NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

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 and nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for future periods.

The balance sheet at December 31, 2010 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, 2010 included in CONSOL Energy Inc.'s Form 10-K.

Basic earnings per share are computed by dividing net income by the weighted average shares outstanding during the reporting period. Dilutive 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 and performance stock options and the assumed vesting of restricted and performance stock units, if dilutive. The number of additional shares is calculated by assuming that outstanding stock options and performance share options were exercised, that outstanding restricted and performance share units were released, and that the proceeds from such activities were used to acquire shares of common stock at the average market price during the reporting period. CONSOL Energy Inc. (CONSOL Energy or Company) includes the impact of pro forma deferred tax assets in determining potential windfalls and shortfalls for purposes of calculating assumed proceeds under the treasury stock method. The table below sets forth the share-based awards that have been excluded from the computation of the diluted earnings per share because their effect would be anti-dilutive:

 

The table below sets forth the share-based awards that have been exercised or released:

The weighted average exercise price per share of the options exercised during the three months ended September 30, 2011 and 2010 was $ 16.69 and $ 16.01 , respectively. The weighted average exercise price per share of the options exercised during the nine months ended September 30, 2011 and 2010 was $20.00 and $ 17.69 , respectively.

The computations for basic and dilutive earnings per share are as follows:

 

NOTE 2—ACQUISITIONS AND DISPOSITIONS:

    On September 30, 2011, CNX Gas Company (CNX Gas) completed a sale to Noble Energy, Inc. (Noble) of 50% of the Company's undivided interest in certain Marcellus Shale oil and gas properties in West Virginia and Pennsylvania covering approximately 628 thousand acres and 50% of the Company's undivided interest in certain of its existing Marcellus Shale wells and related leases. On September 30, 2011, cash proceeds of $ 519,188 were received from Noble. In addition to the cash proceeds, a one year note receivable due on September 30, 2012 in the amount of $ 311,754 and a two year note receivable due on September 30, 2013 in the amount of $ 296,343 have been recorded. These short and long-term notes receivable are included in the Consolidated Balance Sheets as Accounts and Notes Receivables—Other Receivables and Other Assets—Other, respectively. A loss of $ 64,429 on the transaction was recorded and is included in Other Income on the Consolidated Statements of Income. As part of the transaction, CONSOL Energy also received a commitment from Noble Energy to pay one-third of the Company's working interest share of certain drilling and completion costs, up to approximately $ 2,100,000 with certain restrictions.

The following unaudited pro forma combined financial statements are based on CONSOL Energy's historical consolidated financial statements and adjusted to give effect to the September 30, 2011 sale of a 50% interest in certain Marcellus Shale assets. The unaudited pro forma results for the periods presented below are prepared as if the transaction occurred as of January 1, 2010.

The pro forma results are not necessarily indicative of what actually would have occurred if the transaction had been completed as of January 1, 2010, nor are they necessarily indicative of future consolidated results.

On September 30 2011, CNX Gas and Noble formed CONE Gathering LLC (CONE), a joint venture established to develop and operate each company's gas gathering system needs in the Marcellus Shale play. CNX Gas' 50% ownership interest in CONE is accounted for under the equity method of accounting. CNX Gas contributed its existing Marcellus Shale gathering infrastructure which had a net book value of $ 133,181 and Noble contributed cash of approximately $ 73,492 . On September 30, 2011, CONE made a cash distribution to CNX Gas in the amount of $ 73,492 . The cash proceeds have been recorded as cash inflows of $ 66,590 and $ 6,902 in Distributions from Equity Affiliates and Proceeds from the Sale of Assets, respectively, on the Consolidated Statement of Cash Flows. Additionally, a gain of $ 6,388 has been included in Other Income in the Consolidated Statements of Income.

On September 21, 2011 CONSOL Energy entered into an agreement with Antero Resources Appalachian Corp. (Antero), pursuant to which CONSOL Energy assigned to Antero overriding royalty interests (ORRI) of approximately 7% in 115,647 net acres of Marcellus Shale located in nine counties in southwestern Pennsylvania and north central West Virginia, in exchange for $ 193,000 . The net gain of $41,208 is included in Other Income in the Consolidated Statements of Income.

In September 2010, CONSOL Energy completed a sale-leaseback of longwall shields for Enlow Fork. Cash proceeds from the sale were $14,551 , which was the same as our basis in the equipment. Accordingly, no gain or loss was recognized on the transaction. The lease has been accounted for as an operating lease. The lease term is five years.

In June 2010, CONSOL Energy paid Yukon Pocahontas Coal Company $30,000 cash to acquire certain coal reserves and $20,000 cash in advanced royalty payments recoupable against future production. Both payments were made per a settlement agreement in regards to the depositing of untreated water from the Buchanan Mine, a mine operated by one of our subsidiaries, into the void spaces of the nearby mines of one of our other subsidiaries, Island Creek Coal Company.

On June 1, 2010, CONSOL Energy completed the acquisition of CNX Gas Corporation (CNX Gas) outstanding common stock for a cash payment of $966,811 pursuant to a tender offer followed by a short-form merger in which CNX Gas became a wholly owned subsidiary of CONSOL Energy (CNX Gas Acquisition). All of the shares of CNX Gas that were not already owned by CONSOL Energy were acquired at a price of $38.25 per share. CONSOL Energy previously owned approximately 83.3% of the approximately 151  million shares of CNX Gas common stock outstanding. An additional $24,223 cash payment was made to cancel previously vested but unexercised CNX Gas stock options. CONSOL Energy financed the acquisition of CNX Gas shares by means of internally generated funds, borrowings under its credit facilities and proceeds from its offering of common stock.

On April 30, 2010 , CONSOL Energy completed the acquisition of the Appalachian oil and gas exploration and production business of Dominion Resources, Inc. (Dominion Acquisition) for a cash payment as of September 30, 2010 of $3,474,199 which was principally allocated to oil & gas properties, wells and well-related equipment. The acquisition, which was accounted for under the acquisition method of accounting, includes approximately 1 trillion cubic feet equivalents (Tcfe) of net proved reserves and 1.46 million net acres of oil and gas rights within the Appalachian Basin. Included in the acreage holdings are approximately 500   thousand prospective net Marcellus Shale acres located predominantly in southwestern Pennsylvania and northern West Virginia. Dominion is a producer and transporter of natural gas as well as a provider of electricity and related services. The acquisition enhanced CONSOL Energy’s position in the strategic Marcellus Shale fairway by increasing its development assets.

    

The unaudited pro forma results for the three and nine months ended September 30, 2010 , assuming the acquisition had occurred at January 1, 2010, are presented below. Pro forma adjustments include estimated operating results, transaction and financing fees incurred, additional interest related to the $ 2.75 billion of senior unsecured notes and 44,275,000 shares of common stock issued in connection with the transaction.

 

The pro forma results are not necessarily indicative of what actually would have occurred if the Dominion Acquisition had been completed as of January 1, 2010, nor are they necessarily indicative of future consolidated results.

CONSOL Energy incurred $337 and $64,415 of acquisition-related costs as a direct result of the Dominion Acquisition and CNX Gas Acquisition for the three and nine months ended September 30, 2010 , respectively. These expenses have been included within Transaction and Financing Fees on the Consolidated Statements of Income for the period ended September 30, 2010 .

In March 2010, CONSOL Energy completed the sale of the Jones Fork Mining Complex as part of a litigation settlement with Kentucky Fuel Corporation. No cash proceeds were received and $10,482 of litigation settlement expense was recorded in Cost of Goods Sold and Other Operating Charges. The loss recorded was net of $8,700 related to the fair value of estimated amounts to be collected related to an overriding royalty on future mineable and merchantable coal extracted and sold from the property.

For the nine months ended September 30, 2011 , $ 57,713 in contributions were paid to the pension trust for pension benefits from operating cash flows. CONSOL Energy expects to contribute to the pension trust using prudent funding methods. Currently, depending on asset values and asset returns held in the trust, we expect to contribute $ 71,700 to the pension trust in 2011 .

CONSOL Energy does not expect to contribute to the other postemployment benefit plan in 2011 . We intend to pay benefit claims as they become due. For the nine months ended September 30, 2011 , $123,185 of other postemployment benefits have been paid.

For the nine months ended September 30, 2011 , $ 7,781 of proceeds were received under the Patient Protection and Affordable Care Act related to reimbursements from the Federal government for retiree health spending. The proceeds were recorded in Accumulated Other Comprehensive Income in the Consolidated Balance Sheets. There is no guarantee that additional proceeds will be received under this program.