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 months ended March 31, 2013 are not necessarily indicative of the results that may be expected for future periods.

The balance sheet at December 31, 2012 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, 2012 included in CONSOL Energy Inc.'s Form 10-K.

Certain amounts in prior periods have been reclassified to conform with the report classifications of the year ended December 31, 2012, with no effect on previously reported net income or stockholders' equity.

Basic earnings per share are computed by dividing net (loss) income attributable to shareholders 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 share 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 stock units 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 the 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 March 31, 2013 and 2012 was $ 10.65 and $ 13.81 , respectively.

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

 

Changes in Accumulated Other Comprehensive Income / (Loss) by component, net of tax, were as follows:

The following table shows the reclassification of adjustments out of Accumulated Other Comprehensive Loss:

 

*Excludes amounts related to the remeasurement of the Actuarially Determined Long-Term Liabilities for the three months ended March 31, 2013 and March 31, 2012.

NOTE 2—ACQUISITIONS AND DISPOSITIONS:

    

During the three months ended March 31, 2013, CNX Gas Company LLC (CNX Gas Company), a wholly owned subsidiary of CONSOL Energy, completed negotiations with the Allegheny County Airport Authority, which operates the Pittsburgh International Airport and the Allegheny County Airport, for the lease of the oil and gas rights on approximately 9.3 thousand acres.  A majority of these contiguous acres are in the liquids area of the Marcellus Shale play.  CNX Gas Company paid $46,315 as an up-front bonus payment at closing.  Approximately 7.6% of the bonus payment was placed into escrow while negotiations continue for a portion of the acres associated with the Allegheny County Airport and other acres that have potentially defective title.  CNX Gas Company must spud a well by February 21, 2015 and proceed with due diligence to complete the well or the lease terminates and CNX Gas Company foregoes the bonus. Our joint venture partner, Noble Energy, has indicated that it intends to acquire 50% of the acreage and accordingly, incur 50% of the associated costs.

In March 2013, CONSOL Energy completed a sale-leaseback of longwall shields for the Shoemaker Mine. Cash proceeds for the sale were $63,839 . A loss of $279 was recognized due to transaction fees and is included in Other Income in the Consolidated Statement of Income. The lease has been accounted for as an operating lease. The lease term is five years.

In January 2013, CONSOL Energy completed a sale-leaseback of longwall shields for the Bailey Mine. Cash proceeds for the sale were $71,166 . A loss of $358 was recognized due to transaction fees and is included in Other Income in the Consolidated Statement of Income. The lease has been accounted for as an operating lease. The lease term is five years.

On December 21, 2012, CONSOL Energy completed the disposition of its non-producing Ram River & Scurry Ram assets in Western Canada which consisted of 36 thousand acres of coal lands. In December 2012, cash proceeds of $51,869 , of which $48,294 was restricted, were received related to this transaction. These proceeds were net of $637 in transaction fees. The restrictions on the cash were removed during the three months ended March 31, 2013 and are reflected as a Change in Restricted Cash in the Investing section of the Consolidated Statement of Cash Flows. Additionally, a note receivable was recognized in 2012 related to the two additional cash payments to be received in June 2013 and June 2014. Notes receivables of $25,500 and $24,500 were recorded in Accounts and Notes Receivables and Other Assets in the Consolidated Balance Sheet, respectively. The gain on the transaction was $89,943 and was included in Other Income in the Consolidated Statement of Income for the year ended December 31, 2012.

On February 9, 2012, CONSOL Energy completed the disposition of its Burning Star No. 4 property in Illinois, which consisted of 4.3 thousand acres of coal lands and surface rights, for proceeds of $ 13,023 . The gain on the transaction was $ 11,261 and is included in Other Income in the Consolidated Statements of Income for the three month period ended March 31, 2012.

For the three months ended March 31, 2013 , $ 18,560 was 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 $50,000 to the pension trust in 2013 . Net periodic benefit costs are allocated to Costs of Goods Sold and Other Operating Charges and Selling, General and Administrative Expenses in the results of operations.

According to the Defined Benefit Plans Topic of the FASB Accounting Standards Codification, if the lump sum distributions made for the plan year, which for CONSOL Energy is January 1 to December 31, exceed the total of the projected service cost and interest cost for the plan year, settlement accounting is required. Lump sum payments exceeded this threshold during the first quarter of 2013. Accordingly, CONSOL Energy recognized expense of $ 27,115 for the quarter ended March 31, 2013 in Costs of Goods Sold and Other Operating Charges in the results of operations. The settlement charge represented a pro rata portion of the net unrecognized loss based on the percentage reduction in the projected benefit obligation due to the lump sum payments. The settlement charge noted above also resulted in a remeasurement of the pension plan at March 31, 2013. The remeasurement resulted in a change to the discount rate to 4.12% at March 31, 2013 from 4.00% at December 31, 2012. The remeasurement reduced the pension liability by $29,916 . The settlement and the corresponding remeasurement of the pension plan resulted in an adjustment of $35,261 in other comprehensive income, net of $21,770 in deferred taxes. Currently, the settlement and remeasurement of the pension plan will result in a $6,760 reduction to pension expense compared to what was originally expected to be recognized for the remaining nine months of 2013. It is reasonably possible that CONSOL Energy will incur additional settlement charges in 2013, which would require the pension plan to be remeasured using updated assumptions.

CONSOL Energy does not expect to contribute to the other postemployment benefit plan in 2013 . We intend to pay benefit claims as they become due. For the three months ended March 31, 2013 , $41,922 of other postemployment benefits have been paid.

CONSOL Energy does not expect to contribute to the CWP plan in 2013. We intend to pay benefit claims as they become due. For the three months ended March 31, 2013 , $ 2,698 of CWP benefit claims have been paid.

CONSOL Energy does not expect to contribute to the workers’ compensation plan in 2013. We intend to pay benefit claims as they become due. For the three months ended March 31, 2013 , $ 8,640 of workers’ compensation benefits, state administrative fees and surety bond premiums have been paid.

NOTE 5—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:

 

The effective rates for the three months ended March 31, 2013 and 2012 were calculated using the annual effective rate projection on recurring earnings and include tax liabilities related to certain discrete transactions which are described below. The effective tax rate is sensitive to changes in annual profitability and percentage depletion.

During the three months ended March 31, 2012, CONSOL Energy reached an agreement with the Internal Revenue Service Appeals Division on its Extraterritorial Income Exclusion refund claim for tax years 2004-2005. As a result of the agreement, the Company reflected $ 983 as a discrete reduction to income tax expense. The discrete transaction was reflected in the Other line of the rate reconciliation.

The total amounts of uncertain tax positions at March 31, 2013 and 2012 were $ 22,770 and $ 25,570 , respectively. If these uncertain tax positions were recognized, approximately $ 2,071 and $ 3,891 , respectively, would affect CONSOL Energy’s effective tax rate. There were no additions to the liability for unrecognized tax benefits during the three months ended March 31, 2013 and 2012.

CONSOL Energy recognizes interest accrued related to uncertain tax positions in its interest expense. As of March 31, 2013 and 2012 , the Company reported an accrued interest liability relating to uncertain tax positions of $ 5,165 and $ 5,741 , respectively. The accrued interest liability includes interest expense that is reflected in the Company’s Consolidated Statements of Income for the three months ended March 31, 2013 and 2012 of $ 335 and $ 368 , respectively.

CONSOL Energy recognizes penalties related to uncertain tax positions in its income tax expense. As of March 31, 2013 and 2012 , CONSOL Energy had no accrued liability for tax penalties.

CONSOL Energy and its subsidiaries file federal income tax returns with the United States and returns within various states and Canadian jurisdictions. With few exceptions, the Company is no longer subject to United States federal, state, local, or non-U.S. income tax determinations by tax authorities for the years before 2008.

         

Inventories are stated at the lower of cost or market. The cost of coal inventories is determined by the first-in, first-out (FIFO) method. Coal inventory costs include labor, supplies, equipment costs, operating overhead, depreciation, depletion and amortization, and other related costs.

Merchandise for resale is valued using the last-in, first-out (LIFO) cost method. The excess of replacement cost of merchandise for resale inventories over carrying LIFO value was $ 19,726 and $ 19,700 at March 31, 2013 and December 31, 2012 , respectively.

NOTE 7—ACCOUNTS RECEIVABLE SECURITIZATION:

CONSOL Energy and certain of our U.S. subsidiaries are party to a trade accounts receivable facility with financial institutions for the sale on a continuous basis of eligible trade accounts receivable. The facility allows CONSOL Energy to receive on a revolving basis up to $200,000 . The facility also allows for the issuance of letters of credit against the $200,000 capacity. At March 31, 2013 , there were letters of credit outstanding against the facility of $159,281 . CONSOL Energy management believes that these guarantees will expire without being funded, and therefore the commitments will not have a material adverse effect on the Company's financial condition. No amounts related to these financial guarantees and letters of credit are recorded as liabilities on the financial statements.

CNX Funding Corporation, a wholly owned, special purpose, bankruptcy-remote subsidiary, buys and sells eligible trade receivables generated by certain subsidiaries of CONSOL Energy. Under the receivables facility, CONSOL Energy and certain subsidiaries, irrevocably and without recourse, sell all of their eligible trade accounts receivable to CNX Funding Corporation, who in turn sells these receivables to financial institutions and their affiliates, while maintaining a subordinated interest in a portion of the pool of trade receivables. This retained interest, which is included in Accounts and Notes Receivable Trade in the Consolidated Balance Sheets, is recorded at fair value. Due to a short average collection cycle for such receivables, our collection experience history and the composition of the designated pool of trade accounts receivable that are part of this program, the fair value of our retained interest approximates the total amount of the designated pool of accounts receivable. CONSOL Energy will continue to service the sold trade receivables for the financial institutions for a fee based upon market rates for similar services.

In accordance with the Transfers and Servicing Topics of the Financial Accounting Standards Board (FASB) Accounting Standards Codification, CONSOL Energy records transactions under the securitization facility as secured borrowings on the Consolidated Balance Sheets. The pledge of collateral is reported as Accounts Receivable - Securitized and the borrowings are classified as debt in Borrowings under Securitization Facility.

The cost of funds under this facility is based upon commercial paper rates, plus a charge for administrative services paid to the financial institutions. Costs associated with the receivables facility totaled $ 472 and $419 for the three months ended March 31, 2013 and 2012, 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 March 2017 with the underlying liquidity agreement renewing annually each March.

At March 31, 2013 and December 31, 2012 , eligible accounts receivable totaled $199,800 and $200,000 , respectively. There was subordinated retained interest of $10,400 at March 31, 2013 . There was no subordinated retained interest at December 31, 2012 . There were $30,119 borrowings under the Securitization Facility recorded on the Consolidated Balance Sheet as of March 31, 2013 and $37,846 at December 31, 2012. The accounts receivable securitization program decreased by $7,727 in the three months ended March 31, 2013 and there was no change in the three months ended March 31, 2012. The decrease is reflected in the Net Cash Used in Financing Activities in the Consolidated Statement of Cash Flows. In accordance with the facility agreement, the Company is able to receive proceeds based upon the eligible accounts receivable at the previous month end.

Industry Participation Agreements

CONSOL Energy has two significant industry participation agreements (referred to as "joint ventures" or "JVs") that provided drilling and completion carries for our retained interests.

On October 21, 2011, CNX Gas Company, a wholly owned subsidiary of CONSOL Energy, completed a sale to Hess Ohio Developments, LLC (Hess) of 50% of nearly 200 thousand net Utica Shale acres in Ohio. As part of the transaction, CONSOL Energy and Hess entered into a joint development agreement pursuant to which Hess agreed to pay approximately $534,000 in the form of a 50% drilling carry of certain CONSOL Energy working interest obligations as the acreage is developed. Under the asset acquisition agreement, Hess had the right to perform due diligence on the title to the oil and gas interests which we conveyed to them and Hess's aggregate carried cost obligation under the joint venture agreements would be reduced by the value the parties allocated in the transaction to the acreage which subsequently proved to be defective. Based on title work performed by Hess as part of the title defect process, we believe that there are chain of title issues with respect to approximately 38 thousand of the joint venture acres (with a carry value of approximately $153,000 ), most of which likely cannot be cured. We are currently in discussions with Hess regarding an agreement to finally resolve the title defect process. If we are unable to reach an agreement, the title defects that Hess formally asserts will be resolved in arbitration in accordance with the asset acquisition agreement.

  

On September 30, 2011, CNX Gas Company 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 net acres and 50% of the Company's undivided interest in certain of its existing Marcellus Shale wells and related leases. As part of the transaction, CNX Gas Company also received a commitment from Noble 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. These restrictions include the suspension of carry if average Henry Hub natural gas prices are below $4.00 per million British thermal units (MMBtu) for three consecutive months. The carry is currently suspended and will remain suspended until average natural gas prices are above $ 4.00 /MMBtu for three consecutive months. Restrictions also include a $400,000 annual maximum on Noble's carried cost obligation. The aggregate amount of the drilling carry may also be adjusted downward under provisions of the joint venture agreements in certain events.

Under our joint venture agreement with Noble, Noble had the right to perform due diligence on the title to the oil and gas interests which we conveyed to them and to assert that title to the acreage is defective. CONSOL Energy can then review and respond to the asserted title defects, or cure them, and ultimately, if the claim is not resolved, either party can submit the defect to an arbitrator for resolution. If Noble establishes any title defects which are either not resolved in favor of CONSOL Energy or cured by us, then subject to certain deductibles, Noble's aggregate carried cost obligation under the joint venture agreement will be reduced by the value the parties previously allocated to the affected acreage in the transaction. If a significant

percentage of the oil and gas interests we contributed have title defects which cannot be resolved or cured, the carried costs could be materially reduced and our aggregate share of the drilling and completion costs for wells in this joint venture could materially increase. Pursuant to the joint venture agreement, Noble Energy has submitted a final title defect notice to CONSOL Energy. Based on our review of this title defect notice, Noble has asserted title defects with respect to approximately 93 thousand gross deal acres, having a carry value of approximately $610,000 , which we have not yet addressed. We are working closely with Noble to address these alleged defects and we believe that we will resolve or cure most of these defects favorably to CONSOL Energy. To date, we have conceded defects which have an aggregate value of approximately $37,000 in excess of the applicable deductible, and will attempt to cure as many of those defects as possible. The impact of these conceded defects on the Company's financial statements was $6,310 for the three months ended March 31, 2013.

The following table provides information about our industry participation agreements as of March 31, 2013: