part of the mining process, the size of this cave-in created a large air pressure wave that disrupted ventilation and also caused an ignition of methane gas in the area. CONSOL Energy temporarily sealed the mine in order to extinguish the fire that developed after the ignition. Various materials, including nitrogen foam and water were pumped into the mine in order to accelerate the process of creating an inert environment within the mine to extinguish the fire. Coal production resumed on June 16, 2005. Costs of goods sold incurred, net of expected insurance recovery, for the year to date period ended June 30, 2005 were $32 million.
In the 2005 and 2004 periods, agreements were made to buy out sales contracts with several customers in order to release tons committed under lower priced contracts for sale to other customers at higher pricing.
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.
53
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 an 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.
In April 2004, CONSOL Energy began to issue restricted stock units as part of its equity incentive plan. Compensation cost for the restricted stock units is based upon the closing share price at the date of grant and is recognized over the vesting period of the units. The increase in stock-based compensation expense in the 2005 period is due to compensation cost for the 2004 grants being recognized for the full 2005 period as well as additional compensation costs for restricted stock unit grants that occurred in the 2005 period.
Fees related to the accounts receivable securitization program (see Note 8 of Consolidated Financial Statements on this Form 10-Q) have increased in the 2005 period compared to the 2004 period. The increase is attributable to higher average fees charged, offset, in part by lower weighted average outstanding balances under the program.
Miscellaneous cost of goods sold and other charges increased $10 million due to various miscellaneous transactions that occurred throughout both periods, none of which were individually material.
54
Selling, general and administrative costs have decreased due to the following items:
Total Selling, General And Administrative
Costs of professional consulting and other purchased services were higher in the 2004 period compared to the 2005 period primarily due to services provided in 2004 to complete procedures related to a special investigation into matters alleged in an anonymous letter. This decrease was offset, in part, by costs incurred in the year to date 2005 period that were related to various corporate initiatives.
The increase in coal depreciation, depletion and amortization was primarily attributable to assets placed in service after the 2004 period. Equipment and airshafts have been placed in service at Bailey, Enlow, Shoemaker, McElroy and Loveridge that have increased depreciation, depletion and amortization. Increases are also attributable to expansion projects, such as McElroy and Bailey refuse area and plant expansion, that were completed and in service in the 2005 period.
The increase in gas production depreciation, depletion and amortization was primarily due to higher unit-of-production rates in the 2005 period compared to the 2004 period. Rates were recalculated as of April 1, 2005 using updated reserve information. Although rates decreased
55
from those used in the quarter ended March 31, 2005, rates remained above those calculated in the previous year. Gathering depreciation, depletion and amortization is recorded on the straight-line method and remained consistent in both periods.
Interest expense decreased primarily due to a reduction in the weighted average outstanding balance under short-term borrowings in the 2005 period compared to the 2004 period. The weighted average outstanding balance was approximately $14 million in the 2005 period compared to the $113 million in the 2004 period.
The decrease in interest expense related to the 12-year and 15-year secured notes is attributable to the scheduled long-term debt payment of $45 million for the 12-year secured note in June 2004.
56
Increased coal production taxes are primarily due to higher severance taxes and higher black lung excise taxes attributable to higher coal volumes and higher average sales price.
Other coal taxes and other miscellaneous taxes increased primarily due to higher payroll taxes attributable to additional labor expense. Additional labor expenses were attributable to a 5% increase in employee-counts at June 2005 compared to June 2004 and higher labor rates in the period-to-period comparison.
57
Cumulative Effect of Change in Accounting
Effective January 1, 2004, CONSOL Energy changed its method of accounting for workers’ compensation. Prior to the change, CONSOL Energy recorded its workers’ compensation liability on an undiscounted basis. Under the new method, CONSOL Energy recorded its liability on a discounted basis, which has been actuarially determined using various assumptions, including discount rate and future cost trends. CONSOL Energy believes this change was preferable since it aligns the accounting with our other long-term employee benefit obligations, which are recorded on a discounted basis. Additionally, it provides a better comparison with our industry peers, the majority of which record the workers’ compensation liability on a discounted basis.
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.
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 April 1, 2005, CONSOL Energy amended the credit facility to increase the borrowing capacity, reduce cost and extend the term. The amended facility features a five-year, $750 million revolving credit facility, replacing the previous $600 million credit facility, which included the Tranche B credit-linked deposit facility of $200 million. The amended facility includes more favorable pricing. Approximately $1.9 million of previously unamortized bank fees were expensed in the quarter ended June 30, 2005. The amended facility is collateralized by nearly all of the assets of CONSOL Energy and its subsidiaries. Collateral is shared equally and ratably with 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. Fees and interest rate spreads are based on a ratio of financial covenant debt to twelve month trailing earnings before interest, taxes, depreciation and amortization (EBITDA). Covenants in the amended facility limit our ability to dispose of assets, make investments, purchase or redeem CONSOL Energy common stock and merge with another corporation. The amended facility includes a leverage ratio covenant of not more than 3.25 to 1.00, measured quarterly. This ratio was 0.86 to 1.00 at June 30, 2005. The facility also includes an interest coverage ratio covenant of no less than 4.50 to 1.00, measured quarterly. This ratio was 17.70 to 1.00 at June 30, 2005. There are no covenants in the amended facility restricting the level of annual capital expenditures. At June 30, 2005, this facility had approximately $336 million letters of credit issued and had no outstanding borrowings, leaving approximately $414 million of unused capacity.
CONSOL Energy and certain of its U.S. subsidiaries also participate in a receivables securitization facility for the sale on a continuous basis of eligible trade accounts receivable that will provide, on a revolving basis, up to $125.0 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
58
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 is consistent with commercial paper rates plus a charge for administrative services paid to the financial institution. The receivables facility expires in 2006. At June 30, 2005, eligible accounts receivable totaled approximately $124.3 million. The subordinated retained interest at June 30, 2005 was $109.3 million. Accounts receivable totaling $15.0 million were removed from the consolidated balance sheet at June 30, 2005. In accordance with the facility agreement, CONSOL Energy is able to receive proceeds based upon total eligible accounts receivable at the previous month-end. Repayments of $110.0 million were included in cash flows from operating activities in the consolidated statement of cash flows for the six months ended June 30, 2005.
CONSOL Energy believes that cash generated from operations and its borrowing capacity will be sufficient to meet its working capital requirements, anticipated capital expenditures (other than major acquisitions), scheduled debt payments, anticipated dividend payments in 2005 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 one 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 $9.5 million (net of $6.0 million of deferred tax) at June 30, 2005. The ineffective portion of the changes in the fair value of these contracts was insignificant to earnings in the three months and six months ended June 30, 2005.
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.
Cash Flows (in millions)
Cash flows from operating activities
Cash provided by (used in) investing activities
Cash provided by (used in) financing activities
59
Cash flows from operating activities have decreased primarily 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;
60
The following is a summary of our significant contractual obligations at June 30, 2005 (in thousands):
Payments due by Year
Gas Firm Transportation Obligation
Purchase Order Firm Commitments
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 June 30, 2005 (in thousands) to be:
Within 1 Year
1-3 Years
3-5 Years
Total
$332,155
As discussed in “Critical Accounting Policies” and in the notes to our Consolidated Financial Statements in the annual report on Form 10-K for the year ended December 31, 2004, 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 2005 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 June 30, 2005, CONSOL Energy had total long-term debt of $430 million outstanding, including current portion of long-term debt of $4 million. This long-term debt consisted of:
An aggregate principal amount of $249 million of 7.875% notes due in 2012 ($250 million face amount of notes, net of $1 million unamortized debt discount). The notes were issued at 99.174% of the principal amount. Interest on the notes is payable March 1
61
and September 1 of each year. Payment of the principal and premium, if any, and interest on the notes are guaranteed by most of CONSOL Energy’s subsidiaries. The notes are senior secured obligations and rank equally with all other secured indebtedness of the guarantors;
At June 30, 2005, CONSOL Energy had no aggregate principal amounts of borrowings and approximately $336 million of letters of credit outstanding under the senior revolving credit facility.
Stockholders’ Equity and Dividends
CONSOL Energy had stockholders’ equity of $580 at June 30, 2005 and $469 million at December 31, 2004. Comprehensive losses have been recognized for recognition of minimum pension liabilities, various miscellaneous cash flow hedges and an interest rate lock agreement. These transactions were reflected as comprehensive losses and have decreased stockholders’ equity by approximately $93 million, net of tax. See Consolidated Statements of Stockholders’ Equity.
Dividend information for the current year to date is as follows:
Declaration Date
Record Date
Payment Date
July 29, 2005
April 25, 2005
January 28, 2005
Current outstanding indebtedness of CONSOL Energy does not restrict CONSOL Energy’s ability to pay cash dividends up to $0.56 per share per fiscal year, except that the credit facility would not permit dividend payments in the event of a default. The limitation on paying cash dividends up to $0.56 per share per fiscal year will not apply if the leverage ratio covenant is 1.00 to 1.00 or less. This ratio was 0.86 to 1.00 at June 30, 2005.
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.
62
Recent Accounting Pronouncements
In June 2005, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 154, Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3. This Statement provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. This Statement also provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The correction of an error in previously issued financial statements is not an accounting change. However, the reporting of an error correction involves adjustments to previously issued financial statements similar to those generally applicable to reporting an accounting change retrospectively. Therefore, the reporting of a correction of an error by restating previously issued financial statements is also addressed by this Statement. This statement shall be effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005. We do not expect this guidance to have a significant impact on CONSOL Energy.
On December 15, 2004, the FASB released its final revised standard entitled FASB Statement No. 123R, “Share-Based Payment” (SFAS No.123R). This Statement requires that all public entities
63
measure the cost of equity-based service awards based on the grant-date fair value. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award or the requisite service period, which usually is the vesting period. Compensation cost is not recognized for equity instruments for which employees do not render the requisite service. In addition, the SEC Staff issued Staff Accounting Bulletin (SAB) 107 on SFAS No. 123R in March 2005. The SAB was issued to assist preparers by simplifying some of the implementation challenges of SFAS No. 123R while enhancing information that investors receive. This SAB provides guidance related to, among other relevant items, share-based payment transactions with non-employees, valuation methods, the classification of compensation expense, non-GAAP financial measures, first-time adoptions of SFAS No.123R in an interim period, capitalization of compensation cost related to share-based payment arrangements, the accounting for income tax effects, the modification of employee share options prior to adoption of SFAS No. 123R, and disclosures in Management’s Discussion and Analysis subsequent to adoption of SFAS No. 123R. SFAS No.123R is to be effective for public companies as of the beginning of the first annual reporting period that begins after June 15, 2005. CONSOL Energy is currently evaluating the impact of unvested stock options outstanding and plans to adopt the provisions of this statement January 1, 2006.
64
Forward-Looking Statements
We are including the following cautionary statement in this Report on Form 10-Q to make applicable and 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. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “anticipate,” “believe,” “guidance,” “forecast,” “estimate,” “intend,” “predict,” and “continue” or similar words. 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 February 28, 2005, and other periodic reports filed with the Securities and Exchange Commission. These risks, uncertainties and contingencies include, but are not limited to, the following:
65
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.
66
CONSOL Energy has established risk management policies and procedures to strengthen the internal control environment of the marketing of commodities produced from its asset base. All of the derivative instruments are held for purposes other than trading. They are used primarily to mitigate uncertainty and volatility and cover underlying exposures. CONSOL Energy’s market risk strategy incorporates fundamental risk management tools to assess market price risk and establish a framework in which management can maintain a portfolio of transactions within pre-defined risk parameters.
CONSOL Energy believes that the use of derivative instruments along with the risk assessment procedures and internal controls does not expose CONSOL Energy to material risk. The use of derivative instruments could materially affect CONSOL Energy’s results of operations depending on interest rates, exchange rates or market prices. However, we believe that use of these instruments will not have a material adverse effect on our financial position or liquidity.
For a summary of accounting policies related to derivative instruments, see Note 1 of the Notes to the Consolidated Financial Statements in our Annual Report Form 10-K for the year ended December 31, 2004.
Sensitivity analyses of the incremental effects on pre-tax income for the six months ended June 30, 2005 of a hypothetical 10 percent and 25 percent change in natural gas prices for open derivative instruments as of June 30, 2005 are provided in the following table:
Incremental Decrease in Pre-tax Income Assuming a Hypothetical Price, Exchange Rate or Interest Rate Change of:
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 2005 and 2006 anticipated sales of natural gas to fixed prices. The fair value of these contracts was a loss of $9.5 million (net of $6.0 million of deferred tax) at June 30, 2005. The ineffective portion of the changes in the fair value of these contracts was insignificant to earnings in the three months and six months ended June 30, 2005. 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 June 30, 2005, CONSOL Energy had $430 million aggregate principal amount of debt outstanding under fixed-rate instruments and no aggregate principal amount of
67
debt outstanding under variable-rate instruments. CONSOL Energy’s primary exposure to market risk for changes in interest rates relates to its senior revolving credit facility. CONSOL Energy’s senior revolving credit facility bore interest at a weighted average rate of 6.4% during the six months ended June 30, 2005. Due to the level of borrowings against this facility in the six months ended June 30, 2005, a 100 basis-point increase in the average rate for CONSOL Energy’s senior 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.
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.
68
PART II
OTHER INFORMATION
On May 3, 2005 CONSOL Energy held its annual shareholder meeting for the purpose of (1) electing directors, (2) ratifying the retention of PricewaterhouseCoopers LLP as CONSOL Energy’s independent accountants for the year ending December 31, 2005 and (3) approving an amendment and restatement of the CONSOL Energy 1999 Equity Incentive Plan.
Nominee
John Whitmire
J. Brett Harvey
James E. Altmeyer
Phillip W. Baxter
William E. Davis
Raj K. Gupta
Patricia A. Hammick
William P. Powell
Joseph T. Williams
There were no abstentions and broker non-votes with respect to the election of directors.
69
70
71
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
CONSOL ENERGY INC.
Date: August 3, 2005
72
EXHIBIT INDEX