**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C.**





**FORM
      10-K**





**ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d)**


**OF
      THE SECURITIES EXCHANGE ACT OF 1934**




For
                  the fiscal year ended
              Commission
                  File Number**December
                    31, 2006**
              **000-51129**


***JAMES
      RIVER COAL COMPANY***


*(Exact
      name of registrant as specified in its charter)*




***Virginia***
            
            ***54-1602012***(State
                or other jurisdiction
            
            (I.R.S.
                Employerof
                incorporation or organization)
            
            Identification
                No.)***901
                E. Byrd Street, Suite 1600******Richmond,
                Virginia***
            
            ***23219***(Address
                of principal executive offices)
            
            (Zip
                Code)





Registrant’s
      telephone number, including area code **: 
      (804) 780-3000**




Securities
                  registered pursuant
                  to Section 12(b) of the Act:
              Common
                  Stock, par value $0.01 per shareSeries
                  A Participating Cumulative PreferredStock
                  Purchase RightsName
                  of each exchangeon
                  which registered:
              The
                  Nasdaq Global Select MarketSecurities
                  registered pursuant
                  to Section 12(g) of the Act:
              None




Indicate
      by a check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.


Yes   
      o No ý





Indicate
      by a check mark if the registrant is not required to file reports pursuant
      to
      Section 13 or Section 15(d) of the Exchange Act.


Yes o No ý





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 ý No o





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the
      best of Registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any
      amendment to this Form 10-K.


o





Indicate
      by a check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.


Large
      accelerated filer o   Accelerated
      filer ý  Non-accelerated
      filer o





Indicate
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Exchange Act).


Yes o No ý




The
      aggregate market value of the common stock held by non-affiliates of the
      registrant, based upon the closing sale price of Common Stock, par value $0.01
      per share, on June 30, 2006 as reported on the Nasdaq National Market, was
      approximately $204,593,767 (affiliates being, for these purposes only,
      directors, executive officers and holders of more than 5% of the registrant’s
      Common Stock).





Indicate
      by check mark whether the registrant has filed all documents and reports
      required to be filed by Section 12, 13 or 15(d) of the Securities Exchange
      Act
      of 1934 subsequent to the distribution of securities under a plan confirmed
      by a
      court.


Yes ý No    o





The
      number of shares of the registrant’s Common Stock, par value $.01 per share,
      outstanding as of February 28, 2007 was 16,673,067.





**DOCUMENTS
      INCORPORATED BY REFERENCE**





Portions
      of the Proxy Statement for the registrant’s 2007 Annual Meeting of Shareholders,
      to be filed with the Securities and Exchange Commission (the “SEC”), are
      incorporated by reference into Part III of this Annual Report on Form
      10-K .









**JAMES
      RIVER COAL COMPANY**





**TABLE
      OF CONTENTS**


**FORM
      10-K ANNUAL REPORT**




**PART
                  I****Item
                  1.**
              **Business**
              **2****Item
                  1A.**
              **Risk
                  Factors**
              **16****Item
                  1B.**
              **Unresolved
                  Staff Comments**
              **29****Item
                  2.**
              **Properties**
              **29****Item
                  3.**
              **Legal
                  Proceedings**
              **30****Item
                  4.**
              **Submission
                  of Matters to a Vote of Security
                  Holders**
              **30****PART
                  II****Item
                  5.**
              **Market
                      for Registrant’s Common Equity, Related Stockholders Matters****and
                      Issuer Purchases of Equity
                      Securities**
              **31****Item
                  6.**
              **Selected
                  Financial Data**
              **32****Item
                  7.**
              **Management’s
                  Discussion and Analysis of Financial Condition and Results of****Operation**
              **37****Item
                  7A.**
              **Quantitative
                  and Qualitative Disclosures about Market
                  Risk**
              **53****Item
                  8.**
              **Financial
                  Statements and Supplementary
                  Data**
              **53****Item
                  9.**
              **Changes
                  in and Disagreements with Accountants on Accounting
                  and Financial Disclosure**
              **53****Item
                  9A.**
              **Controls
                  and Procedures**
              **53****Item
                  9B.**
              **Other
                  Information**
              **56****PART
                  III****Item
                  10.**
              **Directors,
                  Executive Officers and Corporate Governance of the
                  Registrant**
              **57****Item
                  11.**
              **Executive
                  Compensation**
              **57****Item
                  12.**
              **Security
                    Ownership of Certain Beneficial Owners and Management and Related
                    Stock****Matters**
              **57****Item
                  13.**
              **Certain
                  Relationships and Related Transactions, and Director
                  Independence**
              **57****Item
                  14.**
              **Principal
                  Accountant Fees and
                  Services**
              **57****PART
                  IV****Item
                  15.**
              **Exhibits,
                  and Financial Statement
                  Schedules**
              **58**









**PART
      I**




**Available
      Information**




The
      Company’s website address is *http://* *www.jamesrivercoal.com* . ** The
      Company makes available free of charge through its website its annual report
      on
      Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
      any
      amendments to those reports as soon as reasonably practicable after filing
      or
      furnishing the material to the SEC. You
      may
      read and copy documents the Company files at the SEC’s public reference room at
      450 Fifth Street, N.W., Washington, D.C. 20549. Please
      call the SEC at 1-800-SEC-0330 for information on the public reference room. The
      SEC
      maintains a website that contains annual, quarterly and current reports, proxy
      statements and other information that issuers (including the Company) file
      electronically with the SEC. The
      SEC’s
      website is *http://www.sec.gov* *.*





1


**Item** **1.****Business**





**General
      Business**




**Overview**





We
      mine,
      process and sell bituminous, steam- and industrial-grade coal through six
      operating subsidiaries (“mining complexes”) located throughout eastern Kentucky
      and in southern Indiana. As
      of
      December 31, 2006, o ur
      six
      mining complexes include 15 underground mines, 11 surface mines and ten
      preparation plants, five of
      which have
      integrated rail loadout facilities and
      three of which use
      a
      common loadout facility at a separate location . As of
      December 31, 2006, we believe that we controlled approximately 273 million
      tons
      of proven and probable coal reserves. At
      current production levels, we believe these reserves would support greater
      than
      22 years of production.





In
      2006, we
      produced 12.3
      million tons of coal (including 616,000 tons of coal produced in our mines that are operated by
      contract mine operators) and we purchased another 786,000 tons for resale. Of the 11.7 million tons we produced
      from Company-operated mines, approximately 69% came from underground mines,
      while the remaining 31% came from surface mines. In 2006,
      we generated revenues of $564.8 million and had a net loss of $26.2 million.
      Approximately 88% of our 2006 revenues were generated from coal sales to
      electric utility companies and 12% came from coal sales to industrial and other
      companies or from synfuel handling fees .
      In
      2006, Georgia Power and South Carolina Public Service Authority were our largest
      customers, representing approximately 25% and 16% of our revenues, respectively.
      No other customer accounted for more than 10% of our revenues.




The
      coal
      that we sell is obtained from three sources: our Company-operated mines, mines
      that are operated by independent contract mine operators, and other third
      parties from whom we purchase coal for resale. Contract mining and coal
      purchased from other third parties provide flexibility to increase or decrease
      production based on market conditions. The table below reflects the amount
      and
      percentage of coal obtained from those sources in 2006:




**Tons
                (000)**
            
            **Percentage
                of total coal obtained by the Company**Coal
                produced from Company-operated mines
            
            
            11,652
            
            
            89.3
            %Coal
                obtained from mines operated by independent contractors
            
            
            616
            
            
            4.7
            %Coal
                purchased from other third parties
            
            
            786
            
            
            6.0
            %**13,054**
            
            
            **100**
            **%**




We
      also
      supply coal to a third party synfuel plant and receive fees for the handling,
      shipping and marketing of the synfuel product. Synfuel is a synthetic fuel
      product that is produced by chemically altering coal. In 2006, 1% of our total
      operating revenues came from synfuel handling, shipping and
      marketing.




**Mining
      Methods**




Our
      Company-operated and contractor mines produce coal using different mining
      methods. These methods are room
      and
      pillar underground mining and surface
      mining . These
      methods are described in more detail below.




*Room
      and Pillar* .
      In the
      underground room and pillar method of mining, continuous mining machines cut
      five to nine entries into the coal seam and connect them by driving crosscuts,
      leaving a series of rectangular pillars, or columns of coal, to help support
      the
      mine roof and control the flow of air. Generally, openings are driven 20 feet
      wide and the pillars are 40 to 100 feet wide. As mining advances, a grid-like
      pattern of entries and pillars is formed. When mining advances to the end of
      a
      panel, or section of the mine, retreat mining may begin. In retreat mining,
      as
      much coal as is feasible is mined from the pillars that were created in
      advancing the panel, allowing the roof to cave. When retreat mining is completed
      to the mouth of the panel, the mined panel is abandoned.




2


The
      coal
      face is cut with continuous mining machines and the coal is transported from
      the
      continuous mining machine to the mine conveyor belts using either a continuous
      haulage system, shuttle cars or ram cars. The mine conveyor system consists
      of a
      series of conveyor belts, which transport the coal from the active face areas
      to
      the surface. Once on the surface, the coal is transported to the preparation
      plants where it is processed to remove any impurities. The coal is then
      transported to the clean coal stockpiles or silos from which it is loaded for
      shipment to our customers. Reserve recovery, a measure of the percentage of
      the
      total coal in place that is ultimately produced, using this method of mining
      typically ranges from less than 50% to more than 70%, depending on the shape
      of
      the reserve, the amount of low-cover areas, and the geological characteristics
      of the reserve body.




*Surface
      Mining* .
      Surface
      mining is used when coal is found close to the surface. This
      method involves the removal of overburden (earth and rock covering the coal)
      with heavy earth-moving equipment and explosives, loading out the coal,
      replacing the overburden and topsoil after the coal has been excavated and
      reestablishing vegetation and plant life and making other improvements that
      have
      local community and environmental benefit. Overburden is typically removed
      at
      our mines by either hydraulic shovels or front-end loaders which place the
      overburden into large trucks.





In
      the
      CAPP region, we use the c ontour
      and highwall surface mining methods. Contour and highwall mining is used where
      removal of all the overburden overlying a coal seam is either uneconomical
      or
      impossible due to property control or other issues. With contour mining, a
      contour cut is taken along the outcrop of the seam and the coal is removed
      from
      the exposed pit. Highwall mining can then take place where the seam is exposed
      in the highwall. A highwall miner resembles an underground continuous miner.
      The
      highwall miner cuts entries into the coal seam 10’ wide and 900’ deep. The coal
      is transported to the surface through the augers and loaded into trucks using
      a
      loader. The contour area is then reclaimed by returning overburden to the pit
      and restoring the mountainside to its approximate original contour. Reserve
      recovery using this method of mining is typically approximately
      70%.





As
      of
      December 31, 2006, we had nine Company-operated surface mines including one
      highwall miner and two contract operated surface mines.





**Underground
      Mine Characteristics**





Underground
      mines are characterized as either “drift” mines or “below drainage” mines. Drift
      mines are mines that are developed into the coal seam at a point where the
      seam
      intersects the surface. The area where the seam intersects the surface is
      commonly known as the “outcrop.” Multiple entries are developed into the coal
      seam and are used as airways for mine ventilation, passageways for miners and
      supplies, and entries for conveyor belts that transport coal from the active
      production areas of the mine to the surface.





In
      below
      drainage mines, the coal seam does not intersect the surface in the vicinity
      of
      the mining area. Therefore, the coal seam must be accessed through excavated
      passageways from the surface. These passageways typically consist of vertical
      shafts and angled slopes. The shafts are constructed with diameters ranging
      from
      12 to 24 feet and are used as airways for mine ventilation and passageways
      for
      miners and supplies via elevators. The slopes, when used to house conveyor
      belts
      to transport the mined coal from the active production areas of the mine to
      the
      surface, are typically driven at an angle of less than 17 degrees from the
      horizontal. In addition, the slopes provide passageways for miners and supplies,
      and airways for mine ventilation.





As
      of
      December 31, 2006, we had 14 Company-operated and one contractor operated
      underground mines in operation, of which 11 were drift mines, and the remaining
      three were below-drainage slopes mines.





**Mining
      Operations**





Our
      coal
      production is conducted through five mining complexes in the Central Appalachia
      Region (CAPP) and one mining complex in the Midwest Region. We generally do
      not
      own the land on which we conduct our mining operations. Rather, our coal
      reserves are controlled pursuant to leases from third party landowners. We
      believe that greater than 95% and 90% of our coal reserves in the Central
      Appalachia Region and Midwest Region, respectively, are controlled pursuant
      to
      leases from third party landowners. These leases typically convey mining rights
      to the coal producer in exchange for a per ton fee or royalty payment of a
      percentage of the gross sales price to the lessor. The average royalties for
      coal reserves from our producing properties were approximately 7.9% (excluding
      a
      $4.1 million write-off of a prepaid royalty in the fourth quarter of 2006 in
      connection with the restructuring of  mineral lease contract) and 2.8% of
      produced coal revenue for the year ended December 31, 2006 in the Central
      Appalachia Region and the Midwest Region, respectively.





3


All
      of
      our operations are located on or near public highways and receive electrical
      power from commercially available sources. Existing facilities and equipment
      are
      maintained in good working condition and are continuously updated through
      capital expenditure investments.





The
      following table provides summary information on our mining complexes as of
      December 31, 2006:




****
            ****
            **Number
                and Type of Mines**
            ****
            ****
            ****
            **Quality
                of Shipments for the year ended 2006**
            ******Mining
                Complex**
            ****
            **Underground**
            ****
            **Surface**
            ****
            **Total**
            ****
            **Tons**
              **Shipped**
              **(in
                000’s**
              **of
                tons)**
            ****
            **Sulfur**
              **Content**
            ****
            **Ash**
              **Content**
            ****
            **Average
                BTU**
              **Content**
            *******Central
                Appalachia***Bell
                County Coal Corporation
            
            
            2
            
            
            —
            
            
            2
            
            
            929
            
            
            1.4
            
            
            9.4
            
            
            12,699Bledsoe
                Coal Corporation
            
            
            3
            
            
            2
            
            
            5
            
            
            2,992
            
            
            1.2
            
            
            10.5
            
            
            12,431Blue
                Diamond Coal Corporation
            
            
            4
            
            
            2
            
            
            6
            
            
            1,647
            
            
            0.9
            
            
            9.0
            
            
            12,790Leeco,
                Inc.
            
            
            1
            
            
            1
            
            
            2
            
            
            1,419
            
            
            1.0
            
            
            10.1
            
            
            12,625McCoy
                Elkhorn Coal Corporation
            
            
            4
            
            
            —
            
            
            4
            
            
            2,793
            
            
            1.5
            
            
            8.6
            
            
            12,831***Midwest***Triad
                Mining, Inc
            
            
            1
            
            
            6
            
            
            7
            
            
            3,348
            
            
            2.7
            
            
            8.8
            
            
            11,223





We
      obtained rights to these mining complexes as follows: McCoy Elkhorn and Bell
      County were the original operating companies that made up James River Coal
      Company when we were formed in 1988 through the purchase of General Energy
      Corp.
      In 1992, we acquired the operations of Johns Creek Coal Company and the Bevins
      Branch Preparation Plant, both of which are now included within the McCoy
      Elkhorn complex. The Leeco and Bledsoe operating companies were both acquired
      in
      our acquisition of Transco Coal Company in 1995. The Blue Diamond operating
      company was purchased in 1998. In 1999, we acquired Shamrock Coal Company,
      which
      added mines, reserves, a preparation plant and the Clover loadout facility
      to
      the Bledsoe complex. In 2005, we acquired Triad Mining, Inc.





The
      following summarizes additional information concerning each of our six mining
      complexes:





*Bell
      County* .
      The
      Bell County complex is located in Bell County in eastern Kentucky, and consists
      of two Company-operated underground mines. We use room and pillar mining to
      mine
      the Buckeye Springs and Garmedia seams of coal. Coal is processed at our
      preparation plant and loaded into railcars via an integrated four-hour unit
      train loadout that is serviced
      by both the CSX and Norfolk Southern railroads. As of December 31, 2006, we
      employed 117 mining and support personnel at this complex.





*Bledsoe* .
      The
      Bledsoe complex is located in Leslie and Harlan counties in eastern Kentucky,
      and consists of three Company-operated underground mines, one Company-operated
      surface mine and one contract surface mine. We use room and pillar mining to
      mine the Hazard #4 seam of coal at this complex for our underground mine, and
      our surface mines use the contour method to mine Hazard Seams #7, #10, #11
      and
      #12. Coal is processed at one of two preparation plants and loaded into railcars
      at a separate location via a four-hour unit train loadout on the CSX railroad.
      As of December 31, 2006, we employed 395 mining and support personnel at this
      complex.





*Blue
      Diamond* .
      The
      Blue Diamond complex is located in Leslie, Perry and Letcher counties in eastern
      Kentucky, and consists of four underground and two surface mines. These mines
      are operated by the Company with the exception of one surface mine and one
      underground mine that are operated by contractors. Our Company operated
      underground mines use room and pillar mining to mine the Hazard #4 and Alma
      seams of coal and our contract mine operator use s the same
      method to mine the Leatherwood seam. The surface mines use the contour method
      to
      mine the #9, #5A, and #7 seams. Coal is processed at our preparation plant,
      and
      loaded into railcars via an integrated four-hour unit train loadout on the
      CSX
      railroad. As of December 31, 2006, we employed 269 mining and support personnel
      at this complex.





4


*Leeco* .
      The
      Leeco complex is located in Knott and Perry counties in eastern Kentucky, and
      consists of one Company-operated underground mine and one surface mine with
      a highwall
      miner. Our underground mine uses room and pillar mining to mine the Amburgy
      seam
      of coal and our surface mine uses the contour and highwall mining methods to
      mine the Hazard #8 and #9 seams. Coal is processed at our preparation plant
      and
      loaded into railcars via an integrated four-hour unit train loadout on the
      CSX
      railroad. As of December 31, 2006, we employed 211 mining and support personnel
      at this complex.





*McCoy
      Elkhorn* .
      The
      McCoy Elkhorn complex is located in Pike and Floyd counties in eastern Kentucky,
      and consists of four Company-operated underground mines. We use room and pillar
      mining to mine the Millard, Elkhorn #2, Elkhorn #3, and Pond Creek seams of
      coal. Coal is processed at one of our two preparation plants and loaded into
      railcars via integrated four-hour unit train loadouts on the CSX railroad.
      As of
      December 31, 2006, we employed 422 mining and support personnel at this complex.





*Triad* . The
      Triad
      complex is located in Pike and Knox counties in s outhern
      Indiana and consists of six surface
      mines and one underground mine, all of which we operate.
 We use room and pillar mining to mine the Springfield seam of coal, and
      use the surface mine  method to mine multiple seams, including the
      Danville, Millersburg, Hym era ,
      Bucktown and Springfi el d
      seams.  Coal is processed at one of three active
      preparation plants and loaded into trucks for delivery to the customer or
      by
      rail at our
      Switz City loadout.  The Switz City loadout is serviced by Indiana R ailroad and the
      Indiana Southern Railroad.  As of
      December 31, 2006, we employed approximately 270 mining and support personnel
      at
      this complex.




Contract
      mining represented approximately 4.7% of our coal production in the year ended
      December 31, 2006. Each mining complex monitors its contract mining operations
      and provides geological and engineering assistance to the contract mine
      operators. The contract mine operators generally provide their own equipment
      and
      operate the mines using their employees. Independent contract mine operators
      are
      paid a fixed rate for each ton of saleable product. We are primarily responsible
      for the reclamation activities involved with all contractor-operated mines.
      Contractors that operate surface mines, however, typically are contractually
      obligated to perform, on our behalf, the reclamation activities associated
      with
      the mines they operate. Our relationships with contract mine operators typically
      can be cancelled by either party without penalty by giving between 30 and 60
      days notice.





**Reserves**





We
      have
      an ongoing mineral development drilling and exploration program on our coal
      properties. The purpose of the drilling and exploration program is to assist
      us
      with planning our mining activities and to better assess our coal reserves.
      In
      April 2004, we asked Marshall Miller & Associates, Inc. (“MM&A”) to
      prepare a detailed study of our reserves in Central Appalachia as of March
      31,
      2004 based on all of our geologic information, including our updated drilling
      and mining data. For the Triad properties MM&A also prepared a detailed
      study of Triad’s reserves as of February 1, 2005 for the reserves obtained in
      the acquisition of Triad and as of April 11, 2006 for 15.8 million tons of
      reserves acquired in the second quarter of 2006.  We have used MM&A’s
      March 31, 2004 study as the basis for our current internal estimate of
      our Central Appalachia reserves and MM&A’s February 1, 2005 and April
      11, 2006 studies as the basis for our current internal estimate of our Midwest
      reserves (collectively the “MM&A studies”).





The
      coal
      reserve studies conducted by MM&A were planned and performed to obtain
      reasonable assurance of our subject demonstrated (proven plus probable)
      reserves. In connection with the studies, MM&A prepared reserve maps and had
      certified professional geologists develop estimates based on data supplied
      by us
      and using standards accepted by government and industry.





After
      reviewing the maps and information we supplied, MM&A prepared an independent
      mapping and estimate of our demonstrated reserves using methodology outlined
      in
      U.S. Geological Survey Circular 891 and SEC Industry Guide 7. MM&A developed
      reserve estimation criteria to assure that the basic geologic characteristics
      of
      the reserves ( *e.g.* ,
      minimum
      coal thickness and wash recovery, interval between deep mineable seams, mineable
      area tonnage for economic extraction, etc.) are in reasonable conformity with
      present and recent mine operation capabilities on our various properties.





5


MM&A
      has not conducted a coal reserve study on our December 31, 2006 reserve
      estimate. We continue to have an ongoing mineral development drilling and
      exploration program on our coal properties and plan to update our third party
      reserve study from time to time. Any future negative changes in our reserves
      could have a material adverse impact on our depreciation, depletion and
      amortization expense. A material adverse impact could also lead to a charge
      for
      impairment of the value of our coal property assets.





As
      of December  31, 2006, we
      estimated that we
      controlled approximately 233.0 million tons of proven and probable coal reserves
      in Central Appalachia and 40.2 millions tons of proven and probable coal
      reserves in the Midwest.





Reserves
      for these purposes are defined by SEC Industry Guide 7 as that part of a mineral
      deposit which could be economically and legally extracted or produced at the
      time of the reserve determination. The reserve estimates have been prepared
      using industry-standard methodology to provide reasonable assurance that the
      reserves are recoverable, considering technical, economic and legal limitations.
      Although the MM&A studies found our reserves to be reasonable (not
      withstanding unforeseen geological, market, labor or regulatory issues that
      may
      affect the operations), by assignment, MM&A has not performed an economic
      feasibility study for our reserves. In accordance with standard industry
      practice, we have performed our own economic feasibility analysis for our
      assigned reserves. It is not generally considered to be practical, however,
      nor
      is it standard industry practice, to perform a feasibility study for a company’s
      entire reserve portfolio. In addition, MM&A did not independently verify our
      control of our properties, and has relied solely on property information
      supplied by us. Reserve acreage, average seam thickness, average seam density
      and average mine and wash recovery percentages were verified by MM&A to
      prepare a reserve tonnage estimate for each reserve.





The
      following table provides information on our mining complexes. Except as noted,
      the reserve and quality information is based on the MM& A studies:




**Proven
                  & Probable**
                **Reserves
                  (1)**
                **(millions
                  of tons)**
              
              
              
              **Approximate
                  Overall**
                **Reserve
                  Quality**
                **(2),
                  (3)****Mining
                  Complex**
              
              **As
                  of**
                **Most**
                **Recent**
                **MM&A**
                ******Studies
                  (3)**
              
              **As
                  of**
                **December
                  31,**
                **2006
                  (4)**
              
              **Estimated**
                **Years
                  of**
                **Reserve
                  Life**
                **Based
                  on 2006 Production**
                **Levels**
              
              **Ash**
                **Content****(%)**
              
              **Sulfur**
                **Content**
                **(%)**
              
              **Heat
                  Value**
                **(Btu/lb.)*****Central
                  Appalachia***Bell
                  County
              
              
              12.5
              
              
              11.8
              
              
              19.6
              
              
              5.1
              
              
              1.0
              
              
              13,500Bledsoe
              
              
              59.1
              
              
              58.1
              
              
              20.0
              
              
              7.8
              
              
              1.2
              
              
              13,000Blue
                  Diamond
              
              
              66.2
              
              
              83.6
              
              
              55.1
              
              
              4.7
              
              
              1.1
              
              
              13,700Leeco
              
              
              35.7
              
              
              43.1
              
              
              33.0
              
              
              7.0
              
              
              1.2
              
              
              13,200McCoy
                  Elkhorn
              
              
              33.8
              
              
              36.4
              
              
              13.9
              
              
              5.7
              
              
              1.6
              
              
              13,300**Total/Average**
              
              
              **207.3**
              
              
              **233.0**
              
              
              **26.0**
              
              
              **6.3**
              
              
              **1.3**
              
              
              **13,300*****Midwest***Triad
              
              
              **33.4**
              
              
              **40.2**
              
              
              **12.1**
              
              
              **8.8**
              
              
              **3.2**
              
              
              **12,000**


(1) (1) Proven
          reserves have the highest degree of geologic assurance and are reserves
          for
          which (a) quantity is computed from dimensions revealed in outcrops, trenches,
          workings, or drill holes; grade and/or quality are computed from the results
          of
          detailed sampling and (b) the sites for inspections, sampling and measurement
          are spaced so closely and the geologic character is so well defined that
          size,
          shape, depth and mineral content of reserves are well-established. Probable
          reserves have a moderate degree of geologic assurance and are reserves
          for which
          quantity and grade and/or quality are computed from information similar
          to that
          used for proven reserves, but the sites for inspection, sampling and measurement
          are farther apart or are otherwise less adequately spaced. The degree of
          assurance, although lower than that for proven reserves, is high enough
          to
          assume continuity between points of observation. This reserve information
          reflects recoverable tonnage on an as-received basis with 5.5%
          moisture.
 
 6
 (2) Ash
          and
          sulfur content is expressed as the percent by weight of those constituents
          in
          the coal sample compared to the total weight of the sample being tested.
          Heat
          value is expressed as Btu per pound in the coal based on laboratory testing
          of
          coal samples. The samples are typically obtained from exploratory core
          borings
          placed at strategic locations within the coal reserve area. Approximately
          82% of
          the reserve tons have representative samples (degree of representation
          varies
          from area to area) and 18% of the reserve tons have no site-specific samples
          (and are therefore not included in the overall quality estimate). The samples
          are sent to accredited laboratories for testing under protocols established
          by
          the American Society of Testing and Materials (ASTM). The estimated overall
          quality values are derived by a multiple step process, including: a) for
          each
          mine or reserve area, an arithmetic average quality (dry basis) was prepared
          to
          represent the coal tons within the area, based on samples from the area;
          b) the
          overall quality of reserves for each mine complex was determined by performing
          a
          tonnage-weighted average of the average quality of all mine and reserve
          areas
          within the division; and c) the resulting dry basis overall quality was
          converted to wet product basis to reflect its anticipated moisture content
          at
          the time of sale. The actual quality of the shipped coal may vary from
          these
          estimates due to factors such as: a) the particle size of the coal fed
          to the
          plant; b) the specific gravity of the float media in use at the preparation
          plant; c) the type of plant circuit(s); d) the efficiency of the plant
          circuit(s); e) the moisture content of the final product; and f) customer
          requirements.
 
 (3) For
          the
          CAPP region, represents reserve information for our mining complexes as
          of March
          31, 2004. For the Midwest region, represents weighted average reserve
          information as of February 1, 2005 and April 11, 2006, for the reserves
          obtained
          on the acquisition of the Triad mining complex and for a lease entered
          into
          during 2006, respectively. The reserve information is based on the independent
          reserve studies conducted by MM&A.
 
 (4) Represents
          the Company’s estimate of reserves at December 31, 2006 based on additional
          information or reserves obtained from exploration and acquisition activities,
          production activities or discovery of new geologic information. We calculated
          the adjustments to the reserves in the same manner, and based on the same
          assumptions and qualifications, as used in the MM&A studies described
          above, but these December 31, 2006 estimates have not been reviewed by
          MM&A.




**Processing
      and Transportation**





Coal
      from
      each of our mine complexes is transported by conveyor belt or by truck to one
      of
      our ten preparation plants or directly to one of our load-outs, all of which
      are
      in close proximity to our mining operations. These preparation plants remove
      impurities from the run-of-mine coal (the raw coal that comes directly from
      the
      mine) and offer the flexibility to blend various coals and coal qualities to
      meet specific customer needs. We regularly upgrade and maintain all of our
      preparation plants to achieve a high level of coal cleaning efficiency and
      maintain the necessary capacity.





In
      Central Appalachia, substantially all of our coal is shipped by train and sold
      f.o.b. the railcar at the point of loading; transportation costs are normally
      borne by the purchaser. In addition to our well-positioned unit train loadout
      facilities on the CSX Corporation railroad, our Bell County mining complex
      has
      dual service provided by the CSX and Norfolk Southern Corporation railroads
      in
      Bell County, Kentucky.





In
      the
      Midwest, coal is shipped by train and by truck to our customers. The trucked
      coal is primarily sold f.o.b delivery point with transportation costs borne
      by
      either the customer or us. Coal delivered by train is sold f.o.b. the railcar
      at
      the point of loading, with transportation costs normally borne by the purchaser.
      Our Triad mining complex has rail service provided by Indiana Railroad and
      Indiana Southern Railroad.





Our
      mining complexes are supported by personnel located in London, Kentucky who
      provide engineering and permitting assistance, project management, land
      management and lease administration, coal quality control and quality reporting,
      accounting and purchasing support, and railroad transportation scheduling
      services.




7


**Customers
      and Coal Contracts**




As
      is
      customary in the coal industry, we regularly enter into long-term contracts
      (which we define as contracts with terms of more than one year) with many of
      our
      customers. These arrangements allow customers to secure a supply for their
      future needs and provide us with greater predictability of sales volume and
      sales prices. In 2006, we generated approximately 72% of our total revenues
      from
      seven long-term contracts to sell coal to electric utilities.




For
      the
      year ended December 31, 2006, Georgia Power (25%) and South Carolina Public
      Service Authority (16%) were our largest customers by revenues. No other
      customer accounted for more than 10% of revenues.




The
      terms
      of our contracts result from a bidding and negotiation process with our
      customers. Consequently, the terms of these contracts often vary significantly
      in many respects. Our long-term supply contracts typically contain one or more
      of the following pricing mechanisms:




·
            Fixed
                price contracts;





·
            Annually
                negotiated prices that reflect market conditions at the time;
                or





·
            Base-price-plus-escalation
                methods that allow for periodic price adjustments based on fixed
                percentages or, in certain limited cases, pass-through of actual
                cost
                changes.




A
      limited
      number of our contracts have features of several contract types, such as
      provisions that allow for renegotiation of prices on a limited basis within
      a
      base-price-plus-escalation agreement. Such re-opener provisions allow both
      the
      customer and us an opportunity to adjust prices to a level close to then current
      market conditions. Each contract is negotiated separately, and the triggers
      for
      re-opener provisions differ from contract to contract. Some of our existing
      contracts with re-opener provisions adjust the contract price to the market
      price at the time the re-opener provision is triggered. Re-opener provisions
      could result in early termination of a contract or a reduction in the volume
      to
      be purchased if the parties were to fail to agree on price.




Our
      long-term supply contracts also typically contain force majeure provisions
      allowing for the suspension of performance by the customer or us for the
      duration of specified events beyond the control of the affected party, including
      labor disputes. Some contracts may terminate upon continuance of an event of
      force majeure for an extended period, which are generally three to six months.
      Contracts also typically specify minimum and maximum quality specifications
      regarding the coal to be delivered. Failure to meet these conditions could
      result in substantial price reductions or termination of the contract, at the
      election of the customer. Although the volume to be delivered under a long-term
      contract is stipulated, we, or the buyer, may vary the timing of delivery within
      specified limits.




The
      terms
      of our long-term coal supply contracts also vary significantly in other
      respects, including: coal quantity parameters, flexibility and adjustment
      mechanisms, permitted sources of supply, treatment of environmental constraints,
      options to extend, suspension, termination and assignment provisions, and
      provisions regarding the allocation between the parties of the cost of complying
      with future government regulations.




**Competition**




The
      U.S.
      coal industry is highly competitive, with numerous producers in all coal
      producing regions. We compete against various large producers and hundreds
      of
      small producers. According to the U.S. Department of Energy, the largest
      producer produced approximately 17.8% (based on tonnage produced) of the total
      United States production in 2005, the latest year for which government
      statistics are available. The U.S. Department of Energy also reported 1,398
      active coal mines in the United States in 2005. Demand for our coal by our
      principal customers is affected by:




·
            the
                price of competing coal and alternative fuel supplies, including
                nuclear,
                natural gas, oil and renewable energy sources, such as hydroelectric
                power;





·
            coal
                quality;





8


·
            transportation
                costs from the mine to the customer;
                and





·
            the
                reliability of supply.





Continued
      demand for our coal and the prices that we obtain are affected by demand for
      electricity, environmental and government regulation, technological developments
      and the availability and price of competing coal and alternative fuel
      supplies.




**Employees**





At
      December 31, 2006, we had 1,742
      employees. None of our employees are currently represented by collective
      bargaining agreements. Relations with our employees are generally
      good.




**Government
      Regulation**





The
      coal
      mining industry is subject to extensive regulation by federal, state and local authorities on matters such
      as:





·
            employee
                health and safety;





·
            permitting
                and licensing requirements;





·
            air
                quality standards;





·
            water
                quality standards;





·
            plant,
                wildlife and wetlandprotection;





·
            blasting
                operations;


·
            the
                management and disposal of hazardous and non-hazardous materials
                generated
                by mining operations;


·
            the
                storage of petroleum products and other hazardous
                substances;





·
            reclamation
                and restoration of properties after mining operations are
                completed;





·
            discharge
                of materials into the environment,
                including air emissions and wastewater discharge;





·
            surface
                subsidence from underground mining;
                and





·
            the
                effects of mining operations on groundwater quality and
                availability.





Complying
      with these requirements, including the terms of our permits, has had, and will
      continue to have, a significant effect on our costs of operations. We could
      incur substantial costs, including clean up costs, fines, civil or criminal
      sanctions and third party claims for personal injury or property damage as
      a
      result of violations of or liabilities under these laws and
      regulations.





In
      addition, the utility industry, which is the most significant end-user of coal,
      is subject to extensive regulation regarding the environmental impact of its
      power generation activities, which could affect demand for our coal. The
      possibility exists that new legislation or regulations may be adopted which
      would have a significant impact on our mining operations or our customers’
ability to use coal and may require us or our customers to change operations
      significantly or incur substantial costs.





9


Numerous
      governmental permits and approvals are required for mining operations. In
      connection with obtaining these permits and approvals, we are, or may be,
      required to prepare and present to federal, state or local authorities data
      pertaining to the effect or impact that any proposed exploration for or
      production of coal may have upon the environment, the public, historical
      artifacts and structures, and our employees’ health and safety. The requirements
      imposed by such authorities may be costly and time-consuming and may delay
      commencement or continuation of exploration or production operations. Future
      legislation and administrative regulations may emphasize the protection of
      the
      environment and health and safety and, as a consequence, our activities may
      be
      more closely regulated. Such legislation and regulations, as well as future
      interpretations of existing laws, may require substantial increases in our
      equipment and operating costs and delays, interruptions or a termination of
      operations, the extent of which cannot be predicted.





While
      it
      is not possible to quantify the costs of compliance with all applicable federal
      and state laws, those costs have been and are expected to continue to be
      significant. We estimate that we will make expenditures of approximately $2.0
      million per year for environmental control facilities and complying with new
      safety regulations in 2007 and 2008. These costs are in addition to reclamation
      and mine closing costs and the costs of treating mine water discharge, when
      necessary. Compliance with these laws has substantially increased the cost
      of
      coal mining, but is, in general, a cost common to all domestic coal
      producers.




**Mine
      Health and Safety Laws**




Stringent
      health and safety standards were imposed by federal legislation when the Federal
      Coal Mine Safety and Health Act of 1969 was adopted. The Federal Mine Safety
      and
      Health Act of 1977, which significantly expanded the enforcement of safety
      and
      health standards of the Coal Mine Safety and Health Act of 1969, imposes safety
      and health standards on all mining operations. Regulations are comprehensive
      and
      affect numerous aspects of mining operations, including training of mine
      personnel, mining procedures, blasting, the equipment used in mining operations
      and other matters. The Federal Mine Safety and Health Administration monitors
      compliance with these federal laws and regulations and can impose penalties
      can
      impose under recently enacted regulations maximum penalties of up to $220,000
      for certain violations, as well as closure of the mine. In addition, as part
      of
      the Coal Mine Safety and Health Act of 1969 and the Federal Mine Safety and
      Health Act of 1977, the Black Lung Benefits Revenue Act of 1977 and the Black
      Lung Benefits Reform Act of 1977, as amended in 1981, require payments of
      benefits to disabled coal miners with black lung disease and to certain
      survivors of miners who die from black lung disease.





In
      2001,
      Kentucky made significant changes to its mining laws. A new independent agency,
      the Kentucky Mine Safety Review Commission, was created to assess penalties
      against anyone, including owners or part owners (defined as anyone owning one
      percent or more shares of publicly traded stock), whose intentional violations
      or order to violate mine safety laws place miners in imminent danger of serious
      injury or death. Mine safety training and compliance with state statutes and
      regulations related to coal mining is monitored by the Kentucky Office of Mine
      Safety and Licensing. The Commission can impose a penalty of up to $10,000
      per
      violation, as well as suspension or revocation of the mine license.





The
      mine
      disasters in West Virginia and other states that occurred in 2006 have resulted
      in increased scrutiny of coal mining in general and underground coal mining
      in
      particular. New legislation has been enacted at the state and federal level
      that
      creates requirements for maintaining caches of self-contained self-rescuers
      throughout underground mines; equipping all underground miners with wireless
      communications devices and tracking devices; and in some cases, installing
      cable
      lifelines from the mine portal to all sections of the mine for assistance in
      emergency escape. Additionally, new requirements for prompt reporting of
      accidents and increased fines and penalties for violation of these and other
      regulations have been enacted. The Federal Mine Safety and Health Administration
      issued final regulations in December 2006 that place new or amended requirements
      on all underground mines relating to the storage and use of self-contained
      self-rescuers, evacuation training for miners, the installment and maintenance
      of lifelines and notification of MSHA in the event of an accident.





It
      is our
      responsibility to our employees to provide a safe and healthy environment
      through training, communication, following and improving safety standards and
      investigating all accidents, incidents and losses to avoid reoccurrence. The
      combination of federal and state safety and health regulations in the coal
      mining industry is, perhaps, the most comprehensive system for protection of
      employee safety and health affecting any industry. Most aspects of mine
      operations are subject to extensive regulation. This regulation has a
      significant effect on our operating costs. However, our competitors are subject
      to the same level of regulation.





10




**Black
      Lung Legislation**




Under
      the
      federal Black Lung Benefits Act (as amended) (the “Black Lung Act”), each coal
      mine operator is required to make black lung benefits or contribution payments
      to:





·
            current
                and former coal miners totally disabled from black lung
                disease;





·
            certain
                survivors of a miner who dies from black lung disease or pneumoconiosis;
                and





·
            a
                trust fund for the payment of benefits and medical expenses to any
                claimant whose last mine employment was before January 1, 1970, or
                where a
                miner’s last coal employment was on or after January 1, 1970 and no
                responsible coal mine operator has been identified for claims, or
                where
                the responsible coal mine operator has defaulted on the payment of
                such
                benefits.





Federal
      black lung benefits rates are periodically adjusted according to the percentage
      increase of the federal pay rate.





In
      addition to the Black Lung Act, we also are liable under various state statutes
      for black lung claims. To a certain extent, our federal black lung liabilities
      are reduced by our state liabilities. Our total (federal and state) black lung
      benefit liabilities, including the current portions, totaled approximately
      $26.8
      million at December 31, 2006. These obligations were unfunded at December 31,
      2006.





The
      United States Department of Labor issued a final rule, effective January 19,
      2001, amending the regulations implementing the Black Lung Act. The amendments
      give greater weight to the opinion of the claimant’s treating physician, expand
      the definition of black lung disease and limit the amount of medical evidence
      that can be submitted by claimants and respondents. The amendments also alter
      administrative procedures for the adjudication of claims, which, according
      to
      the Department of Labor, results in streamlined procedures that are less formal,
      less adversarial  and
      easier for participants to understand. These and other changes to the black
      lung
      regulations could significantly increase our exposure to federal black lung
      benefits liabilities. Experience to date related to these changes is not
      sufficient to determine the impact of these changes. The National Mining
      Association challenged the amendments but the courts, to date, with minor
      exception, affirmed the rules. However, the decision left many contested issues
      open for interpretation. Consequently, we anticipate increased litigation until
      the various federal District Courts have had an opportunity to rule on these
      issues.





The
      Kentucky Supreme Court has taken discretionary review of a Kentucky Court of
      Appeals decision, *Bartrum
      v. Hunter Excavating,* which
      rendered unconstitutional a 2002 statute governing black lung claims. The Court
      of Appeals held that to the extent the statute limited evidence, it violated
      due
      process rights. The effect upon future black lung claims, if any, is dependent
      upon the Kentucky Supreme Court’s review.





In
      recent
      years, proposed legislation on black lung reform has been introduced in, but
      not
      enacted by, Congress and the Kentucky legislature. It is possible that
      legislation on black lung reform will be reintroduced for consideration by
      these
      legislative bodies. If any of the proposals that have been introduced are
      passed, the number of claimants who are awarded benefits could significantly
      increase. Any such changes in black lung legislation, if approved, or in state
      or federal court rulings, may adversely affect our business, financial condition
      and results of operations.




**Workers’
      Compensation**




We
      are
      required to compensate employees for work-related injuries. Our accrued workers’
compensation liabilities, including the current portion, were $53.4 million
      at
      December 31, 2006. These obligations are unfunded. Our expense for workers’
compensation was $11.4 million in 2006. Both the federal government and the
      states in which we operate consider changes in workers’ compensation laws from
      time to time. Such changes, if enacted, could adversely affect us.




11


**Environmental** **Laws and Regulations**





We
      are
      subject to various federal environmental laws and regulatory entities,
      including:





·
            the
                Surface Mining Control and Reclamation Act of
                1977;





·
            the
                Clean Air Act;





·
            the
                Clean Water Act;





·
            the
                Toxic Substances Control Act;





·
            the
                Comprehensive Environmental Response, Compensation and Liability
                Act;





·
            the
                U.S. Army Corps of Engineers;and





·
            the
                Resource Conservation and Recovery
                Act.





We
      are
      also subject to state laws of similar scope in each state in which we
      operate.





These
      environmental laws require reporting, permitting and/or approval of many aspects
      of coal operations. Both federal and state inspectors regularly visit mines
      and
      other facilities to ensure compliance. We have ongoing compliance and permitting
      programs designed to ensure compliance with such environmental
      laws.





Given
      the
      retroactive nature of certain environmental laws, we have incurred and may
      in
      the future incur liabilities, including clean-up costs, in connection with
      properties and facilities currently or previously owned or operated as well
      as
      sites to which we or our subsidiaries sent waste materials.




***Surface
      Mining Control and Reclamation Act (SMCRA)***




The
      SMCRA, and its state counterparts, establish operational, reclamation and
      closure standards for all aspects of surface mining as well as many aspects
      of
      underground mining. The Act requires that comprehensive environmental protection
      and reclamation standards be met during the course of and following completion
      of mining activities. Permits for all mining operations must be obtained from
      the Federal Office of Surface Mining Reclamation and Enforcement or, where
      state
      regulatory agencies have adopted federally approved state programs under the
      Act, the appropriate state regulatory authority.





The
      SMCRA
      and similar state statutes, among other things, require that mined property
      be
      restored in accordance with specified standards and approved reclamation plans.
      The mine operator must submit a bond or otherwise secure the performance of
      these reclamation obligations. The earliest a reclamation bond can be fully
      released is five years after reclamation has been achieved. All states impose
      on
      mine operators the responsibility for repairing or compensating for damage
      occurring on the surface as a result of mine subsidence, a possible consequence
      of underground mining. In addition, the Abandoned Mine Reclamation Fund, which
      is part of the SMCRA, imposes a tax on all current mining operations, the
      proceeds of which are used to restore unreclaimed mines closed before 1977.
      The
      maximum tax, effective October 1, 2007, is $0.315 per ton on surface mined
      coal
      and $0.135 per ton on underground-mine coal.





Statement
      of Financial Accounting Standards No. 143 (“Statement No. 143”) provides the
      guidance to account for the costs related to the closure of mines and the
      reclamation of the land upon exhaustion of coal reserves. This statement
      requires the fair value of an asset retirement obligation be recognized in
      the
      period in which it is incurred if a reasonable estimate of fair value can be
      made. The present value of the estimated asset retirement costs are capitalized
      as part of the carrying amount of the long-lived asset. Asset retirement
      obligations primarily relate to the closure of mines and the reclamation of
      the
      land upon exhaustion of coal reserves. At December 31, 2006 and December 31,
      2005, we had accrued $29.7 million and $26.8 million, respectively, related
      to
      estimated mine reclamation costs. The amounts recorded are dependent upon a
      number of variables, including the amount and timing of estimated future
      retirement costs, estimated proven reserves, assumptions involving profit
      margins, inflation rates, and the assumed credit-adjusted risk-free interest
      rate.





12


Our
      future operating results would be adversely affected if these accruals were
      determined to be insufficient. These obligations are unfunded. The amount that
      was expensed for the year ended December 31, 2006 was $2.1 million, while the
      related cash payment for such liability during the same period was $1.1
      million.





We
      also
      lease some of our coal reserves to third-party operators. Under the SMCRA,
      responsibility for unabated violations, unpaid civil penalties and unpaid
      reclamation fees of independent contract mine operators can be imputed to other
      companies which are deemed, according to the regulations, to have “owned” or
“controlled” the contract mine operator. Sanctions against the “owner” or
“controller” are quite severe and can include being blocked, nationwide, from
      receiving new permits and revocation of any permits that have been issued since
      the time of the violations or, in the case of civil penalties and reclamation
      fees, since the time such amounts became due.




***Clean
      Air Act***




The
      federal Clean Air Act and similar state laws and regulations, which regulate
      emissions into the air, affect coal mining and processing operations primarily
      through permitting and/or emissions control requirements. In addition, the
      Environmental Protection Agency (the “EPA”) has issued certain, and is
      considering further, regulations relating to fugitive dust and particulate
      matter emissions that could restrict our ability to develop new mines or require
      us to modify our operations. In July 1997, the EPA adopted new, more stringent
      National Ambient Air Quality Standards for particulate matter, which may require
      some states to change existing implementation plans for particulate matter.
      Because coal mining operations and plants burning coal emit particulate matter,
      our mining operations and utility customers are likely to be directly affected
      when the revisions to the National Ambient Air Quality Standards are implemented
      by the states. Regulations under the Clean Air Act may restrict our ability
      to
      develop new mines or could require us to modify our existing operations, and
      may
      have a material adverse effect on our financial condition and results of
      operations.





The
      Clean
      Air Act also indirectly affects coal mining operations by extensively regulating
      the air emissions of coal-fired electric power generating plants. Coal contains
      impurities, such as sulfur, mercury and other constituents, many of which are
      released into the air when coal is burned. New environmental regulations
      governing emissions from coal-fired electric generating plants could reduce
      demand for coal as a fuel source and affect the volume of our sales. For
      example, the federal Clean Air Act places limits on sulfur dioxide emissions
      from electric power plants. In order to meet the federal Clean Air Act limits
      for sulfur dioxide emissions from electric power plants, coal users need to
      install scrubbers, use sulfur dioxide emission allowances (some of which they
      may purchase), blend high sulfur coal with low sulfur coal or switch to low
      sulfur coal or other fuels. The cost of installing scrubbers is significant
      and
      emission allowances may become more expensive as their availability declines.
      Switching to other fuels may require expensive modification of existing
      plants.





On
      March
      15, 2005, the EPA adopted a new federal rule to cap and reduce mercury emissions
      from both new and existing coal-fired power plants. The reductions will be
      implemented in stages, primarily through a market-based cap-and-trade program.
      Nevertheless, the new regulations will likely require some power plants to
      install new equipment, at substantial cost, or discourage the use of certain
      coals containing higher levels of mercury.





Other
      new
      and proposed reductions in emissions of sulfur dioxides, nitrogen oxides,
      particulate matter or various greenhouse gases may require the installation
      of
      additional costly control technology or the implementation of other measures,
      including trading of emission allowances and switching to other fuels. For
      example, the EPA recently proposed separate regulations to reduce the interstate
      transport of fine particulate matter and ozone through reductions in sulfur
      dioxides and nitrogen oxides throughout the eastern United States. The EPA
      continues to require reduction of nitrogen oxide emissions in 22 eastern states
      and the District of Columbia and will require reduction of particulate matter
      emissions over the next several years for areas that do not meet air quality
      standards for fine particulates and for certain major sources contributing
      to
      those exceedances. In addition, the EPA has issued draft regulations, and
      Congress and several states are now considering legislation, to further control
      air emissions of multiple pollutants from electric generating facilities and
      other large emitters. These new and proposed reductions will make it more costly
      to operate coal-fired plants and could make coal a less attractive fuel
      alternative in the planning and building of utility power plants in the future.
      To the extent that any new and proposed requirements affect our customers,
      this
      could adversely affect our operations and results.





13


Along
      with these regulations addressing ambient air quality, a regional haze program
      initiated by the EPA to protect and to improve visibility at and around national
      parks, national wilderness areas and international parks may restrict the
      construction of new coal-fired power plants whose operation may impair
      visibility at and around federally protected areas and may require some existing
      coal-fired power plants to install additional control measures designed to
      limit
      haze-causing emissions. These requirements could limit the demand for coal
      in
      some locations.





The
      United States Department of Justice, on behalf of the EPA, has filed lawsuits
      against several investor-owned electric utilities and brought an administrative
      action against one government-owned utility for alleged violations of the Clean
      Air Act. Some of these lawsuits have settled, requiring the utilities to pay
      penalties, install pollution control equipment and/or undertake other emission
      reduction measures, and the remaining lawsuits or future lawsuits could require
      the utilities involved to take similar steps, which could adversely impact
      their
      demand for coal.





Any
      reduction in coal’s share of the capacity for power generation could have a
      material adverse effect on our business, financial condition and results of
      operations. The effect such regulations, or other requirements that may be
      imposed in the future, could have on the coal industry in general and on us
      in
      particular cannot be predicted with certainty.





We
      believe we have obtained all necessary permits under the Clean Air Act. We
      monitor permits required by operations regularly and take appropriate action
      to
      extend or obtain permits as needed. Our permitting costs with respect to the
      Clean Air Act are typically less than $100,000 per year.




***Framework
      Convention On Global Climate Change***




The
      United States and more than 160 other nations are signatories to the 1992 United
      Nations Framework Convention on Climate Change, commonly known as the Kyoto
      Protocol, which is intended to reduce or offset emissions of greenhouse gases
      such as carbon dioxide. In December 1997, the signatories to the convention
      established a binding set of emissions targets for developed nations. Although
      the specific emissions targets vary from country to country, the United States
      would be required to reduce emissions to 93% of 1990 levels over a five-year
      budget period from 2008 through 2012. The U.S. Senate has not ratified the
      treaty commitments, and the Bush administration has officially opposed the
      Kyoto
      Protocol and has proposed an alternative to reduce the intensity of United
      States emissions of greenhouse gases. With Russia’s ratification of the Kyoto
      Protocol in 2004, it became binding on all ratifying countries. The
      implementation of the Kyoto Protocol in a number of countries, and other
      emissions limits, such as those adopted by the European Union, could affect
      demand for coal outside the United States. If the Kyoto Protocol or other
      comprehensive regulations focusing on greenhouse gas emissions are implemented
      by the United States, it could have the effect of restricting the use of coal.
      Other efforts to reduce emissions of greenhouse gases and federal initiatives
      to
      encourage the use of coal bed methane gas also may affect the use of coal as
      an
      energy source.




***Clean
      Water Act***




The
      federal Clean Water Act and corresponding state laws affect coal mining
      operations by imposing restrictions on discharges into regulated effluent
      waters. Permits requiring regular monitoring and compliance with effluent
      limitations and reporting requirements govern the discharge of pollutants into
      regulated waters. We believe we have obtained all permits required under the
      Clean Water Act and corresponding state laws and are in substantial compliance
      with such permits. However, new requirements under the Clean Water Act and
      corresponding state laws may cause us to incur significant additional costs
      that
      could adversely affect our operating results.





In
      addition, the U.S. Army Corps of Engineers imposes stream mitigation
      requirements on surface mining operations. These regulations require that
      footage of stream loss be replaced through various mitigation processes, if
      any
      ephemeral, intermittent, or perennial streams are in-filled due to mining
      operations. These regulations may also cause us to incur significant additional
      operating costs.




14


***Comprehensive
      Environmental Response, Compensation and Liability
      Act***




The
      Comprehensive Environmental Response, Compensation and Liability Act (commonly
      known as Superfund) and similar state laws create liabilities for the
      investigation and remediation of releases of hazardous substances into the
      environment and for damages to natural resources. Our current and former coal
      mining operations incur, and will continue to incur, expenditures associated
      with the investigation and remediation of facilities and environmental
      conditions, including underground storage tanks, solid and hazardous waste
      disposal and other matters under these environmental laws. We also must comply
      with reporting requirements under the Emergency Planning and Community
      Right-to-Know Act and the Toxic Substances Control Act.





The
      magnitude of the liability and the cost of complying with environmental laws
      with respect to particular sites cannot be predicted with certainty due to
      the
      lack of specific information available, the potential for new or changed laws
      and regulations and for the development of new remediation technologies and
      the
      uncertainty regarding the timing of remedial work. As a result, we may incur
      material liabilities or costs related to environmental matters in the future
      and
      such environmental liabilities or costs could adversely affect our results
      and
      financial condition. In addition, there can be no assurance that changes in
      laws
      or regulations would not result in additional costs and affect the manner in
      which we are required to conduct our operations.




***Resource
      Conservation and Recovery Act***




The
      RCRA
      and corresponding state laws and regulations affect coal mining operations
      by
      imposing requirements for the treatment, storage and disposal of hazardous
      wastes. Facilities at which hazardous wastes have been treated, stored or
      disposed of are subject to corrective action orders issued by the EPA and other
      potential obligations, which could adversely affect our results and financial
      condition.




**FORWARD-LOOKING
      INFORMATION** ****




From
      time
      to time, we make certain comments and disclosures in reports and statements,
      including this report, or statements made by our officers, which may be
      forward-looking in nature. These
      statements are known as “forward-looking statements,” as that term is used in
      Section 27A of the Securities Act of 1933 and Section 21E of the Securities
      Exchange Act of 1934. **** Examples
      include statements related to our future outlook, anticipated capital
      expenditures, future cash flows and borrowings, and sources of funding. These
      forward-looking statements could also involve, among other things, statements
      regarding our intent, belief or expectation with respect to:




·
            our
                cash flows, results of operation or financial
                condition;





·
            the
                consummation of acquisition, disposition or financing transactions
                and the
                effect thereof on our business;





·
            governmental
                policies and regulatory actions;





·
            legal
                and administrative proceedings, settlements, investigations and
                claims;





·
            weather
                conditions or catastrophic weather-related
                damage;





·
            our
                production capabilities;





·
            availability
                of transportation;





·
            market
                demand for coal, electricity and
                steel;





·
            competition;





·
            our
                relationships with, and other conditions affecting, our
                customers;





15


·
            employee
                workforce factors;





·
            our
                assumptions concerning economically recoverable coal reserve
                estimates;





·
            future
                economic or capital market conditions; and





·
            our
                plans and objectives for future operations and expansion or
                consolidation.





Any
      forward-looking statements are subject to the risks and uncertainties that
      could
      cause actual cash flows, results of operations, financial condition, cost
      reductions, acquisitions, dispositions, financing transactions, operations,
      expansion, consolidation and other events to differ materially from those
      expressed or implied in such forward-looking statements. Any forward-looking
      statements are also subject to a number of assumptions regarding, among other
      things, future economic, competitive and market conditions generally. These
      assumptions would be based on facts and conditions as they exist at the time
      such statements are made as well as predictions as to future facts and
      conditions, the accurate prediction of which may be difficult and involve the
      assessment of events beyond our control.




We
      wish
      to caution readers that forward-looking statements, including disclosures which
      use words such as “believe,” “intend,” “expect,” “may,” “should,” “anticipate,”
“could,” “estimate,” “plan,” “predict,” “project,” or their negatives, and
      similar statements, are subject to certain risks and uncertainties which could
      cause actual results to differ materially from expectations. These risks and
      uncertainties include, but are not limited to, the following: a change in the
      demand for coal by electric utility customers; the loss of one or more of our
      largest customers; our dependency on one railroad for transportation of a large
      percentage of our products; failure to exploit additional coal reserves; failure
      to diversify our operations; increased capital expenditures; increased
      compliance costs; lack of availability of financing sources; the effects of
      regulation and competition; and the risk factors set forth in this Annual Report
      on Form 10-K under Item 1A “Risk Factors.” Those are representative of factors
      that could affect the outcome of the forward-looking statements. These and
      the
      other factors discussed elsewhere in this document are not necessarily all
      of
      the important factors that could cause our results to differ materially from
      those expressed in our forward-looking statements. Forward-looking statements
      speak only as of the date they are made and we undertake no obligation to update
      them.





**Item
      1A.** **Risk
      Factors**




**Risks
      Related to the Coal Industry**





***Because
      the demand and pricing for coal is greatly influenced by consumption patterns
      of
      the domestic electricity generation industry, a reduction in the demand for
      coal
      by this industry would likely cause our revenues and profitability to decline
      significantly.***




We
      derived 88% of our total revenues (contract and spot) in 2006 and 85% of our
      total revenues in 2005, from our electric utility customers. Fuel cost is a
      significant component of the cost associated with coal-fired power generation,
      with respect to not only the price of the coal, but also the costs associated
      with emissions control and credits ( *i.e.* ,
      sulfur
      dioxide, nitrogen oxides, etc.), combustion by-product disposal ( *i.e.* ,
      ash)
      and equipment operations and maintenance ( *i.e.* ,
      materials handling facilities). All of these costs must be considered when
      choosing between coal generation and alternative methods, including natural
      gas,
      nuclear, hydroelectric and others.





Weather
      patterns also can greatly affect electricity generation. Extreme temperatures,
      both hot and cold, cause increased power usage and, therefore, increased
      generating requirements from all sources. Mild temperatures, on the other hand,
      result in lower electrical demand, which allows generators to choose the
      lowest-cost sources of power generation when deciding which generation sources
      to dispatch. Accordingly, significant changes in weather patterns could reduce
      the demand for our coal.




16


Overall
      economic activity and the associated demands for power by industrial users
      can
      have significant effects on overall electricity demand. Robust economic activity
      can cause much heavier demands for power, particularly if such activity results
      in increased utilization of industrial assets during evening and nighttime
      periods.





Any
      downward pressure on coal prices, whether due to increased use of alternative
      energy sources, changes in weather patterns, decreases in overall demand or
      otherwise, would likely cause our profitability to decline.




Deregulation
      of the electric utility industry may cause our customers to be more
      price-sensitive in purchasing coal, which could cause our profitability to
      decline.




Electric
      utility deregulation is expected to provide incentives to generators of
      electricity to minimize their fuel costs and is believed to have caused electric
      generators to be more aggressive in negotiating prices with coal suppliers.
      To
      the extent utility deregulation causes our customers to be more cost-sensitive,
      deregulation may have a negative effect on our profitability.




***Changes
      in the export and import markets for coal products could affect the demand
      for
      our coal, our pricing and our profitability.***




We
      compete in a worldwide market. The pricing and demand for our products is
      affected by a number of factors beyond our control. These factors
      include:




·
            currency
                exchange rates;·
            growth
                of economic development; and





·
            ocean
                freight rates.




Any
      decrease in the amount of coal exported from the United States, or any increase
      in the amount of coal imported into the United States, could have a material
      adverse impact on the demand for our coal, our pricing and our
      profitability.




***Increased
      consolidation and competition in the U.S. coal industry may adversely affect
      our
      revenues and profitability.***




During
      the last several years, the U.S. coal industry has experienced increased
      consolidation, which has contributed to the industry becoming more competitive.
      Consequently, many of our competitors in the domestic coal industry are major
      coal producers who have significantly greater financial resources than us.
      The
      intense competition among coal producers may impact our ability to retain or
      attract customers and may therefore adversely affect our future revenues and
      profitability.




***Fluctuations
      in transportation costs and the availability and dependability of transportation
      could affect the demand for our coal and our ability to deliver coal to our
      customers.***




Increases
      in transportation costs could have an adverse effect on demand for our coal.
      Customers choose coal supplies based, primarily, on the total delivered cost
      of
      coal. Any increase in transportation costs would cause an increase in the total
      delivered cost of coal. That could cause some of our customers to seek less
      expensive sources of coal or alternative fuels to satisfy their energy needs.
      In
      addition, significant decreases in transportation costs from other
      coal-producing regions, both domestic and international, could result in
      increased competition from coal producers in those regions. For instance, coal
      mines in the western United States could become more attractive as a source
      of
      coal to consumers in the eastern United States. if the costs of transporting
      coal from the West were significantly reduced.





Our
      Central Appalachia mines generally ship coal via rail systems. During 2006,
      we
      shipped in excess of 95% of our coal from our Central Appalachia mines via
      CSX.
      In the Midwest, we shipped approximately 63% of our produced coal by truck
      and
      the remainder via rail systems. Our dependence upon railroads and third party
      trucking companies impacts our ability to deliver coal to our customers.
      Disruption of service due to weather-related problems, strikes, lockouts,
      bottlenecks and other events could temporarily impair our ability to supply
      coal
      to our customers, resulting in decreased shipments. Decreased performance levels
      over longer periods of time could cause our customers to look elsewhere for
      their fuel needs, negatively affecting our revenues and
      profitability.




17


In
      past
      years, the major eastern railroads (CSX and Norfolk Southern) have experienced
      an increase in overall rail traffic from the expanding economy and shortages
      of
      both equipment and personnel. This increase in traffic could impact our ability
      to obtain the necessary rail cars to deliver coal to our customers and have
      an
      adverse impact on our financial results.





***Shortages
      or increased costs of skilled labor in the Central Appalachian coal region
      may
      hamper our ability to achieve high labor productivity and competitive
      costs.***




Coal
      mining continues to be a labor-intensive industry. As the demand for coal has
      increased, many producers have attempted to increase coal production, which
      has
      resulted in a competitive market for the limited supply of trained coal miners
      in the Central Appalachian region. In some cases, this market situation has
      caused compensation levels to increase, particularly for “skilled” positions
      such as electricians and mine foremen. To maintain current production levels,
      we
      may be forced to respond to these increases in wages and other forms of
      compensation, and related recruiting efforts by our competitors. Any future
      shortage of skilled miners, or increases in our labor costs, could have an
      adverse impact on our labor productivity and costs and on our ability to expand
      production.




***Government
      laws, regulations and other requirements relating to the protection of the
      environment, health and safety and other matters impose significant costs on
      us,
      and future requirements could limit our ability to produce
      coal.***




We
      are
      subject to extensive federal, state and local regulations with respect to
      matters such as:




·
            employee
                health and safety;·
            permitting
                and licensing requirements;





·
            air
                quality standards;·
            water
                quality standards;





·
            plant,
                wildlife and wetland protection;·
            blasting
                operations;





·
            the
                management and disposal of hazardous and non-hazardous materials
                generated
                by mining operations;·
            the
                storage of petroleum products and other hazardous
                substances;





·
            reclamation
                and restoration of properties after mining operations are
                completed;·
            discharge
                of materials into the environment, including air emissions and wastewater
                discharge;





·
            surface
                subsidence from underground mining; and·
            the
                effects of mining operations on groundwater quality and
                availability.





Complying
      with these requirements, including the terms of our permits, has had, and will
      continue to have, a significant effect on our costs of operations. We could
      incur substantial costs, including clean up costs, fines, civil or criminal
      sanctions and third party claims for personal injury or property damage as
      a
      result of violations of or liabilities under these laws and
      regulations.




The
      coal
      industry is also affected by significant legislation mandating specified
      benefits for retired miners. In addition, the utility industry, which is the
      most significant end user of coal, is subject to extensive regulation regarding
      the environmental impact of its power generating activities. Coal contains
      impurities, including sulfur, mercury, chlorine and other elements or compounds,
      many of which are released into the air when coal is burned. Stricter
      environmental regulations of emissions from coal-fired electric generating
      plants could increase the costs of using coal, thereby reducing demand for
      coal
      as a fuel source or the volume and price of our coal sales, or making coal
      a
      less attractive fuel alternative in the planning and building of utility power
      plants in the future.





18


New
      legislation, regulations and orders adopted or implemented in the future (or
      changes in interpretations of existing laws and regulations) may materially
      adversely affect our mining operations, our cost structure and our customers’
operations or ability to use coal.




The
      majority of our coal supply agreements contain provisions that allow the
      purchaser to terminate its contract if legislation is passed that either
      restricts the use or type of coal permissible at the purchaser’s plant or
      results in too great an increase in the cost of coal. These factors and
      legislation, if enacted, could have a material adverse effect on our financial
      condition and results of operations.




***The
      passage of legislation responsive to the Framework Convention on Global Climate
      Change or similar governmental initiatives could result in restrictions on
      coal
      use.***




The
      United States and more than 160 other nations are signatories to the 1992
      Framework Convention on Global Climate Change, commonly known as the Kyoto
      Protocol, which is intended to limit or capture emissions of greenhouse gases,
      such as carbon dioxide. In December 1997, the signatories to the convention
      established a potentially binding set of emissions targets for developed
      nations. Although the specific emissions targets vary from country to country,
      the United States would be required to reduce emissions to 93% of 1990 levels
      over a five-year budget period from 2008 through 2012. The U.S. Senate has
      not
      ratified the treaty commitments, and the Bush administration has officially
      opposed the Kyoto Protocol and has proposed an alternative to reduce the
      intensity of United States emissions of greenhouse gases. With Russia’s
      ratification of the Kyoto Protocol in 2004, it became binding on all ratifying
      countries. The implementation of the Kyoto Protocol in a number of countries,
      and other emissions limits, such as those adopted by the European Union, could
      affect demand for coal outside the United States. If the Kyoto Protocol or
      other
      comprehensive legislation focusing on greenhouse gas emissions is enacted by
      the
      United States, it could have the effect of restricting the use of coal. Other
      efforts to reduce emissions of greenhouse gases and federal initiatives to
      encourage the use of natural gas also may affect the use of coal as an energy
      source.




***We
      are subject to the federal Clean Water Act and similar state laws which impose
      treatment, monitoring and reporting obligations.***




The
      federal Clean Water Act and corresponding state laws affect coal mining
      operations by imposing restrictions on discharges into regulated waters. Permits
      requiring regular monitoring and compliance with effluent limitations and
      reporting requirements govern the discharge of pollutants into regulated waters.
      New requirements under the Clean Water Act and corresponding state laws could
      cause us to incur significant additional costs that adversely affect our
      operating results.




***New
      regulations have expanded the definition of black lung disease and generally
      made it easier for claimants to assert and prosecute claims, which could
      increase our exposure to black lung benefit
      liabilities.***




In
      January 2001, the United States Department of Labor amended the regulations
      implementing the federal black lung laws to give greater weight to the opinion
      of a claimant’s treating physician, expand the definition of black lung disease
      and limit the amount of medical evidence that can be submitted by claimants
      and
      respondents. The amendments also alter administrative procedures for the
      adjudication of claims, which, according to the Department of Labor, results
      in
      streamlined procedures that are less formal, less adversarial and easier for
      participants to understand. These and other changes to the federal black lung
      regulations could significantly increase our exposure to black lung benefits
      liabilities.




In
      recent
      years, legislation on black lung reform has been introduced but not enacted
      in
      Congress. It is possible that this legislation will be reintroduced for
      consideration by Congress. If any of the proposals included in this or similar
      legislation is passed, the number of claimants who are awarded benefits could
      significantly increase. Any such changes in black lung legislation, if approved,
      may adversely affect our business, financial condition and results of
      operations.





19


***Extensive
      environmental laws and regulations affect the end-users of coal and could reduce
      the demand for coal as a fuel source and cause the volume of our sales to
      decline.***




The
      Clean
      Air Act and similar state and local laws extensively regulate the amount of
      sulfur dioxide, particulate matter, nitrogen oxides, mercury and other compounds
      emitted into the air from electric power plants, which are the largest end-users
      of our coal. Compliance with such laws and regulations, which can take a variety
      of forms, may reduce demand for coal as a fuel source because they require
      significant emissions control expenditures for coal-fired power plants to attain
      applicable ambient air quality standards, which may lead these generators to
      switch to other fuels that generate less of these emissions and may also reduce
      future demand for the construction of coal-fired power plants.




The
      U.S.
      Department of Justice, on behalf of the EPA, has filed lawsuits against several
      investor-owned electric utilities and brought an administrative action against
      one government-owned utility for alleged violations of the Clean Air Act. We
      supply coal to some of the currently-affected utilities, and it is possible
      that
      other of our customers will be sued. These lawsuits could require the utilities
      to pay penalties, install pollution control equipment or undertake other
      emission reduction measures, any of which could adversely impact their demand
      for our coal.




A
      regional haze program initiated by the EPA to protect and to improve visibility
      at and around national parks, national wilderness areas and international parks
      restricts the construction of new coal-fired power plants whose operation may
      impair visibility at and around federally protected areas and may require some
      existing coal-fired power plants to install additional control measures designed
      to limit haze-causing emissions.




The
      Clean
      Air Act also imposes standards on sources of hazardous air pollutants. For
      example, the EPA has announced that it would regulate hazardous air pollutants
      from coal-fired power plants. Under the Clean Air Act, coal-fired power plants
      will be required to control hazardous air pollution emissions by no later than
      2009, which likely will require significant new investment in controls by power
      plant operators. These standards and future standards could have the effect
      of
      decreasing demand for coal.




Other
      so-called multi-pollutant bills, which could regulate additional air pollutants,
      have been proposed by various members of Congress. If such initiatives are
      enacted into law, power plant operators could choose other fuel sources to
      meet
      their requirements, reducing the demand for coal.




***The
      characteristics of coal may make it difficult for coal users to comply with
      various environmental standards related to coal combustion. As a result, they
      may switch to other fuels, which would affect the volume of our
      sales.***




Coal
      contains impurities, including sulfur, nitrogen oxide, mercury, chlorine and
      other elements or compounds, many of which are released into the air when coal
      is burned. Stricter environmental regulations of emissions from coal-fired
      electric generating plants could increase the costs of using coal thereby
      reducing demand for coal as a fuel source, and the volume and price of our
      coal
      sales. Stricter regulations could make coal a less attractive fuel alternative
      in the planning and building of utility power plants in the future.




For
      example, in order to meet the federal Clean Air Act limits for sulfur dioxide
      emissions from electric power plants, coal users may need to install scrubbers,
      use sulfur dioxide emission allowances (some of which they may purchase), blend
      high sulfur coal with low sulfur coal or switch to other fuels. Each option
      has
      limitations. Lower sulfur coal may be more costly to purchase on an energy
      basis
      than higher sulfur coal depending on mining and transportation costs. The cost
      of installing scrubbers is significant and emission allowances may become more
      expensive as their availability declines. Switching to other fuels may require
      expensive modification of existing plants.




On
      March
      15, 2005, the U.S. Environmental Protection Agency adopted a new federal rule
      to
      cap and reduce mercury emissions from both new and existing coal-fired power
      plants. The reductions will be implemented in stages, primarily through a
      market-based cap-and-trade program. Nevertheless, the new regulations will
      likely require some power plants to install new equipment, at substantial cost,
      or discourage the use of certain coals containing higher levels of
      mercury.





20


Other
      new
      and proposed reductions in emissions of sulfur dioxides, nitrogen oxides,
      particulate matter or greenhouse gases may require the installation of
      additional costly control technology or the implementation of other measures,
      including trading of emission allowances and switching to other fuels. For
      example, the Environmental Protection Agency recently proposed separate
      regulations to reduce the interstate transport of fine particulate matter and
      ozone through reductions in sulfur dioxides and nitrogen oxides through the
      eastern United States. The Environmental Protection Agency continues to require
      reduction of nitrogen oxide emissions in 22 eastern states and the District
      of
      Columbia and will require reduction of particulate matter emissions over the
      next several years for areas that do not meet air quality standards for fine
      particulates. In addition, Congress and several states are now considering
      legislation to further control air emissions of multiple pollutants from
      electric generating facilities and other large emitters. These new and proposed
      reductions will make it more costly to operate coal-fired plants and could
      make
      coal a less attractive fuel alternative to the planning and building of utility
      power plants in the future. To the extent that any new or proposed requirements
      affect our customers, this could adversely affect our operations and
      results.




***We
      must obtain governmental permits and approvals for mining operations, which
      can
      be a costly and time consuming process and result in restrictions on our
      operations.***




Numerous
      governmental permits and approvals are required for mining operations. Our
      operations are principally regulated under permits issued by state regulatory
      and enforcement agencies pursuant to the Surface Mining Control and Reclamation
      Act (SMCRA). Regulatory authorities exercise considerable discretion in the
      timing and scope of permit issuance. Requirements imposed by these authorities
      may be costly and time consuming and may result in delays in the commencement
      or
      continuation of exploration or production operations. In addition, we often
      are
      required to prepare and present to federal, state and local authorities data
      pertaining to the effect or impact that proposed exploration for or production
      of coal might have on the environment. Further, the public may comment on and
      otherwise engage in the permitting process, including through intervention
      in
      the courts. Accordingly, the permits we need may not be issued, or, if issued,
      may not be issued in a timely fashion, or may involve requirements that restrict
      our ability to conduct our mining operations or to do so
      profitably.




Prior
      to
      placing excess fill material in valleys, coal mining companies are required
      to
      obtain a permit from the U.S. Army Corps of Engineers under Section 404 of
      the
      Clean Water Act. The permit can be either a simplified Nation Wide Permit #21
      (NWP 21) or a more complicated individual permit. On July 8, 2004, U.S. District
      Judge Joseph R. Goodwin of the Southern District of West Virginia, Huntington
      Division found that NWP 21 is in violation of the Clean Water Act. This ruling
      applied only to certain counties in southern West Virginia (where we do not
      now
      operate) and did allow permits to continue to be issued under the more costly
      and time consuming individual permit process. On November 23, 2005, the
      4 th Circuit
      U.S. Court of Appeals completely reversed Judge Goodwin and held that NWP 21
      are
      valid permits.




In
      January 2005, a virtually identical claim to that filed in West Virginia was
      filed in Kentucky. The plaintiffs in this case, *Kentucky
      Riverkeepers, Inc., et al. v. Colonel Robert A. Rowlette, Jr., et
      al.* ,
      Civil
      Action No 05-CV-36-JBC, seek the same relief as that sought in West Virginia.
      The court heard oral arguments on a summary judgment motion in late 2005 and
      there has been no action by the court since that time. A ruling for the
      plaintiffs in this matter could have an adverse impact on our planned surface
      mining operations.




***We
      have significant reclamation and mine closure obligations. If the assumptions
      underlying our accruals are materially inaccurate, we could be required to
      expend greater amounts than anticipated.***




The
      SMCRA
      establishes operational, reclamation and closure standards for all aspects
      of
      surface mining as well as many aspects of underground mining. We accrue for
      the
      costs of current mine disturbance and of final mine closure, including the
      cost
      of treating mine water discharge where necessary. Under U.S. generally accepted
      accounting principles we are required to account for the costs related to the
      closure of mines and the reclamation of the land upon exhaustion of coal
      reserves. Specifically, the fair value of an asset retirement obligation is
      recognized in the period in which it is incurred if a reasonable estimate of
      fair value can be made. The present value of the estimated asset retirement
      costs is capitalized as part of the carrying amount of the long-lived asset.
      At
      December 31, 2006, we had accrued $29.7 million related to estimated mine
      reclamation costs. These amounts recorded are dependent upon a number of
      variables, including the estimated future retirement costs, estimated proven
      reserves, assumptions involving profit margins, inflation rates, and the assumed
      credit-adjusted risk-free interest rates. Furthermore, these obligations are
      unfunded. If these accruals are insufficient or our liability in a particular
      year is greater than currently anticipated, our future operating results could
      be adversely affected.




21


***Terrorist
      attacks and threats, escalation of military activity in response to such attacks
      or acts of war may negatively affect our business, financial condition and
      results of operations.***




Terrorist
      attacks and threats, escalation of military activity in response to such attacks
      or acts of war may negatively affect our business, financial condition and
      results of operations. Our business is affected by general economic conditions,
      fluctuations in consumer confidence and spending, and market liquidity, which
      can decline as a result of numerous factors outside of our control, such as
      terrorist attacks and acts of war. Future terrorist attacks against U.S.
      targets, rumors or threats of war, actual conflicts involving the United States
      or its allies, or military or trade disruptions affecting our customers could
      cause delays or losses in transportation and deliveries of coal to our
      customers, decreased sales of our coal and extension of time for payment of
      accounts receivable from our customers. Strategic targets such as energy-related
      assets may be at greater risk of future terrorist attacks than other targets
      in
      the United States. In addition, disruption or significant increases in energy
      prices could result in government-imposed price controls. It is possible that
      any, or a combination, of these occurrences could have a material adverse effect
      on our business, financial condition and results of operations.




**Risks
      Related to Our Operations**





***The
      loss of, or significant reduction in, purchases by our largest customers could
      adversely affect our revenues.***




For
      2006,
      we generated approximately 77% of our total revenues from several long-term
      contracts with electrical utilities, including 25% from our largest customer,
      Georgia Power Company, and 16% from South Carolina Public Service Authority.
      At
      December 31, 2006, we had coal supply agreements with these customers that
      expire in 2007 to 2009. The execution of a substantial coal supply agreement
      is
      frequently the basis on which we undertake the development of coal reserves
      required to be supplied under the contract.




Many
      of
      our coal supply agreements contain provisions that permit adjustment of the
      contract price upward or downward at specified times. Failure of the parties
      to
      agree on a price under those provisions may allow either party to either
      terminate the contract or reduce the coal to be delivered under the contract.
      Coal supply agreements also typically contain force majeure provisions allowing
      temporary suspension of performance by the customer or us for the duration
      of
      specified events beyond the control of the affected party. Most coal supply
      agreements contain provisions requiring us to deliver coal meeting quality
      thresholds for certain characteristics such as:





·
            British
                thermal units (Btu’s);·
            sulfur
                content;





·
            ash
                content;·
            grindability;
                and





·
            ash
                fusion temperature.





In
      some
      cases, failure to meet these specifications could result in economic penalties,
      including price adjustments, the rejection of deliveries or termination of
      the
      contracts. In addition, all of our contracts allow our customers to renegotiate
      or terminate their contracts in the event of changes in regulations or other
      governmental impositions affecting our industry that increase the cost of coal
      beyond specified limits. Further, we have been required in the past to purchase
      sulfur credits or make other pricing adjustments to comply with contractual
      requirements relating to the sulfur content of coal sold to our customers,
      and
      may be required to do so in the future.




The
      operating profits we realize from coal sold under supply agreements depend
      on a
      variety of factors. In addition, price adjustment and other provisions may
      increase our exposure to short-term coal price volatility provided by those
      contracts. If a substantial portion of our coal supply agreements are modified
      or terminated, we could be materially adversely affected to the extent that
      we
      are unable to find alternate buyers for our coal at the same level of
      profitability. As a result, we might not be able to replace existing long-term
      coal supply agreements at the same prices or with similar profit margins when
      they expire.




22


***Our
      operating results will be negatively impacted if we are unable to balance our
      mix of contract and spot sales.***




We
      have
      implemented a sales plan that includes long-term contracts (greater than one
      year) and spot sales/short-term contracts (less than one year). We have
      structured our sales plan based on the assumptions that demand will remain
      adequate to maintain current shipping levels and that any disruptions in the
      market will be relatively short-lived. If we are unable to maintain a balance
      of
      contract sales with spot sales, or our markets become depressed for an extended
      period of time, our volumes and margins could decrease, negatively affecting
      our
      operating results.




***Our
      ability to operate our company effectively could be impaired if we lose senior
      executives or fail to employ needed additional
      personnel.***




The
      loss
      of senior executives could have a material adverse effect on our business.
      There
      may be a limited number of persons with the requisite experience and skills
      to
      serve in our senior management positions. We may not be able to locate or employ
      qualified executives on acceptable terms. In addition, as our business develops
      and expands, we believe that our future success will depend greatly on our
      continued ability to attract and retain highly skilled and qualified personnel.
      We might not continue to be able to employ key personnel, or to attract and
      retain qualified personnel in the future. Failure to retain senior executives
      or
      attract key personnel could have a material adverse effect on our operations
      and
      financial results.




***Underground
      mining is subject to increased regulation, and may require us to incur
      additional cost.***





The
      mine
      disasters that occured during 2006 in West Virginia and other states led to
      the
      enactment of significant new federal and state laws and regulations relating
      to
      safety in underground coal mines.   These laws and regulations include
      requirements for constructing and maintaining caches for the storage of
      additional self-contained self rescuers throughout underground mines; constant
      tracking of personnel in the mines; installing cable lifelines from the mine
      portal to all sections of the mine to assist in emergency escape; submission
      and
      approval of emergency response plans; and new and additional safety
      training.  Additionally, new requirements for the prompt reporting of
      accidents and increased fines and penalties for violation of these and existing
      regulations have been implemented.  These new laws and regulations will
      cause us to incur additional costs, which will adversely impact our operating
      performance.





***Unexpected
      increases in raw material costs could significantly impair our operating
      results.***




Our
      coal
      mining operations use significant amounts of steel, petroleum products and
      other
      raw materials in various pieces of mining equipment, supplies and materials,
      including the roof bolts required by the room and pillar method of mining.
      Recently, petroleum prices and other commodity prices have risen significantly,
      and, historically, the prices of scrap steel and petroleum have fluctuated.
      If
      the price of steel or other of these materials continue to increase, our
      operational expenses will increase, which could have a significant negative
      impact on our operating results.




***Coal
      mining is subject to conditions or events beyond our control, which could cause
      our quarterly or annual results to deteriorate.***




Our
      coal
      mining operations are conducted, in large part, in underground mines and, to
      a
      lesser extent, at surface mines. These mines are subject to conditions or events
      beyond our control that could disrupt operations, affect production and the
      cost
      of mining at particular mines for varying lengths of time and have a significant
      impact on our operating results. These conditions or events have
      included:




·
            variations
                in thickness of the layer, or seam, of coal;·
            variations
                in geological conditions;





·
            amounts
                of rock and other natural materials intruding into the coal
                seam;




23


·
            equipment
                failures and unexpected major
                repairs;





·
            unexpected
                maintenance problems;·
            unexpected
                departures of one or more of our contract
                miners;





·
            fires
                and explosions from methane and other sources;·
            accidental
                minewater discharges or other environmental
                accidents;





·
            other
                accidents or natural disasters; and·
            weather
                conditions.





***Mining
      in Central Appalachia is complex due to geological characteristics of the
      region.***




The
      geological characteristics of coal reserves in Central Appalachia, such as
      depth
      of overburden and coal seam thickness, make them complex and costly to mine.
      As
      mines become depleted, replacement reserves may not be available when required
      or, if available, may not be capable of being mined at costs comparable to
      those
      characteristic of the depleting mines. These factors could materially adversely
      affect the mining operations and cost structures of, and customers’ ability to
      use coal produced by, operators in Central Appalachia, including
      us.




***Our
      future success depends upon our ability to acquire or develop additional coal
      reserves that are economically recoverable.***




Our
      recoverable reserves decline as we produce coal. Since we attempt, where
      practical, to mine our lowest-cost reserves first, we may not be able to mine
      all of our reserves as profitably as we do at our current operations. Our
      planned development and exploration projects might not result in significant
      additional reserves, and we might not have continuing success developing
      additional mines. For example, our construction of additional mining facilities
      necessary to exploit our reserves could be delayed or terminated due to various
      factors, including unforeseen geological conditions, weather delays or
      unanticipated development costs. Our ability to acquire additional coal reserves
      in the future also could be limited by restrictions under our existing or future
      debt facilities, competition from other coal companies for attractive
      properties, or the lack of suitable acquisition candidates.




In
      order
      to develop our reserves, we must receive various governmental permits. We have
      not yet applied for the permits required or developed the mines necessary to
      mine all of our reserves. In addition, we might not continue to receive the
      permits necessary for us to operate profitably in the future. We may not be
      able
      to negotiate new leases from the government or from private parties or obtain
      mining contracts for properties containing additional reserves or maintain
      our
      leasehold interests in properties on which mining operations are not commenced
      during the term of the lease.





***Factors
      beyond our control could impact the amount and pricing of coal supplied by
      our
      independent contractors and other third parties.***




In
      addition to coal we produce from our Company-operated mines, we have mines
      that
      typically are operated by independent contract mine operators, and we purchase
      coal from third parties for resale. For 2007, we anticipate approximately 2%
      of
      our total production will come from mines operated by independent contract
      mine
      operators and approximately 2% of our total coal produced will come from third
      party purchased coal sources. Operational difficulties, changes in demand for
      contract mine operators from our competitors and other factors beyond our
      control could affect the availability, pricing and quality of coal produced
      for
      us by independent contract mine operators. The demand for contract mining
      companies has increased significantly due to the current strong market prices
      for coal from Central Appalachia. Disruptions in supply, increases in prices
      paid for coal produced by independent contract mine operators or purchased
      from
      third parties, or the availability of more lucrative direct sales opportunities
      for our purchased coal sources could increase our costs or lower our volumes,
      either of which could negatively affect our profitability.





***We
      face significant uncertainty in estimating our recoverable coal reserves, and
      variations from those estimates could lead to decreased revenues and
      profitability.***




24


Forecasts
      of our future performance are based on estimates of our recoverable coal
      reserves. Estimates of those reserves are based on studies conducted by Marshall
      Miller & Associates, Inc. in accordance with industry-accepted standards
      which we have updated for current activity using similar methodologies. A number
      of sources of information were used to determine recoverable reserves estimates,
      including:




·
            currently
                available geological, mining and property control data and
                maps;·
            our
                own operational experience and that of our
                consultants;





·
            historical
                production from similar areas with similar conditions;·
            previously
                completed geological and reserve
                studies;





·
            the
                assumed effects of regulations and taxes by governmental agencies;
                and·
            assumptions
                governing future prices and future operating
                costs.





Reserve
      estimates will change from time to time to reflect, among other
      factors:





·
            mining
                activities;·
            new
                engineering and geological data;





·
            acquisition
                or divestiture of reserve holdings; and·
            modification
                of mining plans or mining methods.




Therefore,
      actual coal tonnage recovered from identified reserve areas or properties,
      and
      costs associated with our mining operations, may vary from estimates. These
      variations could be material, and therefore could result in decreased
      profitability.




***Our
      operations could be adversely affected if we are unable to obtain required
      surety bonds.***




Federal
      and state laws require bonds to secure our obligations to reclaim lands used
      for
      mining, to pay federal and state workers’ compensation and to satisfy other
      miscellaneous obligations. As of December 31, 2006, we had outstanding surety
      bonds with third parties for post-mining reclamation totaling $54.8 million.
      Furthermore, we have surety bonds for an additional $40.3 million in place
      for
      our federal and state workers’ compensation obligations and other miscellaneous
      obligations. Insurance companies have informed us, along with other participants
      in the coal industry, that they no longer will provide surety bonds for workers’
compensation and other post-employment benefits without collateral. We have
      satisfied our obligations under these statutes and regulations by providing
      letters of credit or other assurances of payment. However, letters of credit
      can
      be significantly more costly to us than surety bonds. The issuance of letters
      of
      credit under our senior secured credit facility also reduces amounts that we
      can
      borrow under our senior secured credit facility for other purposes. If we are
      unable to secure surety bonds for these obligations in the future, and are
      forced to secure letters of credit indefinitely, our profitability may be
      negatively affected.




***We
      have significant unfunded obligations for long-term employee benefits for which
      we accrue based upon assumptions, which, if incorrect, could result in us being
      required to expend greater amounts than anticipated.***




We
      are
      required by law to provide various long-term employee benefits. We accrue
      amounts for these obligations based on the present value of expected future
      costs. We employed an independent actuary to complete estimates for our workers’
compensation and black lung (both state and federal) obligations. At December
      31, 2006, the current and non-current portions of these obligations included
      $26.8 million for coal workers’ black lung benefits and $53.4 million for
      workers’ compensation benefits.





We
      use a
      valuation method under which the total present and future liabilities are booked
      based on actuarial studies. Our independent actuary updates these liability
      estimates annually. However, if our assumptions are incorrect, we could be
      required to expend greater amounts than anticipated. All of these obligations
      are unfunded. In addition, the federal government and the governments of the
      states in which we operate consider changes in workers’ compensation laws from
      time to time. Such changes, if enacted, could increase our benefit expenses
      and
      payments.




25


***We
      may be unable to adequately provide funding for our pension plan obligations
      based on our current estimates of those obligations.***




We
      provide pension benefits to eligible employees. As of December 31, 2006, we
      estimated that our pension plan was underfunded by approximately $13.0 million.
      If future payments are insufficient to fund the pension plan adequately to
      cover
      our future pension obligations, we could incur cash expenditures and costs
      materially higher than anticipated. The pension obligation 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.




***Substantially
      all of our assets are subject to security interests.***




Substantially
      all of our cash, receivables, inventory and other assets are subject to various
      liens and security interests under our debt instruments. If one of these
      security interest holders becomes entitled to exercise its rights as a secured
      party, it would have the right to foreclose upon and sell, or otherwise
      transfer, the collateral subject to its security interest, and the collateral
      accordingly would be unavailable to us and our other creditors, except to the
      extent, if any, that other creditors have a superior or equal security interest
      in the affected collateral or the value of the affected collateral exceeds
      the
      amount of indebtedness in respect of which these foreclosure rights are
      exercised.




***We
      may be unable to comply with restrictions imposed by the terms of our
      indebtedness, which could result in a default under these
      instruments.***




During
      2006, we entered into four amendments to our Prior Senior Secured Facility
      in
      order to revise the financial covenants to levels that we projected we could
      comply with during the year. In February 2007, we entered into new debt
      facilities that replace the Prior Senior Secured Facilities. Our new debt
      instruments impose a number of restrictions on us. A failure to comply with
      these restrictions could adversely affect our ability to borrow under our
      revolving credit facility or result in an event of default under our debt
      instruments. Our debt instruments contain financial and other covenants that
      create limitations on our ability to, among other things, borrow the full amount
      on our revolver, issue letters of credit under our letter of credit facility
      or
      incur additional debt, and require us to maintain various financial ratios
      and
      comply with various other financial covenants. These covenants include the
      following:




·
            minimum
                EBITDA;·
            maximum
                total leverage ratio: and·
            maximum
                limits on capital expenditures.





In
      the
      event of a default, our lenders could terminate their commitments to us and
      declare all amounts borrowed, together with accrued interest and fees,
      immediately due and payable. If this were to occur, we might not be able to
      pay
      these amounts or we might be forced to seek amendments to our debt agreements
      which could make the terms of these agreements more onerous for us and require
      the payment of amendment or waiver fees. Failure to comply with these
      restrictions, even if waived by our lenders, also could adversely affect our
      credit ratings, which could increase our costs of debt financings and impair
      our
      ability to obtain additional debt financing.





***Changes
      in our credit ratings could adversely affect our costs and
      expenses.***




Any
      downgrade in our credit ratings could adversely affect our ability to borrow
      and
      result in more restrictive borrowing terms, including increased borrowing costs,
      more restrictive covenants and the extension of less open credit. This, in
      turn,
      could affect our internal cost of capital estimates and therefore impact
      operational decisions.




***Defects
      in title or loss of any leasehold interests in our properties could limit our
      ability to mine these properties or result in significant unanticipated
      costs.***




26


We
      conduct substantially all of our mining operations on properties that we lease.
      The loss of any lease could adversely affect our ability to mine the associated
      reserves. Because we generally do not obtain title insurance or otherwise verify
      title to our leased properties, our right to mine some of our reserves has
      been
      in the past, and may again in the future be, adversely affected if defects
      in
      title or boundaries exist. In order to obtain leases or rights to conduct our
      mining operations on property where these defects exist, we have had to, and
      may
      in the future have to, incur unanticipated costs. In addition, we may not be
      able to successfully negotiate new leases for properties containing additional
      reserves. Some leases have minimum production requirements. Failure to meet
      those requirements could result in losses of prepaid royalties and, in some
      rare
      cases, could result in a loss of the lease itself.




***Inability
      to satisfy contractual obligations may adversely affect our
      profitability.***




From
      time
      to time, we have disputes with our customers over the provisions of long-term
      contracts relating to, among other things, coal quality, pricing, quantity
      and
      delays in delivery. In addition, we may not be able to produce sufficient
      amounts of coal to meet our commitments to our customers. Our inability to
      satisfy our contractual obligations could result in our need to purchase coal
      from third party sources to satisfy those obligations or may result in customers
      initiating claims against us. We may not be able to resolve all of these
      disputes in a satisfactory manner, which could result in substantial damages
      or
      otherwise harm our relationships with customers.




***The
      termination or disallowance of Section 29 tax credits for synfuel plants by
      the
      Internal Revenue Service could decrease our revenues.***




We
      supply
      coal to a third party synfuel plant and receive fees for the handling, shipping
      and marketing of the synfuel product. Synfuel is a synthetic fuel product that
      is produced by chemically altering coal. In 2006, 1% of our total revenues
      came
      from synfuel handling, shipping and marketing revenues. Sales of the fuel
      processed through these types of facilities are eligible for non-conventional
      fuels tax credits under Section 29 of the Internal Revenue Code. The owner
      of
      the facility that we supply with coal has obtained a Private Letter Ruling
      (“PLR”) from the Internal Revenue Service confirming that the facility produces
      a qualified fuel eligible for Section 29 tax credits. The Section 29 tax credit
      program is scheduled to expire on December 31, 2007. There is a risk that the
      IRS could modify or disallow the Section 29 tax credit, or (in certain
      circumstances related to the market price of oil), terminate the credit earlier
      than expected, making operation of the synfuel plant unprofitable. Additionally,
      recent market prices of oil caused the synfuel plants to cease operations during
      a portion of 2006. Additional synfuel plant closures will result in the loss
      of
      the handling, shipping and marketing fees for our services, which may negatively
      affect our profitability.




***We
      may be unable to exploit opportunities to diversify our
      operations.***




Our
      future business plan may consider opportunities other than underground and
      surface mining in eastern Kentucky and southern Indiana. We will consider
      opportunities to further increase the percentage of coal that comes from surface
      mines. We may also consider opportunities to expand both surface and underground
      mining activities in areas that are outside of eastern Kentucky and southern
      Indiana. We may also consider opportunities in other energy-related areas that
      are not prohibited by the Indenture governing our senior notes due 2012. If
      we
      undertake these diversification strategies and fail to execute them
      successfully, our financial condition and results of operations may be adversely
      affected.





***There
      are risks associated with our acquisition strategy, including our inability
      to
      successfully complete acquisitions, our assumption of liabilities, dilution
      of
      your investment, significant costs and additional financing
      required.***




We
      may
      explore opportunities to expand our operations through strategic acquisitions
      of
      other coal mining companies. We currently have no agreement or understanding
      for
      any specific acquisition. Risks associated with our current and potential
      acquisitions include the disruption of our ongoing business, problems retaining
      the employees of the acquired business, assets acquired proving to be less
      valuable than expected, the potential assumption of unknown or unexpected
      liabilities, costs and problems, the inability of management to maintain uniform
      standards, controls, procedures and policies, the difficulty of managing a
      larger company, the risk of becoming involved in labor, commercial or regulatory
      disputes or litigation related to the new enterprises and the difficulty of
      integrating the acquired operations and personnel into our existing
      business.




27


We
      may
      choose to use shares of our common stock or other securities to finance a
      portion of the consideration for future acquisitions, either by issuing them
      to
      pay a portion of the purchase price or selling additional shares to investors
      to
      raise cash to pay a portion of the purchase price. If shares of our common
      stock
      do not maintain sufficient market value or potential acquisition candidates
      are
      unwilling to accept shares of our common stock as part of the consideration
      for
      the sale of their businesses, we will be required to raise capital through
      additional sales of debt or equity securities, which might not be possible,
      or
      forego the acquisition opportunity, and our growth could be limited. In
      addition, securities issued in such acquisitions may dilute the holdings of
      our
      current or future shareholders.





***Our
      currently available cash may not be sufficient to finance any additional
      acquisitions.***




We
      believe that our cash on hand, the cash provided by our new Term Facility,
      the
      availability under our new Revolver and cash generated from our operations
      will
      provide us with adequate liquidity for at least the next twelve months. However,
      such funds likely will not provide sufficient cash to fund any future
      acquisitions. Accordingly, we may need to conduct additional debt or equity
      financings in order to fund any such additional acquisitions, unless we issue
      shares of our common stock as consideration for those acquisitions. If we are
      unable to obtain any such financings, we may be required to forego future
      acquisition opportunities.




***Our
      current reserve base in the Midwest is limited.***




Our
      southern Indiana mining complex currently has rights to proven and probable
      reserves that we believe will be exhausted in approximately 12.1 years at 2006
      levels of production, compared to our current Central Appalachia mining
      complexes, which have reserves that we believe will last an average of
      approximately 26.0 years at 2006 levels of production. We intend to increase
      our
      reserves in southern Indiana by acquiring rights to additional exploitable
      reserves that are either adjacent to or nearby our current reserves. If we
      are
      unable to successfully acquire such rights on acceptable terms, or if our
      exploration or acquisition activities indicate that such coal reserves or rights
      do not exist or are not available on acceptable terms, our production and
      revenues will decline as our reserves in that region are depleted. Exhaustion
      of
      reserves at particular mines also may have an adverse effect on our operating
      results that is disproportionate to the percentage of overall production
      represented by such mines.




***Surface
      mining is subject to increased regulation, and may require us to incur
      additional costs.***





Surface
      mining is subject to numerous regulations related to blasting activities that
      can result in additional costs. For example, when blasting in close proximity
      to
      structures, additional costs are incurred in designing and implementing more
      complex blast delay regimens, conducting pre-blast surveys and blast monitoring,
      and the risk of potential blast-related damages increases. Since the nature
      of
      surface mining requires ongoing disturbance to the surface, environmental
      compliance costs can be significantly greater than with underground operations.
      In addition, the U.S. Army Corps of Engineers imposes stream mitigation
      requirements on surface mining operations. These regulations require that
      footage of stream loss be replaced through various mitigation processes, if
      any
      ephemeral, intermittent, or perennial streams are in-filled due to mining
      operations. These regulations may cause us to incur significant additional
      costs, which could adversely impact our operating performance.





**Risks
      Relating to our Common Stock**





***The
      market price of our common stock has been volatile and difficult to predict,
      and
      may continue to be volatile and difficult to predict in the future, and the
      value of your investment may decline.***




28


The
      market price of our common stock has been volatile in the past and may continue
      to be volatile in the future. The market price of our common stock will be
      affected by, among other things:




·
            variations
                in our quarterly operating results;·
            changes
                in financial estimates by securities
                analysts;





·
            sales
                of shares of our common stock by our officers and directors or by
                our
                shareholders;·
            changes
                in general conditions in the economy or the financial
                markets;





·
            changes
                in accounting standards, policies or interpretations;·
            other
                developments affecting us, our industry, clients or competitors;
                and





·
            the
                operating and stock price performance of companies that investors
                deem
                comparable to us.





Any
      of
      these factors could have a negative effect on the price of our common stock
      on
      the Nasdaq Global Select Market, make it difficult to predict the market price
      for our common stock in the future and cause the value of your investment to
      decline.




***Dividends
      are limited by our senior secured credit facility.***




We
      do not
      anticipate paying any cash dividends on our common stock in the near future.
      In
      addition, covenants in our senior secured credit facility restrict our ability
      to pay cash dividends and may prohibit the payment of dividends and certain
      other payments.




***Provisions
      of our articles of incorporation, bylaws and shareholder rights agreement could
      discourage potential acquisition proposals and could deter or prevent a change
      in control.***




Some
      provisions of our articles of incorporation and bylaws, as well as Virginia
      statutes, may have the effect of delaying, deferring or preventing a change
      in
      control. These provisions may make it more difficult for other persons, without
      the approval of our Board of Directors, to make a tender offer or otherwise
      acquire substantial amounts of our common stock or to launch other takeover
      attempts that a shareholder might consider to be in such shareholder’s best
      interest. These provisions could limit the price that some investors might
      be
      willing to pay in the future for shares of our common stock.




On
      May
      25, 2004, our shareholders approved a rights agreement which, in certain
      circumstances, including a person or group acquiring, or the commencement of
      a
      tender or exchange offer that would result in a person or group acquiring,
      beneficial ownership of more than 15% of the outstanding shares of our common
      stock, would entitle each right holder, other than the person or group
      triggering the plan, to receive, upon exercise of the right, shares of our
      common stock having a then-current fair value equal to twice the exercise price
      of a right. On November 3, 2006, our Board of Directors increased the applicable
      threshold from 15% to 20%. This shareholder rights agreement provides us with
      a
      defensive mechanism that decreases the risk that a hostile acquirer will attempt
      to take control of us without negotiating directly with our board of directors.
      The shareholder rights agreement may discourage acquirers from attempting to
      purchase us, which may adversely affect the price of our common
      stock.




**Item
      1B** **Unresolved
      Staff Comments**




None




**Item
      2****.**  **Properties**




As
      of
      December 31, 2006, weowned
      approximately 10,800 acresof
      land.
      Our
      mineral rights are primarily controlled through leases. In a mining context,
      control of a property is typically divided into three
      categories:





·
            mineral
                rights, which allows the controlling party to remove the minerals
                on the
                property;





·
            surface
                rights, which allows the controlling party to use and disturb the
                surface
                of the property; and





·
            fee
                control, which includes both mineral and surface
                rights.





29


Our
      rights with respect to properties that we lease vary from lease to lease, but
      encompass mineral rights, surface rights, or both.





The
      coal
      properties that we control in Central Appalachia are located in the Big Sandy,
      Hazard and Upper Cumberland coal districts of the Central Appalachian coal
      basin
      in eastern Kentucky and north central Tennessee *.* These
      three coal districts are located in the Appalachian Plateau structural and
      physiographic province. The coal properties that we control in the Midwest
      are
      part of the Illinois Coal basin and are located in southwest Indiana. We hold
      over 400 leases, the terms of which vary significantly, including the following
      provisions:





·
            length
                of term;





·
            renewal
                requirements;





·
            minimum
                royalties;





·
            recoupment
                provisions;





·
            tonnage
                royalty rates;





·
            minimum
                tonnage royalty rates;





·
            wheelage
                rates;





·
            usage
                fees; and





·
            other
                factors.





Our
      leases typically provide for periodic royalty payments, subject to specified
      annual minimums. The annual minimums are typically based on the forecasted
      tonnage of coal to be produced on the leased property over the term of the
      lease. Payments made pursuant to these minimums for years in which periodic
      royalty payments do not meet the minimums are typically recoupable against
      future periodic production royalties paid within a fixed period of time. We
      typically are responsible for the payment of property taxes due on the
      properties we have under lease.





For
      a
      discussion of our coal reserves see Item 1 Business “Reserves.”





Our
      corporate headquarters are located in Richmond, Virginia and are occupied
      pursuant to a lease that expires in June 2008.




**Item****3.** **Legal
      Proceedings**




We
      are
      parties to a number of legal proceedings incidental to our normal business
      activities, including a large number of workers’ compensation claims. While we
      cannot predict the outcome of these proceedings, in our opinion, any liability
      arising from these matters individually and in the aggregate should not have
      a
      material adverse effect on our consolidated financial position, cash flows
      or
      results of operations.




**Item****4.** **Submission
      of
      Matters to a Vote of Security H** **olders**




There
      were no matters submitted to a vote of security holders of the Company through
      a
      solicitation of proxies or otherwise during the fourth quarter of the Company’s
      year ended December 31, 2006.




30




**PART
      II**




**Item****5.**
            **Market
                for Registrant’s Common Equity, Related Stockholders Matters and Issuers
                Purchases of Equity
                Securities**




**Market
      Information**




On
      January 25, 2005, our
      common stock commenced trading
      on the Nasdaq National
      Market (now known as the Nasdaq Global Select Market under the ticker symbol
      “JRCC”. From
      November 15, 2004 until January 24, 2005, our common stock was quoted on the
      Over-the-Counter Bulletin Board. The
      table  below
      sets forth the high
      and low  sales
      prices for our common stock for the periods
      indicated, as reported by Nasdaq or quoted through the OTC
      Bulletin Board. The per
      share quotations for the periods in which our common stock was traded in
      the over-the-counter market represent inter-dealer prices,
      without adjustment for retail
      mark  ups ,
      mark-down s or commissions and may
      not necessarily represent actual transactions.




**First**
              **Quarter**
            ****
            **Second**
              **Quarter**
            ****
            **Third**
              **Quarter**
            ****
            **Fourth**
              **Quarter**Fiscal
                year ended December 31, 2006High
            
            $
            43.53
            
            
            38.75
            
            
            27.17
            
            
            13.47Low
            
            $
            31.16
            
            
            26.29
            
            
            10.17
            
            
            8.57Fiscal
                year ended December 31, 2005High
            
            $
            45.75
            
            
            40.50
            
            
            52.56
            
            
            51.37Low
            
            $
            37.41
            
            
            28.64
            
            
            34.47
            
            
            36.96





**Recent
      Sales of Unregistered Securities**




We
      issued
      common stock and options to purchase common stock to the following persons
      or
      classes of persons, in reliance upon the exemption contained in Section 4(2)
      of
      the Securities Act of 1933, as follows:




**Recipient**
              
              **No.**
                **Shares**
              
              **No.**
                **Options**
              
              **Date of**
                **Issuance**
              
              **Consideration**
              
              **Option**
                **Exercise
                  Price**Operating
                  and senior management
              
              159,284
              
              —
              
              January
                  10, 2006 to
                October
                  4, 2006
              
              Services
                rendered
              
              N/ANon-employee
                  directors (aggregate)
              
              9,375
              
              35,000
              
              May
                  27, 2006 and
                August
                  22, 2006
              
              Services
                rendered
              
              $14.84
                  to $31.70




Please
      refer to note 8 of our December 31, 2006 consolidated financial statements
      for
      securities authorized to be issued under our 2004 Equity Incentive
      Plan.




**Holders**




As
      of
      December 31, 2006, there were 86 record holders of our common stock.




**Dividends**




We
      have
      not paid any cash dividends on our common stock during the years ended December
      31, 2006, 2005 and 2004. We intend to retain our earnings and do not anticipate
      paying cash dividends in the foreseeable future. Any future determination as
      to
      the payment of cash dividends will depend upon such factors as earnings, capital
      requirements, our financial condition, restrictions in financing agreements
      and
      other factors deemed relevant by the Board of Directors. The payment of cash
      dividends is also currently prohibited by our credit facilities.




31




**Stock
      Performance Graph**





Set
      forth
      below is a line graph comparing the percentage change in the cumulative total
      shareholder return of James River Coal Company’s Common Stock against the
      cumulative total return of the NASDAQ Global Select Stock Market (U.S.) Index
      and the Dow Jones U.S. Coal Index for the period commencing on January 25,
      2005
      (the date the Company’s Common Stock began trading on the Nasdaq Global Select
      Stock Market) and ending on December 31, 2006.




**COMPARISON
        OF 2 YEAR CUMULATIVE TOTAL RETURN***
 Among
        James River Coal Company, The NASDAQ Composite Index
 And
        The
        Dow Jones US Coal Index







*
        $100
        invested on 1/25/05 in stock or on 12/31/04 in index-including reinvestment
        of
        dividends.
 Fiscal
        year ending December 31.




**Item** **6.** **SelectedFinancial
      Data**




In
      March
      2003, the Company and all of its subsidiaries filed voluntary petitions with
      the
      United States Bankruptcy Court for the Middle District of Tennessee for
      reorganization under Chapter 11. Upon emergence from bankruptcy, we adopted
      “fresh start” accounting as contained in the American Institute of Certified
      Public Accountant’s Statement of Position 90-7, *Financial
      Reporting by Entities in Reorganization Under the Bankruptcy
      Code* (“SOP
      90-7”). In connection with the implementation of fresh start accounting, we
      recorded a gain of approximately $178.0 million from the extinguishment of
      our
      debt. Other adjustments were made to reflect the provisions of the Plan of
      Reorganization and to adjust the assets of the reorganized Company to their
      estimated fair value and liabilities to their estimated present value. For
      purposes of applying fresh start accounting, we used an enterprise value for
      the
      reorganized Company of $155 million which was
      based on an appraisal performed for one of our lenders in connection with our
      reorganization. For financial reporting purposes, these transactions were
      reflected in our operating results before emergence.




32




Our
      consolidated financial statements after emergence are those of a new reporting
      entity (the “Successor Company”) and are not comparable to the financial
      statements of the pre-emergence company (the “Predecessor Company”). For a
      complete discussion of our application of fresh start accounting, please refer
      to note 2 of our December 31, 2006 consolidated financial
      statements.





The
      following table presents our selected consolidated financial and operating
      data
      as of and for each of the periods indicated. The selected consolidated financial
      data for years ended December 31, 2006 and 2005, the eight months ended December
      31, 2004 (the successor periods), the four months ended April 30, 2004 and
      for
      the years ended December 31, 2003 and 2002 (predecessor periods) are derived
      from our audited consolidated financial statements. The selected consolidated
      financial and operating data should be read in conjunction with “Management’s
      Discussion and Analysis of Financial Condition and Results of Operations” and
      our consolidated financial statements and related notes.




33
 
  **James
          River Coal Company and Subsidiaries**
 **Selected
          Financial Data**
 **Successor
                    Company**
                
                **Predecessor
                    Company****Year**
                  **Ended**
                  **2006**
                
                **Year**
                  **Ended**
                  **2005**
                
                **Eight****Months**
                  **Ended**
                  **December
                    31,**
                  **2004**
                
                **Four
                    Months**
                  **Ended**
                  **April
                    30,**
                  **2004**
                
                **Year**
                  **Ended**
                  **2003**
                
                **Year**
                  **Ended**
                  **2002**(in
                    thousands, except per share, per ton and number of employees
                    information)**Consolidated
                    Statement of Operations:**Revenues
                
                $
                564,791
                
                
                453,999
                
                
                231,698
                
                
                113,949
                
                
                304,052
                
                
                397,599Cost
                    of coal sold
                
                
                496,799
                
                
                389,222
                
                
                190,926
                
                
                89,294
                
                
                278,939
                
                
                344,222Depreciation,
                    depletion, and amortization
                
                
                74,562
                
                
                51,822
                
                
                21,765
                
                
                12,314
                
                
                40,427
                
                
                46,393Gross
                    profit (loss)
                
                
                (6,570
                )
                
                12,955
                
                
                19,007
                
                
                12,341
                
                
                (15,314
                )
                
                6,984Selling,
                    general, and administrative expenses
                
                
                30,867
                
                
                25,453
                
                
                11,412
                
                
                5,023
                
                
                19,835
                
                
                19,994Other
                    operating expenses
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                26,554Operating
                    income (loss)
                
                
                (34,437
                )
                
                (12,498
                )
                
                7,595
                
                
                7,318
                
                
                (35,149
                )
                
                (39,564
                )Interest
                    expense
                
                
                16,782
                
                
                12,892
                
                
                5,733
                
                
                567
                
                
                18,536
                
                
                29,883Interest
                    income
                
                
                (366
                )
                
                (226
                )
                
                (72
                )
                
                —
                
                
                (144
                )
                
                (1,003
                )Charges
                    associated with repayment of debt
                
                
                —
                
                
                2,524
                
                
                —
                
                
                —
                
                
                —
                
                
                —Miscellaneous
                    income, net
                
                
                (533
                )
                
                (1,067
                )
                
                (833
                )
                
                (331
                )
                
                (1,519
                )
                
                (1,222
                )Reorganization
                    items, net
                
                
                —
                
                
                —
                
                
                —
                
                
                (100,907
                )
                
                7,630
                
                
                —Income
                    tax expense (benefit)
                
                
                (27,151
                )
                
                (14,283
                )
                
                791
                
                
                —
                
                
                (2,891
                )
                
                (8,125
                )Income
                    (loss) before cumulative effect of accounting change
                
                
                (26,169
                )
                
                (12,338
                )
                
                1,976
                
                
                107,989
                
                
                (56,761
                )
                
                (59,097
                )Cumulative
                    effect of accounting change
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                (3,045
                )
                
                —Net
                    income (loss)
                
                
                (26,169
                )
                
                (12,338
                )
                
                1,976
                
                
                107,989
                
                
                (59,806
                )
                
                (59,097
                )Preferred
                    dividends
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                (340
                )
                
                (680
                )Decrease
                    in redemption amount of redeemable common stock
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                8,798Net
                    income (loss) attributable to common shareholders
                
                $
                (26,169
                )
                
                (12,338
                )
                
                1,976
                
                
                107,989
                
                
                (60,146
                )
                
                (50,979
                )
 34




**James
        River Coal Company and Subsidiaries**
 **Selected
        Financial Data**




**Successor
                  Company**
              
              **Predecessor
                  Company****Year**
                **Ended**
                **2006**
              
              **Year**
                **Ended**
                **2005**
              
              **Eight**
                **Months**
                **Ended**
                **December
                  31, 2004**
              
              **Four**
                **Months**
                **Ended**
                **April
                  30,**
                **2004**
              
              **Year**
                **Ended**
                **2003**
              
              **Year**
                **Ended**
                **2002**(in
                  thousands, except per share, per ton and number of employees
                  information)Basic
                  earnings (loss) per common share:Income
                  (loss) before cumulative effect of accounting change
              
              $
              (1.65
              )
              
              (0.83
              )
              
              0.14
              
              
              6,393.67
              
              
              (3,380.78
              )
              
              (3,018.31
              )Cumulative
                  effect of accounting change
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (180.28
              )
              
              —Net
                  income (loss)
              
              
              (1.65
              )
              
              (0.83
              )
              
              0.14
              
              
              6,393.67
              
              
              (3,561.06
              )
              
              (3,018.31
              )Shares
                  used to calculate basic earnings (loss) per common share
              
              
              15,849
              
              
              14,955
              
              
              13,800
              
              
              17
              
              
              17
              
              
              17Diluted
                  earnings (loss) per common share:Income
                  (loss) before cumulative effect of accounting change
              
              $
              (1.65
              )
              
              (0.83
              )
              
              0.14
              
              
              6,393.67
              
              
              (3,380.78
              )
              
              (3,018.31
              )Cumulative
                  effect of accounting change
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (180.28
              )
              
              —Net
                  income (loss)
              
              
              (1.65
              )
              
              (0.83
              )
              
              0.14
              
              
              6,393.67
              
              
              (3,561.06
              )
              
              (3,018.31
              )Shares
                  used to calculate diluted earnings (loss) per share
              
              
              15,849
              
              
              14,955
              
              
              14,623
              
              
              17
              
              
              17
              
              
              17


35




**Successor
                  Company**
              
              **Predecessor
                  Company****December
                  31,**
              
              **April
                  30,**
              
              **December
                  31,****2006**
              
              **2005**
              
              **2004**
              
              **2004**
              
              **2003**
              
              **2002**(in
                  thousands, except per share, per ton and number of employees
                  information)**Consolidated
                  Balance Sheet Data:**Working
                  capital (deficit)
              
              $
              (2,589
              )
              
              6,123
              
              
              10,046
              
              
              5,896
              
              
              9,009
              
              
              (263,149
              )Property,
                  plant, and equipment, net
              
              
              337,780
              
              
              360,000
              
              
              255,575
              
              
              254,259
              
              
              257,156
              
              
              270,989Total
                  assets
              
              
              451,254
              
              
              472,669
              
              
              327,826
              
              
              332,589
              
              
              318,289
              
              
              340,311Long
                  term debt, including current portion
              
              
              167,493
              
              
              150,000
              
              
              95,000
              
              
              6,400
              
              
              —
              
              
              252,876Liabilities
                  subject to compromise
              
              
              —
              
              
              —
              
              
              —
              
              
              319,451
              
              
              319,595
              
              
              —Total
                  shareholders’ equity (deficit)
              
              
              86,397
              
              
              111,267
              
              
              65,585
              
              
              (127,837
              )
              
              (123,601
              )
              
              (68,726
              )


**Successor
                  Company**
              
              **Predecessor
                  Company****Year**
                **Ended**
                **2006**
              
              **Year**
                **Ended**
                **2005**
              
              **Eight**
                **Months**
                **Ended**
                **December
                  31,**
                **2004**
              
              **Four**
                **Months**
                **Ended**
                **April
                  30,**
                **2004**
              
              **Year**
                **Ended**
                **2003**
              
              **Year**
                **Ended**
                **2002**(in
                  thousands, except per share, per ton and number of employees
                  information)**Consolidated
                  Statement of Cash Flow Data:**Net
                  cash provided by operating activities
              
              $
              31,680
              
              
              48,990
              
              
              14,098
              
              
              1,513
              
              
              23,033
              
              
              28,899Net
                  cash used in investing activities
              
              
              (54,738
              )
              
              (135,362
              )
              
              (21,744
              )
              
              (9,463
              )
              
              (15,660
              )
              
              (33,522
              )Net
                  cash provided by (used in) financing activities
              
              
              15,929
              
              
              91,429
              
              
              10,224
              
              
              4,361
              
              
              (2,489
              )
              
              3,347**Supplemental
                  Operating Data:**Tons
                  sold
              
              
              13,128
              
              
              11,091
              
              
              5,775
              
              
              3,107
              
              
              10,083
              
              
              13,926Tons
                  produced
              
              
              13,054
              
              
              11,155
              
              
              5,770
              
              
              3,081
              
              
              9,294
              
              
              12,350Revenue
                  per ton sold (excluding synfuel)
              
              $
              42.67
              
              
              40.19
              
              
              39.21
              
              
              35.98
              
              
              29.53
              
              
              28.26Number
                  of employees
              
              
              1,742
              
              
              1,429
              
              
              1,070
              
              
              984
              
              
              1,127
              
              
              1,145Capital
                  expenditures
              
              $
              62,507
              
              
              84,987
              
              
              25,811
              
              
              9,521
              
              
              20,116
              
              
              22,925




36




**Item
      7.** **Management’s
      Discussion and Analysis of********Financial
      Condition and Results of****Operation**




The
      following discussion and analysis of our financial condition and results of
      operations should be read in conjunction with our consolidated financial
      statements and the accompanying notes and “Selected Financial Data” included
      elsewhere in this f iling.
      This discussion contains forward-looking statements that involve risks and
      uncertainties. Our actual results could differ materially from those anticipated
      in the forward-looking statements as a result of numerous factors, including
      the
      risks discussed in “Risk Factors” in this filing.





**Overview**




We
      mine,
      process and sell bituminous, steam- and industrial-grade coal through six
      operating subsidiaries (“mining complexes”) located throughout eastern Kentucky
      and in southern Indiana. We have two reportable business segments based on
      the
      coal basins in which we operate (Central Appalachia (CAPP) and the Midwest
      (Midwest)). Our Midwest business segment was added in 2005 through the
      acquisition of Triad Mining, Inc. In 2006, our mines produced 12.3 million
      tons
      of coal (including 616,000 tons of contract coal) and we purchased another 786,000 tons for resale. Of the 11.7 million tons we produced
      from Company operated mines, approximately 69% came from underground mines,
      while the remaining 31% came from surface mines. In
      2006,
      we generated revenues of $564.8 million and a net loss of $26.2 million.




***CAPP
      Segment***





In
      Central Appalachia, the majority of our coal is primarily sold to customers
      in
      the southern portion of the South Atlantic region of the United States. The
      South Atlantic Region includes the states of Florida, Georgia, South Carolina,
      North Carolina, West Virginia, Virginia, Maryland and Delaware. According to
      the US Energy Information Administration (EIA), in 2005 the South
      Atlantic region consumed about 17% of all coal for electric generation in the
      United States. The South Atlantic region had an increase in coal consumption
      in
      the electric power sector of 3.4% in 2005. We
      have
      been providing coal to customers in the South Atlantic region since our
      formation in 1988. In 2006, Georgia Power and South Carolina Public Service
      Authority were our largest customers, representing approximately 25% and 16%
      of
      our total revenues, respectively. No other customer accounted for more than
      10%
      of our revenues.





According
      to the EIA, in 2005 coal productions increased in the Appalachia region by
      1.7%.
      Production increases in the Appalachia regions continue to be impacted by
      transportation problems, rising operating costs and difficulty in permitting
      new
      mines. During 2006, our CAPP segment shipped 9.8 million tons of coal. As
      of
      December 31, 2006, we estimate that we controlled approximately 233 million
      tons
      of proven and probable coal reserves. Based on our most recent analysis prepared
      by Marshall Miller & Associates,
      Inc. (“MM&A”) as of March 31, 2004, we estimate that th ese
      reserves have an average heat content of 13,300 Btu per pound and an average
      sulfur content of 1.3%. At current production levels, we believe these reserves
      would support approximately 26 years of production.





Our
      CAPP
      segment continued to experience upward pressure on mining costs during 2006.
      The
      increased costs were primarily due to high labor costs and commodity based
      variable mining costs. We are focused on reducing our operating costs at each
      mine and improving miner productivity. We continue to select
      projects for capital expenditures for
      equipment, facilities, and infrastructure that we believe will provide high
      returns. We also continue to focus our training programs to help our personnel
      be safer and more productive.




***Midwest
      Segment***





In
      the
      Midwest, the majority of our coal is sold in the East North Central Region,
      which includes the states of Illinois, Indiana, Ohio, Michigan and Wisconsin. According
      to the  EIA, in 2005 the East North Central Region consumed about 23%
      of all coal consumed for electric generation in the United States. The East
      North Central Region had an increase in coal consumption for the electric power
      sector of 3.7% in 2005. In
      2006,
      our Midwest segment’s largest customer was Indianapolis Power and Light which
      represented approximately 7% of our total revenues.





37


During
      2006, our Midwest segment shipped 3.3 million tons of coal. We
      believe that coal-fired electric utilities value the high energy coal that
      comprises the majority of our Midwest reserves. As of December 31, 2006, we
      estimate that we controlled approximately 40.2 million tons of proven and
      probable coal reserves. Based on our most recent analyses prepared by MM&A
      as of February 1, 2005 and April 11, 2006, we estimate that t hese
      reserves have an average heat content of 12,000 Btu per pound and average sulfur
      content of 3.2%. At current production levels, we believe these reserves would
      support approximately 12 years of production.




**Reserves**




MM&A
      prepared a detailed study of our CAPP reserves as of March 31, 2004 based on
      all
      of our geologic information, including our updated drilling and mining data.
      MM&A completed their report on our CAPP reserves in June 2004. For the Triad
      properties, MM&A also prepared a detailed study of Triad’s reserves as of
      February 1, 2005 for the reserves obtained in the acquisition of Triad and
      as of
      April 11, 2006 for certain additional reserves acquired in the second quarter
      of
      2006.  The MM&A studies were planned and performed to obtain reasonable
      assurance of the subject demonstrated reserves.  In connection with the
      studies, MM&A prepared reserve maps and had certified professional
      geologists develop estimates based on data supplied by us and Triad using
      standards accepted by government and industry. We have used MM&A’s March 31,
      2004 study as the basis for our current internal estimate of our Central
      Appalachia reserves and MM&A’s February 1, 2005 and April 11, 2006 studies
      as the basis for our current internal estimate of our Midwest reserves.




Reserves
      for these purposes are defined by SEC Industry Guide 7 as that part of a mineral
      deposit which could be economically and legally extracted or produced at the
      time of the reserve determination.  The reserve estimates were
      prepared using industry-standard methodology to provide reasonable assurance
      that the reserves are recoverable, considering technical, economic and legal
      limitations.  Although MM&A has reviewed our reserves and found them to
      be reasonable (notwithstanding unforeseen geological, market, labor or
      regulatory issues that may affect the operations), by assignment, MM&A has
      not performed an economic feasibility study for our reserves.  In
      accordance with standard industry practice, we have performed our own economic
      feasibility analysis for our assigned reserves.  It is not generally
      considered to be practical, however, nor is it standard industry practice,
      to
      perform a feasibility study for a company’s entire reserve portfolio.  In
      addition, MM&A did not independently verify our control of our properties,
      and has relied solely on property information supplied by us. Reserve acreage,
      average seam thickness, average seam density and average mine and wash recovery
      percentages were verified by MM&A to prepare a reserve tonnage estimate for
      each reserve.  There are numerous uncertainties inherent in estimating
      quantities and values of economically recoverable coal reserves as discussed
      in
“Critical Accounting Estimates - Coal Reserves”.




38




Based
        on
        the MM&A reserve studies and the foregoing assumptions and qualifications,
        and after giving effect to our operations from the respective dates of the
        studies through December 31, 2006, we estimate that, as of December 31, 2006,
        we
        controlled approximately 233 million tons of proven and probable coal reserves
        in the CAPP region and 40 millions tons in the Midwest region.  The
        following table provides additional information regarding changes to our
        reserves since December 31, 2005 (in millions of tons):




**CAPP**
                
                **Midwest**
                
                **Total**Proven
                    and Probable Reserves, as of December 31, 2005 (1)
                
                
                241.6
                
                
                20.2
                
                
                261.8Coal
                    Extracted
                
                
                (9.0
                )
                
                (3.3
                )
                
                (12.3
                )Acquisitions
                    (2)
                
                
                —
                
                
                23.5
                
                
                23.5Adjustments
                    (3)
                
                
                6.5
                
                
                (0.2
                )
                
                6.3Divestures
                    (4)
                
                
                (6.1
                )
                
                —
                
                
                (6.1
                )Proven
                    and Probable Reserves, as of December 31, 2006 (1)
                
                
                233.0
                
                
                40.2
                
                
                273.2




1)
      Calculated in the same manner, and based on the same assumptions and
      qualifications, as used in the MM&A studies described above, but these
      estimates have not been reviewed by MM&A.  Proven reserves have the
      highest degree of geologic assurance and are reserves for which (a) quantity
      is
      computed from dimensions revealed in outcrops, trenches, workings, or drill
      holes; grade and/or quality are computed from the results of detailed sampling
      and (b) the sites for inspections, sampling and measurement are spaced so
      closely and the geologic character is so well defined that size, shape, depth
      and mineral content of reserves are well-established.  Probable reserves
      have a moderate degree of geologic assurance and are reserves for which quantity
      and grade and/or quality are computed from information similar to that used
      for
      proven reserves, but the sites for inspection, sampling and measurement are
      farther apart or are otherwise less adequately spaced.  The degree of
      assurance, although lower than that for proven reserves, is high enough to
      assume continuity between points of observation.  This reserve information
      reflects recoverable tonnage on an as-received basis with 5.5%
      moisture.




(2)
      Represents estimated reserves on properties acquired during the relevant
      period.  We calculated the reserves in the same manner, and based on the
      same assumptions and qualifications, as used in the MM&A studies described
      above, except for the reserve study of the 15.8 million tons of reserves
      acquired by our Midwest segment as of April 11, 2006, these estimates have
      not
      been reviewed by MM&A.





(3)
      Represents changes in reserves due to additional information obtained from
      exploration activities, production activities or discovery of new geologic
      information. We calculated the adjustments to the reserves in the same manner,
      and based on the same assumptions and qualifications, as used in the
      MM&A studies described above, but these estimates have not been reviewed by
      MM&A.





(4)
      Represents changes in reserves due to expired leases.




**Key
      Performance Indicators**





We
      manage
      our business through several key performance metrics that provide a summary
      of
      information in the areas of sales, operations, and general and administrative
      costs.





In
      the
      sales area, our long-term metrics are the volume-weighted average remaining
      term
      of our contracts and our open contract position for the next several years.
      During periods of high prices, we may seek to lengthen the average remaining
      term of our contracts and reduce the open tonnage for future periods. In the
      short-term, we closely monitor the Average Selling Price per Ton (ASP), and
      the
      mix between our spot sales and contract sales.





In
      the
      operations area, we monitor the volume of coal that is produced by each of
      our
      principal sources, including company mines, contract mines, and purchased coal
      sources. For our company mines, we focus on both operating costs and operating
      productivity. We closely monitor the cost per ton of our mines against our
      budgeted costs and against our other mines.





In
      the
      selling, general and administrative area, we closely monitor the gross dollars
      spent per mine operation and in support functions. We also regularly measure
      our
      performance against our internally-prepared budgets.





39


**Trends
      In Our Business**





Recently,
      demand has slowed for coal which has led to a softening in coal prices. This
      reduction in demand and prices has been driven by a number of factors including
      a mild winter followed by a cool summer and increased production of coal. We
      believe that the lower coal prices will result in decreased production as it
      will no longer be economical to operate higher cost coal mines. We believe
      that,
      in the long term, the market for coal in the United States remains strong as
      coal continues to be one of the most economical energy sources. However, while
      we are not able to predict when the coal market will begin to strengthen, we
      believe that a projected decrease in production and projected long term increase
      in demand for coal will lead to higher coal prices in the future. A number
      of
      factors beyond our control impact coal prices, including:




·  the
      supply of domestic and foreign coal;




·  the
      demand for electricity;




·  the
      demand for steel and the continued financial viability of the domestic and
      foreign steel industries;




·  the
      cost
      of transporting coal to the customer;




·  domestic
      and foreign governmental regulations and taxes;




· air
      emission standards for coal-fired power plants; and




· the
      price
      and availability of alternative fuels for electricity generation.




As
      discussed previously, our costs of production have increased in recent years,
      particularly in the CAPP region. We expect the higher costs to continue for
      the
      next several years, due to a number of factors, including increased governmental
      regulations, high prices in worldwide commodity markets and a highly competitive
      market for a limited supply of skilled mining personnel.




Our
      business is very sensitive to changes in supply and demand for coal and we
      intend to carefully manage our mines in 2007 to achieve sustainable profit
      margins.  Events beyond our control could impact our profit
      margins.




**2004
      Reorganization**





In
      March
      2003, we and all of our subsidiaries filed voluntary petitions with the United
      States Bankruptcy Court for the Middle District of Tennessee for reorganization
      under Chapter 11. On
      May 6,
      2004, our Plan of Reorganization became effective, and we emerged from Chapter
      11 bankruptcy proceedings. Our implementation of fresh start accounting pursuant
      to SOP 90-7 resulted in material changes to our consolidated financial
      statements, including the valuation of our assets and liabilities at fair value
      in accordance with principles of purchase accounting, and the valuation of
      equity based on a valuation of our business prepared by our independent
      financial advisors.





As
      a
      result of the reorganization transactions and the implementation of fresh start
      accounting, our results of operations after our emergence from bankruptcy are
      those of a new reporting entity (the “Successor Company”), and are not
      comparable to the results of operations of the pre-emergence Company (the
“Predecessor Company”) for prior periods described in this management’s
      discussion and analysis and reported in our consolidated financial
      statements.





Financial
      statements for periods after March 25, 2003 and prior to April 30, 2004 include
      the effects of our bankruptcy proceedings. These include the classification
      of
      certain liabilities as “liabilities subject to compromise,” the classification
      of certain expenses, and gains and losses as reorganization items, and other
      matters described in the notes to our consolidated financial
      statements.





40


**Results
      of Operations**





***Year
      Ended December 31, 2006 Compared with the Year Ended December 31,
      2005***




The
      following table shows selected operating results for 2006 and 2005 (in 000’s,
      except per ton amounts):




**Year
                  Ended December 31,****2006**
              
              **2005**
              
              **Change****Total**
              
              **Per
                  Ton**
              
              **Total**
              
              **Per
                  Ton**
              
              **Total**Volume
                  Shipped (tons)
              
              
              13,128
              
              
              
              
              
              11,091
              
              
              
              
              
              18
              %Coal
                  sales
              
              $
              560,183
              
              
              42.67
              
              $
              445,742
              
              
              40.19
              
              
              26
              %Synfuel
                  handling
              
              
              4,608
              
              
              
              
              
              8,257
              
              
              
              
              
              -44
              %Cost
                  of coal sold
              
              
              496,799
              
              
              37.84
              
              
              389,222
              
              
              35.09
              
              
              28
              %Depreciation,
                  depletion and amortization
              
              
              74,562
              
              
              5.68
              
              
              51,822
              
              
              4.67
              
              
              44
              %Gross
                  profit (loss)
              
              
              (6,570
              )
              
              (0.50
              )
              
              12,955
              
              
              1.17
              
              
              -151
              %Selling,
                  general and administrative
              
              
              30,867
              
              
              2.35
              
              
              25,453
              
              
              2.29
              
              
              21
              %




**Volume
      and Revenues by Segment**




**Year
                  Ended December 31,**2006
              
              2005CAPP
              
              Midwest
              
              CAPP
              
              MidwestVolume
                  Shipped (tons)
              
              
              9,780
              
              
              3,348
              
              
              9,023
              
              
              2,068Coal
                  sales revenue
              
              $
              467,492
              
              
              92,691
              
              
              389,861
              
              
              55,881Average
                  sales price per ton
              
              $
              47.80
              
              
              27.69
              
              
              43.21
              
              
              27.02




In
      2006,
      we shipped 13.1 million tons of coal compared to 11.1 million tons for the
      same
      period in 2005.  This increase was primarily due to a full year of
      production at Triad which added 1.3 million tons in 2006.  Coal
      sales revenue increased from $445.7 million in 2005 to $560.2 million in 2006.
      This increase was due to the increase in shipments and an increase in the
      average sales price per ton for sales under long-term contracts, offset by
      a
      decrease in the average CAPP spot sales price per ton.  In 2006, the CAPP
      region sold 7.9 million tons of coal (80% of total CAPP sales volume) under
      long-term contracts at an average selling price of $44.62 per ton.  In
      2005, the CAPP region sold approximately 7.9 million tons of coal under
      long-term contracts (87% of total CAPP sales volume) at an average selling
      price
      of $40.12 per ton. In 2006, the CAPP region sold approximately 1.9 million
      tons
      (20% of total CAPP sales volume) to the spot market at an average selling price
      of $60.99 per ton.  In 2005, the CAPP region sold 1.1 million tons of coal
      (13% of total CAPP sales volume) to the spot market at an average selling price
      of $64.74 per ton.  The increase in the Midwest was primarily due to a full
      year of shipments in 2006 versus seven months of shipments in 2005. The Midwest
      revenues were primarily from sales under long-term contracts. The average sales
      price per ton in the Midwest increased from $27.02 in 2005 to $27.69 in 2006.




41




****
              ****
              **Year
                  Ended December 31,**
              ********
              ****
              **2006**
              ****
              **2005**
              ********
              ****
              **CAPP**
              ****
              **Midwest**
              ****
              **Corporate**
              ****
              **CAPP**
              
              **Midwest**
              
              **Corporate****Cost
                  of Coal Sold**
              
              $
              420,223
              
              
              76,576
              
              
              —
              
              
              344,094
              
              
              45,128
              
              
              —**Per
                  ton**
              
              
              42.97
              
              
              22.87
              
              
              —
              
              
              38.14
              
              
              21.82
              
              
              —**Depreciation,
                  depletion, and amortization**
              
              
              60,040
              
              
              14,411
              
              
              111
              
              
              43,687
              
              
              7,985
              
              
              150**Per
                  ton**
              
              
              6.14
              
              
              4.30
              
              
              —
              
              
              4.84
              
              
              3.86
              
              
              —




*Cost
      of Coal Sold*





The
      cost
      of coal sold, excluding depreciation, depletion and amortization increased
      from
      $389.2 million in 2005 to $496.8 million in 2006. Our cost per ton of coal
      sold
      in the CAPP region increased from $38.14 per ton in the 2005 period to $42.97
      per ton in the 2006 period. This $4.83 increase in cost per ton of coal sold
      was
      due to several factors.  Labor
      and
      benefit costs increased by $1.73 per ton in 2006 primarily due to increase
      in
      benefits, necessitated by a competitive job market in the coal industry.
      Variable costs increased by $2.24 per ton, primarily due to an increase in
      raw
      materials and maintenance and repair parts and the impact of increased
      regulatory scrutiny in 2006 which has impacted both our productivity and our
      overall mining costs. Cost per ton of coal sold in the Midwest region increased
      from $21.82 in 2005 to $22.87 in 2006. This per ton increase was primarily
      due
      an increase in variable costs per ton, including an increase in raw materials
      costs. In the fourth quarter of 2006, the Company also recorded a $4.1 million
      charge in the CAPP region to write-off of a prepaid royalty in connection with
      the restructuring of a mineral lease contract.




*Depreciation,
      depletion and amortization*




Depreciation,
      depletion and amortization, increased from $51.8 million in 2005 to $74.6
      million in 2006. In the CAPP region, depreciation, depletion and amortization
      increased $16.4 million to $60.0 million or $6.14 per ton, in 2006. This
      increase was due to capital expenditures which increased the depreciable asset
      base. In the Midwest, depreciation, depletion and amortization 2006 was $14.1
      million, or $4.30 per ton.




*Selling,
      general and administrative*




Selling,
      general and administrative expenses increased from $25.5 million for 2005 to
      $30.9 million for 2006. The increase was primarily due to a $1.7 million expense
      for the resolution of a contingent obligation dealing with our previous
      bankruptcy recorded as
      a
      result of congressional action on the coal act in
      the
      fourth quarter of 2006, an increase in bank charges of $1.0 million, $0.9
      million increase in salary and benefits primarily attributed to an increase
      in
      headcount and a $0.7 million increase in stock compensation.




*Income
      Taxes*





Our
      effective tax rates for 2006 and 2005 were 50.9% and 53.7%, respectively. Our
      effective income tax rate is impacted by percentage depletion. Percentage
      depletion is an income tax deduction that is limited to a percentage of taxable
      income from each of our mining properties. Because percentage depletion can
      be
      deducted in excess of cost depletion, it creates a permanent difference and
      directly impacts the effective tax rate. Fluctuations in the effective tax
      rate
      may occur due to the varying levels of profitability (and thus, taxable income
      and percentage depletion) at each of our mine locations.





42





***Year
      Ended December 31, 2005 Compared with the Year Ended December 31,
      2004***





In
      order
      to provide a basis for comparing the year ended December 31, 2005 (“2005”) with
      the year ended December 31, 2004 (“2004”) , the
      operating results of the Successor Company for the eight months ended December
      31, 2004 have been combined with the operating results for the Predecessor
      Company for the four months ended April 30, 2004, for purposes of the following
      table and discussion. The combining of the predecessor and successor accounting
      periods is not permitted by U.S. generally accepted accounting principles.
      Additionally, as explained above, the operating results of the Successor Company
      and the Predecessor Company are not comparable. Additionally,
      the Company’s results of operations include the impact of the Triad acquisition
      subsequent to May 31, 2005.





The
      following table shows selected operating results for 2005 and 2004 (in
      000’s):




**Year
                  Ended December 31,****2005**
              
              **2004**
              
              **Change****Total**
              
              **Per
                  Ton**
              
              **Total**
              
              **Per
                  Ton**
              
              **Total**Volume
                  Shipped (tons)
              
              
              11,091
              
              
              
              
              
              8,882
              
              
              
              
              
              25
              %Coal
                  sales
              
              $
              445,742
              
              
              40.19
              
              
              338,297
              
              
              38.09
              
              
              32
              %Synfuel
                  handling
              
              
              8,257
              
              
              
              
              
              7,350
              
              
              
              
              
              12
              %Cost
                  of coal sold
              
              
              389,222
              
              
              35.09
              
              
              280,220
              
              
              31.55
              
              
              39
              %Depreciation,
                  depletion and amortization
              
              
              51,822
              
              
              4.67
              
              
              34,079
              
              
              3.84
              
              
              52
              %Gross
                  profit
              
              
              12,955
              
              
              1.17
              
              
              31,348
              
              
              3.53
              
              
              -59
              %Selling,
                  general and administrative
              
              
              25,453
              
              
              2.29
              
              
              16,435
              
              
              1.85
              
              
              55
              %




**Volume
      and Revenues by Segment**




**Year
                  Ended December 31,**2005
              
              2004CAPP
              
              Midwest
              
              CAPP
              
              MidwestVolume
                  Shipped (tons)
              
              
              9,023
              
              
              2,068
              
              
              8,882
              
              
              —Coal
                  sales revenue
              
              $
              389,861
              
              
              55,881
              
              
              338,297
              
              
              —Average
                  sales price per ton
              
              $
              43.21
              
              
              27.02
              
              
              38.09
              
              
              —




In
      2005,
      we shipped 11.1 million tons of coal compared to 8.9 million tons in 2004. 
This increase was primarily due to the acquisition of Triad which added 2.1
      million tons in 2005.  Coal
      sales revenue increased from $338.3 million in 2004 to $445.7 million in 2005.
      This increase was due to an increase in the average sales price per ton for
      sales under long-term contracts and spot sales in CAPP and a $55.9 million
      increase due to the acquisition of Triad.  In 2005, the CAPP region sold
      approximately 7.9 million tons of coal under long-term contracts (87% of total
      CAPP sales volume) at an average selling price of $40.12 per ton.  In 2004,
      the CAPP region sold 7.2 million tons of coal (81% of total CAPP sales volume)
      under long-term contracts at an average selling price of $35.22 per ton. 
In 2005, the CAPP region sold 1.1 million tons of coal (13% of total CAPP sales
      volume) to the spot market at an average selling price of $64.74 per ton. 
In 2004, the CAPP region sold approximately 1.7 million tons (19% of total
      CAPP
      sales volume) to the spot market at an average selling price of $50.09 per
      ton.  The Midwest revenues were primarily from sales under long-term
      contracts.




43


****
              ****
              **Year
                  Ended December 31,**
              ********
              ****
              **2005**
              ****
              **2004**
              ********
              ****
              **CAPP**
              ****
              **Midwest**
              ****
              **Corporate**
              ****
              **CAPP**
              
              **Midwest**
              ****
              **Corporate****Cost
                  of Coal Sold**
              
              $
              344,094
              
              
              45,128
              
              
              —
              
              
              280,220
              
              
              —
              
              
              —**Per
                  ton**
              
              
              38.14
              
              
              21.82
              
              
              —
              
              
              31.55
              
              
              —
              
              
              —**Depreciation,
                  depletion, and amortization**
              
              
              43,687
              
              
              7,985
              
              
              150
              
              
              33,961
              
              
              —
              
              
              118**Per
                  ton**
              
              
              4.84
              
              
              3.86
              
              
              —
              
              
              3.82
              
              
              —
              
              
              —




*Cost
      of Coal Sold*





The
      cost
      of coal sold, excluding depreciation, depletion and amortization increased
      from
      $280.2 million in 2004 to $389.2 million in 2005. Our cost per ton of coal
      sold
      in the CAPP region increased from $31.55 per ton in 2004 to $38.14 per ton
      in
      2005. This $6.59 increase in cost per ton of coal sold was due to several
      factors. For production from our company-operated mines, sales related costs
      (primarily royalties and severance taxes) increased by $0.59 per ton as a result
      of increased sales prices. Labor and benefit costs increased at our company
      operated mines by $1.58 per ton in 2005 due to a wage increase to all production
      employees, effective January 1, 2005. The competitive job market in the coal
      industry necessitated this increase. Variable costs increased by $2.26 per
      ton,
      primarily due to rising commodity prices for petroleum and steel based products
      such as belting, roof support materials, mining bits and machine parts. Trucking
      costs increased by $1.02 per ton in 2005 due to higher fuel costs. The remaining
      increase was primarily due to an increase per ton in the cost of our purchased
      coal of $10.38 per ton and our contract coal of $8.26 per ton. Cost per ton
      of
      coal sold in the Midwest region was $21.82 in 2005.




*Depreciation,
      depletion and amortization*




Depreciation,
      depletion and amortization, increased from $34.1 million in 2004 to $51.8
      million in 2005. In the CAPP region, depreciation, depletion and amortization
      increased $9.7 million to $43.7 million or $4.84 per ton. These expenses are
      not
      comparable due to the impact of fresh start accounting on our asset base. In
      the
      Midwest, depreciation, depletion and amortization was $8.0 million in 2005,
      or
      $3.86 per ton, which reflects the depreciation, depletion and amortization
      from
      the acquisition of Triad.




*Selling,
      general and administrative*




Selling,
      general and administrative expenses increased from $16.4 million for 2004 to
      $25.5 million for 2005. Of this increase $2.8 million was related to an increase
      in compensation, salary and benefit costs. In 2005, we added an entire team
      of
      employees dedicated to the development of our new surface mines. This team
      includes technical, operations, and land acquisition personnel to acquire
      additional properties, design the new mines, obtain all necessary permits,
      and
      manage the new mine operations. An additional $0.8 million was related to an
      increase in stock compensation costs primarily reflecting the additional
      restricted shares issued in 2005. Bank charges also increased by $1.5 million,
      primarily reflecting fees related to our letter of credit facility. We also
      had
      a $0.9 million increase in other taxes primarily related to an increase in
      the
      unmined mineral tax rates.




44


*Income
      Taxes*





Our
      effective tax rate for 2005 was 53.7%. Our effective income tax rate is impacted
      by percentage depletion. Percentage depletion is an income tax deduction that
      is
      limited to a percentage of taxable income from each of our mining properties.
      Because percentage depletion can be deducted in excess of cost depletion, it
      creates a permanent difference and directly impacts the effective tax rate.
      Fluctuations in the effective tax rate may occur due to the varying levels
      of
      profitability (and thus, taxable income and percentage depletion) at each of
      our
      mine locations.




**Liquidity
      and Capital Resources**





As
      of
      December 31, 2006, we have outstanding $150 million of Senior Notes due on
      June
      1, 2012 (the Senior Notes). The Senior Notes are unsecured and accrue interest
      at 9.375% per annum. Interest payments on the Senior Notes are required
      semi-annually. We may redeem the Senior Notes, in whole or in part, at any
      time
      on or after June 1, 2009 at redemption prices from 104.86% in 2009 to 100%
      in
      2011. In addition, at any time prior to June 1, 2008, we may redeem up to 35%
      of
      the principal amount of the Senior Notes with the net cash proceeds of a public
      equity offering at a redemption price of 109.375%, plus accrued and unpaid
      interest to the redemption date.





The
      Senior Notes limit our ability, among other things, to pay cash dividends.
      In
      addition, if a change of control occurs (as defined in the Indenture), each
      holder of the Senior Notes will have the right to require us to repurchase
      all
      or a part of the Senior Notes at a price equal to 101% of their principal
      amount, plus any accrued interest to the date of repurchase.




As
      of
      December 31, 2006, we also had a Prior Senior Secured Credit Facility consisting
      of a $25.0 million revolving credit facility (the Prior Revolver) and a $75.0
      million letter of credit facility (the Prior Letter of Credit Facility). The
      Prior Revolver matured on May 31, 2010 and the Prior Letter of Credit Facility
      matured on November 30, 2011. During 2006, we entered into four amendments
      to
      the Prior Senior Secured Facility in order to revise the covenants to levels
      that we projected we could comply with during the year.




On
      February 26, 2007, we entered into a $35.0 million Revolving Credit Agreement
      (the Revolver) and a $100.0 million Term Credit Agreement (collectively the
      Facilities). The Term Credit Agreement consists of a $40.0 million term facility
      (the Term Facility) and a $60.0 million letter of credit facility (the Letter
      of
      Credit Facility). A portion of the proceeds from the Facilities were used to
      repay the Prior Revolver and Prior Letter of Credit Facilities and to pay fees
      and expenses associated with the Facilities. The remaining proceeds are
      available for working capital and other general corporate purposes. The Letter
      of Credit Facility does not constitute a loan to us and accordingly is not
      available for borrowing by us.  The Letter of Credit Facility only supports
      the issuance of up to $60 million of letters of credit. The following is a
      summary of significant terms of the Facilities.




****
              **Revolver**
              ****
              **Term
                  Facility**
              ****
              **Letter
                  of Credit Facility**Maturity
              
              February
                  2012
              
              February
                  2013
              
              February
                  2013Interest/Usage
                  Rate
              
              Our
                  option of Base Rate(a)plus 1.0% or LIBOR plus 2.0% per annum
              
              Our
                  option of Base Rate(a)plus 3.0% or LIBOR plus 4.0% per annum
              
              4.0%
                  per annumMaximum
                  Availability
              
              Lesser
                  of $35.0 million and the borrowing base(b)
              
              $40.0
                  million reduced by any repayments
              
              $60.0
                  millionRepayments
                  prior to maturity
              
              Not
                  Applicable
              
              1%
                  of face amount is due quarterly.
              
              Not
                  applicable




(a)
                Base
                    rate is the higher of (1) the Federal Fund Rate plus 0.5% and
                    (2) the
                    prime rate.


(b)
                The
                    Revolver’s borrowing base is the sum of up to 85% of the eligible accounts
                    receivable plus the lesser of (1) up to 60% of eligible inventory
                    and (2)
                    up to 85% of the net orderly liquidation value of eligible inventory;
                    minus reserves from time to time set by administrative agent.





45




The
      Revolver provides that we can use up to $10.0 million of the Revolver
      availability to issue letters of credit. The Revolver provides for a 2.0% fee
      on
      any outstanding letter of credits issued under the Revolver and a 0.5% fee
      on
      the unused portion of the Revolver. The Facilities require certain mandatory
      prepayments from certain asset sales, incurrence of indebtedness and excess
      cash
      flow. The Facilities include financial covenants that require us to maintain
      a
      minimum EBITDA and a maximum leverage ratio and limit capital expenditures,
      each
      as defined by the agreement. We project that we will be in compliance with
      these
      covenants through 2007. The Facilities are secured by substantially all of
      our
      assets.




The
      following chart reflects the components of our debt as of December 31, 2006
      and
      2005:





**2006**
            
            **2005**Senior
                Notes
            
            $
            150,000
            
            $
            150,000Prior
                Senior Secured Credit Facility - Prior Revolver
            
            
            17,493
            
            
            —Total
                long-term debt
            
            
            167,493
            
            
            150,000Less
                amounts classified as current
            
            
            —
            
            
            —Total
                long-term debt, less current maturities
            
            $
            167,493
            
            $
            150,000




As
      a
      result of the completion of the Facilities we expect to have adequate liquidity
      throughout 2007. The Term Loan provides us with $40 million which we used in
      part to repay the amounts outstanding on the Prior Revolver and costs associated
      with the Facilities. The Revolver will provide us additional availability of
      up
      to $35 million.





Our
      primary source of cash is expected to be sales of coal to our utility and
      industrial customers. The price of coal received can change dramatically based
      on supply and demand and will directly affect this source of cash. Our primary
      uses of cash include the payment of ordinary mining expenses to mine coal,
      capital expenditures and benefit payments. Ordinary mining expenses are driven
      by the cost of supplies, including steel prices and diesel fuel. Benefit
      payments include payments for workers’ compensation and black lung benefits paid
      over the lives of our employees as the claims are submitted. We are required
      to
      pay these when due, and are not required to set aside cash for these payments.
      We have posted surety bonds with state regulatory departments to guarantee
      these
      payments and have issued letters of credit to secure these bonds. We
      believe that our Letter of Credit Facility provides us with the ability to
      meet
      the necessary bonding requirements.





Our
      secondary source of cash is the  Revolver .
      We
      believe that cash on hand, cash generated from our operating activities, and
      availability under the  Revolver  will
      be
      sufficient to meet our working capital needs, to fund our capital expenditures
      for existing operations and to meet our debt service obligations for the next
      twelve months. Nevertheless, there are many factors beyond our control,
      including general economic and coal market conditions that could have a material
      adverse impact on our ability to meet our liquidity needs .




In
      the
      event that the sources of cash described above are not sufficient to meet our
      future cash requirements, we will need to reduce certain planned expenditures,
      seek additional financing, or both. If debt financing is not available on
      favorable terms, we may seek to raise funds through the issuance of our equity
      securities. If such actions are not sufficient, we may need to limit our growth,
      reduce or curtail some of our operations to levels consistent with the
      constraints imposed by our available cash flow, or both. Our ability to seek
      additional debt or equity financing may be limited by our existing and any
      future financing arrangements, economic and financial conditions, or both.
      In
      particular, our Senior Notes and Facilities restrict our ability to incur
      additional indebtedness. We cannot provide assurance that any reductions in
      our
      planned expenditures or in our expansion would be sufficient to cover shortfalls
      in available cash or that additional debt or equity financing would be available
      on terms acceptable to us, if at all.





Currently,
      our primary use of cash during the next several years is expected to be ordinary
      course of business expenses and capital expenditures for existing mines. We
      currently project that our capital expenditures for 2007 will be approximately
      $50 to $55 million.  We expect that such expenditures will be funded
      through cash on hand; cash generated by operations and borrowings under our debt
      Facilities.




46


Net
      cash
      provided by or used in operating activities reflects net income or loss adjusted
      for non-cash charges and changes in net working capital (including non-current
      operating assets and liabilities). Net cash provided by operating activities
      was
      $31.7 million for the year ended December 31, 2006, and net cash provided by
      operating activities was $49.0 million for the year ended December 31, 2005.
      For
      the year ended December 31, 2006, our net income, as adjusted for non cash
      charges, was offset by a $1.0 million increase in cash from our operating assets
      and liabilities. This primarily changes in our operating assets and liabilities
      were a $11.8 million increase in our accounts receivables and an increase in
      accounts payables of $8.9 million. These changes are primarily due to timing
      of
      payments as compared with the prior year.




Net
      cash
      used by investing activities decreased $ 80.6 million
      to $54.7 million for the year ended December 31, 2006 as compared to the year
      ended December 31, 2005. We had a decrease in capital expenditures of $22.5
      million to $62.5 million as compared to prior year. The capital expenditures
      were primarily related to new and replacement mine equipment. In 2005, we also
      incurred expenditures associated with various projects to improve the production
      and efficiency of our mining operations (including Mine 15 at the McCoy
      complex). Additionally, we entered into operating leases in 2006 that allowed
      us
      to expand our surface mining capabilities.




Net
      cash
      provided by financing activities primarily reflects changes in short- and
      long-term financing. Net cash provided by financing activities was $15.9 million
      for the year ended December 31, 2006 and net cash provided by financing
      activities was $91.4 million for the year ended December 31, 2005. During 2006,
      our primary financing activities were $17.5 million of borrowings on the Prior
      Revolver. During 2005, we received $142.1 million of net proceeds from the
      issuance of Senior Notes and $45.0 of net proceeds from the issuance of common
      stock, which was offset by a $95.5 repayment of our previously outstanding
      debt.




**Contractual
      Obligations**





The
      following is a summary of our contractual obligations and commitments as of
      December 31, 2006:




**Payment
                  Due by Period (in thousands)****Contractual
                  Obligations**
              
              **Total**
              
              **2007**
              
              **2008-2009**
              
              **2010-2011**
              
              **Thereafter**Long
                  term debt(1)
              
              $
              167,493
              
              
              17,493
              
              
              —
              
              
              —
              
              
              150,000Interest
                  on long term debt(2)
              
              
              77,343
              
              
              14,062
              
              
              28,125
              
              
              28,125
              
              
              7,031Capital
                  lease obligations(3)
              
              
              271
              
              
              271
              
              
              —
              
              
              —
              
              
              —Operating
                  lease obligations(3)
              
              
              13,560
              
              
              4,344
              
              
              7,252
              
              
              1,964
              
              
              —Royalty
                  obligations(4)
              
              
              165,480
              
              
              18,685
              
              
              36,714
              
              
              32,611
              
              
              77,470Purchase
                  obligations(5)
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —$
              424,147
              
              
              54,855
              
              
              72,091
              
              
              62,700
              
              
              234,501




(1)
                Consists
                    of our Senior Notes and our Prior Revolver. Prior Revolver which
                    is shown
                    as being due in 2007 was repaid with the proceeds from our Term
                    Loan
                    issued in February 2007. The $40.0 million Term Loan is due in
                    2012, but
                    is excluded from the table.





(2)
                Consists
                    of interest payments on our Senior Notes. Our Prior Revolver
                    was repaid in
                    February 2007 and the related interest has been excluded. Additionally,
                    we
                    have excluded the interest issued on our Term Loan which was
                    issued
                    February 2007.




(3)
                Capital
                    lease obligations include the amount of imputed interest over
                    the terms of
                    the leases. See Note 12 in the notes to the consolidated financial
                    statements for additional information on capital and operating
                    leases.





(4)
                Royalty
                    obligations include minimum royalties payable on leased coal
                    rights.
                    Certain coal leases do not have set expiration dates but extend
                    until
                    completion of mining of all merchantable and mineable coal reserves.
                    For
                    purposes of this table, we have generally assumed that minimum
                    royalties
                    on such leases will be paid for a period of ten years. Certain
                    coal leases
                    require payment based on minimum tonnage, for these contracts
                    an average
                    sales price of $48.12 was used to project the future
                    commitment.




(5)
                Purchase
                    obligations, if any, include agreements to purchase coal that
                    include
                    fixed quantities or minimum amounts and a fixed price provision.
                    They do
                    not include agreements to purchase coal with vendors that do
                    not include
                    quantities or minimum tonnages, or monthly purchase
                    orders.
  47


Additionally,
      we have liabilities relating to pension, workers compensation, black lung,
      and
      mine reclamation and closure. As of December 31, 2006, payments related to
      these
      items are estimated to be:




**Payments
                Due by Years (In Thousands)****Within
                1 Year**
            
            **2
                - 3**
              **Years**
            
            **4
                - 5**
              **Years**$18,210
            
            $20,622
            
            $21,657




Our
      determination of these noncurrent 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 2007, our estimates may change from the amounts
      included in the table, and may change significantly, if our assumptions change
      to reflect changing conditions. These assumptions are discussed in the Notes
      to
      the Consolidated Financial Statements and in the Critical Accounting Estimates
      in Management’s Discussion and Analysis.




**Off-Balance
      Sheet Arrangements**





In
      the
      normal course of business, we are a party to certain off-balance sheet
      arrangements, including guarantees, operating leases, indemnifications, and
      financial instruments with off-balance sheet risk, such as bank letters of
      credit and performance or surety bonds. Liabilities related to these
      arrangements are not reflected in our consolidated balance sheets, and, except
      for the operating leases, we do not expect any material impact on our cash
      flow,
      results of operations or financial condition from these off-balance sheet
      arrangements.





We
      use
      surety bonds to secure reclamation, workers’ compensation and other
      miscellaneous obligations. At December 31, 2006, we had $100.8 million of
      outstanding surety bonds with third parties. These bonds were in place to secure
      obligations as follows: post-mining reclamation bonds of $54.8 million, workers’
compensation bonds of $40.3 million, wage payment, collection bonds, and other
      miscellaneous obligation bonds of $5.7 million. Recently, surety bond costs
      have
      increased and the market terms of surety bonds have generally become less
      favorable. To the extent that surety bonds become unavailable, we would seek
      to
      secure obligations with letters of credit, cash deposits, or other suitable
      forms of collateral.





We
      also
      use bank letters of credit to secure our obligations for workers’ compensation
      programs, various insurance contracts and other obligations. At December 31,
      2006, we had $63.6 million of letters of credit outstanding. The
      letters of credits were issued under our Prior Letter of Credit
      Facility.





**Critical
      Accounting Estimates**




***Overview***




Our
      discussion and analysis of our financial condition, results of operations,
      liquidity and capital resources are based upon our consolidated financial
      statements, which have been prepared in accordance with accounting principles
      generally accepted in the United States of America. U.S. generally accepted
      accounting principles require estimates and judgments that affect reported
      amounts for assets, liabilities, revenues and expenses. The estimates and
      judgments we make in connection with our consolidated financial statements
      are
      based on historical experience and various other factors we believe are
      reasonable under the circumstances. Note 1 of the notes to the consolidated
      financial statements lists and describes our significant accounting policies.
      The following critical accounting policies have a material effect on amounts
      reported in our consolidated financial statements.




48


***Workers’
      Compensation***




We
      are
      liable under various state statutes for providing workers’ compensation
      benefits. To fulfill these obligations, we have used self-insurance programs
      with varying excess insurance levels, and, since June 7, 2002, a
      high-deductible, fully insured program. The high deductible, fully insured
      program is comparable to a self-insured program where the excess insurance
      threshold equals the deductible level. In
      June
      of 2005, we became self insured for workers’ compensation for our Kentucky
      operations.




We
      accrue
      for the present value of certain workers’ compensation obligations as calculated
      by an independent actuary based upon assumptions for work-related injury and
      illness rates, discount rates and future trends for medical care costs. The
      discount rate is based on interest rates on bonds with maturities similar to
      the
      estimated future cash flows. The discount rate used to calculate the present
      value of these future obligations was 5.4% at December 31, 2006. Significant
      changes to interest rates result in substantial volatility to our consolidated
      financial statements. If we were to decrease our estimate of the discount rate
      from 5.4% to 4.9%, all other things being equal, the present value of our
      workers’ compensation obligation would increase by approximately $1.5 million. A
      change in the law, through either legislation or judicial action, could cause
      these assumptions to change. If the estimates do not materialize as anticipated,
      our actual costs and cash expenditures could differ materially from that
      currently estimated. Our estimated workers’ compensation liability as of
      December 31, 2006 was $53.4 million.




***Coal
      Miners’ Pneumoconiosis***




We
      are
      required under the Federal Mine Safety and Health Act of 1977, as amended,
      as
      well as various state statutes, to provide pneumoconiosis (black lung) benefits
      to eligible current and former employees and their dependents. We provide these
      benefits through self-insurance programs and, for those claims incurred with
      last exposure after June 6, 2002, a high-deductible, fully insured
      program.




An
      independent actuary has calculated the estimated pneumoconiosis liability based
      on assumptions regarding disability incidence, medical costs, mortality, death
      benefits, dependents and interest rates. The discount rate is based on interest
      rates on high quality corporate bonds with maturities similar to the estimated
      future cash flows. The discount rate used to calculate the present value of
      these future obligations was 5.5% at December 31, 2006. Significant changes
      to
      interest rates result in substantial volatility to our consolidated financial
      statements. If we were to decrease our estimate of the discount rate from 5.5%
      to 5.0%, all other things being equal, the present value of our black lung
      obligation would increase by approximately $1.7 million. A change in the
      law, through either legislation or judicial action, could cause these
      assumptions to change. If these estimates prove inaccurate, the actual costs
      and
      cash expenditures could vary materially from the amount currently estimated.
      Our
      estimated pneumoconiosis liability as of December 31, 2006 was $26.8
      million.




***Defined
      Benefit Pension***




The
      estimated cost and benefits of our non-contributory defined benefit pension
      plans are determined by independent actuaries, who, with our review and
      approval, use various actuarial assumptions, including discount rate, future
      rate of increase in compensation levels and expected long-term rate of return
      on
      pension plan assets. In estimating the discount rate, we look to rates of return
      on high-quality, fixed-income investments. At December 31, 2006, the discount
      rate used to determine the obligation was 5.55%. Significant changes to interest
      rates result in substantial volatility to our consolidated financial statements.
      If we were to decrease our estimate of the discount rate from 5.55% to 5.05%,
      all other things being equal, the present value of our projected benefit
      obligation would increase by approximately $5.3 million. ** The
      rate
      of increase in compensation levels is determined based upon our long-term plans
      for such increases. The rate of increase in compensation levels used was 4.0 %
      for the
      year ended December 31, 2006. The expected long-term rate of return on pension
      plan assets is based on long-term historical return information and future
      estimates of long-term investment returns for the target asset allocation of
      investments that comprise plan assets. The expected long-term rate of return
      on
      plan assets used to determine expense was 7.5% for  the
      year
      ended December 31, 2006. Significant changes to these rates would introduce
      substantial volatility to our pension expense. Our accrued pension obligation
      as
      of December 31, 2006 was $13.0 million.





49




***Reclamation
      and Mine Closure Obligation***




The
      Surface Mining Control Reclamation Act of 1977 establishes operational,
      reclamation and closure standards for all aspects of surface mining as well
      as
      many aspects of underground mining. Our total reclamation and mine-closing
      liabilities are based upon permit requirements and our engineering estimates
      related to these requirements. U.S generally accepted accounting principles
      require that asset retirement obligations be initially recorded as a liability
      based on fair value, which is calculated as the present value of the estimated
      future cash flows. Our management and engineers periodically review the estimate
      of ultimate reclamation liability and the expected period in which reclamation
      work will be performed. In estimating future cash flows, we considered the
      estimated current cost of reclamation and applied inflation rates and a third
      party profit. The third party profit is an estimate of the approximate markup
      that would be charged by contractors for work performed on our behalf. The
      discount rate is based on interest rates of bonds with maturities similar to
      the
      estimated future cash flow. The estimated liability can change significantly
      if
      actual costs vary from assumptions or if governmental regulations change
      significantly. The actual costs could be different due to several reasons,
      including the possibility that our estimates could be incorrect, in which case
      our liabilities would differ. If we perform the reclamation work using our
      personnel rather than hiring a third party, as assumed under U.S. generally
      accepted accounting principles, then the costs should be lower. If governmental
      regulations change, then the costs of reclamation will be impacted. U.S.
      generally accepted accounting principles recognize that the recorded liability
      could be different than the final cost of the reclamation and addresses the
      settlement of the liability. When the obligation is settled, and there is a
      difference between the recorded liability and the amount paid to settle the
      obligation, a gain or loss upon settlement is included in earnings. Our asset
      retirement obligation as of December 31, 2006 was $29.7 million.





***Contingencies***




We
      are
      the subject of, or a party to, various suits and pending or threatened
      litigation involving governmental agencies or private interests. We have accrued
      the probable and reasonably estimable costs for the resolution of these claims
      based upon management’s best estimate of potential results, assuming a
      combination of litigation and settlement strategies. Unless otherwise noted,
      management does not believe that the outcome or timing of current legal or
      environmental matters will have a material impact on our financial condition,
      results of operations, or cash flows. See the notes to the consolidated
      financial statements for further discussion on our contingencies.





***Income
      Taxes***




We
      account for income taxes in accordance with FASB Statement No. 109, Accounting
      for Income Taxes (“Statement No. 109”), which requires that deferred tax assets
      and liabilities be recognized using enacted tax rates for the effect of
      temporary differences between the book and tax bases of recorded assets and
      liabilities. Statement No. 109 also requires that deferred tax assets be reduced
      by a valuation allowance if it is more likely than not that some portion of
      the
      deferred tax asset will not be realized. In evaluating the need for a valuation
      allowance, we take into account various factors, including the expected level
      of
      future taxable income. We have also considered, but not relied upon, tax
      planning strategies in determining the deferred tax asset that will ultimately
      be realized. If actual results differ from the assumptions made in the
      evaluation of the amount of our valuation allowance, we record a change in
      valuation allowance through income tax expense in the period such determination
      is made.





As
      of December
      31, 2006 and 2005 ,
      we had
      no valuation allowance recorded for deferred tax assets.





***Coal
      Reserves***




There
      are
      numerous uncertainties inherent in estimating quantities and values of
      economically recoverable coal reserves. Many of these uncertainties are beyond
      our control. As a result, estimates of economically recoverable coal reserves
      are by their nature uncertain. Information about our reserves consists of
      estimates based on engineering, economic and geological data initially assembled
      by our staff and analyzed by Marshall Miller & Associates, Inc. The reserve
      information has subsequently been updated by our staff. The updates to the
      reserves have been c alculated
      in the same manner, and based on the same assumptions and qualifications, as
      used in the MM&A studies described above, but these updates to the reserve
      estimates have not been reviewed by MM&A. A
      number
      of sources of information were used to determine accurate recoverable reserves
      estimates, including:




·
                all
                    currently available
                    data;




50




·
            our
                own operational experience and that of our
                consultants;





·
            historical
                production from similar areas with similar
                conditions;





·
            previously
                completed geological and reserve
                studies;





·
            the
                assumed effects of regulations and taxes by governmental agencies;
                and





·
            assumptions
                governing future prices and future operating
                costs.





Reserve
      estimates will change from time to time to reflect, among other
      factors:





·
            mining
                activities;





·
            new
                engineering and geological data;





·
            acquisition
                or divestiture of reserve holdings;
                and





·
            modification
                of mining plans or mining methods.




Each
      of
      these factors may in fact vary considerably from the assumptions used in
      estimating reserves. For these reasons, estimates of the economically
      recoverable quantities of coal attributable to a particular group of properties,
      and classifications of these reserves based on risk of recovery and estimates
      of
      future net cash flows, may vary substantially. Actual production, revenue and
      expenditures with respect to reserves will likely vary from estimates, and
      these
      variances could be material. In particular, a variance in reserve estimates
      could have a material adverse impact on our annual expense for depreciation,
      depletion and amortization and on our annual calculation for potential
      impairment. For a further discussion of our coal reserves, see
“Reserves.”





**Recent
      Accounting Pronouncements**




In
      July
      2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
      No. 48, *Accounting
      for Uncertainty in Income Taxes—an interpretation of FASB Statement
      No. 109* (FIN 48), which clarifies the accounting for uncertainty in tax positions.
      This Interpretation requires companies to recognize in financial statements,
      the
      impact of a tax position, if that position is more likely than not of being
      sustained on audit, based on the technical merits of the position. The
      provisions of FIN 48 are effective as of the beginning of our 2007 fiscal year,
      with the cumulative effect of the change in accounting principle recorded as
      an
      adjustment to opening retained earnings. We believe that the impact of adopting
      FIN 48 will be immaterial to our consolidated financial statements.




In
      September 2006, the FASB issued FASB No. 158, *Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans* (SFAS
      158). Effective for its year ended December 31, 2006, SFAS 158 required that
      we
      recognize the overfunded or underfunded status of its defined benefit plan
      (the
      Plan) as an asset or liability in the 2006 year end balance sheet, with changes
      in the funded status recognized through comprehensive income in the year in
      which they occur. We also elected to adopt the provision of FASB 158 that
      requires a change in the measure date for the funded status of the Plan to
      the
      year end balance. The impact of adopting SFAS 158 resulted in an increase in
      the
      pension liabilities and a decrease in accumulated other comprehensive income
      of
      approximately $5.9 million, prior to any deferred tax adjustment. In connection
      with the change in its measurement date, we recorded an adjustment to decrease
      the pension liability by $1.0 million, an increase in accumulated other
      comprehensive income of $1.6 million and a decrease in retained earnings of
      $0.6
      million, prior to any deferred tax adjustment.





We
      adopted Statement of Financial Accounting Standards (SFAS) 123 (revised 2004), *Share-Based
      Payment* (SFAS
      123R), on January 1, 2006, using the modified prospective method. Prior to
      2006,
      we accounted for stock based compensation using the intrinsic value method
      under
      Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock
      Issued to Employees” as permitted under SFAS No. 123, “Accounting for
      Stock-Based Compensation.” Accordingly, compensation costs for stock options
      granted to employees were not recognized in net income as the exercise price
      of
      options granted was equal to or greater than the market value of the stock
      at
      the date of grant. We provided pro forma net income and earnings per share
      amounts as if stock option expense had been recognized based on fair value
      in
      the footnotes, as required.




51




**Other
      Supplemental Information**




***Labor
      and Turnover***





Recruiting,
      hiring, and retaining skilled mine production personnel has become challenging
      during the past several years. This is due to the aging of the industry
      workforce and the availability of other suitable positions for potential
      employees. The current strong market prices and historically high production
      levels have also contributed to a higher level of turnover as competing coal
      mining companies attempt to increase production.





Based
      on
      average employment of production personnel in Central Appalachia, our gross
      turnover has been approximately 21.7% during the twelve months ended December
      31, 2006. Our net turnover in Central Appalachia during this period, after
      considering employees that have left and been rehired, is approximately 12.9%.
      We believe that our retention of employees is equal to, or better than, other
      coal mining companies in our operating area.





We
      are
      actively working to improve our results in this area including the payment
      of
      safety incentives that we believe will further reduce our employee turnover
      and
      improve employee relations.





***Sales
      Commitments***




As
      of
      December 31, 2006, we had the following contractual commitments (including
      long
      term and short term contracts) to ship coal at a fixed and known
      price:




2007
              
              2008
              
              2009AveragePrice
                  Per
                Ton
              
              Tons
                (000’s)
              
              AveragePrice
                  PerTon
              
              Tons(000’s)
              
              AveragePrice
                  PerTon
              
              Tons(000’s)CAPP
              
              $
              46.83
              
              
              8,099
              
              $
              49.09
              
              
              2,000
              
              $
              50.56
              
              
              1,000Midwest
                  (a)
              
              $
              26.46
              
              
              2,002
              
              $
              27.20
              
              
              1,700
              
              $
              27.25
              
              
              1,495




(a)
              Certain
                  contracts in the Midwest include a customer option to increase
                  or decrease
                  the stated tons in the contract. We have included option tons that
                  we
                  believe will be exercised based on current market prices. The prices
                  for
                  the Midwest in years 2007 to 2009 are minimum base price amounts
                  that will
                  be adjusted for fuel escalators.




52




**Item
      7a.****Quantitative
      and Qualitative Disclosures about Market Risk**




Our
      $150
      million Senior Notes have a fixed interest rate and are not sensitive to changes
      in the general level of interest rates.  Our Revolver and Term Facility
      entered into in February of 2007 have floating interest rates based on our
      option of either the base rate or LIBOR rate. Upon entering into the Revolver
      and Term Facility in February 2007, we had no borrowing outstanding under the
      Revolver and $40.0 million outstanding under the Term Facility. We are
      considering whether to use interest rate swaps to manage this risk. A 100 basis
      point (1.0%) increase in the average interest rate for our floating rate
      borrowings would increase our annual interest expense by approximately $0.1
      million for each $10 million of borrowings under the Revolver and Term
      Facilities.





We
      manage
      our commodity price risk through the use of long-term coal supply agreements,
      which we define as contracts with a term of one year or more, rather than
      through the use of derivative instruments. We believe that the percentage of
      our
      sales pursuant to long-term contracts was approximately 79% for the year ended
      December 31, 2006.




All
      of
      our transactions are denominated in U.S. dollars, and, as a result, we do not
      have material exposure to currency exchange-rate risks.





We
      are
      not engaged in any foreign currency exchange rate or commodity price-hedging
      transactions and we have no trading market risk .




**Item****8.****Financial
      Statements and Supplementary Data**




See
      list
      of Financial Statements on page F-1.




**I****tem
      9.****Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosures**




None.





**Item
      9A.****Controls
      and Procedures**




Pursuant
      to Rule 13a-15(b) under the Securities Exchange Act of 1934 (“Exchange Act”),
      the Company carried out an evaluation, with the participation of the Company’s
      management, including the Company’s Chief Executive Officer (“CEO”) and Chief
      Accounting Officer (“CAO”) (the Company’s principal financial and accounting
      officer), of the effectiveness of the Company’s disclosure controls and
      procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of the
      end of the period covered by this report. Based upon that evaluation, the
      Company’s CEO and CAO concluded that the Company’s disclosure controls and
      procedures are effective to ensure that information required to be disclosed
      by
      the Company in the reports that the Company files or submits under the Exchange
      Act, is recorded, processed, summarized and reported, within the time periods
      specified in the SEC’s rules and forms, and that such information is accumulated
      and communicated to the Company’s management, including the Company’s CEO and
      CAO, as appropriate, to allow timely decisions regarding required
      disclosure.




***Management’s
      Report on Internal Controls over Financial
      Reporting***





Internal
      control over financial reporting is a process to provide reasonable assurance
      regarding the reliability of consolidated financial reporting and the
      preparation of financial statements for external purposes in accordance with
      U.S. generally accepted accounting principles.  There has been no change in
      the Company’s internal control over financial reporting during the year ended
      December 31, 2006 that has materially affected, or is reasonably likely to
      materially affect, the Company’s internal control over financial reporting.




53




The
      Company’s management, including the Company’s CEO and CAO, does not expect that
      the Company’s disclosure controls and procedures or the Company’s internal
      controls will prevent all errors and all fraud. A control system, no matter
      how
      well conceived and operated, can provide only reasonable, not absolute,
      assurance that the objectives of the control system are met. Further, the design
      of a control system must reflect the fact that there are resource constraints,
      and the benefits of controls must be considered relative to their costs. Because
      of the inherent limitations in all control systems, no evaluation of the
      controls can provide absolute assurance that all control issues and instances
      of
      fraud, if any, within the Company have been detected.





Management
      conducted an evaluation of the effectiveness of our internal control over
      financial reporting based on the framework in *Internal
      Control - Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission. Based
      on this evaluation, management concluded that the company’s internal control
      over financial reporting was effective as of December 31, 2006.





KPMG
      LLP
      has audited this assessment of our internal control over financial reporting;
      as
      stated in their report, which is included in Item 9A .




54




***Report
      of Independent Registered Public Accounting Firm***





The
      Board
      of Directors


James
      River Coal Company:





We
      have
      audited management’s assessment, included in the accompanying Management’s
      Report on Internal Control over Financial Reporting *,* that
      James River Coal Company and subsidiaries (the Company) maintained effective
      internal control over financial reporting as of December 31, 2006, based on
      criteria established in *Internal
      Control—Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
      The Company’s management is responsible for maintaining effective internal
      control over financial reporting and for its assessment of the effectiveness
      of
      internal control over financial reporting. Our responsibility is to express
      an
      opinion on management’s assessment and an opinion on the effectiveness of the
      Company’s internal control over financial reporting based on our
      audit.





We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, evaluating management’s assessment, testing and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.





A
      company’s internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with U.S. generally accepted accounting principles. A company’s internal control
      over financial reporting includes those policies and procedures that (1) pertain
      to the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with U.S. generally
      accepted accounting principles, and that receipts and expenditures of the
      company are being made only in accordance with authorizations of management
      and
      directors of the company; and (3) provide reasonable assurance regarding
      prevention or timely detection of unauthorized acquisition, use, or disposition
      of the company’s assets that could have a material effect on the financial
      statements.





Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.





In
      our
      opinion, management’s assessment that the Company maintained effective internal
      control over financial reporting as of December 31, 2006, is fairly stated,
      in
      all material respects, based on criteria established in *Internal
      Control—Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission
      (COSO). ** Also,
      in
      our opinion, the Company maintained, in all material respects, effective
      internal control over financial reporting as of December 31, 2006, based on criteria
      established in *Internal
      Control—Integrated Framework* issued
      by the Committee of
      Sponsoring Organizations of the Treadway Commission (COSO) .




55




We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the consolidated balance sheets of James River
      Coal Company and subsidiaries as of December 31, 2006 and 2005 (Successor
      Company), and the related consolidated statements of operations, changes in
      shareholders’ equity (deficit) and comprehensive income (loss), and cash flows
      for the years then ended (Successor Company), the eight months ended December
      31, 2004 (Successor Company), and the four months ended April 30, 2004
      (Predecessor Company), and our report dated March 15, 2007 ** expressed
      an unqualified opinion on those consolidated financial statements.






Richmond,
      Virginia


March
      15,
      2007





**Item
      9B.****Other
      Information**





None.




56




**PART
      III**




**Item****10.****Directors
      and Executive Officers of the Registrant**




The
      information contained under
      the headings “Election of Director s”,
      “Section 16(a) Beneficial Ownership Reporting Compliance ” “ Board
      Matters ”
and
      “Management” in the definitive Proxy Statement used in connection with the
      solicitation of proxies for the Company’s 2007 Annual Meeting of Shareholders,
      to be filed with the Commission, is hereby incorporated herein by
      reference .





**Item****11.****Executive
      Compensation**




The
      information contained under
      the headings “Compensation
      Committee Report,”  “Executive Compensation ,” “ Equity
      Compensation Plans ,” and “Compensation
      Committee Interlocks and Insider Participation ”
in
      the
      definitive Proxy Statement used in connection with the solicitation of proxies
      for the Company’s 2007 Annual Meeting of Shareholders ,  to
      be
      filed with the Commission , is
      hereby incorporated herein by reference .





**Item
      12.****Security****Ownership
      of Certain Beneficial Owners and Management and Related Stock
      Matters**





The
      information contained under
      the headings “Principal
      Shareholders and
      Securities Ownership of Management, ”
and
      “Equity Compensation Plans”
in
      the definitive Proxy Statement used in connection with the solicitation of
      proxies for the Company’s 2007 Annual Meeting of Shareholders, to be filed with
      the Commission, is hereby incorporated herein by reference .





**Item****13.****Certain****Relationships
      and Related Transactions**





The
      information contained under
      the heading “Compensation
      Committee Interlocks and Insider Participation ”
in
      the
      definitive Proxy Statement used in connection with the solicitation of proxies
      for the Company’s 2007 Annual Meeting of Shareholders, to be filed with the
      Commission, is hereby incorporated herein by reference .





**Item
      14.****Principal
      Accountant Fees and Services**




The
      information contained under the heading “Independent Registered Public
      Accountants” in the definitive Proxy Statement used in connection with the
      solicitation of proxies for the
      Company’s 200 7 Annual
      Meeting of Shareholders , to be filed
      with the Commission,
      is hereby incorporated herein by reference .




57


**PART
      IV**




**Item
      15.****Exhibits
      and Financial Statement****Schedules**





**(a)**  The
      following documents are filed as part of this Report:




**1.** **Financial
      Statements**





The
      following financial statements and related report of Independent Registered
      Public Accounting Firm are incorporated in Item 8 of this
      report:





Report
      of
      Independent Registered Public Accounting Firm





Consolidated
      Balance Sheets as of December 31, 2006 and 2005





Consolidated
      Statements of Operations for the years ended December 31, 2006 and 2005
      (Successor), the eight months ended December 31, 2004 (Successor) and the four
      months ended April 30, 2004 (Predecessor)





Consolidated
      Statements of Changes in Shareholders’ Equity (Deficit) and Comprehensive Income
      (Loss) for the years ended December 31, 2006 and 2005 (Successor), the eight
      months ended December
      31, 2004 (Successor) and the four months ended April 30, 2004 (Predecessor)





Consolidated
      Statements of Cash Flows for the for the years ended December 31, 2006 and
      2005
      (Successor), the eight months ended December 31, 2004 (Successor) and the four
      months ended April 30, 2004 (Predecessor)




Notes
      to
      Consolidated Financial Statements




**2.** **Financial
      Statement Schedules**




**None.**




**3.** **Exhibits**




The
      following exhibits are required to be filed with this Report by Item 601 of
      Regulation S-K:




58




**Exhibit
                  Number**
              
              **Description**2.1#
              
              Second
                  Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy
                  Code of the Registrant and its Subsidiaries, dated as of April
                  20,
                  20042.2##
              
              Stock
                  Purchase Agreement by and among James River Coal Company, Triad
                  Mining,
                  Inc. and the Stockholders of Triad Mining, Inc. dated as of March
                  30,
                  20053.1#
              
              Amended
                  and Restated Articles of Incorporation of the Registrant, as
                  Amended3.2^^^
              
              Amended
                  and Restated Bylaws of the Registrant4.1#
              
              Specimen
                  common stock certificate4.2#
              
              Rights
                  Agreement between the Registrant and SunTrust Bank as Rights Agent,
                  dated
                  as of May 25, 20044.3^^^
              
              Amendment
                  No. 1 to Rights Agreement between the Registrant and Computer Share
                  Trust
                  Company N.A., successor to SunTrustBank, as Rights Agent, dated
                  as of
                  November 3, 200610.1#
              
              Registration
                  Rights Agreement by and among the Registrant and the Shareholders
                  identified therein, dated May 6, 200410.2#
              
              Loan
                  and Security Agreement by and among the Registrant and its Subsidiaries,
                  the Lenders that are Signatories thereto, Wells Fargo Foothill,
                  Inc. and
                  Morgan Stanley Senior Funding, Inc., dated as of May 6,
                  200410.3#
              
              $75,000,000
                  Term Loan Agreement by and among the Registrant and its Subsidiaries,
                  the
                  Lenders from time to time party thereto and BNY Asset Solutions
                  LLC, dated
                  as of May 6, 200410.4*#
              
              Employment
                  Agreement between the Registrant and Peter T. Socha, dated as of
                  May 7,
                  200410.5*#
              
              2004
                  Equity Incentive Plan of the Registrant10.6#
              
              Form
                  of Indemnification Agreement between the Registrant and its officers
                  and
                  directors10.7**#
              
              Agreement
                  for Purchase and Sale of Coal among Georgia Power Company, the
                  Registrant
                  and James River Coal Sales, Inc., dated as of March 11,
                  200410.8**#
              
              Fuel
                  Supply Agreement #141944 between South Carolina Public Service
                  Authority
                  and the Registrant, dated as of March 1, 200410.9^
              
              Triad
                  Registration Rights Agreement between the Registrant and the Shareholders
                  named therein, dated as of May 31, 2005.10.10###
              
              Credit
                  Agreement between Registrant and PNC Bank, National Association
                  and Morgan
                  Stanley Senior Funding, Inc. dated as of May 31, 200510.11^
              
              Amendment
                  No. 1 and Waiver to the Credit Agreement between the Registrant
                  and PNC
                  Bank, National Association and Morgan Stanley Senior Funding, Inc.,
                  dated
                  February 22, 200610.12^^
              
              Amendment
                  No. 2 and Waiver to the Credit Agreement between the Registrant
                  and PNC
                  Bank, National Association and Morgan Stanley Senior Funding, Inc.,
                  dated
                  May 30, 200610.13
              
              Amendment
                  No. 3 and Waiver to the Credit Agreement between the Registrant
                  and PNC
                  Bank, National Association and Morgan Stanley Senior Funding, Inc.,
                  dated
                  November 7, 200610.14
              
              Amendment
                  No. 4 to the Credit Agreement between the Registrant and PNC Bank,
                  National Association and Morgan Stanley Senior Funding, Inc., dated
                  December 27, 200610.15
              
              $100,000,000
                  Term Credit Agreement by and among the Registrant, certain of its
                  subsidiaries, the Lenders thereto, Morgan Stanley Senior Funding,
                  Inc., as
                  Administrative Agent, Sole Bookrunner and Lead Arranger, and Morgan
                  Stanley & Co. Incorporated, as Collateral Agent, dated as of February
                  26, 2007
  59
  10.16
              
              $35,000,000
                  Revolving Credit Agreement by and among the Registrant, certain of
                  its subsidiaries, the Lenders thereto, and General Electric Capital
                  Corporation, as Co-Lead Arranger, Administrative Agent and Collateral
                  Agent, with Morgan Stanley Senior Funding, Inc., having acted as
                  Co-Lead
                  Arranger, dated as of February 26, 200721^
              
              Subsidiaries
                  of the Registrant23.1
              
              Consent
                  of Marshall Miller & Associates, Inc.23.2
              
              Consent
                  of KPMG LLP (filed herewith)31.1
              
              Certification
                  of Peter T. Socha, President and Chief Executive Officer of James
                  River
                  Coal Company, pursuant to rule 13a-14(a) or 15d-14(a) of the Exchange
                  Act,
                  as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2002.31.2
              
              Certification
                  of Samuel M. Hopkins, II, Vice President and Chief Accounting Officer
                  of
                  James River Coal Company, pursuant to rule 13a-14(a) or 15d-14(a)
                  of the
                  Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley
                  Act
                  of 2002.32.1
              
              Certification
                  of Peter T. Socha, President and Chief Executive Officer of James
                  River
                  Coal Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant
                  to
                  Section 906 of the Sarbanes-Oxley Act of 2002.32.2
              
              Certification
                  of Samuel M. Hopkins, II, Vice President and Chief Accounting Officer
                  of
                  James River Coal Company, pursuant to 18 U.S.C. Section 1350, as
                  adopted
                  pursuant to Section 906 of the Sarbanes-Oxley Act of
                  2002.




*
            Management
                contract or compensatory plan or
                arrangement.




**
                Portions
                    of these documents have been omitted and filed separately with
                    the
                    Securities and Exchange Commission pursuant to a request for
                    confidential
                    treatment of the omitted portions.


#
            Filed
                in the Company’s Registration Statement on Form S-1, initially filedas
                ofAugust
                13, 2004, as amended.




##
            Filed
                in the Company’s Registration Statement on Form S-1, initially filedas
                ofApril
                19, 2005, as amended




###
            Filed
                in the Company’s Quarterly Report on 10-Q, filed November 14,
                2005




^
            Filed
                in the Company’s Quarterly Report on 10-K, filed March 16,
                2006




^^
            Filed
                in the Company’s Quarterly Report on 10-Q, filed August 9,
                2006




^^^
            Filed
                in the Company’s Quarterly Report on 10-Q, filed November 9,
                2006




60


**INDEX
      TO CONSOLIDATED FINANCIAL STATEMENTS**




**Audited
                  Financial Statements**
              **Page**Report
                  of Independent Registered Public Accounting
                  Firm
              F-2Consolidated
                  Balance Sheets as of December 31, 2006 and 2005
              F-3Consolidated
                  Statements of Operations for the years ended
                  December 31, 2006 and 2005 (Successor),the
                  eight months ended December 31, 2004 (Successor) and the
                  four months endedApril
                  30, 2004 (Predecessor)
              F-5Consolidated
                  Statements of Changes in Shareholders’ Equity
                  (Deficit) and Comprehensive Income(Loss)
                  for the years ended December 31, 2006 and 2005
                  (Successor), the eight months endedDecember
                  31, 2004 (Successor) and the four months ended April
                  30, 2004 (Predecessor)
              F-6Consolidated
                  Statements of Cash Flows for the years ended
                  December 31, 2006 and 2005 (Successor),the
                  eight months ended December 31, 2004 (Successor) and the
                  four months endedApril
                  30, 2004 (Predecessor)
              F-7Notes
                  to Consolidated Financial
                  Statements
              F-8




F-1




Reportof
      Independent Registered Public Accounting
      Firm




The
      Board
      of Directors


James
      River Coal Company:




We
      have
      audited the accompanying consolidated balance sheets of James River Coal Company
      and subsidiaries (the Company) as of December 31, 2006 and 2005 (Successor
      Company), and the related consolidated statements of operations, changes in
      shareholders’ equity (deficit) and comprehensive income (loss), and cash flows
      for the years then ended (Successor Company), the eight months ended December
      31, 2004 (Successor Company), and the four months ended April 30, 2004
      (Predecessor Company). These consolidated financial statements are the
      responsibility of the Company’s management. Our responsibility is to express an
      opinion on these consolidated financial statements based on our
      audits.




We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.




In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of James River Coal Company
      and
      subsidiaries as of December 31, 2006 and 2005 (Successor Company), and the
      results of their operations and their cash flows for the years then ended
      (Successor Company), the eight months ended December 31, 2004 (Successor
      Company), and the four months ended April 30, 2004 (Predecessor Company), in
      conformity with U.S. generally accepted accounting principles.




As
      described more fully in Notes 1 and 2 to the consolidated financial statements,
      the Company was reorganized under a plan of reorganization confirmed by the
      United States Bankruptcy Court for the Middle District of Tennessee, effective
      May 6, 2004. In connection with the Company’s emergence from Chapter 11, all
      assets and liabilities were restated to their respective fair values in order
      to
      reflect the effects of fresh start accounting. As a result of the application
      of
      fresh start accounting, the consolidated financial statements of the Successor
      Company are presented on a different basis than those of the Predecessor Company
      and, therefore, are not comparable in all respects.




As
      discussed in Note 1 to the consolidated financial statements, effective January
      1, 2006, the Company adopted the provisions of Statement of Financial Accounting
      Standards No. 123(R), *Share-Based
      Payment* ,
      and on
      December 31, 2006, the Company adopted the provisions of Statement of Financial
      Accounting Standards No. 158, *Employers’
      Accounting for Defined Pension and Other Postretirement Plans.*




We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of the Company’s internal
      control over financial reporting as of December 31, 2006, based on criteria
      established in *Internal
      Control—Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission (COSO),
      and our report dated March 15, 2007 expressed an unqualified opinion on
      management’s assessment of, and the effective operation of, internal control
      over financial reporting *.*











Richmond,
      Virginia


March
      15,
      2007





F-2


**JAMESRIVER
      COAL COMPANY**


**AND
      SUBSIDIARIES**


Consolidated
      Balance Sheets


December
      31, 2006 and 2005


(in
      thousands, except share data)




**December
                    31, 2006**
                
                **December
                    31, 2005****Assets**Current
                    assets:Cash
                    and cash equivalents
                
                $
                1,807
                
                
                8,936Receivables:Trade
                
                
                47,383
                
                
                35,326Other
                
                
                853
                
                
                1,099Total
                    receivables
                
                
                48,236
                
                
                36,425Inventories:Coal
                
                
                5,512
                
                
                7,481Materials
                    and supplies
                
                
                7,448
                
                
                6,536Total
                    inventories
                
                
                12,960
                
                
                14,017Prepaid
                    royalties
                
                
                3,851
                
                
                4,213Other
                    current assets
                
                
                4,288
                
                
                4,126Total
                    current assets
                
                
                71,142
                
                
                67,717Property,
                    plant, and equipment, at cost:Land
                
                
                5,719
                
                
                6,142Mineral
                    rights
                
                
                190,346
                
                
                194,824Buildings,
                    machinery and equipment
                
                
                264,551
                
                
                207,558Mine
                    development costs
                
                
                21,727
                
                
                16,380Construction-in-progress
                
                
                189
                
                
                7,438Total
                    property, plant, and equipment
                
                
                482,532
                
                
                432,342Less
                    accumulated depreciation, depletion, and amortization
                
                
                144,752
                
                
                72,342Property,
                    plant and equipment, net
                
                
                337,780
                
                
                360,000Goodwill
                
                
                26,492
                
                
                28,048Other
                    assets
                
                
                15,840
                
                
                16,904Total
                    assets
                
                $
                451,254
                
                
                472,669




See
        accompanying notes to consolidated financial statements.




F-3


**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Consolidated
      Balance Sheets


December
      31, 2006 and 2005


(in
      thousands, except share data)




**December
                  31, 2006**
              
              **December
                  31, 2005****Liabilities
                  and Shareholders’
                  Equity**Current
                  liabilities:Current
                  installments of obligations under capital leases
              
              $
              262
              
              
              395Accounts
                  payable
              
              
              42,065
              
              
              32,855Accrued
                  salaries, wages, and employee benefits
              
              
              4,733
              
              
              4,289Workers’
                  compensation benefits
              
              
              9,300
              
              
              10,050Black
                  lung benefits
              
              
              2,630
              
              
              2,930Accrued
                  taxes
              
              
              6,028
              
              
              4,215Other
                  current liabilities
              
              
              8,713
              
              
              6,860Total
                  current liabilities
              
              
              73,731
              
              
              61,594Long-term
                  debt, less current maturities
              
              
              167,493
              
              
              150,000Other
                  liabilities:Noncurrent
                  portion of workers’ compensation benefits
              
              
              44,134
              
              
              42,231Noncurrent
                  portion of black lung benefits
              
              
              24,136
              
              
              24,352Pension
                  obligations
              
              
              13,011
              
              
              13,598Asset
                  retirement obligations
              
              
              27,394
              
              
              24,930Obligations
                  under capital leases, excluding current installments
              
              
              —
              
              
              230Deferred
                  income taxes
              
              
              13,160
              
              
              44,240Other
              
              
              1,798
              
              
              227Total
                  other liabilities
              
              
              123,633
              
              
              149,808Total
                  liabilities
              
              
              364,857
              
              
              361,402Commitments
                  and contingencies (note 13)Shareholders’
                  equity:Preferred
                  stock, $1.00 par value. Authorized 10,000,000 shares
              
              
              —
              
              
              —Common
                  stock, $.01 par value. Authorized 100,000,000 shares;issued
                  and outstanding 16,669,376 and 16,652,681 sharesas
                  of December 31, 2006 and 2005, respectively
              
              
              167
              
              
              167Paid-in-capital
              
              
              124,191
              
              
              135,923Deferred
                  stock-based compensation
              
              
              —
              
              
              (13,226
              )Accumulated
                  deficit
              
              
              (37,704
              )
              
              (11,187
              )Accumulated
                  other comprehensive loss
              
              
              (257
              )
              
              (410
              )Total
                  shareholders’ equity
              
              
              86,397
              
              
              111,267Total
                  liabilities and shareholders’ equity
              
              $
              451,254
              
              
              472,669




See
        accompanying notes to consolidated financial statements.


F-4


**JAMESRIVER
      COAL COMPANY**


**AND
      SUBSIDIARIES**


Consolidated
      Statements of Operations


(in
      thousands, except per share data)


**Successor**
              
              **Successor**
              
              **Successor**
              
              
              **Predecessor****Year**
              
              **Year**
              
              **Eight
                  Months**
              
              
              **Four
                  Months****Ended**
              
              **Ended**
              
              **Ended**
              
              
              **Ended****December
                  31,**
              
              **December
                  31,**
              
              **December
                  31,**
              
              
              **April
                  30,****2006**
              
              **2005**
              
              **2004**
              
              
              **2004**Revenues
              
              $
              564,791
              
              
              453,999
              
              
              231,698
              
              
              
              113,949Cost
                  of sales:Cost
                  of coal sold
              
              
              496,799
              
              
              389,222
              
              
              190,926
              
              
              
              89,294Depreciation,
                  depletion, and amortization
              
              
              74,562
              
              
              51,822
              
              
              21,765
              
              
              
              12,314Total
                  cost of sales
              
              
              571,361
              
              
              441,044
              
              
              212,691
              
              
              
              101,608Gross
                  profit (loss)
              
              
              (6,570
              )
              
              12,955
              
              
              19,007
              
              
              
              12,341Selling,
                  general, and administrative expenses
              
              
              30,867
              
              
              25,453
              
              
              11,412
              
              
              
              5,023Total
                  operating income (loss)
              
              
              (37,437
              )
              
              (12,498
              )
              
              7,595
              
              
              
              7,318Interest
                  expense
              
              
              16,782
              
              
              12,892
              
              
              5,733
              
              
              
              567Interest
                  income
              
              
              (366
              )
              
              (226
              )
              
              (72
              )
              
              
              —Charges
                  associated with repayment of debt (note 5)
              
              
              —
              
              
              2,524
              
              
              —
              
              
              
              —Miscellaneous
                  income, net
              
              
              (533
              )
              
              (1,067
              )
              
              (833
              )
              
              
              (331
              )Total
                  other expenses, net
              
              
              15,883
              
              
              14,123
              
              
              4,828
              
              
              
              236Income
                  (loss) before reorganization items and income taxes
              
              
              (53,320
              )
              
              (26,621
              )
              
              2,767
              
              
              
              7,082Reorganization
                  items, net (note 14)
              
              
              —
              
              
              —
              
              
              —
              
              
              
              (100,907
              )Income
                  (loss) before income taxes
              
              
              (53,320
              )
              
              (26,621
              )
              
              2,767
              
              
              
              107,989Income
                  tax expense (benefit)
              
              
              (27,151
              )
              
              (14,283
              )
              
              791
              
              
              
              —Net
                  income (loss)
              
              $
              (26,169
              )
              
              (12,338
              )
              
              1,976
              
              
              
              107,989Earnings
                  (loss) per common share (note 15)Basic
                  earnings (loss) per common share
              
              $
              (1.65
              )
              
              (0.83
              )
              
              0.14
              
              
              
              6,393.67Shares
                  used to calculate basic earnings (loss) per share
              
              
              15,849
              
              
              14,955
              
              
              13,800
              
              
              
              17Diluted
                  earnings (loss) per common share
              
              $
              (1.65
              )
              
              (0.83
              )
              
              0.14
              
              
              
              6,393.67Shares
                  used to calculate dilutive earnings (loss) per share
              
              
              15,849
              
              
              14,955
              
              
              14,623
              
              
              
              17




See accompanying notes to consolidated financial
      statements.




F-5




**JAMESRIVER
      COAL COMPANY**


**AND
      SUBSIDIARIES**


Consolidated
      Statements of Changes in Shareholders’


Equity
      (Deficit) and Comprehensive Income (Loss)





(in
      thousands)




**Predecessor
                  Company**
              
              **Common
                  stock shares**
              
              **Common
                  stock par value**
              
              **Paid-in-capital**
              
              **Deferred
                  stock based compensation**
              
              **Retained
                  earnings (accumulated deficit)**
              
              **Subscribed
                  shares**
              
              **Accumulated
                  other comprehensive income (loss)**
              
              **Total****Balances,
                  December 31, 2003**
              
              
              17
              
              $
              —
              
              
              226
              
              
              —
              
              
              (107,989
              )
              
              (821
              )
              
              (15,017
              )
              
              (123,601
              )Net
                  income
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              107,989
              
              
              —
              
              
              —
              
              
              107,989Minimum
                  pension liability adjustment
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (692
              )
              
              (692
              )Comprehensive
                  income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              107,297Application
                  of fresh start accounting (note 2)Cancellation
                            of Predecessor common stock
              
              
              (17
              )
              
              —
              
              
              (226
              )
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (226
              )Elimination
                        of Predecessor accumulated other comprehensive loss and subscribed
                        shares
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              821
              
              
              15,709
              
              
              16,530**Balances,
                  April 30, 2004**
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —**Successor
                  Company**Issuance
                  of Successor common stock
              
              
              13,800
              
              $
              138
              
              
              63,153
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              63,291Net
                  income
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              1,976
              
              
              —
              
              
              —
              
              
              1,976Unrealized
                  gain on marketable securities, net
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              43
              
              
              43Comprehensive
                  income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              2,019Issuance
                  of restricted stock awards
              
              
              916
              
              
              9
              
              
              8,631
              
              
              (8,640
              )
              
              —
              
              
              —
              
              
              —
              
              
              —Cost
                  to register common stock
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (825
              )
              
              —
              
              
              —
              
              
              (825
              )Stock
                  based compensation
              
              
              —
              
              
              —
              
              
              —
              
              
              1,100
              
              
              —
              
              
              —
              
              
              —
              
              
              1,100**Balances,
                  December 31, 2004**
              
              
              14,716
              
              
              147
              
              
              71,784
              
              
              (7,540
              )
              
              1,151
              
              
              —
              
              
              43
              
              
              65,585Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (12,338
              )
              
              —
              
              
              —
              
              
              (12,338
              )Minimum
                  pension liability adjustment, net
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (410
              )
              
              (410
              )Reclassification
                      adjustment on sale of marketable securities
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (43
              )
              
              (43
              )Comprehensive
                  loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (12,791
              )Issuance
                      of restricted stock awards, net of forfeitures
              
              
              132
              
              
              2
              
              
              8,073
              
              
              (8,075
              )
              
              —
              
              
              —
              
              
              —
              
              
              —Issuance
                      on common stock net of offering costs of $3,696
              
              
              1,500
              
              
              15
              
              
              45,039
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              45,054Common
                  stock issued in acquisition (note 3)
              
              
              338
              
              
              3
              
              
              10,997
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              11,000Repurchase
                  of shares for tax withholding
              
              
              (36
              )
              
              —
              
              
              (1,158
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              (1,158
              )Tax
                  benefit on vested shares of restricted stock
              
              
              —
              
              
              —
              
              
              1,058
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              1,058Stock
                  based compensation
              
              
              —
              
              
              —
              
              
              —
              
              
              2,389
              
              
              —
              
              
              —
              
              
              —
              
              
              2,389Exercise
                  of stock options
              
              
              3
              
              
              —
              
              
              93
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              93Capital
                  contribution, net of tax
              
              
              —
              
              
              —
              
              
              37
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              37**Balances,
                  December 31, 2005**
              
              
              16,653
              
              
              167
              
              
              135,923
              
              
              (13,226
              )
              
              (11,187
              )
              
              —
              
              
              (410
              )
              
              111,267Adoption
                  of SFAS 123R (note 1)
              
              
              —
              
              
              —
              
              
              (13,226
              )
              
              13,226
              
              
              —
              
              
              —
              
              
              —
              
              
              —Adoption
                  of SFAS 158 (note 1)Pension
                  plan
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (348
              )
              
              —
              
              
              (2,650
              )
              
              (2,998
              )Black
                  lung obligation
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              1,324
              
              
              1,324Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (26,169
              )
              
              —
              
              
              —
              
              
              (26,169
              )Minimum
                  pension liability adjustment, net
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              1,479
              
              
              1,479Comprehensive
                  loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (24,690
              )Issuance
                      of restricted stock awards, net of forfeitures
              
              
              99
              
              
              1
              
              
              (1
              )
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —Repurchase
                  of shares for tax withholding
              
              
              (83
              )
              
              (1
              )
              
              (2,350
              )
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (2,351
              )Stock
                  based compensation
              
              
              —
              
              
              —
              
              
              3,845
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              3,845**Balances,
                  December 31, 2006**
              
              
              16,669
              
              $
              167
              
              
              124,191
              
              
              —
              
              
              (37,704
              )
              
              —
              
              
              (257
              )
              
              86,397




See
        accompanying notes to consolidated financial statements.





F-6




**JAMESRIVER
      COAL COMPANY**


**AND
      SUBSIDIARIES**


Consolidated
      Statements of Cash Flows


(in
      thousands)




**Successor**
            
            
            **Predecessor****Year**
              **Ended**
              **December
                31,**
              **2006**
            
            **Year**
              **Ended**
              **December
                31,**
              **2005**
            
            **Eight
                Months**
              **Ended**
              **December
                31,**
              **2004**
            
            
            **Four
                Months**
              **Ended**
              **April
                30,**
              **2004**Cash
                flows from operating activities:Net
                income (loss)
            
            $
            (26,169
            )
            
            (12,338
            )
            
            1,976
            
            
            
            107,989Adjustments
                  to reconcile net income (loss) to net cash provided by operating
                  activitiesDepreciation,
                  depletion, and amortization of property, plant, and
                  equipment
            
            
            74,562
            
            
            51,822
            
            
            21,765
            
            
            
            12,314Accretion
                of asset retirement obligations
            
            
            2,066
            
            
            1,562
            
            
            807
            
            
            
            397Amortization
                of debt issue costs
            
            
            1,282
            
            
            919
            
            
            275
            
            
            
            —Stock-based
                compensation
            
            
            3,845
            
            
            2,389
            
            
            1,100
            
            
            
            —Deferred
                income tax expense (benefit)
            
            
            (24,994
            )
            
            (14,707
            )
            
            766
            
            
            
            —Gain
                (loss) on sale or disposal of property, plant, and
                equipment
            
            
            113
            
            
            43
            
            
            (36
            )
            
            
            19Write-off
                of deferred financing costs
            
            
            —
            
            
            1,733
            
            
            —
            
            
            
            —Fresh
                start accounting adjustment
            
            
            —
            
            
            —
            
            
            —
            
            
            
            (111,533
            )Non-cash
                reorganization items
            
            
            —
            
            
            —
            
            
            —
            
            
            
            10,010Changes
                in operating assets and liabilities:Receivables
            
            
            (11,811
            )
            
            4,488
            
            
            4,604
            
            
            
            (12,882
            )Inventories
            
            
            1,057
            
            
            (4,838
            )
            
            6,619
            
            
            
            (4,028
            )Prepaid
                royalties and other current assets
            
            
            200
            
            
            3,747
            
            
            3,093
            
            
            
            (1,236
            )Other
                assets
            
            
            983
            
            
            (100
            )
            
            (7,001
            )
            
            
            132Accounts
                payable
            
            
            8,854
            
            
            13,351
            
            
            (11,177
            )
            
            
            (2,921
            )Accrued
                salaries, wages, and employee benefits
            
            
            444
            
            
            490
            
            
            (2,408
            )
            
            
            1,429Accrued
                taxes
            
            
            (538
            )
            
            (474
            )
            
            (58
            )
            
            
            139Other
                current liabilities
            
            
            1,853
            
            
            2,427
            
            
            (404
            )
            
            
            1,535Workers’
                compensation benefits
            
            
            1,153
            
            
            4,008
            
            
            (1,886
            )
            
            
            1,417Black
                lung benefits
            
            
            1,620
            
            
            (1,286
            )
            
            (830
            )
            
            
            (547
            )Pension
                obligations
            
            
            (3,062
            )
            
            (2,803
            )
            
            (1,887
            )
            
            
            (609
            )Asset
                retirement obligations
            
            
            (1,349
            )
            
            (1,378
            )
            
            (477
            )
            
            
            (108
            )Other
                liabilities
            
            
            1,571
            
            
            (65
            )
            
            (743
            )
            
            
            (4
            )Net
                cash provided by operating activities
            
            
            31,680
            
            
            48,990
            
            
            14,098
            
            
            
            1,513Cash
                flows from investing activities:Additions
                to property, plant, and equipment
            
            
            (62,507
            )
            
            (84,987
            )
            
            (25,811
            )
            
            
            (9,521
            )Payment
                for acquisitions, net of cash acquired
            
            
            —
            
            
            (59,404
            )
            
            —
            
            
            
            —Proceeds
                from sale of property, plant and equipment
            
            
            7,769
            
            
            185
            
            
            4,123
            
            
            
            86Proceeds
                from sale of investments
            
            
            —
            
            
            440
            
            
            —
            
            
            
            —(Increase)
                decrease in restricted cash
            
            
            —
            
            
            8,404
            
            
            (56
            )
            
            
            (28
            )Net
                cash used in investing activities
            
            
            (54,738
            )
            
            (135,362
            )
            
            (21,744
            )
            
            
            (9,463
            )Cash
                flows from financing activities:Proceeds
                from issuance of long-term debt
            
            
            —
            
            
            150,000
            
            
            20,000
            
            
            
            —Repayment
                of long-term debt
            
            
            —
            
            
            (95,468
            )
            
            —
            
            
            
            —Proceeds
                from (repayments of) Revolver, net
            
            
            17,493
            
            
            —
            
            
            —
            
            
            
            —Proceeds
                from (repayments of) short-term borrowings
            
            
            —
            
            
            —
            
            
            (6,400
            )
            
            
            6,400Net
                proceeds from issuance of common stock
            
            
            —
            
            
            45,054
            
            
            —
            
            
            
            —Common
                stock registration costs
            
            
            —
            
            
            —
            
            
            (825
            )
            
            
            —Principal
                payments under capital lease obligations
            
            
            (363
            )
            
            (400
            )
            
            (370
            )
            
            
            (165
            )Debt
                issuance costs
            
            
            (1,201
            )
            
            (7,866
            )
            
            (2,181
            )
            
            
            (1,874
            )Capital
                contributions and proceeds from stock options exercised
            
            
            —
            
            
            109
            
            
            —
            
            
            
            —Net
                cash provided by financing activities
            
            
            15,929
            
            
            91,429
            
            
            10,224
            
            
            
            4,361Increase
                (decrease) in cash
            
            
            (7,129
            )
            
            5,057
            
            
            2,578
            
            
            
            (3,589
            )Cash
                and cash equivalents at beginning of period
            
            
            8,936
            
            
            3,879
            
            
            1,301
            
            
            
            4,890Cash
                and cash equivalents at end of period
            
            $
            1,807
            
            
            8,936
            
            
            3,879
            
            
            
            1,301




See
        accompanying notes to consolidated financial statements.
  F-7




**JAMESRIVER
        COAL COMPANY**
 **AND
        SUBSIDIARIES**
 Notes
        to
        Consolidated Financial Statements


**(1)** **Summary
      of Significant Accounting Policies and Other Information**




***Description
      of Business and Principles of Consolidation***




The
      Company mines, processes and sells bituminous, steam- and industrial-grade
      coal
      through five operating complexes located throughout eastern Kentucky and one
      in
      southern Indiana. The Company acquired its operations in southern Indiana in
      May
      2005 (see note 3). Substantially all coal sales and accounts receivable relate
      to the electric utility and industrial markets.





The
      consolidated financial statements include the accounts of James River Coal
      Company and its wholly owned subsidiaries. All significant intercompany accounts
      and transactions have been eliminated in consolidation.




***Bankruptcy
      and Restructuring***




In
      March
      2003, James River Coal Company and subsidiaries (the Company) filed a voluntary
      petition for relief under Chapter 11 with the United States Bankruptcy Court
      for
      the Middle District of Tennessee. On April 21, 2004 the United States Bankruptcy
      Court for the Middle District of Tennessee confirmed the Company’s Plan of
      Reorganization (the Plan). The Plan of Reorganization became effective May
      6,
      2004 (the Effective Date) which is the date on which the Company formally
      emerged from Chapter 11. Pursuant to the Plan, the Company’s unsecured creditors
      claims were discharged and terminated.





The
      Company’s accompanying consolidated financial statements for the four months
      ended April 30, 2004 have been prepared in accordance with the American
      Institute of Certified Public Accountants’ Statement of Position 90-7, *Financial
      Reporting by Entities in Reorganization under the Bankruptcy
      Code* (SOP
      90-7), which provides guidance for financial reporting by entities that have
      filed petitions under Bankruptcy. As a result, all assets and liabilities were
      restated to reflect their respective fair values. Although the Effective Date
      of
      the Plan of Reorganization was May 6, 2004, the consummation of the Plan of
      Reorganization has been reflected as of April 30, 2004, the end of the Company’s
      most recent fiscal month prior to the Effective Date. The consolidated financial
      statements after emergence are those of a new reporting entity (the Successor)
      and are not comparable to the consolidated financial statements of the
      pre-emergence Company (the Predecessor). A black line has been drawn in the
      financial statements to distinguish Predecessor and Successor financial
      information. See note 2 for further discussion.




***Cash
      and Cash Equivalents***




Cash
      and
      cash equivalents are stated at cost. Cash equivalents consist of highly-liquid
      investments with an original maturity of three months or less when purchased.




***Trade
      Receivables***




Trade
      receivables are recorded at the invoiced amount and do not bear interest. The
      Company evaluates the need for an allowance for doubtful accounts based on
      review of historical write off experience and industry data. The Company has
      determined that no allowance is necessary for trade receivables as of December
      31, 2006 and 2005. The Company does not have any off-balance sheet credit
      exposure related to its customers.




F-8




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements




***Inventories***




Inventories
      of coal and materials and supplies are stated at the lower of cost or market.
      Cost is determined using the average cost for coal inventories and the first-in,
      first-out method for materials and supplies. Coal inventory costs include labor,
      supplies, equipment cost, depletion, royalties, black lung tax, reclamation
      tax
      and preparation plant cost.




***Asset
      Retirement Obligations***




Asset
      retirement obligations are initially recorded as a liability based on fair
      value, which is calculated as the present value of the estimated future cash
      flows, in the period in which it is incurred. The estimate of ultimate
      reclamation liability and the expected period in which reclamation work will
      be
      performed is reviewed periodically by the Company’s management and engineers. In
      estimating future cash flows, the Company considers the estimated current cost
      of reclamation and applies inflation rates and a third party profit. The third
      party profit is an estimate of the approximate markup that would be charged
      by
      contractors for work performed on behalf of the Company. When the liability
      is
      initially recorded, the offset is capitalized by increasing the carrying amount
      of the related long-lived asset. Over time, the liability is accreted to its
      present value each period, and the capitalized cost is depreciated over the
      useful life of the related asset. Accretion expense is included in cost of
      produced coal. To the extent there is a difference between the liability
      recorded and the cost incurred, a gain or loss upon settlement is recognized.
      At
      December 31, 2006 and 2005, the Company had accrued $29.7 million and $26.8
      million, respectively, related to estimated mine reclamation costs.




The
      change in the asset retirement obligation for the years ended December 31,
      2006
      and 2005 is as follows (in thousands):




**2006**
              
              **2005**Asset
                  retirement obligation at beginning of year
              
              $
              26,775
              
              
              15,979Liabilities
                  incurred
              
              
              1,729
              
              
              2,722Liabilities
                  assumed in acquisition
              
              
              —
              
              
              7,861Revisions
                  in estimated cash flows
              
              
              226
              
              
              24Accretion
                  expense
              
              
              2,066
              
              
              1,562Liabilities
                  settled
              
              
              (1,082
              )
              
              (1,373
              )Asset
                  retirement obligation at end of year
              
              
              29,714
              
              
              26,775Less
                  amount included in other current liabilities
              
              
              (2,320
              )
              
              (1,845
              )Total
                  non-current liability
              
              $
              27,394
              
              
              24,930




***Property,
      Plant, and Equipment***




Expenditures
      for maintenance and repairs are charged to expense, and the costs of mining
      equipment rebuilds and betterments that extend the useful life are capitalized.
      Depreciation is provided principally using the straight-line method based upon
      estimated useful lives, generally ten to 20 years for buildings and one to
      seven years for machinery and equipment. Equipment held under capital
      leases is amortized using the straight line method over the lesser of the lease
      term or the estimated useful life of the asset. Mine development costs are
      capitalized and amortized by the units of production method over estimated total
      recoverable proven and probable reserves. Amortization of mineral rights is
      provided by the units of production method over estimated total recoverable
      proven and probable reserves.




F-9




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements




***Impairment
      of Long-Lived Assets***




Long-lived
      assets, such as property, plant, and equipment are reviewed for impairment
      whenever events or changes in circumstances indicate that the carrying amount
      of
      an asset may not be recoverable. Recoverability of assets to be held and used
      is
      measured by a comparison of the carrying amount of an asset to estimated
      undiscounted future cash flows expected to be generated by the asset. If the
      carrying amount of an asset exceeds its estimated future cash flows, an
      impairment charge is recognized for the amount by which the carrying amount
      of
      the asset exceeds the fair value of the asset. The Company did not recognize
      any
      impairment charges during the periods presented.




***Goodwill***




Goodwill
      represents the excess of purchase price and related costs over the value
      assigned to the net tangible and identifiable intangible assets of businesses
      acquired. Goodwill is not amortized but is tested for impairment annually,
      or if
      certain circumstances indicate a possible impairment may exist. Impairment
      testing is performed at a reporting unit level. An impairment loss generally
      would be recognized when the carrying amount of the reporting unit exceeds
      the
      fair value of the reporting unit, with the fair value of the reporting unit
      determined using a discounted cash flow analysis.




***Prepaid
      Royalties***




Mineral
      rights are often acquired in exchange for advance royalty payments. Royalty
      payments representing prepayments recoupable against future production are
      capitalized, and amounts expected to be recouped within one year are
      classified as a current asset. As mining occurs on these leases, the prepayment
      is offset against earned royalties and is included in the cost of coal sold.
      Amounts determined to be nonrecoupable are charged to expense.




***Revenue
      Recognition***




Revenues
      include sales to customers of Company-produced coal and coal purchased from
      third parties. The Company recognizes revenue from the sale of Company-produced
      coal and coal purchased from third parties at the time delivery occurs
      and risk of loss passes to the customer, which is either upon shipment
      or upon customer receipt of coal based on contractual terms. Also, the sales
      price must be determinable and collection reasonably assured.





***Income
      Taxes***




Income
      taxes are accounted for under the asset and liability method. Deferred tax
      assets and liabilities are recognized for the future tax consequences
      attributable to differences between the financial statement carrying amounts
      of
      existing assets and liabilities and their respective tax bases and operating
      loss and tax credit carryforwards. Deferred tax assets and liabilities are
      measured using enacted tax rates expected to apply to taxable income in the
      years in which those temporary differences are expected to be recovered or
      settled. The income tax benefit for the year ended December 31, 2006 includes
      a
      deferred income tax benefit of $1.3 million or $0.08 per basic and fully diluted
      share due to a reduction in future state tax rates as enacted in 2005.
      Management evaluated the quantitative and qualitative impact of this adjustment,
      individually and in the aggregate, on previously reported periods, on the
      current fiscal period and on earnings taken as a whole. Based upon this
      evaluation, management concluded that the adjustment is not material to the
      Company’s financial statements taken as a whole. Adjusted for the benefit
      for the reduction in state tax rates, our effective tax rate for the year ended
      December 31, 2006 is 48.5%.




F-10
 
  **JAMES
        RIVER COAL COMPANY**
 **AND
        SUBSIDIARIES**
 Notes
        to
        Consolidated Financial Statements




Our
      effective income tax rate is impacted by percentage depletion. Percentage
      depletion is an income tax deduction that is limited to a percentage of taxable
      income from each of our mining properties. Because percentage depletion can
      be
      deducted in excess of cost depletion, it creates a permanent difference and
      directly impacts the effective tax rate. Fluctuations in the effective tax
      rate
      may occur between fiscal periods due to the varying levels of profitability
      (and
      thus, taxable income and percentage depletion) at each of our mine
      locations.




***Accumulated
      Other Comprehensive Income (Loss)***




The
      accumulated other comprehensive loss at December 31, 2006 includes a $1.6
      million actuarial loss (net of $1.0 million of taxes) on the Company’s pension
      plan and a $1.3 million actuarial gain (net of $0.8 million of taxes) on its
      black lung obligation (see Recent Accounting Pronouncements). The accumulated
      other comprehensive loss at December 31, 2005, represents the aggregate minimum
      pension liability adjustment.




***Workers’
      Compensation***




The
      Company is liable for workers’ compensation benefits for traumatic injuries
      under state workers’ compensation laws in which it has operations. Except as
      indicated, the Company is self insured for workers’ compensation for its
      Kentucky operations, with specific excess insurance purchased from independent
      insurance carriers to cover individual traumatic claims in excess of the
      self-insured limits. For the period from 1979 to 1982, claims are covered by
      a
      third party insurance company. For the period June 2002 to June 2005, claims
      are
      covered through the voluntary market using a deductible program. The Company’s
      operations in Indiana are covered by a third party insurance company.




The
      Company accrues for workers’ compensation benefits by recognizing a liability
      when it is probable that the liability has been incurred and the cost can be
      reasonably estimated. The Company provides information to independent actuaries,
      who after review and consultation with the Company with regards to actuarial
      assumptions, including discount rate, prepare an evaluation of the liabilities
      for workers’ compensation benefits.




***Black
      Lung Benefits***




The
      Company is responsible under the Federal Coal Mine Health and Safety Act of
      1969, as amended, and various states’ statutes for the payment of medical and
      disability benefits to employees and their dependents resulting from occurrences
      of coal worker’s pneumoconiosis disease (black lung). The Company provides for
      federal and state black lung claims through a self-insurance program for its
      Central Appalachia operations. The Company uses the service cost method to
      account for its self-insured black lung obligation. The liability measured
      under
      the service cost method represents the discounted future estimated cost for
      former employees either receiving or projected to receive benefits, and the
      portion of the projected liability relative to prior service for active
      employees projected to receive benefits. The Company has insured its black
      lung
      obligation for its Midwest operations.




The
      periodic expense for black lung claims under the service cost method represents
      the service cost, which is the portion of the present value of benefits
      allocated to the current year, interest on the accumulated benefit obligation,
      and amortization of unrecognized actuarial gains and losses. Prior to the
      adoption of SFAS 158 (see Recent Accounting Pronouncements), the Company
      amortized any unrecognized actuarial gains and losses over the average remaining
      work life of the workforce. With the adopton of SFAS 158, such actuarial gains
      and losses are included as a component of accumulated other comprehensive income
      (loss).




F-11
 
  **JAMES
        RIVER COAL COMPANY**
 **AND
        SUBSIDIARIES**
 Notes
        to
        Consolidated Financial Statements




Annual
      actuarial studies are prepared by independent actuaries using certain
      assumptions to determine the liability. The calculation is based on assumptions
      regarding disability incidence, medical costs, mortality, death benefits,
      dependents, and interest rates. These assumptions are derived from actual
      Company experience and industry sources.




***Health
      Claims***




The
      Company is self-insured for certain health care coverage. The cost of this
      self-insurance program is accrued based upon estimates of the costs for known
      and anticipated claims. The Company recorded an estimated amount to cover known
      claims and claims incurred but not reported of $1.8 million and $1.7 million
      as
      of December 31, 2006 and 2005, respectively, which is included in accrued
      salaries, wages, and employee benefits.




***Equity-Based
      Compensation Plan***




The
      Company adopted Statement of Financial Accounting Standards (SFAS) 123 (revised
      2004), *Share-Based
      Payment* (SFAS
      123R), on January 1, 2006, using the modified prospective method. Prior to
      2006,
      the Company accounted for stock based compensation using the intrinsic value
      method under Accounting Principles Board Opinion No. 25 (APB 25), “Accounting
      for Stock Issued to Employees” as permitted under SFAS 123, “Accounting for
      Stock-Based Compensation.” Accordingly, compensation costs for stock options
      granted to employees were not recognized in the consolidated statements of
      operations as the exercise price of options granted was equal to or greater
      than
      the market value of the stock at the date of grant. The company provided pro
      forma earning and earnings per share amounts as if stock option expense had
      been
      recognized based on fair value in the footnotes, as required.





The
      Company has elected the modified prospective transition method as permitted
      by
      SFAS 123R. Prior periods have not been restated to reflect the impact of stock
      option expense. Stock option expense will be recorded for all newly granted
      or
      modified options, as well as, unvested stock options that are expected to vest
      over the service period beginning on January 1, 2006. Stock option expense
      is
      generally recognized on a straight-line basis over the stated vesting period.
      The Company expensed $245,000 related to stock options in the year ended
      December 31, 2006. The adoption of SFAS 123R did not impact the accounting
      for
      the Company’s remaining unvested stock-based compensation associated with the
      restricted stock.





Prior
      to
      the adoption of SFAS 123R the Company recorded in equity the deferred stock
      based compensation associated with outstanding unvested restricted stock. Upon
      adoption of SFAS 123R on January 1, 2006, the deferred stock based compensation
      was reclassified to paid in capital.





***Use
      of Estimates***




Management
      of the Company has made a number of estimates and assumptions relating to the
      reporting of assets, liabilities, revenues and expenses and the disclosure
      of
      contingent assets and liabilities in order to prepare these consolidated
      financial statements in conformity with accounting principles generally accepted
      in the United States of America. Significant estimates made by management
      include the valuation allowance for deferred tax assets, asset retirement
      obligations and amounts accrued related to the Company’s workers’ compensation,
      black lung, pension and health claim obligations. Actual results could differ
      from these estimates.




F-12
 
  **JAMES
        RIVER COAL COMPANY**
 **AND
        SUBSIDIARIES**
 Notes
        to
        Consolidated Financial Statements




***Recent
      Accounting Pronouncements***




In
      July
      2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
      No. 48, *Accounting
      for Uncertainty in Income Taxes—an interpretation of FASB Statement
      No. 109* (FIN 48), which clarifies the accounting for uncertainty in tax positions.
      This Interpretation requires companies to recognize in financial statements,
      the
      impact of a tax position, if that position is more likely than not of being
      sustained on audit, based on the technical merits of the position. The
      provisions of FIN 48 are effective as of the beginning of our 2007 fiscal year,
      with the cumulative effect of the change in accounting principle recorded as
      an
      adjustment to opening retained earnings. The Company believes that the impact
      of
      adopting FIN 48 on our financial statements will have an immaterial impact
      on
      our consolidated financial statements.




In
      September 2006, the FASB issued FASB No. 158, *Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans* (SFAS
      158). Effective for the year ended December 31, 2006, SFAS 158 requires that
      the
      Company recognize the underfunded status of its defined benefit plan (the Plan)
      and black lung obligation as a liability in the 2006 year end consolidated
      balance sheet, with  changes
      in the funded status recognized through other comprehensive income in the year
      in which they occur. The Company also elected early to adopt the provision
      of
      SFAS 158 that requires a change in the measure date for the funded status of
      the
      Plan to the year end balance. The table below details the incremental effect
      of
      applying SFAS 158 on individual line items of the Consolidated Balance Sheet.
      See Notes 7 and 10 for further information on the effects of adoption related
      to
      each plan.




**Adoption
                  of SFAS 158**
              ****
              **Increase**
              ********
              ****
              **Prior
                  to**
              ****
              **Impact
                  of**
              ****
              **(decrease)**
              ********
              ****
              **change
                  in**
              ****
              **change
                  in**
              ****
              **on
                  account**
              ********
              ****
              **measurement**
              ****
              **measurement**
              ****
              **due
                  to application**
              ********
              ****
              **date**
              ****
              **date**
              ****
              **of
                  SFAS 158**Pension
                  Obligation
              
              
              5,909
              
              
              (1,054
              )
              
              4,855Non
                  current portion of blacklung
                  benefits
              
              
              (2,136
              )
              
              —
              
              
              (2,136
              )Deferred
                  income tax liability
              
              
              (1,434
              )
              
              389
              
              
              (1,045
              )Accumulated
                  other comprehensiveincome
                  (loss)
              
              
              (2,339
              )
              
              1,013
              
              
              (1,326
              )Accumulated
                  deficit
              
              
              —
              
              
              (348
              )
              
              (348
              )
  **(2)** **Fresh
      Start Accounting**




The
      Company implemented fresh start accounting and reporting in accordance with
      SOP
      90-7 on April 30, 2004, the end of the Company’s most recent fiscal month prior
      to the Effective Date. Fresh start accounting requires that the reorganization
      value of the reorganized debtors be allocated to their assets in conformity
      with
      FASB Statement No. 141, *Business
      Combinations* ,
      for
      transactions reported under the purchase method. The enterprise value (value
      of
      the net assets and liabilities excluding cash, debt, and capital leases) of
      the
      reorganized company was estimated to range from $145 million to $165 million
      based on a third-party valuation prepared in connection with the bankruptcy
      proceedings. For purposes of applying fresh start accounting, an enterprise
      value for the reorganized company of $155 million was utilized.




F-13
 
  **JAMES
        RIVER COAL COMPANY**
 **AND
        SUBSIDIARIES**
 Notes
        to
        Consolidated Financial Statements




The
      effects of the Plan and the application of fresh-start accounting on the
      Company’s pre-confirmation consolidated balance sheet include adjustments to
      record the gain on the debt extinguished under the plan and adjustments to
      record the assets of the Company at their estimated fair value and the
      liabilities of the Company at their estimated present values. The reorganization
      value was derived from the enterprise value for the reorganized company as
      follows: (in thousands)




Estimated
                enterprise value of the reorganized company
            
            $
            155,000Borrowings
                under credit facility
            
            
            (6,400
            )Capital
                leases assumed
            
            
            (1,396
            )Cash
                balance excluded from enterprise value
            
            
            1,301Administrative
                claims payable excluded from enterprise value
            
            
            (10,214
            )138,291Less:
                new secured debt issued to extinguish prepetition debt
            
            
            75,000Fair
                value of common shares issued to extinguish pre-petition
                debt
            
            $
            63,291




F-14
 
  **JAMES
        RIVER COAL COMPANY**
 **AND
        SUBSIDIARIES**
 Notes
        to
        Consolidated Financial Statements




**Fresh
                Start Adjustments****Assets**
            
            **Predecessor**
              **Company**
              **April,
                30,**
              **2004**
            
            **Debt**
              **Extinguishment**
            
            
            
            **Reorganization**
              **Adjustments**
            
            
            
            **Successor**
              **Company**
              **April
                30,**
              **2004**Cash
            
            $
            1,301
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            1,301Receivables
            
            
            35,838
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            35,838Inventories
            
            
            11,930
            
            
            —
            
            
            
            
            
            1,079
            
            
            (2)
            
            
            13,009Prepaid
                royalties
            
            
            9,932
            
            
            —
            
            
            
            
            
            (362
            )
            
            (2)
            
            
            9,570Other
                current assets
            
            
            4,463
            
            
            —
            
            
            
            
            
            (347
            )
            
            (2)
            
            
            4,116**Total
                current assets**
            
            
            63,464
            
            
            —
            
            
            
            
            
            370
            
            
            
            
            
            63,834Land
                and mineral rights
            
            
            223,004
            
            
            —
            
            
            
            
            
            (57,567
            )
            
            (2)
            
            
            165,437Buildings,
                machinery, and equipment
            
            
            236,901
            
            
            —
            
            
            
            
            
            (155,050
            )
            
            (2)
            
            
            81,851Mine
                development costs
            
            
            12,984
            
            
            —
            
            
            
            
            
            (12,984
            )
            
            (2)
            
            
            —Construction-in-progress
            
            
            974
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            974473,863
            
            
            —
            
            
            
            
            
            (225,601
            )
            
            
            
            
            248,262Less
                accumulated depreciation, depletion, and amortization
            
            
            219,604
            
            
            —
            
            
            
            
            
            (219,604
            )
            
            (2)
            
            
            —**Net
                property, plant, and equipment**
            
            
            254,259
            
            
            —
            
            
            
            
            
            (5,997
            )
            
            
            
            
            248,262Restricted
                cash
            
            
            8,348
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            8,348Other
                long-term assets
            
            
            6,518
            
            
            (3,110
            )
            
            (1)
            
            
            (734
            )
            
            (2)
            
            
            2,674**Total
                assets**
            
            $
            332,589
            
            
            (3,110
            )
            
            
            
            
            (6,361
            )
            
            
            
            
            323,118


F-15




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements




**Fresh
                Start Adjustments****Liabilities
                and Shareholders’ Equity (Deficit)**
            
            **Predecessor**
              **Company**
              **April,
                30,**
              **2004**
            
            **Debt**
              **Extinguishment**
            
            
            
            **Reorganization**
              **Adjustments**
            
            
            
            **Successor**
              **Company**
              **April
                30,**
              **2004**Borrowings
                under DIP credit agreement
            
            $
            6,400
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            6,400Current
                installments of obligations under capital leases
            
            
            749
            
            
            —
            
            
            
            
            
            (272
            )
            
            (3)
            
            
            477Accounts
                payable
            
            
            26,293
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            26,293Accrued
                salaries, wages and employee benefits
            
            
            4,501
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            4,501Workers’
                compensation benefits
            
            
            9,500
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            9,500Black
                lung benefits
            
            
            2,500
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            2,500Accrued
                taxes
            
            
            3,588
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            3,588Other
                current liabilities
            
            
            4,037
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            4,037**Total
                current liabilities**
            
            
            57,568
            
            
            —
            
            
            
            
            
            (272
            )
            
            
            
            
            57,296Long
                term debt
            
            
            —
            
            
            75,000
            
            
            (1)
            
            
            —
            
            
            
            
            
            75,000Noncurrent
                portion of workers’ compensation benefits
            
            
            42,699
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            42,699Noncurrent
                portion of black lung benefits
            
            
            10,661
            
            
            —
            
            
            
            
            
            13,610
            
            
            (4)
            
            
            24,271Pension
                obligations
            
            
            14,267
            
            
            —
            
            
            
            
            
            3,363
            
            
            (5)
            
            
            17,630Asset
                retirement obligations
            
            
            13,963
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            13,963Obligations
                under capital leases, excluding current installments
            
            
            1,159
            
            
            —
            
            
            
            
            
            (240
            )
            
            (3)
            
            
            919Deferred
                income taxes
            
            
            —
            
            
            —
            
            
            
            
            
            27,391
            
            
            (6)
            
            
            27,391Other
                long term liabilities
            
            
            658
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            658**Total
                other liabilities**
            
            
            83,407
            
            
            —
            
            
            
            
            
            44,124
            
            
            
            
            
            127,531Liabilities
                subject to compromise
            
            
            319,451
            
            
            (319,451
            )
            
            (1)
            
            
            —
            
            
            
            
            
            —**Total
                liabilities**
            
            
            460,426
            
            
            (244,451
            )
            
            
            
            
            43,852
            
            
            
            
            
            259,827Common
                stock
            
            
            —
            
            
            138
            
            
            (1)
            
            
            —
            
            
            
            
            
            138Paid-in-capital
            
            
            226
            
            
            63,153
            
            
            (1)
            
            
            (226
            )
            
            (7)
            
            
            63,153Retained
                earnings (accumulated deficit)
            
            
            (111,533
            )
            
            178,050
            
            
            (1)
            
            
            (66,517
            )
            
            (7)
            
            
            —Subscribed
                shares
            
            
            (821
            )
            
            —
            
            
            
            
            
            821
            
            
            (7)
            
            
            —Accumulated
                other comprehensive income (loss)
            
            
            (15,709
            )
            
            —
            
            
            
            
            
            15,709
            
            
            (7)
            
            
            —**Total
                shareholders’ equity (deficit)**
            
            
            (127,837
            )
            
            241,341
            
            
            
            
            
            (50,213
            )
            
            
            
            
            63,291**Total
                liabilities and shareholders’ equity**
            
            $
            332,589
            
            
            (3,110
            )
            
            
            
            
            (6,361
            )
            
            
            
            
            323,118




F-16




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements




The
      following is a description of the fresh start adjustments for debt
      extinguishment and reorganization adjustments:





*Extinguishment
      of Debt*





(1)
            Liabilities
                subject to compromise that were extinguished in bankruptcy consist
                of (in
                thousands):




Pre-petition
                bank loan agreement
            
            $
            207,807Pre-petition
                senior note
            
            
            37,953Accrued
                and unpaid interest
            
            
            12,234Terminated
                interest rate swap
            
            
            8,434Total
                secured
            
            
            266,428Promissory
                notes
            
            
            5,176Redeemable
                preferred stock
            
            
            8,500Accounts
                payable and other
            
            
            39,347Total
                unsecured
            
            
            53,023Total
                liabilities subject to compromise
            
            $
            319,451





The
      Company issued new common shares, new secured debt, and transferred its interest
      in specified life insurance policies held in a rabbi trust to the creditors
      in
      full satisfaction of pre-petition claims. The gain on extinguishment of
      pre-petition claims is calculated as follows (in thousands):




Liabilities
                  subject to compromise
              
              $
              319,451Less:
                  Assets of rabbi trust transferred to creditors
              
              
              (3,110
              )Less:
                  New secured debt issued in exchange for pre-petition debt
              
              
              (75,000
              )Less:
                  Fair value of common shares issued
              
              
              (63,291
              )Gain
                  on extinguishment of pre-petition claims
              
              $
              178,050




*Reorganization
      Adjustments*





(2)
              In
                  connection with the application of fresh start accounting, the
                  Company
                  made adjustments aggregating approximately $6.3 million to record
                  its
                  identifiable assets at fair value as follows (in thousands):




**Increase/(Decrease)**Coal
                  inventories
              
              $
              1,079Prepaid
                  royalties
              
              
              (362
              )Other
                  current assets
              
              
              (347
              )Land
                  and mineral rights
              
              
              (57,567
              )Buildings,
                  machinery and equipment
              
              
              (155,050
              )Mine
                  development costs
              
              
              (12,984
              )Less
                  accumulated depreciation, depletion, and amortization
              
              
              219,604Other
                  long-term assets
              
              
              (734
              )Total
                  fair value adjustments to identifiable assets
              
              $
              (6,361
              )




F-17
 
  **JAMES
        RIVER COAL COMPANY**
 **AND
        SUBSIDIARIES**
 Notes
        to
        Consolidated Financial Statements




(3)
            Contractual
                terms of certain capital lease agreements were renegotiated during
                bankruptcy. Obligations under capital leases were adjusted to reflect
                the
                revised terms.





(4)
            The
                liability for black lung benefits was adjusted to reflect the total
                discounted benefit obligation.





(5)
            The
                pension liability was been adjusted to reflect the total discounted
                projected benefit obligation of the
                plan.





(6)
            Deferred
                income taxes have been adjusted to reflect differences in the book
                and tax
                basis of the revalued assets and liabilities of the Company after
                application of fresh start accounting. In addition to the $27.4 million
                increase in deferred tax liability that was originally recorded in
                connection with the fresh start accounting adjustment, the Company
                recorded an additional increase in the deferred tax liability of
                $11.9
                million to adjust the fair values assigned to certain assets and
                liabilities for purposes of applying fresh start accounting.





(7)
            The
                equity of the predecessor company, including subscribed shares and
                accumulated other comprehensive loss, was eliminated in fresh start
                accounting.





**(3)** **Acquisition
      of Triad Mining, Inc.**




On
      May
      31, 2005, the Company purchased all of the outstanding stock of Triad Mining,
      Inc. (Triad).   Triad directly and through its wholly-owned
      subsidiary, Triad Underground Mining, LLC, owns and operates six surface mines
      and one underground mine in southern Indiana.  The purchase price,
      including related costs and fees, of approximately $70.4 million (net of cash
      received) was funded through the issuance of 338,295 shares of the Company’s
      common stock valued at $11.0 million and cash from the Company’s equity and debt
      offerings in May 2005.  The value of the shares issued was based on the
      market price of the Company’s stock over a reasonable period before and after
      the date at which the number of shares to be issued became fixed.  The
      acquisition was accounted for as a purchase.





The
      Company also entered into an agreement with two of Triad’s principals to issue
      common stock valued at up to $5.0 million, if prior to May 31, 2007 the Company
      obtains the right to own, lease or mine certain proven and probable reserves.
      As
      of December 31, 2006, no amounts have been paid under this
      agreement.





The
      purchase accounting allocations related to the acquisition have been recorded
      in
      the accompanying consolidated financial statements as of, and for periods
      subsequent to, May 31, 2005, the date of acquisition of Triad. The following
      table summarizes the estimated fair values of the assets acquired and the
      liabilities assumed at the date of acquisition (in
      thousands):




F-18




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements




Accounts
                  receivable
              
              $
              9,672Coal
                  inventory
              
              
              1,872Other
                  current assets
              
              
              1,852Property,
                  plant and equipment
              
              
              37,151Mineral
                  rights
              
              
              22,538Goodwill
                  (non-deductible)
              
              
              26,492Other
                  assets
              
              
              465Current
                  liabilities
              
              
              (6,934
              )Asset
                  retirement obligations
              
              
              (7,861
              )Deferred
                  taxes
              
              
              (14,256
              )Other
                  long term liabilities
              
              
              (587
              )Total
                  purchase price, net of cash received of $5,414
              
              $
              70,404






Had
      the
      acquisition of Triad occurred at the beginning of 2004, revenues, net income
      (loss) and net income (loss) per diluted share would have been $493.6 million,
      $(12.2) million and $(0.79), respectively, for the year ended December 31,
      2005
      and $284.8 million, $3.1 million and $0.19, respectively, for the eight months
      ended December 31, 2004. As the cash portion of the Triad purchase price was
      paid from a portion of the proceeds from the Senior Notes and the concurrent
      stock offering, the portion of these transactions that were necessary to
      complete the Triad acquisition are also assumed to have occurred at the
      beginning of the pro forma period. Pro forma information for the four months
      ended April 30, 2004 (predecessor company) has not been provided due to the
      differing capital structure prior to the application of fresh start accounting.
      Triad had unaudited revenues of $28.5 million and unaudited income before taxes
      of $4.3 million for the four months ended April 30, 2004.




**(4)** **Other
      Current Assets**




Other
      current assets at December 31, 2006 and 2005 are as follows (in
      thousands):




**2006**
              
              **2005**Prepaid
                  insurance
              
              $
              3,583
              
              
              2,809Income
                  tax receivable
              
              
              —
              
              
              346Other
              
              
              705
              
              
              971$
              4,288
              
              
              4,126




F-19




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements




**(5)** **Long
      Term Debt and Interest Expense**




Long-term
      debt is as follows at December 31, 2006 and 2005 (in thousands):




**2006**
            
            **2005**Senior
                Notes
            
            $
            150,000
            
            
            150,000Prior
                Senior Secured Credit Facility –Revolver
            
            
            17,493
            
            
            —Total
                long-term debt
            
            
            167,493
            
            
            150,000Less
                amounts classified as current
            
            
            —
            
            
            —Total
                long-term debt, less current maturities
            
            $
            167,493
            
            
            150,000




***Senior
      Notes***




In
      May
      2005, the Company issued $150 million of Senior Notes due on June 1, 2012 (the
      Senior Notes).  The Senior Notes are unsecured and accrue interest at
      9.375% per annum.  Interest payments on the Senior Notes are required
      semi-annually.  The Company may redeem the Senior Notes, in whole or in
      part, at any time on or after June 1, 2009 at redemption prices ranging from
      104.86% in 2009 to 100% in 2011.  In addition, at any time prior to June 1,
      2008, the Company may redeem up to 35% of the principal amount of the Senior
      Notes with the net cash proceeds of a public equity offering at a redemption
      price of 109.375%, plus accrued and unpaid interest to the redemption
      date.




The
      Senior Notes limit the Company’s ability, among other things, to pay cash
      dividends.  In addition, if a change of control occurs (as defined in the
      Indenture), each holder of the Senior Notes will have the right to require
      the
      Company to repurchase all or a part of the Senior Notes at a price equal to
      101%
      of their principal amount, plus any accrued interest to the date of
      repurchase.




***Senior
      Secured Credit Facilities***




On
      February 26, 2007, the Company entered into a $35.0 million Revolving Credit
      Agreement (the Revolver) and a $100.0 million Term Credit Agreement
      (collectively the Facilities). The Term Credit Agreement consists of a $40.0
      million term facility (the Term Facility) and a $60.0 million letter of credit
      facility (the Letter of Credit Facility). A portion of the proceeds from the
      Facilities were used to repay the Prior Revolver and Letter of Credit Facilities
      and to pay fees and expenses associated with the Facilities. The remaining
      proceeds are available for working capital and other general corporate purposes.
      The Letter of Credit Facility does not constitute a loan to the Company and
      accordingly is not available for borrowing by the Company.  The Letter of
      Credit Facility only supports the issuance of up to $60 million of letters
      of
      credit by the Company. The following is a summary of significant terms of the
      Facilities.




F-20


**JAMES
        RIVER COAL COMPANY**
 **AND
        SUBSIDIARIES**
 Notes
        to
        Consolidated Financial Statements




Revolver
              
              Term
                  Facility
              
              Letter
                  of Credit
                FacilityMaturity
              
              February
                  2012
              
              February
                  2013
              
              February
                  2013Interest/Usage
                  Rate
              
              Company’s
                  option of Base Rate(a)plus 1.0% or LIBOR plus 2.0% per annum
              
              Company’s
                  option of Base Rate(a)plus 3.0% or LIBOR plus 4.0% per annum
              
              4.0%
                  per annumMaximum
                  Availability
              
              Lesser
                  of $35.0 million and the borrowing base(b)
              
              $40.0
                  million reduced by any repayments
              
              $60.0
                  millionRepayments
                  prior to maturity
              
              Not
                  Applicable
              
              1%
                  of face amount is due quarterly.
              
              Not
                  applicable




(a)
            Base
                rate is the higher of (1) the Federal Fund Rate plus 0.5% and (2)
                the
                prime rate.


(b)
            The
                Revolver’s borrowing base is the sum of up to 85% of the eligible accounts
                receivable plus the lesser of (1) up to 60% of eligible inventory
                and (2)
                up to 85% of the net orderly liquidation value of eligible inventory;
                minus reserve from time to time set by administrative agent.




The
      Revolver provides that the Company can use up to $10.0 million of the Revolver
      availability to issue letters of credit. The Revolver provides for a 2.0% fee
      on
      any outstanding letter of credits issued under the Revolver and a 0.5% fee
      on
      the unused portion of the Revolver. The Facilities require certain mandatory
      prepayments from certain asset sales, incurrence of indebtedness and excess
      cash
      flow. The Facilities include financial covenants that require the Company to
      maintain a minimum EBITDA and a maximum leverage ratio and limit capital
      expenditures, each as defined by the agreement. The Facilities are secured
      by
      substantially all of the Company’s assets.




As
      of
      February 28, 2007, the Company had $40.0 million outstanding under the Term
      Facility and no amounts outstanding under the Revolver.  As
      of
      February 28, 2007, virtually all of the Revolver is available to the
      Company.  As
      a
      result of the completion of the Facilities, the Company expects to have adequate
      liquidity and be in compliance with the above covenants throughout
      2007.




***Prior
      Senior Secured Credit***




As
      discussed above, all amounts outstanding under the Company Prior Senior Secured
      Credit Facility were repaid with proceeds from the Term Facility on February
      26,
      2007. The Prior Senior Secured Credit Facility consisted of a $25.0 million
      revolving credit facility (the Prior Revolver) and a $75.0 million letter of
      credit facility (the Prior Letter of Credit Facility).  The Prior Revolver
      was scheduled to mature on May 31, 2010 and the Prior Letter of Credit Facility
      was scheduled to mature on November 30, 2011.  The Prior Senior Secured
      Credit Facility was secured by substantially all of the Company’s assets. The
      Company entered into Amendment Number 1 and Waiver to the Prior Senior Secured
      Credit Facility on February 22, 2006, Amendment Number 2 and Waiver to the
      Prior
      Senior Secured Credit Facility on May 30, 2006, Amendment Number 3 and Waiver
      to
      the Prior Senior Secured Credit Facility on November 7, 2006 and Amendment
      Number 4 to the Prior Senior Secured Credit Facility on December 27, 2006
      (collectively the Credit Amendments).  During
      2006, we entered into these four amendments and waivers in order to revise
      the
      financial covenants to levels that we projected we could comply with during
      the
      year.




F-21


**JAMES
          RIVER COAL COMPANY**
 **AND
          SUBSIDIARIES**
 Notes
          to
          Consolidated Financial Statements


Proceeds
      from the Prior Revolver were available for working capital needs and other
      general corporate purposes.  The Prior Revolver had an interest rate per
      annum equal to a rate based on the Company’s leverage ratio (the Applicable
      Rate) plus the Company’s option of either (i) the greater of (a) the prime rate
      or (b) the federal funds open rate plus 0.5% or (ii) a Euro Rate as defined
      in
      the credit agreement. The Applicable Rate ranged from 1.00% to 1.75% for
      borrowing based on the prime rate or federal funds open rate and 2.00% to 2.75%
      for borrowing based on the Euro Rate.  In connection with Amendment Number
      4 to the Prior Senior Secured Credit Facility, the Applicable Rate was fixed
      at
      3.5% for borrowing based on the prime rate or federal funds open rate and 4.75%
      for borrowings based on the Euro rate. The Prior Revolver also required a 0.5%
      commitment fee on the unused balance of the Prior Revolver. As of December
      31,
      2006, the Company had $17.5 million outstanding under the Prior Revolver. As
      of
      December 31, 2006, the Company had $25.0 million of total availability under
      the
      Prior Revolver (including the amount outstanding at December 31, 2006).




The
      Prior
      Letter of Credit Facility did not constitute a loan to the Company and
      accordingly was not available for borrowing by the Company.  The Prior
      Letter of Credit Facility only supported the issuance of up to $75 million
      of
      letters of credit by the Company. The Company paid a 3.0% per annum fee
      (Commitment Fee) on the full balance of the Prior Letter of Credit Facility
      and
      an additional 0.25% annual fee on the average balance of letters of credit
      issued under the Prior Letter of Credit Facility. In connection with Amendment
      Number 4 to the Prior Senior Secured Credit Facility, the Commitment Fee was
      fixed at 4.75%.





With
      the
      exception of certain permitted transactions, the Prior Senior Secured Credit
      Facility required mandatory repayments or reductions in the amount of 50% of
      the
      net proceeds of any sale or issuance of equity securities, 100% of the net
      proceeds of any incurrence of certain indebtedness and 100% of the net proceeds
      of any sale or other disposition of any assets. Voluntary prepayments were
      permitted at any time.





The
      Prior
      Senior Secured Credit Facility and the Senior Notes contained financial
      covenants including a fixed charge coverage ratio, leverage ratio, senior
      secured leverage ratio and maximum annual limits on capital expenditures. 
The Company’s debt covenants also prohibit payment of cash dividends.  As a
      result of the Amendments, the Company was in compliance with all of the
      financial covenants as of December 31, 2006.





***Interest
      Expense and Other***





During
      the years ended December 31, 2006 and 2005 and the eight months ended December
      31, 2004, the Company paid $14.7 million, $10.5 million and $5.5 million in
      interest, respectively.





Until
      the
      date of filing of bankruptcy, the Company accrued interest on its debt
      obligations. The Company determined that there was insufficient collateral
      to
      cover the interest portion of the scheduled payments on its pre-petition debt
      obligations. As of the bankruptcy date the Company ceased accruing interest
      on
      all the pre-petition secured debt obligations . If
      such
      interest had continued to be accrued, interest expense for the four months
      ended
      April 30, 2004 would have been approximately $7.6 million higher than reported.
      During the four months ended April 30, 2004, the Company paid $0.3 million
      in
      interest.





During
      the year ended December 31, 2005, the Company used a portion of the proceeds
      from the Senior Notes and the related equity offering to repay all outstanding
      amounts under the then existing credit and term facilities. The Company incurred
      a prepayment penalty of $791,000 as result of the repayment of the then existing
      credit facility. Additionally, the Company wrote off $1.7 million of deferred
      financing costs associated with the then existing credit and term facilities.
      The prepayment penalty and the write off of the deferred financing costs have
      been included in charges associated with repayment of debt on the consolidated
      statements of operations.





F-22
 
 **JAMES
            RIVER COAL COMPANY**
 **AND
            SUBSIDIARIES**
 Notes
            to
            Consolidated Financial Statements


In
      connection with the repayment of the Prior Senior Secured Credit Facility,
      the
      Company will write off all deferred financing costs associated with that
      facility during the first quarter of 2007. As of December 31, 2006, the Company
      had deferred financing costs of $6.5 million related to the Prior Senior Secured
      Credit Facility included in other assets on the consolidated balance sheet.




**(6)** **Workers’
      Compensation Benefits**




As
      of
      December 31, 2006 and 2006, workers’ compensation benefit obligation consisted
      of the following (in thousands):




**2006**
              
              **2005**Workers’
                  compensation benefits
              
              $
              53,434
              
              $
              52,281Less
                  current portion
              
              
              9,300
              
              
              10,050Noncurrent
                  portion of workers’ compensation benefits
              
              $
              44,134
              
              $
              42,231




Actuarial
      assumptions used in the determination of the liability for the self-insured
      portion of workers’ compensation benefits included a discount rate of 5.4%, 5.1%
      and 5.25% at December 31, 2006, 2005 and 2004, respectively.




**(7)** **Pneumoconiosis
      (Black Lung) Benefits**




As
      of
      December 31, 2006 and 2005, black lung benefits obligation consisted of the
      following (in thousands):




**2006**
              
              **2005**Black
                  lung benefits
              
              $
              26,766
              
              $
              27,282Less
                  current portion
              
              
              2,630
              
              
              2,930Noncurrent
                  portion of black lung benefits
              
              $
              24,136
              
              $
              24,352





F-23


**JAMES
          RIVER COAL COMPANY**
 **AND
          SUBSIDIARIES**
 Notes
          to
          Consolidated Financial Statements


As
      discussed in Note 1, the Company adopted SFAS 158 on December 31, 2006. The
      impact of adopting the provisions of SFAS 158 on our black lung obligation
      was
      to decrease the black lung obligation by $2.1 million, increase accumulated
      comprehensive income (loss) by $1.3 million and increase deferred income taxes
      liabilities by $0.8 million.




A
      reconciliation of the changes in the black lung benefit obligation is as follows
      (in 000’s):


**2006**
              
              **2005**Beginning
                  of the year black lung obligation
              
              $
              27,282
              
              $
              28,730Liabilities
                  assumed in acquisition
              
              
              —
              
              
              587Adoption
                  of SFAS 158
              
              
              (2,136
              )Change
                  in unprovided actuarial loss
              
              
              —
              
              
              901Service
                  cost
              
              
              523
              
              
              348Interest
                  cost
              
              
              1,392
              
              
              1,379Amortization
                  of the actuarial loss
              
              
              293
              
              
              217Benefit
                  payments
              
              
              (588
              )
              
              (1,188
              )End
                  of year accumulated black lung obligation
              
              
              26,766
              
              
              30,974Unamortized
                  actuarial loss
              
              
              —
              
              
              (3,692
              )Accrued
                  black lung obligation
              
              $
              26,766
              
              $
              27,282




The
      actuarial assumptions used in the determination of accumulated black lung
      obligations as of December 31, 2006 and 2005 included a discount rate of 5.5%
      and 5.1%, respectively. A 1.0% decrease in the discount rate used at December
      31, 2006, would increase the black lung obligation by approximately $3.7
      million. For purposes of determining net periodic expense related to such
      obligations, the Company used a discount rate of 5.1%, 5.25%, 5.5% and 5.5%
      for
      the years ended December 31, 2006 and 2005 (Successor), the eight months
      ended December 31, 2004 (Successor) and the four months ended
      April 30, 2004 (Predecessor).




As
      of
      December 31, 2006, the Company has a $1.3 million net actuarial gain recorded
      in
      accumulated other comprehensive loss on its black lung obligation. The Company
      expects to recognize $180,000 of this net gain during the ended December 31,
      2007.




**(8)** **Equity**




***Preferred
      Stock and Shareholder Rights Agreement***




The
      Company has authorized 10,000,000 shares of preferred stock, $1.00 par value
      per
      share, the rights and preferences of which are established by the Board of
      Directors. The Company has reserved 500,000 of these shares as Series A
      Participating Cumulative Preferred Stock for issuance under a shareholder rights
      agreement (the Rights Agreement).




On
      May
      25, 2004, the Company’s shareholders approved the Rights Agreement and declared
      a dividend of one preferred share purchase right (Right) for each two shares
      of
      common stock outstanding.  Each Right entitles the registered holder to
      purchase from the Company one one-hundredth (1/100) of a share of our Series
      A
      Participating Cumulative Preferred Stock, par value $1.00 per share, at a price
      of $200 per one one-hundredth of a Series A preferred share.  The Rights
      are not exercisable until a person or group of affiliated or associated persons
      (an Acquiring Person) has acquired or announced the intention to acquire 15%
      or
      more of the Company’s outstanding common stock. Effective November 3, 2006, the
      Company amended its Shareholder Rights Agreement to increase the level of
      shareholdings that trigger the applicability of the Rights Agreement to 20
      percent of the total shares of common stock outstanding.




F-24


**JAMES
        RIVER COAL COMPANY**
 **AND
        SUBSIDIARIES**
 Notes
        to
        Consolidated Financial Statements


In
      the
      event that the Company is acquired in a merger or other business combination
      transaction or 50% or more of the Company’s consolidated assets or earning power
      is sold after a person or group has become an Acquiring Person, each holder
      of a
      Right, other than the Rights beneficially owned by the Acquiring Person (which
      will thereafter be void), will receive, upon the exercise of the Right, that
      number of shares of common stock of the acquiring company which at the time
      of
      such transaction will have a market value of two times the exercise price of
      the
      Right.  In the event that any person becomes an Acquiring Person, each
      Right holder, other than the Acquiring Person (whose Rights will become void),
      will have the right to receive upon exercise that number of shares of common
      stock having a market value of two times the exercise price of the
      Right.




The
      rights will expire May 25, 2014, unless that expiration date is extended. The
      Board of Directors may redeem the Rights at a price of $0.001 per Right at
      any
      time prior to the time that a person or group becomes an Acquiring
      Person.




***Equity
      Based Compensation***




Under
      the
      2004 Equity Incentive Plan (the Plan), participants may be granted stock options
      (qualified and nonqualified), stock appreciation rights (SARs), restricted
      stock, restricted stock units, and performance shares. The total number of
      shares that may be awarded under the Plan is 1,650,000, and no more than
      1,000,000 of the shares reserved under the Plan may be granted in the form
      of
      incentive stock options.




Shares
      awarded or subject to purchase under the Plan that are not delivered or
      purchased, or revert to the Company as a result of forfeiture or termination,
      expiration or cancellation of an award or that are used to exercise an award
      or
      for tax withholding, will be again available for issuance under the Plan. At
      December 31, 2006, there were 507,912 shares available under the Plan for future
      awards.




*Restricted
      Stock Awards*




Pursuant
      to the Plan certain directors and employees have been awarded restricted common
      stock with such shares vesting over three to five years. The related expense
      is
      amortized over the vesting period. Restricted shares subject to continuing
      vesting requirements are included in diluted shares outstanding.




*Performance
      Stock Awards*




Performance
      stock awards have been made to certain employees pursuant to the Plan. The
      expected cost of these shares were reflected in income over the performance
      period. No unearned performance stock awards remained outstanding as of January
      1, 2006.




*Stock
      Options Awards*




Pursuant
      to the Plan certain directors and employees have been awarded options to
      purchase common stock with such shares vesting ratably over three to five years.
      The Company’s stock options have been issued at exercise prices equal to or
      greater than the fair value of the Company’s stock at the date of grant.




F-25


**JAMES
          RIVER COAL COMPANY**
 **AND
          SUBSIDIARIES**
 Notes
          to
          Consolidated Financial Statements


Prior
      to
      January 1, 2006, the Company accounted for stock-based compensation under
      the recognition and measurement provisions of APB 25. Under APB 25, the Company
      generally recognized compensation expense only for restricted stock. The Company
      recognized the compensation expense associated with the restricted stock ratably
      over the associated service period.





Effective
      January 1, 2006, the Company adopted the fair value recognition provisions
      of SFAS 123R, using the modified prospective transition method, and therefore
      has not restated the results of prior periods. Under this transition method,
      stock-based compensation expense for 2006 includes (i) compensation expense
      for all stock-based compensation awards granted prior to, but not yet vested
      as
      of, January 1, 2006, based on the grant date fair value estimated in
      accordance with the original provisions of SFAS 123, and (ii) compensation
      expense for all share-based payment awards granted after January 1, 2006
      based on estimated grant-date fair values. Compensation expense is adjusted
      for
      estimated forfeitures and is recognized on a straight-line basis over the
      requisite service period of the award. The Company estimated future forfeiture
      rates based on its historical experience.





The
      following table highlights the expense related to share-based payment for the
      periods ended December 31 (in 000’s):




**Year
                  Ended**
              
              **Eight
                  monthsended****2006**
              
              **2005**
              
              **2004**Restricted
                  stock
              
              $
              3,600
              
              
              2,235
              
              
              562Performance
                  stock
              
              
              —
              
              
              154
              
              
              538Stock
                  options
              
              
              245
              
              
              —
              
              
              —Stock
                  based compensation
              
              $
              3,845
              
              
              2,389
              
              
              1,100Stock
                  based compensation, net of taxes
              
              $
              2,384
              
              
              1,481
              
              
              682




F-26
 
 **JAMES
            RIVER COAL COMPANY**
 **AND
            SUBSIDIARIES**
 Notes
            to
            Consolidated Financial Statements


The
      following table is a reconciliation of the Company’s net loss and loss per share
      to pro forma net loss and pro forma net loss per share for the year ended
      December 31, 2005 and the eight months ended December 31, 2004, as if the
      Company had adopted the provisions of SFAS 123R for options granted under the
      Company’s stock option plans (in 000’s, except per share data):




**Eight
                  Months****Year
                  ended**
              
              **Ended****December
                  31,**
              
              **December
                  31,****2005**
              
              **2004**Net
                  income (loss), as reported
              
              $
              (12,338
              )
              
              1,976Add:
                  Net stock-based employee compensation reported
              
              
              1,481
              
              
              785Deduct:
                  Net stock-based employee compensation under FAS123R
              
              
              (1,482
              )
              
              (479
              )Pro
                  forma net income (loss)
              
              $
              (12,339
              )
              
              2,282Income
                  (loss) per share:Basic
                    - as reported
              
              $
              (0.83
              )
              
              0.14Basic
                    pro forma
              
              $
              (0.83
              )
              
              0.17Diluted-
                    as reported
              
              $
              (0.83
              )
              
              0.14Diluted-
                    pro forma
              
              $
              (0.83
              )
              
              0.16





The
      fair
      value of the restricted stock outstanding and issued is equal to the value
      of
      shares at the grant date. At this time, the Company does not expect any of
      its
      restricted shares or options to be forfeited before vesting. The fair value
      of
      stock options was estimated using the Black-Scholes option pricing model. The
      Company used the following assumptions to value the stock options issued during
      the periods indicated below:




****
              ****
              **Year
                  Ended**
              ****
              **Year
                  Ended**
              ********
              ****
              **December
                  31,**
                **2006**
              ****
              **December
                  31,**
                **2005**Dividend
                  yield
              
              
              0.0
              %
              
              0.0
              %Expected
                  volatility factor*(1)*
              
              
              40.0%-45.0
              %
              
              40.0
              %Weighted
                  average expected volatility
              
              
              43.0
              %
              
              40.0
              %Risk-free
                  interest rate*(2)*
              
              
              4.8%-5.0
              %
              
              4.6
              %Expected
                  term (in years)
              
              
              6.5
              
              
              6.5




(1)
              The
                  Company used historical experience to estimate its volatility.




(2)
            The
                risk-free interest rate for periods is based on U.S. Treasury yields
                in
                effect at the time of grant*.*




F-27
 
 **JAMES
            RIVER COAL COMPANY**
 **AND
            SUBSIDIARIES**
 Notes
            to
            Consolidated Financial Statements


The
      following is a summary of performance stock, restricted stock and stock option
      awards:




****
              ****
              **Performance
                  Stock******
              ****
              **Restricted
                  Stock**********
              ****
              **Stock
                  Options**********
              ********
              ****
              ****
              **Weighted**
              
              ****
              ****
              **Weighted**
              
              ****
              ****
              **Weighted**
              ********
              ****
              ****
              ****
              **Average**
              
              ****
              ****
              **Average**
              ****
              ****
              ****
              **Average**
              ********
              ****
              **Number
                  of**
              
              **Fair
                  Value**
              
              **Number
                  of**
              ****
              **Fair
                  Value**
              ****
              **Number
                  of**
              ****
              **Exercise**
              ********
              ****
              **Shares**
              
              **at
                  Issue**
              
              **Shares**
              ****
              **at
                  Issue**
              ****
              **Shares**
              ****
              **Price**Outstanding
                  at April 31, 2004
              
              
              —
              
              $
              —
              
              
              —
              
              $
              —
              
              
              —
              
              $
              —Granted
              
              
              100,000
              
              
              4.59
              
              
              839,000
              
              
              4.96
              
              
              270,000
              
              
              13.41Exercised/Vested
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —Canceled
              
              
              —
              
              
              —
              
              
              (23,300
              )
              
              4.59
              
              
              —
              
              
              —December
                  31, 2004
              
              
              100,000
              
              
              4.59
              
              
              815,700
              
              
              4.97
              
              
              270,000
              
              
              13.41Granted
              
              
              —
              
              
              —
              
              
              346,470
              
              
              35.88
              
              
              40,000
              
              
              33.62Exercised/Vested
              
              
              —
              
              
              4.59
              
              
              (161,952
              )
              
              4.97
              
              
              (3,334
              )
              
              15.00Canceled
              
              
              (81,250
              )
              
              —
              
              
              (133,867
              )
              
              5.72
              
              
              (70,666
              )
              
              17.26December
                  31, 2005
              
              
              18,750
              
              
              —
              
              
              866,351
              
              
              17.22
              
              
              236,000
              
              
              15.66Granted
              
              
              —
              
              
              —
              
              
              168,659
              
              
              16.77
              
              
              50,000
              
              
              21.58Exercised/Vested
              
              
              (18,750
              )
              
              4.59
              
              
              (225,614
              )
              
              14.84
              
              
              —
              
              
              —Canceled
              
              
              —
              
              
              —
              
              
              (69,676
              )
              
              12.85
              
              
              (24,999
              )
              
              23.23December
                  31, 2006
              
              
              —
              
              
              —
              
              
              739,720
              
              
              18.25
              
              
              261,001
              
              
              16.07




The
      following table summarizes additional information about the stock options
      outstanding at December 31, 2006.




**Range
                  of**
                **Exercise**
                **Price**
              
              **Shares**
              
              **Weighted**
                **Average**
                **Exercise
                  Price**
              
              **Weighted**
                **Average**
                **Remaining
                  Contractual**
                **Life
                  (Years)**
              
              **Aggregate**
                **Intrinsic**
                **Value
                  (1)**
                **(in
                  000**’**s)****Oustanding
                  at December 31, 2006**
              
              
              $10.80-$33.75
              
              
              261,001
              
              $
              16.07
              
              
              7.8
              
              $
              —**Exercisable
                  at December 31, 2006**
              
              
              $10.80-$33.75
              
              
              109,337
              
              $
              15.33
              
              
              7.4
              
              $
              —**Vested
                  and expected to vest at December 31, 2006**
              
              
              
              
              
              261,001
              
              $
              16.07
              
              
              7.8
              
              $
              —
  (1)
                The
                    difference between a stock award's exercise price and the underlying
                    stock's market price at December 31, 2006.
  No
          value
          is assigned to stock awards whose option price exceeds the the stock's
          market
          price at December 31, 2006.


The
      following table summarizes the Company’s total unrecognized compensation cost
      related to stock based compensation as of December 31, 2006.




Weighted
                  AverageRemaining
                  PeriodUnearned
              
              Of
                  ExpenseCompensation
              
              Recognition(in
                  000’s)
              
              (in
                  years)Stock
                  Options
              
              $
              555
              
              
              2.1Restricted
                  Stock
              
              
              11,542
              
              
              3.0Total
              
              $
              12,097




F-28


**JAMES
          RIVER COAL COMPANY**
 **AND
          SUBSIDIARIES**
 Notes
          to
          Consolidated Financial Statements


**(9)** **Income
      Taxes**




Income
      tax expense (benefit) consists of (in thousands):




**Eight
                months**
            
            
            **Four
                Months****Year**
            
            **Year**
            
            **Ended**
            
            
            **Ended****Ended**
            
            **Ended**
            
            **December
                31,**
            
            
            **April
                30,****2006**
            
            **2005**
            
            **2004**
            
            
            **2004**Current:Federal
            
            $
            (2,686
            )
            
            22
            
            
            25
            
            
            
            -State
            
            
            529
            
            
            402
            
            
            -
            
            
            
            -(2,157
            )
            
            424
            
            
            25
            
            
            
            -Deferred:Federal
            
            
            (17,203
            )
            
            (12,084
            )
            
            692
            
            
            
            -State
            
            
            (7,791
            )
            
            (2,623
            )
            
            74
            
            
            
            -(24,994
            )
            
            (14,707
            )
            
            766
            
            
            
            -$
            (27,151
            )
            
            (14,283
            )
            
            791
            
            
            
            -






A
      reconciliation of income taxes computed at the statutory federal income tax
      rate
      to the expense (benefit) for income taxes included in the consolidated
      statements of operations is presented below:




**Eight
                  months**
              
              
              **Four
                  Months****Year**
              
              **Year**
              
              **Ended**
              
              
              **Ended****Ended**
              
              **Ended**
              
              **December
                  31,**
              
              
              **April
                  30,****2006**
              
              **2005**
              
              **2004**
              
              
              **2004**Federal
                  income taxes at statutory rates
              
              
              (34.0
              )%
              
              (34.0
              )%
              
              34.0
              %
              
              
              34.0
              %Percentage
                  depletion
              
              
              (8.9
              )
              
              (15.2
              )
              
              (42.0
              )
              
              
              (2.2
              )Other
                  permanent items
              
              
              0.9
              
              
              (2.2
              )
              
              12.3
              
              
              
              —Effect
                  of state tax rate change, net
              
              
              (3.9
              )
              
              —
              
              
              —
              
              
              
              —Non-taxable
                  gain on debt discharge
              
              
              —
              
              
              —
              
              
              —
              
              
              
              (35.1
              )Non-deductible
                  reorganization costs
              
              
              —
              
              
              —
              
              
              —
              
              
              
              3.3Change
                  in valuation allowance
              
              
              —
              
              
              —
              
              
              23.8
              
              
              
              —State
                  income taxes, net of federal
              
              
              (5.2
              )
              
              (5.5
              )
              
              1.8
              
              
              
              —Other,
                  net
              
              
              0.2
              
              
              3.2
              
              
              (1.3
              )
              
              
              —(50.9
              )%
              
              (53.7
              )%
              
              28.6
              %
              
              
              —
              %




F-29


**JAMES
          RIVER COAL COMPANY**
 **AND
          SUBSIDIARIES**
 Notes
          to
          Consolidated Financial Statements


The
      tax
      effects of temporary differences that give rise to significant portions of
      the
      deferred tax assets and deferred tax liabilities at December 31, 2006 and
      2005 are presented below (in 000’s):




**2006**
              
              **2005**Deferred
                  tax assets:Accruals
                  for financial reporting purposes, principallyworkers’
                  compensation and black lung obligations
              
              $
              46,142
              
              
              50,040Net
                  operating loss carryforwards
              
              
              36,780
              
              
              21,264Accumulated
                  comprehensive income
              
              
              157
              
              
              247Total
                  gross deferred tax assets
              
              
              83,079
              
              
              71,551Less
                  valuation allowance
              
              
              —
              
              
              —Net
                  deferred tax asset
              
              
              83,079
              
              
              71,551Deferred
                  tax liabilities - property, plant and equipment,principally
                  due to differences in depreciation, depletionand
                  amortization
              
              
              96,239
              
              
              115,791Net
                  deferred liability
              
              $
              (13,160
              )
              
              (44,240
              )




As
      of December
      31, 2006 and 2005 ,
      we had
      no valuation allowance recorded for taxes, as management believes it is more
      likely than not that the deferred tax assets will be realized.




At
      December 31, 2006, the Company has consolidated NOLs for federal income tax
      purposes of approximately $101.4 million which expire beginning in 2023 and
      consolidated Kentucky net operating loss carryforwards of approximately $57.6
      million which expire beginning in 2023. These net operating loss carryforwards
      generate a combined federal and state tax benefit of approximately $36.8
      million.




In
      addition to the $27.4 million deferred tax liability that was originally
      recorded in connection with the fresh start accounting adjustment (see note
      2),
      the Company recorded additional increase deferred tax liabilities of $6.5
      million in 2004 and $9.8 million in 2005 and a decrease in the deferred tax
      liabilities of $4.4 million in 2006 to properly recognize the tax basis
      differences of values assigned to certain assets and liabilities for purposes
      of
      applying fresh start accounting. These adjustments to the fresh start accounting
      resulted in an increase to the amount allocated to mineral rights.





The
      Company made no income tax payments for the four months ended April 30, 2004.
      The Company made income tax payments of $2.6 million for the eight months ended
      December 31, 2004. During the year ended December 31, 2006 and 2005, the Company
      received income tax refunds of $3.1 million and $1.8 million.




**(10)** **Employee
      Benefit Plans**




***Defined
      Benefit Pension Plan***




Substantially
      all employees in the Company’s CAPP segment who meet certain length of service
      requirements are covered by a qualified noncontributory defined benefit pension
      plan. The Company’s funding policy is to contribute annually an amount at least
      equal to the minimum funding requirements actuarially determined in accordance
      with the Employee Retirement Income Security Act of 1974.




The
      plan
      assets for the qualified defined benefit pension plan are held by an independent
      trustee. The plan’s assets include cash and cash equivalents, corporate and
      government bonds, preferred and common stocks. The Company has an internal
      investment committee that sets investment policy, selects and monitors
      investment managers and monitors asset allocation.




F-30
 
 **JAMES
            RIVER COAL COMPANY**
 **AND
            SUBSIDIARIES**
 Notes
            to
            Consolidated Financial Statements


The
      investment policy for the pension plan assets includes the objectives of
      providing growth of capital and income while achieving a target annual rate
      of
      return of 7.5% over a full market cycle, approximately 5 to 7 years.
      Diversification of assets is employed to reduce risk. The current target asset
      allocation is 70% for equity securities (including 45% Large Cap, 15% Small
      Cap,
      10% International) and 30% for cash and interest bearing securities. The
      investment policy is based on the assumption that the overall portfolio
      volatility will be similar to that of the target allocation. Given the
      volatility of the capital markets, strategic adjustments in various asset
      classes may be required to rebalance asset allocation back to its target policy.
      Investment fund managers are not permitted to invest in certain securities
      and
      transactions as outlined by the investment policy statements specific to each
      investment category without prior investment committee approval.




To
      develop the expected long-term rate of return on assets assumption, the Company
      considered the historical returns and the future expectations for returns for
      each asset class, as well as the target asset allocation of the pension
      portfolio. This evaluation resulted in the selection of the 7.5% long-term
      rate
      of return on assets assumption for the year ended December 31,
      2006.




As
      discussed in Note 1, the Company adopted SFAS 158 on December 31, 2006. The
      impact of adopting the provisions of SFAS 158 that requires the recognition
      of
      the underfunded status of our defined benefit plan was to increase the
      pension liabilities by $5.9 million, decrease accumulated other comprehensive
      income by $3.7 million and decrease deferred income tax liabilities by $2.2
      million. The impact of the adoption of the provisions of SFAS 158 to change
      the
      measurement date of its benefit obligation to December 31, 2006 was to decrease
      the pension liability by $1.1 million, increase accumulated other comprehensive
      income by $1.0 million, increase accumulated deficit by $0.3 million
      and increase deferred income tax liabilities by $0.4 million.




The
      fair
      value of the major categories of qualified defined benefit pension plan assets
      includes the following (dollars in thousands):


****
              ****
              **2006**
              ****
              **2005**
              ********
              ****
              **Amount**
              ****
              **Percentage**
              ****
              **Amount**
              ****
              **Percentage**Equity
                  securities
              
              $
              39,226
              
              
              72.8
              %
              $
              30,728
              
              
              70.1
              %Debt
                  securities
              
              
              14,207
              
              
              26.4
              %
              
              12,278
              
              
              28.0
              %Other
                  (includes cash and cash equivalents)
              
              
              441
              
              
              0.8
              %
              
              858
              
              
              1.9
              %$
              53,874
              
              
              100.0
              %
              $
              43,864
              
              
              100.0
              %




F-31




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements




The
      following table sets forth changes in the plan’s benefit obligations, changes in
      the fair value of plan assets, and funded status at December 31, 2006 and
      2005 (in thousands):




**2006**
              
              **2005**Change
                  in benefit obligation:Projected
                  benefit obligation at beginning of year
              
              $
              62,635
              
              
              58,636Service
                  cost
              
              
              2,497
              
              
              2,105Interest
                  cost
              
              
              3,217
              
              
              3,170Actuarial
                  loss
              
              
              397
              
              
              418Adjustment
                  for change in measurement period
              
              
              581
              
              
              —Benefits
                  paid
              
              
              (2,442
              )
              
              (1,694
              )Projected
                  benefit obligation at end of year
              
              $
              66,885
              
              
              62,635Change
                  in plan assets:Fair
                  value of plan assets at beginning of year
              
              $
              43,864
              
              
              36,743Actual
                  return on plan assets
              
              
              7,067
              
              
              3,779Employer
                  contributions
              
              
              5,385
              
              
              5,036Benefits
                  paid
              
              
              (2,442
              )
              
              (1,694
              )Fair
                  value of plan assets at end of year
              
              $
              53,874
              
              
              43,864Reconciliation
                  of funded status:Funded
                  status
              
              $
              (13,011
              )
              
              (18,771
              )Unrecognized
                  actuarial loss
              
              
              —
              
              
              5,830Net
                  amount recognized
              
              $
              (13,011
              )
              
              (12,941
              )Amounts
                  recognized in the consolidated balance sheetsconsist
                  of:Accrued
                  benefit liability
              
              $
              (13,011
              )
              
              (13,598
              )Accumulated
                  other comprehensive loss
              
              
              —
              
              
              657Net
                  amount recognized
              
              $
              (13,011
              )
              
              (12,941
              )




The
      accumulated benefit obligation of the plan was approximately $60.4 million
      and
      $57.5 million as of December 31, 2006 and 2005, respectively. Company
      contributions in 2007 are expected to be approximately $4.7
      million.




F-32
 
  **JAMES
        RIVER COAL COMPANY**
 **AND
        SUBSIDIARIES**
 Notes
        to
        Consolidated Financial Statements


The
      components of net periodic benefit cost and benefits paid by period are as
      follows (in thousands):


**Successor**
              
              
              **Predecessor****Year**
              
              **Year**
              
              **Eight
                  Months**
              
              
              **Four
                  Months****Ended**
              
              **Ended**
              
              **December
                  31,**
              
              
              **April
                  30,****2006**
              
              **2005**
              
              **2004**
              
              
              **2004**Service
                  cost
              
              $
              2,497
              
              
              2,105
              
              
              1,223
              
              
              
              611Interest
                  cost
              
              
              3,217
              
              
              3,170
              
              
              1,959
              
              
              
              965Expected
                  return on plan assets
              
              
              (3,390
              )
              
              (3,061
              )
              
              (1,721
              )
              
              
              (811
              )Amortization
                  of prior service cost
              
              
              —
              
              
              —
              
              
              —
              
              
              
              130Recognized
                  actuarial loss
              
              
              —
              
              
              19
              
              
              —
              
              
              
              340Net
                  periodic benefit cost
              
              $
              2,324
              
              
              2,233
              
              
              1,461
              
              
              
              1,235Benefits
                  paid
              
              $
              2,442
              
              
              1,694
              
              
              1,288
              
              
              
              563




During
      Fresh Start Accounting (see note 2), the Company adjusted the previously
      unrecognized actuarial loss and prior service costs to zero. As of December
      31,
      2006, the Company has a $1.6 million net actuarial loss recorded in accumulated
      other comprehensive loss on its defined benefit plan. The Company does not
      expect to recognize any of the net actuarial gain or loss in the year ended
      December 31, 2007.




F-33




**JAMES
      RIVER COAL COMPANY**


**AND
        SUBSIDIARIES**
 Notes
        to
        Consolidated Financial Statements




The
      weighted-average assumptions used to determine the pension benefit obligations
      are as follows:




**2006**
              
              **2005**Discount
                  rate
              
              
              5.55
              %
              
              5.25
              %Expected
                  return on plan assets
              
              
              7.50
              %
              
              7.50
              %Rate
                  of compensation increase
              
              
              4.00
              %
              
              4.00
              %Measurement
                  date
              
              
              December
                  31, 2006
              
              
              October
                  1, 2005




The
      weighted-average assumptions used to determine the net periodic benefit cost
      are
      as follows:




**2006**
              
              **2005**
              
              **2004**Discount
                  rate
              
              
              5.25
              %
              
              5.50
              %
              
              6.00
              %Expected
                  return on plan assets
              
              
              7.50
              %
              
              8.00
              %
              
              8.00
              %Rate
                  of compensation increase
              
              
              4.00
              %
              
              4.00
              %
              
              4.00
              %Measurement
                  date
              
              
              October
                  1, 2005
              
              
              October
                  1, 2004
              
              
              October
                  1, 2003




The
      following benefit payments are expected to be paid (based on the assumptions
      described above (in thousands)).




Year
                  ended December 31:2007
              
              $
              2,8622008
              
              
              2,2302009
              
              
              2,4142010
              
              
              2,5962011
              
              
              2,8482012-2016
              
              
              19,125




***Savings
      and Profit Sharing Plan***




The
      Company sponsors profit sharing plans and defined contribution pension plans.
      All U.S. employees are eligible for at least one of the Company’s plans. The
      Company’s contributions vary depending on the plan and cannot exceed the maximum
      allowable for tax purposes.  The
      Company recognized approximately $3.4 million, $2.1 million, $588,000 and
      $253,000 of expense relating to the Savings and Profit Sharing Plan for the
      years ended December 31, 2006 and 2005, the eight months ended December 31,
      2004
      and the four months ended April 30, 2004, respectively.




F-34




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements




**(11)** **Major
      Customers**




During
      2006, approximately 41% of total revenues were from two customers, the largest
      of which represented 25% of revenues. During 2005, approximately 44% of revenues
      were from two customers, the largest of which represented 27% of revenues.
      These
      customers for 2006 and 2005 are both included in the CAPP segment in Note 17.
      During the eight months ended December 31, 2004, approximately 50% of revenues
      were from two customers, the largest of which represented 30% of revenues.
      In
      the four months ended April 30, 2004, approximately 54% of revenues were from
      two customers, the largest of which represented 31% of revenues.




**(12)** **Leases**




The
      Company leases equipment and various other properties under non-cancelable
      long-term leases, expiring at various dates. Certain leases contain options
      that
      would allow the Company to extend the lease or purchase the leased asset at
      the
      end of the base lease term.  Future
      minimum lease payments under noncancelable operating leases (with initial or
      remaining lease terms in excess of one year) and future minimum capital
      lease payments as of December 31, 2006 were as follows (in
      thousands):




**Capital**
              
              **Operating****leases**
              
              **leases**Year
                  ended December 31:2007
              
              $
              271
              
              $
              4,3442008
              
              
              —
              
              
              4,1222009
              
              
              —
              
              
              3,1302010
              
              
              —
              
              
              1,1782011
              
              
              —
              
              
              786271
              
              $
              13,560Less
                  amount representing interest (at 8.5%)
              
              
              9Present
                  value of net minimum capital lease payments
              
              $
              262




The
      Company incurred rent expense on equipment and offices space of approximately
      $2.3 million, $1.0 million, $462,000 and $278,000 for the years ended December
      31, 2006 and 2005, the eight months ended December 31, 2004 and the four months
      ended April 30, 2004, respectively.




The
      net
      book value of the equipment under capital leases was $77,283 at
      December 31, 2006.




F-35




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements


**(13)** **Commitments
      and Contingencies**




Future
      minimum royalty commitments under coal lease agreements at December 31,
      2006 were as follows (in thousands):




**Royalty****commitments**Year
                  ended December 31:2007
              
              $
              18,6852008
              
              
              19,5862009
              
              
              17,1282010
              
              
              16,4842011
              
              
              16,1272012
                  and thereafter
              
              
              77,470$
              165,480




Certain
      coal leases do not have set expiration dates but extend until completion of
      mining of all merchantable and mineable coal reserves. For purposes of this
      table, we have generally assumed that minimum royalties on such leases will
      be
      paid for a period of ten years.





Certain
      coal leases require payment based on minimum tonnage, for these contracts an
      average sales price of $48.12 was used to project the future
      commitment.




The
      Company has established irrevocable letters of credit totaling $63.6 million
      as
      of December 31, 2006 to guarantee performance under certain contractual
      arrangements. The letters of credit were issued under the Prior Letter of Credit
      Facility. The Prior Letter of Credit Facility was replaced by the Letter of
      Credit Facility (note 5).




The
      Company is involved in various claims and legal actions arising in the ordinary
      course of business. In the opinion of management, the ultimate disposition
      of
      these matters will not have a material adverse effect on the Company’s
      consolidated financial position, results of operations or
      liquidity.




F-36




****JAMES
      RIVER COAL COMPANY****


****AND
      SUBSIDIARIES****


Notes
      to
      Consolidated Financial Statements




**(14)** **Reorganization
      Items, Net**





Reorganization
      items consist of the following (in thousands):


**Predecessor****Four
                  months****ended
                  April 30,****2004**Professional
                  fees and administrative expenses
              
              $
              10,685Gain
                  on settlements of obligations, net
              
              
              (111,533
              )Interest
                  income
              
              
              (59
              )$
              (100,907
              )




Cash
      paid
      for reorganization items totaled $850,000, $8.1 million and $1.2 million for
      the
      year ended December 31, 2005, the eight months ended December 31, 2004 and
      the
      four months ended April 30, 2004.




**(15)** **Earnings
      (Loss) Per Share**




Basic
      earnings (loss) per share is computed by dividing net income (loss) available
      to
      common shareholders by the weighted average number of common shares outstanding
      during the period, excluding restricted common stock subject to continuing
      vesting requirements. Diluted earnings per share is calculated based on the
      weighted average number of common shares outstanding during the period and,
      when
      dilutive, potential common shares from the exercise of stock options and
      restricted common stock subject to continuing vesting requirements, pursuant
      to
      the treasury stock method.




F-37




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements


The
      following table provides a reconciliation of the number of shares used to
      calculate basic and diluted earnings (loss) per share (in
      thousands):




**Successor**
              
              **Predecessor****Year
                  Ended**
                **December
                  31,**
                **2006**
              
              **Year
                  Ended**
                **December
                  31,**
                **2005**
              
              **Eight
                  Months**
                **Ended**
                **December
                  31,**
                **2004**
              
              **Four
                  Months**
                **Ended**
                **April
                  30,**
                **2004**Weighted
                  average numberof
                  common sharesoutstanding:Basic
              
              
              15,849
              
              
              14,955
              
              
              13,800
              
              
              17Effect
                  of dilutive instruments
              
              
              —
              
              
              —
              
              
              823
              
              
              —Diluted
              
              
              15,849
              
              
              14,955
              
              
              14,623
              
              
              17




On
      May 6,
      2004 the Company emerged from bankruptcy under a joint plan of reorganization.
      On that date the Company cancelled all existing equity securities and issued
      13,799,994 shares of new common stock, which were distributed pro-rata to the
      pre-petition secured creditors.




For
      periods in which there was a loss, the Company has excluded from its diluted
      earning per share calculation options to purchase shares with underlying
      exercise prices less than the average market prices and the unvested portion
      of
      time vested restricted shares, as inclusion of these securities would have
      reduced the net loss per share.  The excluded instruments would have
      increased the diluted weighted average number of common shares by approximately
      861,074 and 959,000 for the years ended December 31, 2006 and 2005,
      respectively.




**(16)** **Fair
      Value of Financial Instruments**




The
      estimated fair value of financial instruments has been determined by the Company
      using available market information. As of December 31, 2006 and 2005, except
      for
      long-term debt obligations, the carrying amounts of all financial instruments
      approximate their fair values due to their short maturities.




The
      Company believes that the fair value of its Senior Notes was $135.0 million
      and
      $157.1 million at December 31, 2006 and 2005, respectively, based on available
      market information at that date. The Company believes that the carrying amount
      of the Prior Revolver portion of its Prior Senior Secured Credit Facility
      approximates the fair value due to the variable interest rate and the recent
      amendment to that facility (Note 5).




F-38




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements


**(17)** **Segment
      Information**




The
      Company mines, processes and sells bituminous, steam-and industrial-grade coal
      to electric utilities and industrial customers. The Company has two segments
      based on the coal basins in which the Company operates. These basins are located
      in Central Appalachian (CAPP) and in the Midwest (Midwest). The Company’s CAPP
      operations are located in eastern Kentucky and the Company’s Midwest operations
      are located in southern Indiana. Coal quality, coal seam height, transportation
      methods and regulatory issues are generally consistent within a basin.
      Accordingly, market and contract pricing have been developed by coal basin.
      The
      Company manages its coal sales by coal basin, not by individual mine complex.
      Mine operations are evaluated based on their per-ton operating costs. Operating
      segment results for the years ended December 31, 2006 and 2005 are shown below
      (segment results for periods prior to the acquisition of Triad on May 31, 2005
      are not provided as the Company had only one segment) (amounts in
      thousands).




F-39




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements




Years
                  EndedDecember
                  31,2006
              
              2005RevenuesCAAP
              
              $
              472,100
              
              
              398,118Midwest
                  (1)
              
              
              92,691
              
              
              55,881Corporate
              
              
              —
              
              
              —Total
              
              $
              564,791
              
              
              453,999Depreciation,
                  depletion and amortizationCAAP
              
              $
              60,040
              
              
              43,687Midwest
                  (1)
              
              
              14,411
              
              
              7,985Corporate
              
              
              111
              
              
              150Total
              
              $
              74,562
              
              
              51,822Total
                  operating income (loss)CAAP
              
              $
              (20,425
              )
              
              94Midwest
                  (1)
              
              
              (512
              )
              
              1,349Corporate
              
              
              (16,500
              )
              
              (13,941
              )Total
              
              $
              (37,437
              )
              
              (12,498
              )Interest
                  IncomeCAPP
                  and Midwest (1)(2)
              
              $
              —
              
              
              —Corporate
              
              
              (366
              )
              
              (226
              )Total
              
              $
              (366
              )
              
              (226
              )Interest
                  ExpenseCAPP
                  and Midwest (1)(2)
              
              $
              —
              
              
              —Corporate
              
              
              16,782
              
              
              12,892Total
              
              $
              16,782
              
              
              12,892Income
                  tax benefitCAPP
                  and Midwest (1)(2)
              
              $
              —
              
              
              —Corporate
              
              
              (27,151
              )
              
              (14,283
              )Total
              
              $
              (27,151
              )
              
              (14,283
              )Net
                  earnings (loss) (2)CAAP
              
              $
              (20,425
              )
              
              94Midwest
                  (1)
              
              
              (512
              )
              
              1,349Corporate
              
              
              (5,232
              )
              
              (13,781
              )Total
              
              $
              (26,169
              )
              
              (12,338
              )





(1)
              Includes
                  the results of operation of Triad from the date of its acquistion
                  (May 31,
                  2005).
  (2)
              The
                  Company does not allocate interest income, interest expense or
                  income
                  taxes to its segments.




F-40




**JAMES
      RIVER COAL COMPANY**


**AND
      SUBSIDIARIES**


Notes
      to
      Consolidated Financial Statements




December
                  31,2006
              
              2005Total
                  AssetsCAAP
              
              $
              351,846
              
              
              363,265Midwest
              
              
              93,384
              
              
              99,357Corporate
              
              
              6,024
              
              
              10,047Total
              
              $
              451,254
              
              
              472,669GoodwillCAAP
              
              $
              —
              
              
              —Midwest
                  (1)
              
              
              26,492
              
              
              28,048Corporate
              
              
              —
              
              
              —Total
              
              $
              26,492
              
              
              28,048




Years
                  EndedDecember
                  31,2006
              
              2005Capital
                ExpendituresCAAP
              
              $
              53,906
              
              
              83,038Midwest
              
              
              8,585
              
              
              1,837Corporate
              
              
              16
              
              
              112Total
              
              $
              62,507
              
              
              84,987




(1)
              The
                  decrease in goodwill in the Midwest is the result of a decrease
                  in net
                  deferred taxes that had beenrecorded
                  as part of the preliminary purchase price allocation.
  F-41
  **JAMES
        RIVER COAL COMPANY**
 **AND
        SUBSIDIARIES**
 Notes
        to
        Consolidated Financial Statements


**(18)   
      Quarterly Information (Unaudited)**




Set
      forth
      below is the Company’s quarterly financial information for the previous two
      fiscal years (dollars in 000’s, except per share amounts):




**Three
                  Months Ended****March
                  31,**
              
              **June
                  30,**
              
              **September 30,**
              
              **December 31,****2006**
              
              **2006**
              
              **2006**
              
              **2006**Total
                  revenue
              
              $
              146,676
              
              
              140,176
              
              
              138,107
              
              
              139,832Gross
                  profit (loss)
              
              
              10,010
              
              
              561
              
              
              (2,502
              )
              
              (14,639
              )Income
                  (loss) from operations
              
              
              3,766
              
              
              (6,959
              )
              
              (10,461
              )
              
              (23,783
              )Income
                  (loss) before taxes
              
              
              102
              
              
              (10,652
              )
              
              (14,314
              )
              
              (28,456
              )Net
                  income (loss)
              
              
              1,401
              
              
              (3,364
              )
              
              (8,414
              )
              
              (15,792
              )Income
                  (loss) per share (Basic and Diluted):
              
              $
              0.09
              
              
              (0.21
              )
              
              (0.53
              )
              
              (0.99
              )




**Three
                  Months Ended****March
                  31,**
              
              **June
                  30,**
              
              **September 30,**
              
              **December 31,****2005**
              
              **2005**
              
              **2005**
              
              **2005**Total
                  revenue
              
              $
              97,875
              
              
              113,313
              
              
              122,937
              
              
              119,874Gross
                  profit (loss)
              
              
              7,455
              
              
              10,777
              
              
              2,094
              
              
              (7,371
              )Income
                  (loss) from operations
              
              
              2,420
              
              
              3,843
              
              
              (4,557
              )
              
              (14,204
              )Income
                  (loss) before taxes
              
              
              378
              
              
              (1,268
              )
              
              (8,136
              )
              
              (17,595
              )Net
                  income (loss)
              
              
              309
              
              
              (1,017
              )
              
              (2,200
              )
              
              (9,430
              )Income
                  (loss) per share (Basic and Diluted):
              
              $
              0.02
              
              
              (0.07
              )
              
              (0.14
              )
              
              (0.60
              )




F-42


**SIGNATURES**




Pursuant
      to the requirements of Section 13 or 15(d) 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, on the 16th day of March,
      2007.




**JAMES RIVER COAL
              COMPANY**By:
            /s/ Peter
              T. SochaPeter T. Socha
              Chairman of the Board,
              President and Chief Executive Officer
              (principal executive
                officer)




Pursuant
      to the requirements of the Securities Exchange Act of 1934, this Report has
      been
      signed below by the following persons on behalf of the Registrant in the
      capacities indicated on the 16th day of March, 2006.


**Signature**
              
              **Title**/s/
                  Peter T. Socha
              
              Chairman
                  of the Board, President and Chief Executive Officer (principal
                  executive
                  officer)Peter
                  T. Socha/s/
                  Samuel M. Hopkins, II
              
              Vice
                  President and Chief Accounting Officer (principal financial officer
                  and
                  principal accounting officer)Samuel
                  M. Hopkins, II/s/
                  W. Douglas Blackburn, Jr.
              
              DirectorW.
                  Douglas Blackburn, Jr./s/
                  Alan F. Crown
              
              DirectorAlan
                  F. Crown/s/
                  Ronald J. FlorJancic
              
              DirectorRonald
                  J. FlorJancic/s/
                  Leonard J. Kujawa
              
              DirectorLeonard
                  J. Kujawa/s/
                  Joseph H. Vipperman
              
              DirectorJoseph
                  H. Vipperman