CNX Resources Corp quarterly report, Q2 FY2010

Business context and reporting period

The supplied filing is CONSOL Energy Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2010—not a filing identified as CNX Resources Corp. It reports coal, natural gas and other operations. Results include the Dominion exploration and production business from May 1, 2010; CNX Gas became wholly owned on June 1, 2010.

Financial performance and liquidity

Amounts below are in millions of dollars unless stated otherwise.

Metric	Q2 2010	Q2 2009	Six months 2010	Six months 2009
Revenue and other income	$1,289.3	$1,070.6	$2,529.4	$2,289.3
Earnings before income taxes	$96.1	$173.3	$238.3	$458.0
Net income attributable to CONSOL shareholders	$66.7	$113.3	$166.9	$309.2
Diluted EPS	$0.29	$0.62	$0.81	$1.69
Net cash from operating activities	Not presented quarterly	$505.8	$566.2

Revenue and other income rose 20.4% in Q2 and 10.5% year to date, but pretax earnings fell 44.5% and 48.0%, respectively. Net income attributable to shareholders declined 41.2% in Q2 and 46.0% year to date. Approximate pretax margin was 7.5% in Q2 2010 versus 16.2% in Q2 2009; the filing’s revenue measure includes other income.
Q2 results included $17.5 million in acquisition and financing fees; six-month fees were $64.1 million. Interest expense increased to $65.0 million in Q2 from $6.9 million, and to $73.2 million for six months from $15.5 million, largely reflecting acquisition-related bond issuance.
Six-month investing cash outflow was $5,036.7 million, including $3,475.7 million for Dominion, $991.0 million to acquire CNX Gas’s noncontrolling interest, and $577.6 million of capital expenditures. Financing provided $4,499.6 million, including $2,750.0 million from notes and $1,828.9 million from stock issuance. Cash declined $31.3 million to $34.3 million.
At June 30, current assets were $1,043.8 million and current liabilities $1,608.2 million, implying a current ratio of about 0.65 and negative working capital of about $564.3 million. Cash was $34.3 million; accounts receivable securitization borrowings were $200 million.
Long-term debt and capital leases totaled $3,168.9 million on the balance sheet, including $46.3 million current portion. The company also had $358.6 million in short-term notes and $200 million in securitization borrowings. The $1.5 billion CONSOL revolver had $292.2 million drawn and $268.0 million of letters of credit, leaving $939.8 million available; CNX Gas’s $700 million facility had $66.4 million drawn and $14.9 million of letters of credit, leaving $618.7 million available.
CONSOL’s leverage ratio was 4.23 to 1.00 against a 4.75 maximum covenant; interest coverage was 8.65 to 1.00 against a 2.00 minimum. Its senior secured leverage ratio was 1.01 to 1.00 against a 2.50 maximum. CNX Gas also reported covenant headroom.
Cash capital expenditures were $577.6 million for six months, versus $496.4 million in 2009. Dividends remained $0.10 per share quarterly; the filing states future dividends are discretionary.

Material changes versus prior period

The April 30 Dominion acquisition cost approximately $3.474 billion and added about 1 Tcfe of proved reserves and 1.46 million acres, including approximately 500,000 prospective net Marcellus acres. Preliminary acquisition accounting assigned $3,540.7 million to property, plant and equipment; valuations remained subject to review.
The March equity offering issued 44.3 million shares and raised approximately $1.829 billion net. The company issued $1.5 billion of 8.00% notes due 2017 and $1.25 billion of 8.25% notes due 2020. CNX Gas was acquired for approximately $991 million, including vested options.
Coal results were pressured by lower steam-coal prices and higher unit costs. In Q2, steam-coal tons sold rose 6.1%, but average selling price fell 7.8%; steam segment pretax earnings declined to $128 million from $220 million. Buchanan’s return to operations and stronger metallurgical demand supported metallurgical coal earnings.
Gas segment pretax earnings were $54 million in Q2, broadly level with $53 million a year earlier, but six-month earnings fell to $128 million from $142 million. The Dominion acquisition contributed production, while Marcellus output grew; the company reported 26 producing Marcellus wells at June 30, versus 15 a year earlier.
Other coal costs included a $52.9 million six-month Fola reclamation charge, including $27.9 million in Q2, and $25 million of 2010 litigation settlement expense related to Buchanan Mine water deposits. These items weighed on reported earnings.

Outlook, commentary, risks and contingencies

No specific company-wide earnings or production guidance is provided. Management expected metallurgical coal markets to retain strong longer-term pricing, while acknowledging near-term softness. Thermal coal prospects were described as improving. Management expected natural-gas prices to recover to the mid-$5 range by 2012, citing market strip pricing, and said Marcellus economics and proximity to Northeast markets supported profitability in the current price environment.
Management cited uncertain demand, gas oversupply and commodity-price volatility. Key operational and regulatory risks include mine safety requirements, permitting restrictions, potential climate and methane rules, hydraulic-fracturing regulation, mine-water treatment requirements, and reclamation obligations.
The Dunkard Creek matter may require a centralized mine-water treatment plant costing up to or more than $100 million, potentially plus civil penalties; investigations and consent decree negotiations were ongoing. The company said accelerated compliance or penalties could be material.
Fola reclamation liability was estimated at $65 million or more, with detailed plans and cost estimates still being developed. The filing says future costs could be material.
Other disclosed exposures include a Pennsylvania dam-damage claim seeking $58 million; approximately 22,500 asbestos claims against Fairmont Supply, for which it has no insurance; Ward Transformer Superfund remediation estimates of approximately $64 million plus $11 million for additional areas, with another area not yet costed; and CNX Gas shareholder litigation where damages, if awarded, could be material.
Management reported $1,499.8 million of guarantees, letters of credit and surety bonds, plus $691.7 million of unconditional purchase obligations. It believed guarantees would expire without funding, but the filing notes some contingencies could result in material future costs.
Natural-gas hedges had a fair-value asset of $103.6 million at June 30, 2010; $41.7 million of unrealized gain was expected to be reclassified into earnings over the next year. A hypothetical 10% and 25% gas-price change implied $30.5 million and $76.3 million incremental pretax-income sensitivity, respectively, with underlying hedged items expected to offset much of the exposure.
Management stated cash from operations and available borrowing capacity should cover working capital, planned capital spending, debt service and anticipated dividends, but emphasized dependence on future operating performance and market conditions. Disclosure controls were assessed as effective, with no material quarterly change in internal control over financial reporting.

Investor verification priorities

Confirm the issuer and security: this text is CONSOL Energy Inc.’s 2010 10-Q and does not establish that it is a CNX Resources filing.
Review Dominion’s final purchase-price allocation and subsequent contribution to production, cash flow and earnings; reported acquired-business net income included in results was only $0.6 million through June 30.
Assess normalized earnings and cash generation excluding acquisition/financing charges, Fola reclamation, litigation settlements and other unusual items.
Monitor debt service, covenant headroom, liquidity and the effect of the new 8.00% and 8.25% notes, including restrictions on dividends and other actions.
Track the cost and timing of Dunkard Creek treatment, Fola reclamation, Ward Transformer remediation, the Ryerson Park Dam matter and CNX Gas shareholder litigation.
Test management’s commodity-market assumptions and hedge economics against realized coal and gas prices, production, volumes, and the disclosed sensitivity analysis.