10-K 1 fm10k-2005.htm

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

[X] Annual Report Under Section 13 or 15(d) of the Securities Exchange Act
of 1934

For the fiscal year ended December 31, 2005

[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the transition period from ________________ to ___________________.

Commission file number 0-26509

NATIONAL COAL CORP.

(Exact name of registrant as specified in its charter)

FLORIDA 65-0601272
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)

8915 GEORGE WILLIAMS ROAD
KNOXVILLE, TN 37923
(Address of Principal Executive Offices)

Registrant's telephone number, including area code: (865) 690-6900

Securities registered pursuant to Section 12(b) of the Act:

NONE

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, PAR VALUE $.0001 PER SHARE

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

Yes |_| No |X|

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

Yes |_| No |X|

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes |X| No |_|

Indicate by check mark 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. |_|

Indicate by check mark whether the registrant is a large accelerated
filed, and accelerated filed or a non-accelerated filer.

Large Accelerated Filer |_| Accelerated Filer |_| Non-accelerated Filer |X|

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

Yes |_| No |X|

The aggregate market value of the voting and non-voting common equity
held by non-affiliates computed by reference to the price at which the common
equity was last sold, or the average bid and asked price of such common equity,
as of the last business day of the registrant's most recently completed second
fiscal quarter was $25,181,656.

As of March 28, 2006, the issuer had 14,140,245 shares of common stock,
par value $.0001 per share, issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

NONE

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NATIONAL COAL CORP.
INDEX TO FORM 10-K

PART I PAGE
------ ----

Item 1. Business.................................................... 2

Item 1A. Risk Factors................................................ 20

Item 1B. Unresolved Staff Comments................................... 30

Item 2. Properties.................................................. 30

Item 3. Legal Proceedings........................................... 34

Item 4. Submission of Matters to a Vote of Security Holders......... 35

PART II

Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer purchases of Equity Securities........... 35

Item 6. Selected Financial Data..................................... 36

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

Report of Independent Registered Public Accounting Firm..... 56

Consolidated Balance Sheet.................................. 57

Consolidated Statements of Operations....................... 58

Consolidated Statements of Cash Flows....................... 59

Consolidated Statement of Changes in Stockholders' Equity... 60

Notes to Consolidated Financial Statements.................. 61

Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 83

Item 9A. Controls and Procedures..................................... 83

Item 9B Other Information........................................... 83

PART III

Item 10. Directors and Executive Officers of the Registrant.......... 84

Item 11. Executive Compensation...................................... 87

Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.................. 95

Item 13. Certain Relationships and Related Transactions.............. 97

Item 14. Principal Accountant Fees and Services...................... 97

PART IV

Item 15. Exhibits and Financial Statement Schedules.................. 98

PART I

This report, including the sections entitled "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operation" and "Business," contains "forward-looking statements" that include
information relating to future events, future financial performance, strategies,
expectations, competitive environment, regulation and availability of resources.
These forward-looking statements include, without limitation, statements
regarding: proposed new services; our expectations concerning litigation,
regulatory developments or other matters; statements concerning projections,
predictions, expectations, estimates or forecasts for our business, financial
and operating results and future economic performance; statements of
management's goals and objectives; and other similar expressions concerning
matters that are not historical facts. Words such as "may," "will," "should,"
"could," "would," "predicts," "potential," "continue," "expects," "anticipates,"
"future," "intends," "plans," "believes" and "estimates," and similar
expressions, as well as statements in future tense, identify forward-looking
statements.

Forward-looking statements should not be read as a guarantee of future
performance or results, and will not necessarily be accurate indications of the
times at, or by which, that performance or those results will be achieved.
Forward-looking statements are based on information available at the time they
are made and/or management's good faith belief as of that time with respect to
future events, and are subject to risks and uncertainties that could cause
actual performance or results to differ materially from those expressed in or
suggested by the forward-looking statements. Important factors that could cause
these differences include, but are not limited to:

o the worldwide demand for coal;

o the price of coal;

o the supply of coal and other competitive factors;

o the costs to mine and transport coal;

o the ability to obtain new mining permits;

o the costs of reclamation of previously mined properties;

o the risks of expanding coal production;

o industry competition;

o our ability to continue to finance and execute our growth
strategies;

o general economic conditions; and

o other factors discussed under the headings "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Business."

Forward-looking statements speak only as of the date they are made. You
should not put undue reliance on any forward-looking statements. We assume no
obligation to update forward-looking statements to reflect actual results,
changes in assumptions or changes in other factors affecting forward-looking
information, except to the extent required by applicable securities laws. If we
do update one or more forward-looking statements, no inference should be drawn
that we will make additional updates with respect to those or other
forward-looking statements.

ITEM 1. BUSINESS.

CORPORATE OVERVIEW

We mine, process and sell high quality bituminous steam coal from mines
located in East Tennessee and Southeastern Kentucky. We own the coal mineral
rights to approximately 74,600 acres of land and lease the rights to
approximately 40,900 additional acres. We have expanded our operations
considerably since commencing operations at a single surface mine in Tennessee
in July 2003. As of December 31, 2005, our mining complexes included three
underground mines, two surface mines, and one highwall mine. In addition, we
have four preparation plants, two active and two inactive, and four unit train
loading facilities, two active and two inactive, served by the CSX and Norfolk
Southern ("NS") railroads. We hold permits that allow us to open five new mines
close to our current operations. As of December 31, 2005, we controlled
approximately 38.5 million estimated recoverable tons. During the year ended
December 31, 2005, we generated total revenues of $65.9 million and Adjusted
EBITDA of $8.4 million and sold approximately 1,216,000 tons of coal. During the
three months ended December 31, 2005, we generated total revenues of $20.2
million and Adjusted EBITDA of $1.9 million and sold approximately 366,000 tons
of coal. We expect our production to increase significantly as we continue to
expand operations.

Since our inception, our revenues have resulted primarily from the sale
of coal to electric utility companies in the Southeastern United States.
According to the U.S. Department of Energy, Energy Information Administration
("EIA"), in 2004 the Southeast region accounted for 23% of coal generated
electricity in the United States. Also according to the EIA, the long-term
outlook for coal demand in the Southeast is favorable, as coal generated
electricity in our region is expected to grow at a rate of 2.0% per year
according to the EIA. In addition, the Southeast region is projected by the EIA
to account for 27% of the expansion of coal generated electricity in the United
States over the next 20 years. For the year ended December 31, 2005,
approximately 92% of our revenue was generated from coal sales to electric
utility companies in the Southeastern United States and our largest customers
were Georgia Power, South Carolina Public Authority (Santee Cooper) and East
Kentucky Power, representing approximately 35%, 26% and 10% of our revenues,
respectively.

In the year ended December 31, 2005, our mines produced approximately
1.2 million tons of coal. Approximately 54% of our production for 2005 was
produced at underground mines and 46% was produced at our surface and highwall
mine operations. We have taken advantage of a strong pricing environment to
obtain long-term (greater than 12 months in duration) supply agreements with key
customers at prices averaging over $50 per ton. We plan to continue to
capitalize on the currently strong pricing environment by pursuing additional
long-term contracts and selling coal on the spot market for the remainder of our
production.

BUSINESS STRATEGY

FOCUS ON SAFETY AND ENVIRONMENTAL STEWARDSHIP. We are committed to
establishing a reputation as the operator of the safest and most environmentally
responsible mines in the country. Our ability to minimize lost-time injuries
will improve our cost structure, foster strong governmental and community
relationships and enhance our financial performance. We believe that
environmental regulations will continue to become more restrictive, and that our
commitment to environmental excellence will enhance our ability to comply with
regulations.

INCREASE PRODUCTION AND DEVELOP RESERVES. We have expanded our sales
from 357,000 tons in 2004 to 1,216,000 tons in 2005. We plan to continue to
significantly expand coal production in 2006 by continuing to increase
production. We hold permits allowing us to open five additional mines on our
properties. We also have applied for permits to open and operate seven
additional mines. At December 31, 2005, we controlled approximately 38.5 million
estimated recoverable tons, and we believe that we have substantial unproven
deposits which we plan to develop.

IMPROVE PRODUCTION EFFICIENCIES. We plan to continue to improve our
operating efficiencies through greater economies of scale and significant
capital improvements. As we expand production in our existing mines and begin
production in new mines, we plan to increasingly leverage our fixed cost
infrastructure and reduce our per ton production costs. In addition, to expand
our production and achieve new efficiencies, we intend to spend approximately
$7.0 million to modernize and activate a large preparation plant and rail
loadout facility that will enable us to greatly expand our processing capacity
in the southern portion of our Tennessee reserves. In February 2006, we
purchased a forty-two mile railroad line through a wholly-owned subsidiary that
will connect more of our facilities to the Norfolk-Southern railroad in Oneida,
TN, thereby reducing our internal transportation costs from this area. This
railroad will also significantly increase our shipping capacity.

CONTINUE TO DEVELOP STRONG CUSTOMER RELATIONSHIPS. Since we commenced
operations in July 2003, we have worked hard to develop a reputation for
reliability, consistent quality and customer service, as evidenced by the
long-term contracts we have entered into with Santee Cooper, Georgia Power and
Duke Energy. We intend to continue to develop our strong relationships with our
existing customer base and new customers in order to enhance our market position
and secure favorable long-term contracts based on our planned production.

CONTINUE TO ACQUIRE CONTIGUOUS RESERVES. Our mining properties in
Tennessee and Kentucky are located in close proximity to one another and are
well served by adjacent railroad and interstate highway access. In addition, we
believe that opportunities may exist to acquire nearby mines to further leverage
our railroad access and preparation plant facilities.

HISTORY

Our operations prior to April 30, 2003 reflect only the operations of
National Coal Corporation, a Tennessee corporation. Prior to April 30, 2003,
National Coal Corp., a Florida corporation, formerly known as Southern Group
International, Inc., was a "blank check" company, which is a company that has no
specific business plan or purpose or has indicated that its business plan is to
engage in a merger or acquisition with an unidentified company or companies. On
April 30, 2003, National Coal Corporation consummated a reorganization in which
all of the outstanding shares of National Coal Corporation, a privately-held
Tennessee corporation, were exchanged for 8,549,975 shares of Southern Group,
Inc., which subsequently changed its name to National Coal Corp., a Florida
corporation. National Coal Corporation was formed in January 2003, and from
inception through June 30, 2003, National Coal Corporation was in the
exploration stage with no operating revenue. During the third quarter of 2003,
we commenced coal mining operations and were no longer in the exploration stage.
As a result of the reorganization of the group and the commencement of operating
activities, our results for the eleven months from inception (January 30, 2003)
to December 31, 2003 are not comparable to those for the twelve months ended
December 31, 2005 and 2004.

MINING OPERATIONS

At December 31, 2005, we were mining coal from two surface mines, three
underground mines and one highwall mine located in Tennessee and Kentucky.

TENNESSEE MINES

SURFACE MINE TN NO. 7. We acquired this surface mine in October 2004 as
part of an acquisition of mining permits and mineral rights from Robert Clear
Coal Corporation. This mine is located on the Ketchen Tract. This mine uses a
front end loader and dozer method of surface mining multiple seams of coal and
is located near Elk Valley in East Tennessee. Production started in the fourth
quarter of 2004.

Typically, coal from this mine is either trucked directly to our
customers or to our Turley rail loadout facility, which is located on the
Norfolk-Southern railroad. This loadout facility was an asset

acquired from US Coal, Inc. in April 2004. From the date of acquisition until
December 31, 2005, we produced approximately 283,004 tons of coal from this
mine.

There are an estimated 1,200 mineable acres located in the permitted
area. There are three major seams and multiple minor seams within the permitted
area that are suitable for mining. The property's average seam height is 32
inches. The average quality of all mineable seams for this mine is 12,000 Btu
per pound and sulfur content is approximately 2.0 pounds per million Btu.

DEEP MINE TN NO. 1. In August 2004, we began mining operations at mine
TN No. 1 pursuant to a lease agreement with Lexington Coal, LLC. Mine TN No. 1
is located near Devonia, Tennessee, on part of our New River Tract, and the
lease agreement with Lexington Coal was part of the acquisition of those mineral
rights. Mine TN No. 1 is an underground mine operating in the Pee Wee coal seam
and utilizes continuous mining equipment. Coal produced from this location was
typically trucked to our preparation plant in Smoky Junction, TN and then
trucked to our rail load-out facility in Turley, TN where the coal was either
trucked directly to one customer or shipped via rail on the Norfolk-Southern
railroad. This mine was closed in April 2005.

DEEP MINE TN NO. 9. In mid April 2004, we acquired a mining permit and
mineral rights to Mine TN No. 9 located near Smoky Junction, TN, from U.S. Coal,
Inc., and commenced extracting coal. Mine TN No. 9 is an underground mine
operating in the Pee Wee coal seam and utilizes continuous mining equipment.
Coal produced from this location was typically processed at our Smoky Junction,
TN preparation plant and then trucked to our rail load-out facility in Turley,
TN where the coal was either trucked directly to one customer or shipped via
rail on the Norfolk-Southern railroad. This mine was closed in May 2005.

DEEP MINE TN NO. 11. In April 2004, we acquired this underground mine
as part of an acquisition of mining permits, mineral rights and coal leases with
the Tennessee Valley Authority ("TVA") from U.S. Coal, Inc. This mine utilizes a
continuous mining method of extraction and is located on the TVA tract near
Smoky Junction, in East Tennessee. Production started in the fourth quarter of
2004.

Typically, coal from this deep mine is trucked to our Smoky Junction
preparation plant where it is washed and then trucked to our Turley rail loadout
facility, which is located on the Norfolk-Southern railroad. Both the Smoky
Junction and Turley facilities were acquired from US Coal. From the start of
production in November 2004 until December 31, 2005, we produced approximately
337,014 tons of coal from this mine.

Mine TN No. 11 is located on an estimated 1,000 mineable acres with an
average seam height of less than 35 inches. Typical coal quality for this mine
is 12,500 Btu per pound and sulfur content is less than 2.2 pounds per million
Btu.

KENTUCKY MINES

DEEP MINE KY NO. 1. In November 2004, we acquired this underground mine
as part of an acquisition of mining permits and mineral rights from Appalachian
Fuels, LLC. This mine is located on the Begley and Straight Creek tracts. This
mine utilizes a continuous or "room and pillar" mining method of extraction and
is located on the Straight Creek property in Southeastern Kentucky. We currently
use a contract miner to mine this property.

The coal from this deep mine is trucked to our nearby Brittain
preparation plant where it is washed and then trucked to our Viall rail loadout
facility that is located on the CSX railroad. Both the Brittain and Viall
facilities were assets acquired from Appalachian Fuels. From the date of
acquisition, November 2004, until December 31, 2005, we produced approximately
221,363 tons of coal from this mine.

DEEP MINE KY NO. 2. In November 2004, we acquired this reserve as part
of an acquisition of mining permits and mineral rights from Appalachian Fuels,
LLC. This mine is located on the Begley and Straight Creek tracts, which is the
same permitted area and coal seam as Mine KY No. 1, but did not start producing
coal until 2005. This mine utilizes a continuous or "room and pillar" mining
method of extraction and is located on the Straight Creek property in
Southeastern Kentucky. We currently use a contract miner to mine this property.

We truck coal from this mine to our nearby Brittain preparation plant
where it is washed and then trucked to our Viall rail loadout facility that is
located on the CSX railroad. Since initiating operations in 2005 until December
31, 2005, we produced approximately 74,202 tons of coal from this mine.

Mines KY No. 1 and 2 are both located on an estimated 605 mineable
acres with an average seam height of less than 40 inches. Typical coal quality
for this mine is 12,500 Btu per pound and sulfur content is less than 2.0 pounds
per million Btu.

HIGH WALL MINER KY NO. 3. In November 2004, we acquired this coal
reserve as part of the Appalachian Fuels, LLC acquisition which is located on
the Begley and Straight Creek tracts. The highwall miner was purchased in March
2005 and coal extraction began in April 2005. We truck coal from this mine to
our Viall rail loadout facility that is located on the CSX railroad. From April
1 through December 31, 2005, we produced approximately 163,241 tons of coal
under our agreement with a contract miner, which operates this mine for us.

SURFACE MINE KY NO. 4. In November 2004, we acquired this surface mine
as part of the Appalachian Fuels, LLC acquisition which is located on the Begley
and Straight Creek tracts. This surface mine facilitates the clearing of a
"highwall" primarily for purposes of using the highwall miner. The mine was
operated by a subcontractor from June 1 through August 8, 2005, at which time we
began operating the mine using our own employees. From June 1 through December
31, 2005, we produced approximately 27,733 tons of coal from this mine.

The highwall miner and surface mine, Nos. 3 and 4, are both located on
an estimated 3,982 acres with an average seam height of approximately 32 inches.
Typical coal quality for this mine is 12,500 Btu per pound and sulfur content is
less than 2.0 pounds per million Btu.

HIGHWALL MINE KY NO. 6. In November 2004, we acquired this highwall
mine as part of an acquisition of mining permits and mineral rights from
Appalachian Fuels, LLC. Mine KY No. 6 is located on the Begley and Straight
Creek tracts. A second highwall miner was purchased in February 2006 and coal
extraction from Mine KY No. 6 began shortly thereafter. We truck coal from this
mine to our Viall rail loadout facility that is located on the CSX railroad. We
currently use a contract miner to mine this property.

PERMITTED NON-OPERATING MINES

Currently, we have five issued mining permits for mines that are not
yet operating. The five issued permits are for mines located in Tennessee. We
have also applied for permits, or have permit applications in various stages of
processing, that should enable us to operate an additional seven mines.

TRANSPORTATION

Our Tennessee and Kentucky operations are both within a few miles of
major interstate highways, which provide access for trucking transport of our
coal. Our Turley, Tennessee rail load-out facility is immediately adjacent to a
portion of the Norfolk-Southern rail system, and our Straight Creek, Kentucky
rail load-out facility is immediately adjacent to a portion of the CSX rail
system. In February 2006, through a wholly-owned subsidiary, we purchased
forty-two miles of railroad track from Norfolk-Southern Railroad which will
connect our Baldwin facility in Devonia, Tennessee to the Norfolk-Southern rail
system in Oneida, Tennessee.

We use employee drivers and independent contractors to haul coal from
the mine sites to our preparation plants and loadout facilities. We own our
trucks and employ drivers through our wholly-owned subsidiary, NC
Transportation, Inc.

RAILROAD LOADING AND PREPARATION PLANT FACILITIES

We currently have two active railroad loading facilities; the Turley
railroad load-out facility in Turley, Tennessee, and the Viall railroad load-out
facility in Straight Creek, Kentucky, and two inactive railroad loading
facilities located in Smoky Junction, Tennessee and Devonia, Tennessee. The
Baldwin railroad facility, located at Devonia, Tennessee, is currently
undergoing capital improvements to become operational.

Each railroad load-out facility is in close proximity to a preparation
plant. The Smoky Junction, Tennessee preparation plant is fully operational and
has an estimated capacity of 720,000 clean tons per year. The Brittain
preparation plant in Straight Creek, Kentucky is fully functional and has an
estimated annual capacity of 1.8 million clean tons.

The preparation plants in Turley, Tennessee, and Pine Mountain,
Kentucky, are not currently in use and would need capital improvements to become
operational. We intend, subject to availability of funds, to improve the rail
and preparation plant facilities where necessary to serve our growing production
needs.

EMPLOYEES

At December 31, 2005, we had 244 full-time employees, of which 211 were
engaged in direct mining or processing operations, fourteen in mining
supervision, and nineteen in executive management, sales, legal and general
administration. None of our employees are covered by a collective bargaining
agreement. We consider our relationship with our employees to be favorable. We
utilize the services of independent consultants as needed. The miners and
supervisors are based in East Tennessee and Southeastern Kentucky; the Chief
Executive Officer/President, Chief Operating Officer, Chief Financial Officer
and General Counsel are based in Knoxville, Tennessee.

MARKETING AND SALES

Our marketing and sales efforts are based at the corporate office in
Knoxville, Tennessee and are led by our Vice President of Sales, who has over
twenty-five years of sales experience in the coal industry. Our sales efforts
primarily are focused on increasing our customer base of electric utilities in
the Southeastern region of the United States. We are also targeting industrial
customers. We do not anticipate exporting any of our production for the
foreseeable future.

During the year ended December 31, 2005, we sold over 1,216,000 tons of
coal, 366,000 tons of which were sold in the fourth quarter, at an average price
of nearly $53.66 per ton, resulting in approximately $65.3 million in coal
sales. Our top two customers, both electric utilities, represented approximately
60% of the tonnage relating to these coal sales.

CUSTOMERS

During the twelve months ended December 31, 2005, we generated all of
our coal sales revenue from fifteen customers, eight of which were electric
utilities (92%), six of which were industrial companies (8%) and one was a coal
reseller (‹1%). All of our sales in 2003 and in the first nine months of
2004 were made pursuant to short term contracts with our electric utility and
industrial customers. Sales to coal resellers were made on a spot basis. Most of
our coal sales in the fourth quarter 2004 through December 31, 2005 were derived
from long-term contracts. We intend to expand the number of customers we serve
as our coal production increases, and to enter into long term contracts for the
majority of our coal production to obtain greater price certainty for our coal.
At December 31, 2005, we had six contracts of one year or longer. The following
table summarizes, as of December 31, 2005, the tons of coal that we are
committed to deliver at prices determined under existing long-term contracts,
which prices are subject to annual adjustment under the terms of our contracts,
during the calendar years 2006 through 2010:

------------- --------------- ---------------
CALENDAR YEAR TONS AVG. $/ TON DOLLAR VALUE
------------- --------------- ---------------

2006.................. 1,429,000 $52.16 $ 74,532,250
2007.................. 1,230,000 $52.02 $ 63,985,500
2008.................. 300,000 $51.35 $ 15,403,500
2009.................. 60,000 $59.48 $ 3,568,500
2010.................. 15,000 $69.45 $ 1,041,750
------------- --------------- ---------------
Total............. 3,034,000 $52.25 $158,531,500
============= =============== ===============

COMPETITION

The coal industry is intensely competitive. We compete with numerous
domestic coal producers. We also compete with producers of other fuels used in
electricity generation, including nuclear, natural gas and hydroelectric
producers. In addition to competition from other fuels, coal quality, the
marginal cost of producing coal in various regions of the country, and
transportation costs are major determinants of the price for which our coal can
be sold.

THE COAL INDUSTRY

A major contributor to the world energy supply, coal represented over
24% of the world's primary energy consumption in 2003 according to the World
Coal Institute. The primary use for coal is to fuel electric power generation.
In 2004, coal-fired plants generated 50% of the electricity produced in the
United States, according to the EIA. The United States produces over one-fifth
of the world's coal and is the second largest coal producer in the world,
exceeded only by China. Other leading coal producers include India, Australia,
and South Africa. The United States is the holder of the largest coal reserves
in the world.

We operate in the Central/Southern Appalachia region. The
Central/Southern Appalachia region contains coalfields in eastern Kentucky,
Tennessee, Alabama, Southwestern Virginia, and Central and Southern West
Virginia. Production declined in all major sections of Central/Southern
Appalachia except for Southern West Virginia, which has grown due to the
expansion of more economically attractive surface mines. The region has
experienced significant consolidation in the past several years due to modest
demand growth and strong competition from Western coal. We believe
Central/Southern Appalachian operators market approximately 67% of their coal to
electric generators, principally in the Southeastern United States.
Central/Southern Appalachia producers also sell extensively in the export market
and to industrial customers. We believe the coal of Central/Southern Appalachia
has an average heat content of 12,500 Btu per pound and generally has low sulfur
content.

COAL MINING TECHNIQUES

Coal mining operations can be divided into surface and underground
mining methods. The most appropriate mining technique is determined by coal seam
characteristics such as location and recoverable reserve base. Drill-hole data
are used initially to define the size, depth and quality of the coal reserve
area before committing to a specific extraction technique. All coal mining
techniques rely heavily on technology, improvements to which have resulted in
increased productivity. The five most common mining techniques are continuous
mining, longwall mining, truck-and-shovel mining, dragline mining, and highwall
mining, the newest technique. We use continuous mining, truck-and-shovel mining
and highwall mining.

SURFACE MINING. Generally, it is easier and cheaper to mine coal seams
that are thick and located close to the surface than it is to mine thin
underground seams. Typically, coal-mining operations will begin at the part of
the coal seam that is closest to the surface and most economical to mine. As the
seam is mined, it becomes more difficult and expensive to mine because the seam
either becomes thinner or protrudes more deeply into the earth, requiring
removal of more material over the seam, known as "overburden." As the amount of
overburden increases the cost to mine coal increases. For example, many seams of
coal in Central Appalachia are between one to ten feet thick and located
hundreds of feet below the surface. In contrast, seams in the Powder River Basin
of Wyoming may be eighty feet thick and located only 100 feet below the surface.

TRUCK-AND-SHOVEL MINING. Truck-and-shovel mining is a surface mining
method that uses either large electric-powered shovels or front end loaders
("loaders") to remove the earth or OVERBURDEN that covers the coal. The
overburden is loaded onto large off-road trucks, and the overburden is used to
backfill pits after coal removal. Loaders load coal into coal trucks for
transportation to the preparation plant or rail load-out. Seam recovery using
the truck-and-shovel method is typically 90%. Productivity depends on size of
equipment, geological composition and the ratio of overburden to coal.
Productivity varies between 250 to 400 tons per miner shift in the Powder River
Basin where the overburden ratio is approximately four to one, to thirty to
eighty tons per miner shift in Central Appalachia where the overburden ratio is
approximately twenty to one.

HIGHWALL MINING. Highwall mining is a surface mining method in which a
continuous mining machine is driven by remote control into the seam exposed by
previous open cut operations, or "highwall", which was the result of surface
mining operations. A continuous haulage system carries the coal from the digging
face to the surface for stockpiling and transport. This process forms a series
of parallel, unsupported cuts along the highwall. It is vital that the coal
pillars remaining between adjacent drives are capable of supporting the
overburden structure.

DEEP MINING. Those seams that are too deep to surface mine can be
economically mined with specialized equipment matched to the thickness of the
coal seam. Underground mining methods consist of "room and pillar" and "longwall
mining." Room and pillar mining typically requires using a continuous miner to
cut a system of entries into the coal, leaving pillars to support the strata
above the coal. Shuttle cars then transport the coal from the digging face to a
conveyor belt for transport to the surface. This method is often used to mine
thin seams, and seam recovery is typically 50% or less. Longwall mining requires
a sophisticated array of equipment that cuts a block of coal as wide as 1000
feet and as long as 5000 feet. This mining method requires a very large, thick
seam of coal and a sophisticated array of expensive mining equipment. Most
underground mining in the U.S. is performed using continuous miners.

COAL CHARACTERISTICS

HEAT VALUE. The heat value of coal is commonly measured in Btu per
pound of coal. Coal found in the Eastern and mid-Western regions of the United
States, including Central Appalachia, tends to have a heat content ranging from
10,000 to 15,000 Btu per pound. Most coal found in the Western United States
ranges from 8,000 to 10,000 Btu per pound. The weight of moisture in coal, as
sold, is included in references to Btu per pound of coal, unless otherwise
indicated.

SULFUR CONTENT. Sulfur content can vary from seam to seam and sometimes
within each seam. Coal combustion produces sulfur dioxide, the amount of which
varies depending on the chemical composition and the concentration of sulfur in
the coal. Low sulfur coal has a variety of definitions, and in using this term,
we refer to coal with sulfur content of 2.0% or less by weight. Compliance coal
refers to coal with a sulfur content of less than 1.2 pounds of sulfur dioxide
per million Btu. The strict emissions standards of the Clean Air Act have
increased demand for low sulfur coal. We expect continued high demand for low
sulfur coal as electric generators meet the current Phase II requirements of the
Clean Air Act (1.2 pounds or less of sulfur dioxide per million Btu).

Sub-bituminous coal typically has lower sulfur content than bituminous
coal, but some bituminous coal in Colorado, Eastern Kentucky, Tennessee,
Southern West Virginia and Utah also has a low sulfur content.

OTHER. Ash is the inorganic residue remaining after the combustion of
coal. As with sulfur content, ash content varies from seam to seam. Ash content
is an important characteristic of coal for electric generating plants as it
affects combustion performance and utilities must handle and dispose of ash
following combustion.

Moisture content of coal varies by the type of coal, the region where
it is mined and the location of coal within a seam. In general, high moisture
content decreases the heat value and increases the weight of the coal, thereby
making it more expensive to transport with less combustion efficiency. Moisture
content in coal, as sold, can range from approximately 5% to 30% of the coal's
weight. Generally, the moisture content of coal from Central Appalachia ranges
from 5% to 9%.

The other major market for coal is the steel industry. The type of coal
used in steel making is referred to as metallurgical coal and is distinguished
by special quality characteristics that include high carbon content, low
expansion pressure and various other chemical attributes. Metallurgical coal is
also

high in heat content (as measured in Btu), and therefore is desirable to
utilities as fuel for electricity generation. Consequently, metallurgical coal
producers have the ongoing opportunity to select the market that provides
maximum revenue. The premium price offered by steel makers for the metallurgical
quality attributes is typically higher than the price offered by utility coal
buyers that value only the heat content.

Once raw coal is mined, it is often crushed, sized and washed in
preparation plants where product consistency and heat content are improved. This
process involves crushing the coal to the required size, removing impurities
and, where necessary, blending it with other coal to match customer
specifications.

When some types of coal are super-heated in the absence of oxygen, they
form a hard, dry, caking form of coal called "coke." Steel production uses coke
as a fuel and reducing agent to smelt iron ore in a blast furnace. Most of the
coking coal comes from coal found in Northern and Central Appalachia.

COAL PRICES

Coal prices vary dramatically by region and are determined by a number
of factors. The two principal components of the delivered price of coal are the
price of coal at the mine, which is influenced by mine operating costs and coal
quality, and the cost of transporting coal from the mine to the point of use.
Electric utilities purchase coal on the basis of its total delivered cost per
million Btu. The higher the Btu of the coal, the fewer tons the utility needs to
buy to meet its requirements.

PRICE AT THE MINE. The price of coal at the mine is influenced by
geological characteristics such as seam thickness, overburden ratios and depth
of underground reserves. Eastern United States coal is more expensive to mine
than Western coal because of thinner coal seams and thicker overburden.
Underground mining, prevalent in the Eastern United States, has higher costs
than surface mining because it requires more people, greater development costs,
and higher costs to remove impurities.

In addition to direct mining costs, the price of coal at the mine is
also a function of quality characteristics such as heat value, sulfur, ash and
moisture content. Metallurgical coal has higher carbon and lower ash content and
is usually priced as much as $10 per ton higher than steam coal produced in the
same regions. Higher prices are paid for special coking coal with low volatility
characteristics. Very few coal seams possess these unique metallurgical coal
qualities.

TRANSPORTATION COSTS. Coal used for domestic consumption is generally
sold FREIGHT ON BOARD, or FOB, at the mine and shipped by railroad or by truck.
The buyer normally bears the transportation costs. Export coal, however, is
usually sold at the loading port, and coal producers are responsible for
arranging and paying for shipment to the export coal-loading facility. The buyer
does not acquire ownership of the coal or pay for it until it is loaded onto the
ship.

Most electric generators arrange long-term shipping contracts with
rail, truck, or barge companies to assure stable delivered costs. Transportation
can be a large component of a buyer's cost, especially if long distances are
involved such as from Wyoming to the Southeast. Although the buyer pays the
freight, transportation costs are still important to coal mining companies
because the buyer may choose a supplier based on the cost of transportation.
According to the National Mining Association, railroads account for nearly
two-thirds of total United States coal shipments. Trucks and overland conveyors
haul coal over shorter distances, while lake carriers and ocean vessels move
coal mainly to export markets. Some domestic coal is shipped over the Great
Lakes. Most coal mines are served by a single rail company, but much of the
Powder River Basin is served by two competing rail carriers. Coal mines in
Central Appalachia generally are served by either the Norfolk-Southern or the
CSX rail lines.

REGULATORY MATTERS

Federal, state and local authorities regulate the United States coal
mining industry with respect to matters such as employee health and safety,
permitting and licensing requirements, air quality standards,

water pollution, plant and wildlife protection, the reclamation and restoration
of mining properties, the discharge of materials into the environment, surface
subsidence from underground mining, and the effects of mining on groundwater
quality and availability. The Mine Safety and Health Administration, or MSHA, is
the U.S. Department of Labor agency responsible for the health and safety of
miners. The Office of Surface Mining, or OSM, is the Department of the Interior
agency which governs the issuance of permits and is responsible for overseeing
the reclamation, restoration and other environmental processes for our industry.

The industry is also affected by significant legislation mandating
certain benefits for current and retired coal miners. Numerous federal, state
and local governmental permits and approvals are required for mining operations.
We believe that we have obtained all permits currently required to conduct our
present mining operations and are in compliance with all MSHA and OSM
regulations pursuant to our operations. We may be required to prepare and
present to federal, state or local authorities data pertaining to the effect or
impact that a proposed development for, or production of, coal may have on the
environment. These requirements could prove costly and time-consuming, and could
delay commencing or continuing development or production operations. Future
legislation and administrative regulations may emphasize the protection of the
environment and, as a consequence, our activities may be more closely regulated.
Such legislation and regulations, as well as future interpretations and more
rigorous enforcement of existing laws, may require substantial increases in
equipment and operating costs and delays, interruptions or a termination of
operations, the extent of which cannot be predicted.

We endeavor to conduct our mining operations in compliance with all
applicable federal, state and local laws and regulations. However, because of
extensive and comprehensive regulatory requirements, violations during mining
operations occur from time to time. The majority of any such violations result
from natural causes, such as heavy rainfall or diverse temperature conditions,
that cause physical changes to the land surface or water levels resulting in
excess sedimentation in streams or land slides. None of the violations to date
or the monetary penalties assessed upon us have been material.

MINE SAFETY AND HEALTH

Stringent health and safety standards have been in effect since
Congress enacted the Coal Mine Health and Safety Act of 1969. The Federal Mine
Safety and Health Act of 1977 significantly expanded the enforcement of safety
and health standards and imposed safety and health standards on all aspects of
mining operations.

Most states, including the states of Tennessee and Kentucky in which we
operate, have programs for mine safety and health regulation and enforcement.
Collectively, federal and state safety and health regulation in the coal mining
industry is perhaps the most comprehensive and pervasive system for protection
of employee health and safety affecting any segment of United States industry.
While regulation has a significant effect on our operating costs, our regional
competitors are subject to the same degree of regulation.

ENVIRONMENTAL LAWS

We are subject to various federal and state environmental laws. Some of
these laws, discussed below, place many requirements on our coal mining
operations. Federal and state regulations require regular monitoring of our
mines and other facilities to ensure compliance.

SURFACE MINING CONTROL AND RECLAMATION ACT

The SMCRA, which is administered by OSM, establishes mining,
environmental protection and reclamation standards for all aspects of surface
mining as well as many aspects of deep mining. Mine operators must obtain SMCRA
permits and permit renewals for mining operations from the OSM. Where state
regulatory agencies have adopted federal mining programs under the act as in
Kentucky, the state becomes the regulatory authority.

SMCRA permit provisions include requirements for coal prospecting; mine
plan development; topsoil removal, storage and replacement; selective handling
of overburden materials; mine pit backfilling and grading; protection of the
hydrologic balance; subsidence control for underground mines; surface drainage
control; mine drainage and mine discharge control and treatment; and
re-vegetation.

Before a SMCRA permit is issued, a mine operator must submit a bond or
otherwise secure the performance of reclamation obligations. The Abandoned Mine
Land Fund, which is part of SMCRA, requires a fee on all coal produced. The
proceeds are used to reclaim mine lands closed prior to 1977 and to pay health
care benefit costs of orphan beneficiaries of the Combined Fund. The fee, which
partially expired on September 30, 2004, is $0.35 per ton on surface-mined coal
and $0.15 per ton on deep-mined coal. Since that date, a fee is assessed each
year to cover the expected health care benefit costs of the orphan
beneficiaries.

SMCRA stipulates compliance with many other major environmental
programs. These programs include the Clean Air Act, Clean Water Act, Resource
Conservation and Recovery Act ("RCRA"), Comprehensive Environmental Response,
Compensation, and Liability Acts ("CERCLA") superfund and employee right-to-know
provisions. Besides OSM, other Federal and State regulatory agencies are
involved in monitoring or permitting specific aspects of mining operations. The
United States Environmental Protection Agency ("EPA") is the lead agency for
States or Tribes with no authorized programs under the Clean Water Act, RCRA and
CERCLA. The United States Army Corps of Engineers ("COE") regulates activities
affecting navigable waters and the United States Bureau of Alcohol, Tobacco and
Firearms ("ATF") regulates the use of explosive blasting.

We do not believe there are any substantial matters that pose a risk to
maintaining our existing mining permits or hinder our ability to acquire future
mining permits. It is our policy to comply with all requirements of the Surface
Mining Control and Reclamation Act and the state laws and regulations governing
mine reclamation.

CLEAN AIR ACT

The coal industry has witnessed a recent shift in demand to low sulfur
coal production driven by regulatory restrictions on sulfur dioxide emissions
from coal-fired power plants. The Clean Air Act, the Clean Air Act Amendments
and the corresponding state laws that regulate the emissions of materials into
the air, affect coal mining operations both directly and indirectly. Direct
impacts on coal mining and processing operations may occur through Clean Air Act
permitting requirements and/or emission control requirements relating to
particulate matter, such as fugitive dust, including future regulation of fine
particulate matter measuring ten micrometers in diameter or smaller. The Clean
Air Act indirectly affects coal mining operations by extensively regulating the
air emissions of sulfur dioxide, nitrogen oxides, mercury and other compounds
emitted by coal-fueled electricity generating plants.

For example, in 1995, Phase I of the Clean Air Act Acid Rain program
required high sulfur coal plants to reduce their emissions of sulfur dioxide to
2.5 pounds or less per million Btu, and in 2000, Phase II of the Clean Air Act
tightened these sulfur dioxide restrictions further to 1.2 pounds of sulfur
dioxide per million Btu. Currently, electric power generators operating
coal-fired plants can comply with these requirements by:

o burning lower sulfur coal, either exclusively or mixed with
higher sulfur coal;
o installing pollution control devices such as scrubbers, which
reduce the emissions from high sulfur coal;
o reducing electricity generating levels; or
o purchasing or trading emission credits to allow them to comply
with the sulfur dioxide emission compliance requirements.

However, as new and proposed laws and regulations, including the Clean
Air Interstate Rule and the Clean Air Mercury Rule, require further reductions
in emissions, coal-fired utilities may need to install

additional pollution control equipment, such as wet scrubbers, to comply.
Installation of such additional pollution control equipment could potentially
result in a decrease in the demand for low sulfur coal (because sulfur would be
removed by the new equipment), potentially driving down prices for low sulfur
coal.

CLEAN WATER ACT

The Clean Water Act of 1972 affects coal mining operations by
establishing water quality standards and regulating alteration of surface water
bodies. Much of the responsibility for standard setting, monitoring, and
enforcement is delegated to state agencies, with federal oversight. There are
three major aspects in the standard-setting process. First, the states establish
use designations for all surface water bodies. Second, scientifically-based
water quality criteria (numeric or narrative) are established to be protective
of the designated uses. These criteria include total maximum daily load ("TMDL")
discharge standards which are monitored and enforced through the National
Pollution Discharge Elimination System ("NPDES"). Water discharges from each
mine operation are regulated within the NPDES process. The third component is
the anti-degradation standard, which establishes characteristics of "high
quality streams", and prohibits their degradation. Standards for discharging
water from mine sites to high quality streams are very stringent. Upgrading
stream designations to "high quality" in the areas in which coal mine operations
are located can potentially result in increased water treatment costs that can
increase both permitting costs and coal production costs.

RESOURCE CONSERVATION AND RECOVERY ACT

The Resource Conservation and Recovery Act, which was enacted in 1976,
affects coal mining operations by establishing requirements for the treatment,
storage and disposal of hazardous waste. Coal mine waste, such as overburden and
coal cleaning waste, are exempted from hazardous waste management.

Subtitle C of RCRA exempted fossil fuel combustion wastes from
hazardous waste regulation until the EPA completed a report to Congress and made
a determination on whether the wastes should be regulated as hazardous. In a
1993 regulatory determination, the EPA addressed some high-volume, low- toxicity
coal combustion wastes generated at electric utility and independent power
producing facilities. In May 2000, the EPA concluded that coal combustion wastes
do not warrant regulation as hazardous under RCRA. The EPA is retaining the
hazardous waste exemption for these wastes. However, the EPA has determined that
national non-hazardous waste regulations under RCRA Subtitle D are needed for
coal combustion wastes disposed in surface impoundments and landfills and used
as mine-fill. The agency also concluded beneficial uses of these wastes, other
than for mine filling, pose no significant risk and no additional national
regulations are needed. As long as this exemption remains in effect, it is not
anticipated that regulation of coal combustion waste will have any material
effect on the amount of coal used by electricity generators.

FEDERAL AND STATE SUPERFUND STATUTES

Superfund and similar state laws affect coal mining and hard rock
operations by creating a liability for investigation and remediation in response
to releases of hazardous substances into the environment and for damages to
natural resources. Under Superfund, joint and several liabilities may be imposed
on waste generators, site owners or operators and others regardless of fault.

GLOBAL CLIMATE CHANGE

The United States, Australia, and more than 160 other nations are
signatories to the 1992 Framework Convention on Climate Change, which is
intended to limit emissions of greenhouse gases such as carbon dioxide. In
December 1997, in Kyoto, Japan, the signatories to the convention established a
binding set of emission targets for developed nations. Although the specific
emission 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.
Although the United States did not ratify the emission targets and no
comprehensive regulations focusing on greenhouse gas emissions are in place,
these restrictions, whether through ratification of the emission targets or
other efforts to stabilize or reduce greenhouse gas emissions, could adversely
affect the price and demand for coal. According to the Energy Information
Administration's Emissions of Greenhouse Gases in the United States 2001, coal
accounts for 32% of greenhouse gas emissions in the United States, and efforts
to control greenhouse gas emissions could result in reduced use of coal if
electricity generators switch to lower carbon sources of fuel. In March 2001,
President Bush reiterated his opposition to the Kyoto Protocol and further
stated that he did not believe that the government should impose mandatory
carbon dioxide emission reductions on power plants. In February 2002, President
Bush announced a new approach to climate change, confirming the Administration's
opposition to the Kyoto Protocol and proposing voluntary actions to reduce the
greenhouse gas intensity of the United States. Greenhouse gas intensity measures
the ratio of greenhouse gas emissions, such as carbon dioxide, to economic
output. The President's climate change initiative calls for a reduction in
greenhouse gas intensity over the next ten years, which is approximately
equivalent to the reduction that has occurred over each of the past two decades.

PERMITTING

Mining companies must obtain numerous permits that impose strict
environmental and safety regulations on their operations. These provisions
include requirements for coal prospecting, mine plan development, topsoil
removal, storage and replacement, selective handling of overburden materials,
mine pit backfilling and grading, protection of the hydrologic balance,
subsidence control for underground mines, surface drainage control, mine
drainage and mine discharge control and treatment, and revegetation.

We must obtain permits from applicable state regulatory authorities
before we begin to mine reserves. The mining permit application process is
initiated by collecting baseline data to adequately characterize the pre-mine
environmental condition of the permit area. This work includes surveys of
cultural resources, soils, vegetation, wildlife, assessment of surface and
ground water hydrology, climatology and wetlands. In conducting this work, we
collect geologic data to define and model the soil and rock structures and coal
that will be mined. We develop mine and reclamation plans by utilizing this
geologic data and incorporating elements of the environmental data. The mine and
reclamation plans incorporate the provisions of the Surface Mining Control and
Reclamation Act of 1977 (the "SMCRA"), state programs and the complementary
environmental programs that impact coal mining. Also included in the permit
application are documents defining ownership and agreements pertaining to coal,
minerals, oil and gas, water rights, rights of way, and surface land along with
documents required of the Office of Surface Mining's Applicant Violator System.

Once a permit application is prepared and submitted to the regulatory
agency, it goes through a completeness review, technical review and public
notice and comment period prior to approval. SMCRA mine permits can take over a
year to prepare, depending on the size and complexity of the mine, and often
require six months to two years for approval. Regulatory authorities have
considerable discretion in the timing of permit issuance and the public has the
right to comment on and otherwise engage in the permitting process, including
through intervention in the courts.

We do not believe there are any substantial matters that pose a risk to
maintaining our existing mining permits or hinder our ability to acquire future
mining. It is our policy to ensure that our operations are in full compliance
with the requirements of the SMCRA and state laws and regulations governing mine
reclamation.

TECHNOLOGY

Coal mining technology is continually evolving and improving. Longwall
mining technology has increased the average recovery of coal from large blocks
of underground coal from 50% to 70%. At larger surface mines, haul trucks have
capacities of up to 400 tons, which is nearly double the maximum

capacity of the largest haul trucks used a decade ago. This increase in
capacity, along with larger excavating equipment, has increased overall mine
productivity.

We do not have any licenses, patents, or trademarks and do not depend
on licensed technology to conduct our operations.

RECENT COAL MARKET CONDITIONS

U.S. coal production more than doubled from 1968 to 1998 due largely to
changes in work practices and the introduction of new technologies that have
greatly increased mine productivity. According to the EIA, overall coal mine
productivity, measured in short tons produced per miner hour, has increased from
3.8 tons in 1990 to 6.8 tons in 2004.

According to traded coal indices and reference prices, U.S. and
international coal demand is currently at high levels. Coal prices have
increased significantly between 1994 and 2004, and have gone up significantly in
Central Appalachia in every year since 2002. We believe that current trends in
the U.S. coal industry are among the most positive witnessed over the past
decade, supported primarily by:

o stronger industrial demand following a recovery in the U.S.
manufacturing sector;
o relatively low customer stockpiles;
o production difficulties and reserve degradation experienced by
some U.S. coal producers;
o capacity constraints of U.S. nuclear-powered electricity
generators;
o high current and forward prices for natural gas and oil;
o transportation disruptions including constrained rail line
capacity and increased costs faced by the trucking industry;
and
o increased international demand for U.S. coal for electricity
generation and steelmaking, driven by global economic growth,
high ocean freight rates and the weak U.S. dollar.

U.S. spot coal prices have experienced significant volatility over the
past few years. Starting in late 2000 and continuing through mid-2001, U.S. spot
coal prices began to rise as a result of reduced supply, higher demand from
utility and industrial consumers, and rising natural gas and oil prices.
Beginning in the middle of 2001, U.S. coal prices declined due to the weakening
domestic economy, higher utility consumer inventories and increases in supply as
the coal production market reacted to the stronger prices during the late
2000/early 2001 period. Spot prices for coal remained relatively low through the
end of 2001 and during all of 2002.

U.S. coal prices have steadily increased since mid-2003, particularly
for coal sourced in the Eastern United States. In 2005, coal prices in Central
Appalachia remained relatively unchanged despite unseasonal weather in the
Southeast. Cooler summer temperatures and a warmer than normal winter did little
to lower the price of Central Appalachian coal. Many utilities are now trying to
lock in prices for future supplies of coal.

DEMAND FOR U.S. COAL PRODUCTION

ELECTRICITY GENERATION

Coal produced in the United States is used primarily by utilities to
generate electricity, by steel companies to produce coke for use in blast
furnaces and by industry to heat and power foundries, cement plants, paper
mills, chemical plants and other manufacturing and processing facilities.
Significant quantities of coal are also exported from both East and West coast
terminals. According to the EIA, almost all of the coal consumed in the United
States in 2004 was from domestic production sources, given that imports
represent less than 3% of total domestic consumption. Coal produced in the
United States is also exported, primarily from East coast terminals. The
breakdown of 2004 U.S. coal consumption by sector, according to the EIA, is as
follows:

END USE: TONS (MILLIONS) % OF TOTAL
------------------- ------------------
Electric Power 1,015 91.9%
Other Industrial Plants 61 5.6%
Coke Plants 24 2.1%
Residential & Commercial 4 0.4%
------------------- ------------------
Total 1,104 100.0%
Source: EIA

Coal has long been favored as an electricity generating fuel by
regulated utilities because of its basic economic advantage. The largest cost
component in electricity generation is fuel. According to the National Mining
Association, coal is the cheapest source of power fuel per million Btu,
averaging less than one-fifth the price of both petroleum and natural gas in
2004. According to the EIA, for a new coal-fired plant built today, fuel costs
would represent about one-half of total operating costs, while the share for a
new natural-gas-fired plant would be almost 90%. Coal used as fuel to generate
electricity is commonly referred to as "steam coal." Other factors that
influence each utility's choice of electricity generation mode include facility
cost, fuel transportation infrastructure, environmental restrictions and other
factors. The breakdown of U.S. electricity generation by fuel source in 2004, as
estimated by the EIA, is as follows:

ELECTRICITY GENERATION SOURCE: % OF TOTAL ELECTRICITY GENERATION
---------------------------------
Coal 50%
Nuclear 20%
Natural Gas 18%
Hydro 7%
Petroleum 3%
Other 2%
--------
Total 100%
Source: EIA

The EIA projects that generators of electricity will increase their
demand for coal as demand for electricity increases. Because coal-fired
generation is used in most cases to meet base load requirements, coal
consumption has generally grown at the pace of electricity demand growth. Demand
for electricity has historically grown in proportion to U.S. economic growth as
measured by gross domestic product.

INCREASING U.S ELECTRICITY DEMAND (1980 - 2025)

1980 1985 1990 1995 2000 2005E 2010P 2015P 2020P 2025P
---- ---- ---- ---- ---- ----- ----- ----- ----- -----
(Billion Kilowatt Hours)

Net Electricity Consumption 2,094 2,324 2,837 3,164 3,592 3,845 4,272 4,643 5,043 5,470

Source: EIA

According to the EIA, from 1990 to 2004 coal consumption in the United
States increased from 905 million tons to 1.1 billion tons, or 22%. The largest
driver of increased coal consumption during this period was increased demand for
electricity. The EIA estimates that coal use for electricity generation is
expected to increase by 1.6% per year on average through 2025, as coal remains
one of the lowest cost fuel sources for domestic electric power producers.

U.S. ELECTRICITY PRODUCTION AND COAL CONSUMPTION TRENDS (1995 - 2004)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
------ ------- ------ ------ ------- ------- ------ ------ ------- ------
PRODUCTION BY FUEL: (Billion Kilowatt Hours)
Coal 1,709 1,795 1,845 1,874 1,881 1,966 1,904 1,933 1,974 1,976
Nuclear 673 675 629 674 728 754 769 780 764 789
Natural Gas 496 455 479 531 556 601 639 691 650 700
Hydroelectric 308 344 353 319 313 270 208 256 267 262
Petroleum 75 81 93 129 118 111 125 95 119 118
Other 92 94 94 94 98 100 92 104 109 109
------ ------- ------ ------ ------- ------- ------ ------ ------- ------
TOTAL PRODUCTION 3,354 3,444 3,492 3,620 3,695 3,802 3,737 3,859 3,883 3,953

(Million Short Tons)
COAL CONSUMPTION 962 1,006 1,030 1,037 1,039 1,084 1,060 1,066 1,095 1,104
Source: EIA

We believe that existing coal-fired plants will supply much of the
projected increase in the demand for electricity because they possess excess
capacity that can be utilized at low incremental costs. The National Energy
Technology Laboratory has identified 124 coal-fired plants, representing 73,000
megawatts of electric generation capacity, that have been proposed and are
currently in various stages of development.

RESTRUCTURING OF THE ELECTRIC INDUSTRY.

In October 1992, Congress enacted the Energy Policy Act of 1992, which
gave wholesale electricity suppliers access to the transmission lines of U.S.
utility companies. In May 1996, the Federal Energy Regulatory Commission
("FERC") issued the first of a series of orders establishing rules to promote
competition in wholesale electricity markets by providing wholesale electricity
suppliers open access to electricity transmission systems. In 1999, the FERC
issued a rule to encourage the establishment of regional transmission
organizations. Wholesale competition has resulted in a substantial increase in
non-utility generating capacity in the United States.

Some individual states are also proceeding with their own deregulation
initiatives. The pace of deregulation differs significantly from state to state.
As of September 2003, seventeen states and the District of Columbia had either
enacted legislation leading to the deregulation of the electricity market or
issued a regulatory order to implement retail access that would allow customers
to choose their own supplier of generation. Five states have delayed
restructuring and twenty-seven are not actively pursuing deregulation. In
California, where supply and demand imbalances created electricity supply
shortages, the California Public Utilities Commission suspended deregulation.

A possible consequence of deregulation is downward pressure on fuel
prices. However, because of coal's cost advantage and because some coal-fueled
generating facilities are underutilized in the current regulated electricity
market, we believe that additional coal demand would arise as electricity
markets are deregulated if the most efficient coal-fueled power plants are
operated at greater capacity.

U.S. COAL PRODUCTION AND DISTRIBUTION.

In 2004, total coal production as estimated by the Department of Energy
was 1.1 billion tons. The primary producing regions in the United States are
Appalachia (35%) (including West Virginia,

Kentucky, Tennessee and Pennsylvania), Interior (13%) (including Illinois,
Indiana and Western Kentucky) and Western (52%) (including Wyoming, Utah and
Colorado). All of our coal production comes from the Central Appalachian region.
In 2004, approximately 67% of U.S. coal was produced by surface mining methods.
The remaining 33% was produced by underground mining methods that include room
and pillar mining and longwall mining.

U.S. COAL PRODUCTION

1998 1999 2000 2001 2002 2003 2004
---- ---- ---- ---- ---- ---- ----
AREA: (Tons in Millions)
Appalachian 460.4 425.6 419.4 431.2 396.2 376.1 390.4
Interior 168.4 162.5 143.5 146.9 146.6 146.0 145.8
Western 488.8 512.3 510.7 547.9 550.4 549.7 575.2
Total 1,117.6 1,100.4 1,073.6 1,126.0 1,093.2 1,071.8 1,111.4

Source: Coal Industry Annual Review and Coal Weekly, 1998-2004, EIA (including
2004 estimated data).

CENTRAL APPALACHIA. We operate in Central Appalachia. Central
Appalachia, which includes Eastern Kentucky, Virginia, Tennessee and Southern
West Virginia, generated 21% of the total U.S. coal production in 2004. We
believe coal mined from this region generally has a high heat content of between
12,000 and 14,000 Btu per pound and a low sulfur content ranging from 0.7% to
1.5%. From 2000 to 2004, according to the EIA, the Central Appalachian region
experienced a decline in production from 261 million tons to 232 million tons,
or an 11% decline, primarily as a result of the depletion of economically
attractive reserves, permitting issues and increasing costs of production, which
was partially offset by production increases in Southern West Virginia due to
the expansion of more economically attractive surface mines.

The structural issues in Central Appalachia have led to high barriers
to entry. The geological characteristics of Central Appalachian coal reserves,
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. In addition, as
compared to mines in the Powder River Basin, permitting, licensing and other
environmental and regulatory requirements are more costly and time-consuming to
satisfy. These factors could materially adversely affect the mining operations
and cost structures of, and customers' ability to use coal produced by, our
mines in Central Appalachia.

GLOSSARY OF TERMS

ASH. The impurities consisting of iron, alumina and other incombustible
matter contained in coal. Since ash increases the weight of coal, it adds to the
cost of handling and can affect the burning characteristics of coal.

BRITISH THERMAL UNIT OR "BTU." A measure of the thermal energy required
to raise the temperature of one pound of pure liquid water one degree Fahrenheit
at the temperature at which water has its greatest density (39 degrees
Fahrenheit).

CLEAN AIR ACT AMENDMENTS. A comprehensive set of amendments to the
federal law governing the nation's air quality adopted in 1990. The Clean Air
Act was originally passed in 1970 to address significant air pollution problems
in our cities. The 1990 amendments broadened and strengthened the original law
to address specific problems such as acid deposition, urban smog, hazardous air
pollutants and stratospheric ozone depletion.

COAL SEAM. Coal deposits occur in layers. Each layer is called a
"seam."

COMPLIANCE COAL. The coal having a sulfur dioxide content of 1.2 pounds
or less per million Btu, as required by Phase II of the Clean Air Act.

CONTINUOUS MINING. A form of underground, room-and-pillar mining that
uses a continuous mining machine to cut coal from the seam and load it onto
conveyors or into shuttle cars which transport it to the surface for processing.

DEEP MINE. An underground coal mine.

FOSSIL FUEL. Fuel such as coal, petroleum or natural gas formed from
the fossil remains of organic material.

HIGHWALL MINING. Highwall mining is a method of coal mining in which a
continuous mining machine is driven by remote control into the seam exposed by
previous open cut operations, or "highwall", which was the result of surface
mining operations. A continuous haulage system carries the coal from the miner
to an open-air installation for stockpiling and transport.

METALLURGICAL COAL. Various grades of coal suitable for carbonization
to make coke for steel manufacture. Also known as "met" coal, it possesses four
important qualities: volatility, which affects coke yield; the level of
impurities, which affects coke quality; composition, which affects coke
strength; and basic characteristics, which affect coke oven safety. Met coal has
a particularly high Btu, but low ash content.

OVERBURDEN. The layers of earth and rock covering a coal seam. In
surface mining operations, overburden is removed prior to coal extraction.

OVERBURDEN RATIO/STRIPPING RATIO. The amount of overburden that must be
removed compared to a given quantity of coal. It is commonly expressed in cubic
yards per ton of coal or as a ratio comparing the thickness of the overburden
with the thickness of the coal bed.

PILLAR. An area of coal left to support the overlying strata in a mine.
Pillars are sometimes left permanently to support surface structures.

RECLAMATION. A process of restoring land and the environment to an
approved state following mining activities. The process commonly includes
"re-contouring" or reshaping the land to its approximate original appearance,
restoring topsoil and planting native grass and ground covers. Reclamation
operations are usually underway before the mining of a particular site is
completed. Reclamation is closely regulated by both state and federal law.

RESERVE. That part of a mineral deposit that could be economically and
legally extracted or produced at the time of the reserve determination.

ROOF. A stratum of rock or other mineral above a coal seam or the
overhead surface of an underground coal working place. Same as "back" or "top."

ROOM-AND-PILLAR MINING. The most common method of underground mining in
which the mine roof is supported mainly by coal pillars left at regular
intervals. Rooms are placed where the coal is mined; pillars are areas of coal
left between the rooms

SCRUBBER (FLUE GAS DESULFURIZATION UNIT). Any of several forms of
chemical/physical devices which operate to neutralize sulfur compounds formed
during coal combustion. These devices combine the sulfur in gaseous emissions
with other chemicals to form inert compounds, such as gypsum, that must then be
removed for disposal. Although effective in substantially reducing sulfur from
combustion gases, scrubbers require about 6% to 7% of a power plant's electrical
output and thousands of gallons of water to operate.

STEAM COAL. Coal used by power plants and industrial steam boilers to
produce electricity or process steam. It generally is lower in Btu heat content
and higher in volatile matter than metallurgical coal.

SUB-BITUMINOUS COAL. A dull, black coal that ranks between lignite and
bituminous coal. Its moisture content is between 20% and 30% by weight, and its
heat content ranges from 7,800 to 9,500 Btu per pound of coal.

SULFUR. One of the elements present in varying quantities in coal that
contributes to environmental degradation when coal is burned. Sulfur dioxide is
produced as a gaseous by-product of coal combustion.

SULFUR CONTENT. Coal is commonly classified by its sulfur content due
to the importance of sulfur in environmental regulations. "Low sulfur" coal has
a variety of definitions but typically is used as a classification for coal
containing 2.0% or less sulfur.

SURFACE MINE. A coal mine in which the coal lies near the surface and
can be extracted by removing the covering layer of soil (see "Overburden").
About 60% of total United States coal production comes from surface mines
including highwall mines.

TON. A "short" or net ton is equal to 2,000 pounds. A "long" or British
ton is 2,240 pounds; a "metric" ton is approximately 2,205 pounds. The short ton
is the unit of measure referred to in this document.

TRUCK-AND-SHOVEL MINING. A form of mining where large shovels are used
to remove overburden, which is used to backfill pits after the coal is removed.
Smaller shovels load coal in haul trucks for transportation to the preparation
plant or rail loading facility.

UNDERGROUND MINE. Also known as a "deep" mine. Usually located several
hundred feet below the earth's surface, an underground mine's coal is removed
mechanically and transferred by shuttle car or conveyor to the surface. Most
underground mines are located east of the Mississippi River and account for
about 40% of annual United States coal production.

ITEM 1A. RISK FACTORS.

CAUTIONARY STATEMENTS AND RISK FACTORS

Several of the matters discussed in this document contain
forward-looking statements that involve risks and uncertainties. Factors
associated with the forward-looking statements that could cause actual results
to differ materially from those projected or forecast are included in the
statements below. In addition to other information contained in this report,
readers should carefully consider the following cautionary statements.

RISKS RELATED TO OUR BUSINESS

OUR SUBSTANTIAL LEVEL OF INDEBTEDNESS COULD ADVERSELY AFFECT OUR FINANCIAL
CONDITION.

We have, and will continue to have substantial indebtedness. At
December 31, 2005, we had approximately $55.0 million principal value of total
senior debt, and for the twelve months ended December 31, 2005 our ratio of
Adjusted EBITDA to interest expense was 2.1:1 and our ratio of total senior debt
to Adjusted EBITDA was 6.1:1. Our indebtedness could be increased by an
additional $10.0 million under a future credit facility, which will have
priority over senior debt with respect to security interests in the collateral.
Our high level of indebtedness could have important consequences, including the
following:

o reducing our ability to obtain additional financing;
o reducing our cash flow;
o placing us at a competitive disadvantage compared to our
competitors that may have proportionately less debt or greater
financial resources;

o hindering our flexibility in dealing with changes in our
business and the industry; and
o making us more vulnerable to economic downturns and adverse
developments.

DESPITE EXISTING DEBT LEVELS, WE MAY STILL BE ABLE TO INCUR SUBSTANTIALLY MORE
DEBT, WHICH WOULD INCREASE THE RISKS ASSOCIATED WITH OUR LEVERAGE.

We may be able to incur substantial amounts of additional debt in the
future, including debt under a future credit facility, which will have priority
over senior debt with respect to security interests in the collateral, and debt
resulting from the issuance of additional notes. Although the terms of the
senior debt and any future credit facility may limit our ability to incur
additional debt, such terms do not and will not prohibit us from incurring
substantial amounts of additional debt for specific purposes or under certain
circumstances. The incurrence of additional debt could adversely impact our
ability to service payments on senior debt.

WE MAY NOT BE ABLE TO GENERATE THE SIGNIFICANT AMOUNT OF CASH NEEDED TO PAY
INTEREST AND PRINCIPAL AMOUNTS ON OUR DEBT.

We rely primarily on our ability to generate cash in the future to
service our debt. If we do not generate sufficient cash flows to meet our debt
service and working capital requirements, we may need to seek additional
financing. If we are unable to obtain financing on terms that are acceptable to
us, we could be forced to sell our assets or those of our subsidiaries to make
up for any shortfall in our payment obligations under unfavorable circumstances.
The indentures currently in place and any future credit facility will limit our
ability to sell assets and also restrict use of the proceeds from any such sale.
Therefore, even if forced to do so, we may not be able to sell assets quickly
enough or for sufficient amounts to enable us to meet our debt obligations.

WE FACE NUMEROUS UNCERTAINTIES IN ESTIMATING OUR ECONOMICALLY RECOVERABLE COAL
RESERVES, AND INACCURACIES IN OUR ESTIMATES COULD RESULT IN LOWER THAN EXPECTED
REVENUES, HIGHER THAN EXPECTED COSTS OR DECREASED PROFITABILITY.

We estimate that as of December 31, 2005, we control approximately 80.8
million tons of proven and probable in-place reserves, including approximately
38.5 million tons of reserves that are recoverable at this time. We base our
reserves estimates on engineering, economic and geological data assembled and
analyzed by our staff, which includes various engineers and geologists, and
aspects of which have been reviewed by outside firms. Our estimates of our
proven and probable reserves and our recoverable reserves, as well as the Btu or
sulfur content of our reserves, may be revised and updated to reflect the
resolution of uncertainties and assumptions, the production of coal from the
reserves and new drilling or other data received.

In January 2006, we engaged Marshall Miller & Associates, Inc., an
independent mining engineering firm, to evaluate our reserves. Their evaluation
efforts are ongoing and they have not yet submitted their final report. Future
estimates of our reserves, including estimates prepared by Marshall Miller,
could be materially different from current estimates. There are numerous
uncertainties inherent in estimating quantities and qualities of and costs to
mine recoverable reserves, including many factors beyond our control. Estimates
of economically recoverable coal reserves and net cash flows necessarily depend
upon a number of variable factors and assumptions, all of which may vary
considerably from actual results such as:

o geological and mining conditions which may not be fully
identified by available exploration data or which may differ
from experience in current operations;
o historical production from the area compared with production
from other similar producing areas;
o the assumed effects of regulation and taxes by governmental
agencies; and

o assumptions concerning coal prices, operating costs, mining
technology improvements, severance and excise tax, development
costs and reclamation costs.

For these reasons, estimates of the economically recoverable quantities
and qualities attributable to any particular group of properties,
classifications of reserves based on risk of recovery and estimates of net cash
flows expected from particular reserves prepared by different engineers or by
the same engineers at different times may vary substantially. Actual coal
tonnage recovered from identified reserve areas or properties and revenues and
expenditures with respect to our reserves may vary materially from estimates. As
a result, the reserve estimates set forth in this report may differ materially
from our actual reserves. Inaccuracies in our estimates related to our reserves
could result in lower than expected revenues, higher than expected costs, or
decreased profitability.

OUR FUTURE SUCCESS DEPENDS UPON OUR ABILITY TO CONTINUE ACQUIRING AND DEVELOPING
COAL RESERVES THAT ARE ECONOMICALLY RECOVERABLE AND TO RAISE THE CAPITAL
NECESSARY TO FUND OUR EXPANSION.

Our recoverable reserves will decline as we produce coal. We have not
yet applied for the permits required or developed the mines necessary to use all
of the coal deposits under our mineral rights. Furthermore, we may not be able
to mine all of our coal deposits as efficiently as we do at our current
operations. Our future success depends upon our conducting successful
exploration and development activities and acquiring properties containing
economically recoverable coal deposits. In addition, we must also generate
enough capital, either through our operations or through outside financing, to
mine these additional reserves. Our current strategy includes increasing our
coal deposits base through acquisitions of other mineral rights, leases, or
producing properties and continuing to use our existing properties. Our ability
to further expand our operations may be dependent on our ability to obtain
sufficient working capital, either through cash flows generated from operations,
or financing activities, or both. Mining coal in Central Appalachia can present
special difficulties. Characteristics of the land and permitting process in
Central Appalachia, where all of our mines are located, may adversely affect our
mining operations, our costs and the ability of our customers to use the coal
that we mine. The geological characteristics of Central Appalachian coal
reserves, 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. In addition, as
compared to mines in the Powder River Basin, permitting, licensing and other
environmental and regulatory requirements are more costly and time-consuming to
satisfy. These factors could materially adversely affect our mining operations
and costs, and our customers' abilities to use the coal we mine.

OUR ABILITY TO IMPLEMENT OUR PLANNED DEVELOPMENT AND EXPLORATION PROJECTS IS
DEPENDENT ON MANY FACTORS, INCLUDING THE ABILITY TO RECEIVE VARIOUS GOVERNMENT
PERMITS.

Our planned development and exploration projects and acquisition
activities may not result in the acquisition of significant additional coal
deposits and we may not have continuing success developing additional mines. For
example, we may not be successful in acquiring contiguous properties that will
leverage our existing facilities. In addition, in order to develop our coal
deposits, we must receive various governmental permits. Before a mining permit
is issued on a particular parcel, interested parties are eligible to file
petitions to declare the land unsuitable for mining. For example, on November
10, 2005, two environmental groups filed a petition to halt the expansion of
surface mining activities on the New River Tract and surrounding areas. We
cannot predict whether we will continue to receive the permits necessary for us
to expand our operations.

DEFECTS IN TITLE OR LOSS OF ANY LEASEHOLD INTERESTS IN OUR PROPERTIES COULD
ADVERSELY AFFECT OUR ABILITY TO MINE THESE PROPERTIES.

We conduct, or plan to conduct, a significant part of our mining
operations on properties that we lease. A title defect or the loss of any lease
could adversely affect our ability to mine the associated reserves. Title to
most of our owned or leased properties and mineral rights is not usually
verified until we make a commitment to develop a property, which may not occur
until after we have obtained necessary permits and completed exploration of the
property. In some cases, we rely on title information or representations and
warranties provided by our lessors or grantors. Our right to mine some of our
reserves may be adversely affected if defects in title or boundaries exist or if
a lease expires. Any challenge to our title could delay the exploration and
development of the property and could ultimately result in the loss of some or
all of our interest in the property and could increase our costs. In addition,
if we mine on property that we do not own or lease, we could incur liability for
such mining. Some leases have minimum production requirements or require us to
commence mining in a specified term to retain the lease. 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.

DUE TO VARIABILITY IN COAL PRICES AND IN OUR COST OF PRODUCING COAL, AS WELL AS
CERTAIN PROVISIONS IN OUR LONG TERM CONTRACTS, WE MAY BE UNABLE TO SELL COAL AT
A PROFIT.

We typically sell our coal for a specified tonnage amount and at a
negotiated price pursuant to short-term and long-term contracts. For the year
ended December 31, 2005, 100% of the coal we produced was sold under long-term
contracts. Price adjustment, "price reopener" and other similar provisions in
long-term supply agreements may reduce the protection from short-term coal price
volatility traditionally provided by such contracts. Two of our long-term
contracts, representing 36% of our sales in the year ended December 31, 2005 and
which expire at the end of 2007 and 2008, contain provisions allowing the
purchase price to be renegotiated or adjusted based on market prices at the time
at periodic intervals. Any adjustment or renegotiation leading to a
significantly lower contract price would result in decreased revenues and lower
our gross margins. Coal supply agreements also typically contain force majeure
provisions allowing temporary suspension of performance by us or our customers
during the duration of specified events beyond the control of the affected
party. Most of our coal supply agreements contain provisions requiring us to
deliver coal meeting quality thresholds for certain characteristics such as Btu,
sulfur content, ash content, hardness and ash fusion temperature. Failure to
meet these specifications could result in economic penalties, including price
adjustments, the rejection of deliveries or, in the extreme, termination of the
contracts. Consequently, due to the risks mentioned above with respect to
long-term supply agreements, we may not achieve the revenue or profit we expect
to achieve from these sales commitments. In addition, we may not be able to
successfully convert these sales commitments into long-term supply agreements.

THE COAL INDUSTRY IS HIGHLY CYCLICAL, WHICH SUBJECTS US TO FLUCTUATIONS IN
PRICES FOR OUR COAL.

We are exposed to swings in the demand for coal, which has an impact on
the prices for our coal. The demand for coal products and, thus, the financial
condition and results of operations of companies in the coal industry, including
us, are generally affected by macroeconomic fluctuations in the world economy
and the domestic and international demand for energy. In recent years, the price
of coal has been at historically high levels, but these price levels may not
continue. Any material decrease in demand for coal could have a material adverse
effect on our operations and profitability.

WE DEPEND HEAVILY ON A SMALL NUMBER OF LARGE CUSTOMERS, THE LOSS OF ANY OF WHICH
WOULD ADVERSELY AFFECT OUR OPERATING RESULTS.

For the year ended December 31, 2005, we derived approximately 71% of
our coal revenues from sales to our three largest customers. At December 31,
2005, we had coal supply agreements with these customers that expire at various
times through 2008. When these agreements expire, we may not be

successful at renegotiating them and these customers may not continue to
purchase coal from us pursuant to long-term coal supply agreements. If a number
of these customers were to significantly reduce their purchases of coal from us,
or if we were unable to sell coal to them on terms as favorable to us as the
terms under our current agreements, our financial condition and results of
operations could suffer materially.

SIGNIFICANT COMPETITION FROM ENTITIES WITH GREATER RESOURCES COULD RESULT IN OUR
FAILURE.

We operate in a highly competitive industry with national and
international energy resources companies. Some of our competitors have longer
operating histories and substantially greater financial and other resources than
we do. Our competitors' use of their substantially greater resources could
overwhelm our efforts to operate successfully and could cause our failure.

THERE IS NO ASSURANCE THAT OUR LIMITED REVENUES WILL BE SUFFICIENT TO OPERATE
PROFITABLY, OR THAT WE WILL GENERATE GREATER REVENUES IN THE FUTURE.

We were formed to create a regional coal producer in Tennessee. We had
no revenues from inception until the third quarter 2003 when we began mining
operations. We are not profitable and have a limited operating history. We must
be regarded as a risky venture with all of the unforeseen costs, expenses,
problems, risks and difficulties to which such ventures are subject.

Our coal sales for calendar 2005 were approximately $65.3 million.
There is no assurance that we can achieve greater sales or generate profitable
sales. We expect that many coal producers could produce and sell coal at cheaper
prices per ton than our production cost rates, which could adversely affect our
revenues and profits, if any. There is no assurance that we will ever operate
profitably. There is no assurance that we will generate continued revenues or
any profits, or that the market price of our common stock will be increased
thereby.

IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME
ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR SHAREHOLDERS' OWNERSHIP COULD BE
DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED.

Our business strategy may include expansion through internal growth, or
by acquiring complementary businesses, or by establishing strategic
relationships with targeted customers. In order to do so or to fund our other
activities, we may issue additional equity securities that could dilute our
shareholders' stock percentage ownership. We may also assume additional debt and
incur impairment losses related to goodwill and other tangible assets if we
acquire another company and this could negatively impact our results of
operations.

OUR INABILITY TO DIVERSIFY OUR OPERATIONS MAY SUBJECT US TO ECONOMIC
FLUCTUATIONS WITHIN OUR INDUSTRY.

Our limited financial resources reduce the likelihood that we will be
able to diversify our operations. Our probable inability to diversify our
activities into more than one business area will subject us to economic
fluctuations within a particular business or industry and therefore increase the
risks associated with our operations.

CERTAIN PROVISIONS IN OUR SERIES A CONVERTIBLE PREFERRED STOCK MAY IMPACT OUR
ABILITY TO OBTAIN ADDITIONAL FINANCING IN THE FUTURE.

In addition to cash flows generated from operations, we may need to
raise capital in the future through the issuance of securities. In order to
issue securities that rank senior to our Series A convertible preferred stock in
terms of liquidation preference, redemption rights or dividend rights, we must
obtain the affirmative consent of holders of at least 75% of the outstanding
shares of our Series A convertible

preferred stock. If we are unable to obtain the consent of these holders in
connection with future financings, we may be unable to raise additional capital
on acceptable terms, or at all.

THE LOSS OF KEY MANAGEMENT PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS.

We are heavily dependent upon the skills, talents, and abilities of our
executive officers and board of directors to implement our business plan. Given
the intense competition for qualified management personnel in our industry, the
loss of the services of any key management personnel may significantly and
detrimentally affect our business and prospects. We may not be able to retain
some or all of our key management personnel, and even if replaceable, it may be
time consuming and costly to recruit qualified replacement personnel.

OUR DIRECTOR AND OFFICER INDEMNIFICATION POLICIES IN CONJUNCTION WITH THE
PROVISIONS OF FLORIDA LAW COULD RESULT IN SUBSTANTIAL UN-RECOUPABLE EXPENDITURES
AND REDUCED REMEDIES AGAINST DIRECTORS AND OFFICERS.

Florida Revised Statutes provide for the indemnification of our
directors, officers, employees, and agents, under certain circumstances, against
attorney's fees and other expenses incurred by them in any litigation to which
they become a party arising from their association with or activities on our
behalf. We will also bear the expenses of such litigation for any of our
directors, officers, employees, or agents, upon such person's promise to repay
us such amounts, if it is ultimately determined that such person was not
entitled to indemnification. This indemnification policy could result in
substantial expenditures by us that we will be unable to recoup.

Florida Revised Statutes exclude personal liability of our directors to
us and our stockholders for monetary damages for breach of fiduciary duty except
in certain specified circumstances. Accordingly, we will have a much more
limited right of action against our directors than otherwise would be the case.
This provision does not affect the liability of any director under federal or
applicable state securities laws.

THERE IS NO ASSURANCE THAT WE WILL FIND PURCHASERS OF OUR PRODUCT AT PROFITABLE
PRICES.

If we are unable to achieve supply contracts, or are unable to find
buyers willing to purchase our coal at profitable prices, our revenues and
operating profits could suffer.

THE COAL INDUSTRY IS INTENSELY COMPETITIVE, AND OUR FAILURE TO COMPETE
EFFECTIVELY COULD REDUCE OUR REVENUE AND MARGINS, AND DELAY OR PREVENT OUR
ABILITY TO SERVICE OUR DEBT.

We operate in a highly competitive industry with regional, national and
international energy resources companies. We compete based primarily on price,
and we believe that the principal factors that determine the price for which our
coal can be sold are:

o competition from energy sources other than coal;
o coal quality;
o efficiency in extracting and transporting coal; and
o proximity to customers.

Some of our competitors have longer operating histories and
substantially greater financial and other resources than we do. Our failure to
compete effectively could reduce our revenues and margins, and delay or prevent
our ability to make payments on our debt.

IF TRANSPORTATION FOR OUR COAL BECOMES UNAVAILABLE OR UNECONOMIC FOR OUR
CUSTOMERS, OUR ABILITY TO SELL COAL COULD SUFFER.

Transportation costs represent a significant portion of the total cost
of delivered coal and, as a result, play a critical role in a customer's
purchasing decision. Increases in transportation costs could make our coal less
competitive as a source of energy or could make some of our operations less
competitive than other sources of coal.

Coal producers depend upon rail, barge, trucking, overland conveyor and
other systems to deliver coal to its customers. While U.S. coal customers
typically arrange and pay for transportation of coal from the mine to the point
of use, disruption of these transportation services because of weather-related
problems, strikes, lock-outs or other events could temporarily impair our
ability to supply coal to our customers and thus could adversely affect our
results of operations.

WE FACE RISKS INHERENT TO MINING WHICH COULD INCREASE THE COST OF OPERATING OUR
BUSINESS.

Our mining operations are subject to conditions beyond our control that
can delay coal deliveries or increase the cost of mining at particular mines for
varying lengths of time. These conditions include weather and natural disasters,
unexpected maintenance problems, key equipment failures, variations in coal seam
thickness, variations in the amount of rock and soil overlying the coal deposit,
variations in rock and other natural materials and variations in geologic
conditions. Any of these factors could increase the cost of operating our
business, which would lower or eliminate our margins.

A SHORTAGE OF SKILLED LABOR IN THE MINING INDUSTRY COULD POSE A RISK TO
ACHIEVING OPTIMAL LABOR PRODUCTIVITY AND COMPETITIVE COSTS, WHICH COULD
ADVERSELY AFFECT OUR PROFITABILITY.

Efficient coal mining using modern techniques and equipment requires
skilled laborers, preferably with at least a year of experience and proficiency
in multiple mining tasks. In order to support our planned expansion
opportunities, we intend to sponsor both in-house and vocational coal mining
programs at the local level in order to train additional skilled laborers. In
the event the shortage of experienced labor continues or worsens or we are
unable to train the necessary amount of skilled laborers, there could be an
adverse impact on our labor productivity and costs and our ability to expand
production and therefore have a material adverse effect on our earnings. In
addition, we have supplemented our direct workforce through the use of contract
miners. If our contract miners are unable to perform their duties as expected,
we may experience temporary disruptions in our production. For example, in
October 2005, we terminated our agreement with one of our contract miners, and
as a result we were required to purchase coal to satisfy our sales requirements.
We do not expect that this will have a material effect on our results of
operations for 2006. However, if difficulties with our contract miners arise in
the future, there could be an adverse effect on our productivity and costs and
our ability to expand production and therefore have a material adverse effect on
our earnings.

THE GOVERNMENT EXTENSIVELY REGULATES OUR MINING OPERATIONS, WHICH IMPOSES
SIGNIFICANT COSTS ON US, AND FUTURE REGULATIONS COULD INCREASE THOSE COSTS OR
LIMIT OUR ABILITY TO PRODUCE COAL.

Federal, state and local authorities regulate the coal mining industry
with respect to matters such as employee health and safety, permitting and
licensing requirements, air quality standards, water pollution, plant and
wildlife protection, reclamation and restoration of mining properties after
mining is completed, the discharge of materials into the environment, surface
subsidence from underground mining and the effects that mining has on
groundwater quality and availability. In addition, legislation mandating
specified benefits for retired coal miners affects our industry.

Numerous governmental permits and approvals are required for mining
operations. We are 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 costs,

liabilities and requirements associated with these regulations may be costly and
time-consuming and may delay commencement or continuation of exploration or
production operations. The possibility exists that new legislation and/or
regulations and orders may be adopted that may materially adversely affect our
mining operations, our cost structure and/or our customers' ability to use coal.
New legislation or administrative regulations (or judicial interpretations of
existing laws and regulations), including proposals related to the protection of
the environment that would further regulate and tax the coal industry, may also
require us or our customers to change operations significantly or incur
increased costs. The majority of our coal supply agreements contain provisions
that allow a 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 specified increases in the cost of coal or its use. These factors and
legislation, if enacted, could have a material adverse effect on our financial
condition and results of operations. In addition, the United States and over 160
other nations are signatories to the 1992 Framework Convention on Climate Change
which is intended to limit emissions of greenhouse gases, such as carbon
dioxide. In December 1997, in Kyoto, Japan, the signatories to the convention
established a binding set of emission targets for developed nations. Although
the specific emission targets vary from country to country, the United States
would be required to reduce emissions to by 5% from 1990 levels over a five-year
period from 2008 through 2012. Although the United States has not ratified the
emission targets and no comprehensive regulations focusing on U.S. greenhouse
gas emissions are in place, these restrictions, whether through ratification of
the emission targets or other efforts to stabilize or reduce greenhouse gas
emissions, could adversely impact the price of and demand for coal. According to
the EIA's "Emissions of Greenhouse Gases in the United States 2001," coal
accounts for approximately one-third of carbon dioxide emissions in the United
States, and efforts to control carbon dioxide emissions could result in reduced
use of coal if electricity generators switch to sources of fuel with lower
carbon dioxide emissions. Further developments in connection with regulations or
other limits on carbon dioxide emissions could have a material adverse effect on
our financial condition or results of operations.

IF THE COAL INDUSTRY EXPERIENCES OVERCAPACITY IN THE FUTURE, OUR PROFITABILITY
COULD BE IMPAIRED.

During the mid-1970s and early 1980s, a growing coal market and
increased demand for coal attracted new investors to the coal industry, spurred
the development of new mines and resulted in added production capacity
throughout the industry, all of which led to increased competition and lower
coal prices. Similarly, an increase in future coal prices could encourage the
development of expanded capacity by new or existing coal producers. Any
overcapacity could reduce coal prices in the future.

OUR OPERATIONS COULD BE ADVERSELY AFFECTED IF WE FAIL TO MAINTAIN REQUIRED
BONDS.

Federal and state laws require bonds or cash deposits to secure our
obligations to reclaim lands used for mining, to pay federal and state workers'
compensation, to secure coal lease obligations and to satisfy other
miscellaneous obligations. At December 31, 2005, $257,500 was on deposit with
OSM for reclamation bonds related to our Patterson Mountain mining operations.
In addition, we have approximately $6.14 million of cash invested in
certificates of deposit, against which irrevocable bank letters of credit are
written in favor of OSM and have posted a $700,000 letter of credit secured by
our executive office building in favor of OSM. Reclamation bonds are typically
renewable on a yearly basis if they are not posted with cash. Our failure to
maintain, or inability to acquire, bonds that are required by state and federal
law would have a material adverse effect on us. That failure could result from a
variety of factors including the following:

o lack of availability, higher expense or unfavorable market
terms of new bonds;
o restrictions on the availability of collateral for current and
future third-party bond issuers under the terms of our
indenture or new credit facility; and
o the exercise by third-party bond issuers of their right to
refuse to renew the bonds.

TERRORIST THREATS AND ENVIRONMENTAL ZEALOTRY 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. Our business also may be affected by environmental activists
who engage in activities intended to disrupt our business operations. In
particular, environmental activists have conducted protests outside the homes of
certain of our executives, including our Chief Executive Officer. We have spent
approximately $600,000 during the year ended December 31, 2005 on security
measures and related legal fees, largely as a result of the actions of some
environmental activists. 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 may materially
adversely affect our operations. As a result, there could be 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.

A SUBSTANTIAL OR EXTENDED DECLINE IN COAL PRICES COULD REDUCE OUR REVENUES AND
THE VALUE OF OUR COAL RESERVES.

The prices we charge for coal depend upon factors beyond our control,
including:

o the supply of, and demand for, domestic and foreign coal;
o the demand for electricity;
o the proximity to, capacity of, and cost of transportation
facilities;
o domestic and foreign governmental regulations and taxes;
o air emission standards for coal-fired power plants;
o regulatory, administrative and court decisions;
o the price and availability of alternative fuels, including the
effects of technological developments; and
o the effect of worldwide energy conservation measures.

Our results of operations are dependent upon the prices we charge for
our coal as well as our ability to improve productivity and control costs.
Decreased demand would cause spot prices to decline and require us to increase
productivity and lower costs in order to maintain our margins. If we are not
able to maintain our margins, our operating results could be adversely affected.
Therefore, price declines may adversely affect operating results for future
periods and our ability to generate cash flows necessary to improve productivity
and invest in operations.

OUR ABILITY TO COLLECT PAYMENTS FROM OUR CUSTOMERS COULD BE IMPAIRED DUE TO
CREDIT ISSUES.

Our ability to receive payment for coal sold and delivered depends on
the continued creditworthiness of our customers. Our customer base may not be
highly creditworthy. If deterioration of the creditworthiness of customers or
trading counterparties occurs, our business could be adversely affected.

RISKS RELATED TO OUR COMMON STOCK

A LIMITED PUBLIC MARKET EXISTS FOR OUR SECURITIES, WHICH MAY RESTRICT OUR
SHAREHOLDERS' ABILITY TO TRADE IN OUR STOCK.

There is a limited public market for our common stock and no assurance
can be given that a market will continue or that a shareholder will ever be able
to liquidate his investment without considerable delay, if at all. Our stock
price may be highly volatile. Factors such as those discussed in this section
may have a significant impact upon the market price of our securities. Due to
the low price of our securities, many brokerage firms may not be willing to
effect transactions in our securities. Even if a purchaser finds a broker
willing to effect a transaction in our securities, the combination of brokerage
commissions, state transfer taxes, if any, and any other selling costs may
exceed the selling price. Further, many lending institutions will not permit the
use of such securities as collateral for any loans.

WE DO NOT INTEND TO PAY DIVIDENDS ON SHARES OF OUR COMMON STOCK.

Historically, we have not paid dividends on shares of our common stock
and do not anticipate paying any cash dividends on shares of our common stock in
the foreseeable future. The terms of the indenture related to our 10.5% Senior
Secured Notes due 2010 and any future credit facility will each restrict our
ability to pay dividends on shares of our common stock.

OUR ISSUANCE OF MORE SHARES OF COMMON STOCK MAY RESULT IN THE LOSS OF CONTROL BY
PRESENT MANAGEMENT AND SHAREHOLDERS.

We may issue further shares as consideration for cash, assets or
services out of our authorized but not issued common stock that could, upon
issuance, represent a majority of our voting power and equity. The result of
such an issuance would be that those new shareholders and management would
control us, and unknown persons could replace our management at that time. Such
an occurrence would result in a greatly reduced percentage of ownership of us by
our current shareholders.

WE OPERATE IN AN INDUSTRY THAT IS SUBJECT TO SIGNIFICANT FLUCTUATIONS IN
OPERATING RESULTS FROM QUARTER TO QUARTER THAT MAY RESULT IN UNEXPECTED
REDUCTIONS IN REVENUE AND STOCK PRICE VOLATILITY.

Factors that may influence our quarterly operating results include:

o the worldwide demand for coal;
o the price of coal;
o the supply of coal and other competitive factors;
o the costs to mine and transport coal;
o the ability to obtain new mining permits;
o the costs of reclamation of previously mined properties; and
o industry competition.

Due to these factors, it is possible that in some quarters our
operating results may be below our shareholders' expectations and those of
public market analysts. If this occurs, the price of our common stock would
likely be adversely affected.

OUR STOCK PRICE MAY DECREASE, WHICH COULD ADVERSELY AFFECT OUR BUSINESS AND
CAUSE OUR SHAREHOLDERS TO SUFFER SIGNIFICANT LOSSES.

The following factors could cause the market price of our common stock
to decrease, perhaps substantially:

o the failure of our quarterly operating results to meet
expectations of investors or securities analysts;

o adverse developments in the financial markets, the coal and
energy industries and the worldwide or regional economies;
o interest rates;
o changes in accounting principles;
o sales of common stock by existing security holders;
o announcements of key developments by our competitors; and
o the reaction of markets and securities analysts to
announcements and developments involving our Company.

Our business strategy may include expansion through internal growth by
acquiring complementary businesses or by establishing strategic relationships
with targeted customers. In order to do so, or to fund our other activities, we
may issue additional equity securities that could dilute our shareholders' stock
percentage ownership. We may also assume additional debt and incur impairment
losses related to goodwill and other tangible assets if we acquire another
company which could negatively impact our results of operations.

OFFICERS AND DIRECTORS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH
COULD LIMIT OUR SHAREHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY
TRANSACTIONS.

As of March 28, 2006, our officers and directors and their affiliates
owned approximately 42.8% of our outstanding voting shares. As a result, our
officers and directors are able to exert considerable influence over the outcome
of any matters submitted to a vote of the holders of our common stock, including
the election of our Board of Directors. The voting power of these shareholders
could also discourage others from seeking to acquire control of us through the
purchase of our common stock which might depress the price of our common stock.

ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

ITEM 2. PROPERTIES.

Our executive offices are located at 8915 George Williams Road,
Knoxville, TN 37923; the telephone number is (865) 690-6900 and the facsimile
number is (865) 691-9982. We own our corporate office space. The bases of
operations for our mining activities are located in Anderson, Campbell and Scott
Counties, Tennessee, and Bell, Harlan and Leslie Counties, Kentucky. We also
lease storage space in East Tennessee to house our maps and other geological
data. We have pledged our corporate office space as collateral to secure a bank
letter of credit issued in favor of OSM for a portion of one of our reclamation
bonds. Additionally, we have granted our senior secured lender a security
interest in all our owned and leased mining properties.

In Tennessee, we own the coal mineral rights to approximately
sixty-five thousand (65,000) acres and lease another approximately eight
thousand four hundred (8,400) acres in Anderson, Campbell and Scott Counties.
The owned mineral rights lie on a contiguous tract of land which is sometimes
referred to as the New River Tract mineral rights assemblage, which had
previously been mined by Tennessee Mining, Inc., and is located approximately
twenty-five miles northwest of Knoxville, Tennessee. Portions of the New River
Tract mineral rights extend into Anderson, Campbell and Scott Counties,
Tennessee.

We also lease coal mineral rights to approximately four thousand four
hundred acres (4,400) from the Tennessee Valley Authority, property which is
east of the New River Tract and covers areas on both

Cross Mountain and Adkins Mountain, which extend into Anderson, Campbell and
Scott Counties, Tennessee. We also lease property in Anderson County, Tennessee
from Lexington Coal, LLC, and in the Elk Valley area of East Tennessee pursuant
to mineral rights we acquired from Robert Clear Coal Corporation.

In Kentucky, we own the coal mineral rights to approximately ten
thousand four hundred (10,400) acres and lease approximately twenty-seven
thousand three hundred fifty (27,350) acres of the Straight Creek and Pine
Mountain properties in Bell, Harlan and Leslie Counties. We acquired these
mineral rights (both owned and leased) from Appalachian Fuels, LLC in November
2004.

We decide on a case by case basis whether to obtain a title review from
a licensed attorney prior to purchasing or leasing property. In determining
whether to conduct a title review, we will consider information we have about
the particular property, including, for example, personal knowledge of our
employees or consultants, or historical information from the previous owners, or
information obtained from surrounding property owners. We have not obtained
title insurance in connection with acquisitions of coal reserves, and generally
will not do so in future acquisitions. However, we do have a commitment of title
insurance on our Tennessee properties, scheduled to be issued in April 2006,
obtained in conjunction with the issuance of our senior secured notes. We had a
title examination made of the New River Tract when we purchased it from
Cumberland Timber Company, LLC. The title review was conducted by a law firm,
the principal partner of which was at the time a member of our Board of
Directors, and occurred while we were a privately held company. We did not
conduct a title review of the Straight Creek Tract we acquired from Appalachian
Fuels, LLC.

GEOLOGY

Known coal bearing strata on the New River Tract includes coal beds
from the Crab Orchard and Crooked Fork groups, and the Slatestone, Indian Bluff,
Graves Gap, Red Oak Mountain, Vowell Mountain and Cross Mountain formations.
Only coal seams from the Blue Gem coal, located near the top of the Slatestone
formation upwards, occur on the New River Tract. Core drilling has indicated the
existence of coal as low as the Wilder coals at the top of the Gizzard Group.
The strata that exists above the water drainage level consist mainly of
relatively thick shale and siltstone sequences with sandstone layers. Coal seams
occur in the shale sequences. There are six coal major seams on the New River
Tract that we are targeting, and all of these seams are above the water drainage
level. There are other coal seams in this area that contain coal, but
insufficient information is available to estimate mineability. The northern
portion of the New River Tract property has not been explored by core drilling
because the terrain generally is more difficult to access and the costs to
explore this area are greater than we are willing to expend at this time.

Known coal bearing strata on the Straight Creek, Kentucky property
include coal beds in the Hazard 4A, 8, 9 and 10 and Copeland seams (on Pine
Mountain) and Hazard 4, 8, 9 and 10 seams (on Straight Creek Mountain

COAL RESERVES

"Reserves" are defined by the U.S. Securities and Exchange Commission's
("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. "Recoverable" reserves are defined as coal that is economically
recoverable using existing equipment and methods under federal and state laws
currently in effect. Some of our reserves are classified as proven reserves.
"Proven (Measured) Reserves" are defined by the SEC Industry Guide 7 as 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 inspection, 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.
Information about our reserves consists of estimates based on engineering,
economic and geological data assembled and analyzed by our internal engineers,
as well as studies prepared by certified professional

geologists based upon data provided by us. "Probable (Indicated) Reserves" for
which quantity and grade and/or quality are computed from information similar to
that used for proven (measured) 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 (Measured)
Reserves, is high enough to assume continuity between points of observation.
Reserve estimates are updated periodically using geologic data taken from drill
holes, adjacent mine workings, outcrop prospect openings and other sources. Coal
tonnages are categorized according to coal quality, seam thickness, mineability
and location relative to existing mines and infrastructure.

As with most other coal-producing companies in Central Appalachia, a
portion of our coal reserves are controlled pursuant to leases from third party
landowners. These leases convey mining rights to the coal producer in exchange
for a per ton or percentage of gross sales price royalty payment to the lessor.
These leases are not scheduled to expire prior to expiration of projected mining
activities. Under current mining plans, we expect that all reported leased
reserves will be mined out within the period of existing leases or within the
time period of assured lease renewals.

Our reported coal reserves are those that can be economically and
legally extracted or produced at the time of their determination. In determining
whether our reserves meet this standard, we take into account, among other
things, mining methods, seam thickness, previous mining, outcrop variability,
and coal quality. We calculated our reserves by relying on measured seam
thickness, known coal densities, measured coal acres and anticipated mining
methodology minus any previous mining. We have obtained, or we believe we have a
high probability of obtaining, all required permits or government approvals with
respect to our reserves.

We currently estimate that at December 31, 2005, 38.5 million tons of
our estimated 80.8 million tons of proven and probable in-place reserves are
recoverable by us. This estimate takes into account various factors that affect
our ability to recover our reserves, including but not limited to current coal
prices; the mining methods that may be used to extract particular reserves;
geological and mining conditions; historical production from similar areas with
similar conditions; the assumed effects of regulations and taxes by governmental
agencies; assumptions governing future prices; future operating, development and
reclamation costs; and mining technology improvements.

Our reserve estimates are based on geological data assembled and
analyzed by our staff of geologists and engineers. Reserve estimates will be
periodically updated to reflect past coal production, new drilling information
and other geologic or mining data. Acquisitions or sales of coal properties will
also change our reserves. Changes in mining methods or technology may increase
or decrease the recovery basis for a coal seam. Our reserve estimates are
subject to change as a result of various factors, including the acquisition,
divestiture or depletion of reserves or the future analysis of known or existing
data. We intend to engage third parties periodically to review or audit our
reserve estimates. The most recent third party audit of certain of our reserves
was conducted in November 2004.

In January 2006, we engaged Marshall Miller & Associates, Inc.
(Marshall Miller) to perform an evaluation of our reserves. Their evaluation
efforts are ongoing and they have not yet submitted their final report. Future
estimates of our reserves, including estimates prepared by Marshall Miller,
could be materially different from current estimates. There are numerous
uncertainties inherent in estimating quantities and qualities of recoverable
reserves, including many factors beyond our control.

In addition, we believe that we have unproven deposits that have not
yet been classified as reserves. Unproven deposits are coal-bearing bodies that
have not been sufficiently sampled and analyzed in trenches, outcrops, drilling,
and underground workings to assume continuity between sample points. This coal
does not qualify as a commercially viable coal reserve as prescribed by SEC
standards until a final comprehensive evaluation based on unit cost per ton,
recoverability, and other material factors concludes legal and economic
feasibility. Unproven coal deposits may be classified as such by either limited
property control or geologic limitations, or both. These unproven deposits are
located immediately adjacent to our known reserves. There has been previous
mining activity on or near some of

these sites, but we have not yet done adequate drilling or other exploration
necessary to properly define these areas as reserves.

With respect to our reserve estimates, see "Risk Factors - We face
numerous uncertainties in estimating our economically recoverable coal reserves,
and inaccuracies in our estimates could result in lower than expected revenues,
higher than expected costs or decreased profitability."

The following table provides proven and probable, recoverable reserve
data assigned to specific tracts as of December 31, 2005:

LOCATION CONTROL ACRES PROVEN/PROBABLE RECOVERABLE
--------------------- -------------- ---------- --------------- -----------
(Millions of Tons)
TENNESSEE RESERVES:
New River Tract Owned 65,000 40.8 17.1
Ketchen Tract Leased 7,000 6.7 4.4
TVA Tract Leased 4,400 6.6 3.3
Other Leased 1,400 1.6 0.8
KENTUCKY RESERVES:
Straight Creek Tract Leased 26,400 8.9 4.8
Pine Mountain Tract Owned & Leased 10,400 13.2 6.6
Begley Tract Leased 950 3.0 1.5
---------- --------------- -----------
Totals 115,550 80.8 38.5
---------- --------------- -----------

The following map shows the locations of National Coal's properties:

ITEM 3. LEGAL PROCEEDINGS.

In December 2004, we succeeded to a permit for a coal mining operation
in Campbell County, Tennessee and in so doing became the real party in interest
in a pending civil action filed by a group of environmental organizations,
including Save Our Cumberland Mountains, Inc. in the United States District
Court for the Eastern District of Tennessee (Save Our Cumberland Mountains v.
Gale A. Norton et al. and National Coal Corporation). In September 2003
Plaintiffs alleged that issuance of the original permit was flawed because the
U.S. Department of the Interior Office of Surface Mining ("OSM"), the federal
agency which issued the permit, had not complied with the requirements of the
National Environmental Policy Act ("NEPA") and asked that the permit be revoked
by the Court. The District Court dismissed the plaintiffs' action and the
plaintiffs subsequently appealed to the Sixth Circuit Court. Hearings are
scheduled for later in 2006. Concurrent with the appeal, the same plaintiffs
filed a similar action in the Eastern District of Tennessee alleging a NEPA
violation with respect to OSM's approval of an application for a revision of the
same permit (Tennessee Clean Water Network v. Norton, et al.). The Court issued
a scheduling order requiring a briefing by October 2006. An unfavorable outcome
of either action would not involve direct monetary damages; however significant
financial losses could result from curtailed mining operations. We believe that
these matters will be resolved favorably and without a material impact on our
cash flows, results of operations or financial condition.

In March 2006, the Company was named as defendant in a complaint filed
in the United States District Court for the Eastern District of Kentucky by Chas
Coal, LLC, the sublessor of certain coal mining rights at the Company's
operations in Kentucky (Chas Coal LLC vs. National Coal Corporation). The
Company is the sublessee of these rights as the result of a 2004 acquisition.
The complaint alleges that the sublease agreement does not convey rights to the
coal seams in question and the Company

extracted coal during 2005 without right or interest. Management believes that
the complaint lacks merit and this matter will be resolved favorably without a
material impact on its cash flows, results of operations or financial condition.

During 2005, we were audited by our previous workers' compensation
insurance provider who informed us that we owed an additional approximately $1.4
million in premiums for the year ended April 15, 2005. The matter primarily
involves the application of premium rates to employees performing certain job
functions. In January 2006, we attempted to settle the dispute by submitting a
full accounting of the matter with a payment of approximately $427,000 to the
previous insurance provider. Currently, the matter has not been resolved nor has
any legal action been pursued by either party.

We are named a party to other legal actions, claims, arbitration and
administrative proceedings from time to time in the ordinary course of business.
Management does not expect the outcome of pending or threatened proceedings to
have a material impact on its cash flows, results of operations or financial
condition.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.

On or about December 27, 2005, in excess of 75% of the 1,421.45
then-outstanding shares of our Series A convertible preferred stockholders
approved, by written consent, the issuance of our 10.5% Senior Secured Notes due
2010 and related transactions. The consent of at least 75% of our Series A
convertible preferred stockholders was required by our Articles of Incorporation
for the issuance of such securities and certain related transactions. Series A
Convertible preferred stockholders representing 1,200.23 shares of our Series A
convertible preferred stock approved the transaction.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.

COMMON STOCK

On April 22, 2005, our common stock listing was transferred from
Over-the-Counter Bulletin Board to The NASDAQ Capital Market (formerly known as
The NASDAQ SmallCap Market) under the symbol "NCOC". Prior to the third quarter
of 2003, there was no established trading market for our common stock. The
following table sets forth, for the periods indicated, the high and low sales
prices for our common stock from January 1, 2004 through December 31, 2005. The
information has been adjusted to reflect a one-for-four reverse stock split of
our common stock which took effect at the close of business on January 12, 2005.
The following quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission, and may not represent actual transactions.

HIGH LOW
---- ---

YEAR ENDED DECEMBER 31, 2004
First Quarter.......................... $ 5.60 $ 0.88
Second Quarter......................... 5.80 3.60
Third Quarter.......................... 12.60 5.00
Fourth Quarter......................... 16.00 8.00

YEAR ENDED DECEMBER 31, 2005
First Quarter.......................... $ 13.50 $ 7.00
Second Quarter......................... 7.85 5.45
Third Quarter.......................... 8.25 5.50
Fourth Quarter......................... 7.45 6.10

On March 28, 2006, the closing sales price of our common stock as
reported on the NASDAQ Capital Market was $6.50 per share. As of March 28, 2006,
there were approximately 128 holders of record of our common stock.

We have submitted an application to The NASDAQ Stock Market, Inc. for
our common stock to be quoted on the NASDAQ National Market System. We
anticipate that NASDAQ will make a decision on our application shortly following
our filing of this report.

DIVIDENDS

We are restricted from making cash dividend payments on our common
stock under the terms of our Series A 5% convertible preferred stock and our
10.5% Senior Secured Notes due 2010 and we intend to retain any future earnings
for use in our business. We are required to make semi-annual cash dividend
payments to holders of our Series A 5% convertible preferred stock on each of
June 30 and December 31. During the year ended December 31, 2005, we paid
approximately $1,125,000 in dividends to the holders of our Series A 5%
convertible preferred stock. We are required to make semi-annual interest
payments on our 10.5% Senior Secured Notes due 2010 semi-annually on each of
June 15 and December 15 during the term of such notes, beginning on June 15,
2006.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

ELEVEN
MONTHS
ENDED
TWELVE MONTHS ENDED DECEMBER
DECEMBER 31, 31,
--------------------- --------
2005 2004 2003
-------- -------- --------
(In thousands, except per share,
per ton and number of employee
CONSOLIDATED STATEMENT OF INCOME DATA: amounts)

Coal Sales Revenue ...................... $ 65,258 $ 16,871 $ 1,013
Total Revenue ........................... 65,873 16,999 1,191
Operating Loss .......................... (2,563) (7,040) (3,036)
Net Loss ................................ (6,791) (10,429) (3,333)
Net loss per share - basic .............. (0.58) (2.60) (0.36)
Net loss per share - diluted ............ (0.58) (2.60) (0.36)
Preferred Dividends Per Share ........... (0.08) (0.02) --

CONSOLIDATED BALANCE SHEET DATA:
Working Capital (Deficit) ............... $ 18,331 $ (3,921) $ (5,511)
Restricted Cash (1) ..................... 6,625 4,527 258
Property, plant and equipment (2) ....... 50,902 35,909 2,346
Total assets ............................ 90,407 44,551 2,831
Long-term debt (3) ...................... 60,015 19,724 4,682
Total Liabilities ....................... 73,791 25,949 5,757
Shareholders' equity .................... 16,616 18,601 (2,927)

OTHER DATA:
EBITDA (4) .............................. $ 7,877 $ (4,566) $ (2,419)
Adjusted EBITDA (4) ..................... 8,358 (3,436) (2,074)
Tons of coal sold ....................... 1,216 357 11
Average cash cost per ton sold (5) ...... $ 44.97 $ 53.89 $ 89.28
Coal revenue per ton sold ............... $ 54.60 $ 47.32 $ 25.05
Capital expenditures .................... $ 19,853 $ 22,527 $ 1,224
Number of Employees ..................... 244 133 25

(1) Consists of certificates of deposit and other cash primarily
collateralizing reclamation liabilities.

(2) Includes coal mineral rights, net of accumulated amortization and
depletion.

(3) Includes obligations under capital leases.

(4) EBITDA is defined as net income (loss) plus (i) other (income) expense,
(ii) interest and financing fees, and (iii) depreciation, depletion,
accretion and amortization. Adjusted EBITDA is defined as EBITDA plus
stock based compensation expense. We present EBITDA and Adjusted EBITDA
to enhance understanding of our operating performance. We use EBITDA
and Adjusted EBITDA as criteria for evaluating our performance relative
to that of our peers, including measuring our cost effectiveness and
return on capital, assessing our allocations of resources and
production efficiencies and making compensation decisions. We believe
that EBITDA and Adjusted EBITDA are operating performance measures that
provide investors and analysts with a measure of our operating
performance and permit them to evaluate our cost effectiveness and
production efficiencies relative to competitors. In addition, our
management uses EBITDA and Adjusted EBITDA to monitor and evaluate our
business operations. However, EBITDA and Adjusted EBITDA are not
measurements of financial performance under accounting principles
generally accepted in the United States of America ("GAAP") and may not
be comparable to other similarly titled measures of other companies.
EBITDA and Adjusted EBITDA should not be considered as alternatives to
cash flows from operating activities, determined in accordance with
GAAP, as indicators of cash flows. The following reconciles our net
loss to EBITDA and Adjusted EBITDA:

ELEVEN
MONTHS
ENDED
TWELVE MONTHS ENDED DECEMBER
DECEMBER 31, 31,
-------------------- --------
2005 2004 2003
-------- -------- --------
Net loss ................................... $ (6,791) $(10,429) $ (3,333)
Other (Income) expense ..................... 261 41 (75)
Interest and financing fees ................ 3,967 3,349 372
Depreciation, depletion, accretion and
amortization ........................... 10,108 2,473 617
-------- -------- --------
EBITDA ..................................... $ 7,545 $ (4,566) $ (2,419)
Stock-based compensation expense ........... 813 1,130 345
-------- -------- --------
Adjusted EBITDA ............................ $ 8,358 $ (3,436) $ (2,074)
======== ======== ========

(5) Average cash cost per ton is calculated as the sum of cost of sales and
general and administrative expense (excluding depreciation, depletion,
accretion and amortization), divided by the number of produced tons
sold. Although average cash cost per ton is not a measure of
performance calculated in accordance with GAAP, management believes
that it is useful to investors in evaluating the Company because it is
widely used in the coal industry as a measure to evaluate a company's
control over its cash costs. Average cash cost per ton should not be
considered in isolation or as a substitute for measures of performance
in accordance with GAAP. In addition, because average cash cost per ton
is not calculated identically by all companies, the presentation here
may not be comparable to other similarly titled measures of other
companies. The table below reconciles the GAAP measure of total
operating costs and expenses to average cash cost per ton:

TWELVE MONTHS ENDED DECEMBER 31, ELEVEN MONTHS ENDED
---------------------------------------------- DECEMBER 31,
2005 2004 2003
------------------- --------------------- --------------------
$ PER TON $ PER TON $ PER TON
--------- ------- --------- ------- --------- -------
Total operating expenses $68,436.2 $24,038.4 $ 4,226.5
Less: Cost of purchased coal 4,445.8 2,350.9 --
Less: Depreciation, depletion,
accretion and amortization 10,107.7 2,473.4 617.2

--------- --------- ---------
AVERAGE CASH COST $53,882.7 $44.29 $19,214.1 $53.89 $ 3,609.4 $89.28

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.

The following discussion and analysis should be read together with the
Consolidated Financial Statements of National Coal Corp. and the "Notes to
Consolidated Financial Statements" included elsewhere in this report. This
discussion summarizes the significant factors affecting the consolidated
operating results, financial condition and liquidity and cash flows of National
Coal Corp. for the fiscal years ended December 31, 2005 and 2004 and for the
eleven months ended December 31, 2003. Except for historical information, the
matters discussed in this Management's Discussion and Analysis of Financial
Condition and Results of Operation are forward-looking statements that involve
risks and uncertainties and are based upon judgments concerning various factors
that are beyond our control.

OVERVIEW

We mine, process and sell high quality bituminous steam coal from mines
located in East Tennessee and Southeastern Kentucky. We own the coal mineral
rights to approximately 74,600 acres of land and lease the coal mineral rights
to approximately 40,900 additional acres. We have expanded our operations
considerably since commencing operations at a single surface mine in Tennessee
in July 2003. Currently, our mining complexes include three underground mines,
two surface mines, and two highwall miners. In addition, we have four
preparations plants, two active and two inactive, and four unit train loading
facilities, two active and two inactive, served by the CSX and Norfolk &
Southern ("NS") railroads. We hold permits that allow us to open five new mines
close to our current operations. As of December 31, 2005, we estimate that we
controlled approximately 38.5 million tons of Proven (Measured) and Probable
(Indicated) recoverable coal reserves. During the year ended December 31, 2005,
we generated total revenues of $65.9 million and Adjusted EBITDA of $8.4 million
and sold approximately 1,216,400 tons of coal. During the three months ended
December 31, 2005, we generated total revenues of $20.2 million and Adjusted
EBITDA of $1.9 million and sold approximately 366,000 tons of coal.

Since our inception, our revenues have resulted primarily from the sale
of coal to electric utility companies in the Southeastern United States.
According to the EIA, in 2004 the Southeast region accounted for 23% of
coal-generated electricity production in the United States, more than any other
U.S. region. We believe that the long-term outlook for coal demand in the
Southeast is favorable, as coal-generated electricity production in our region
is expected to grow at a rate of 2.0% per year according to the EIA. In
addition, the Southeast region is projected by the EIA to account for 27% of the
expansion of coal-generated electricity production in the United States over the
next 20 years. For the year ended December 31, 2005, approximately 86% of our
revenue was generated from coal sales to electric utility companies in the
Southeastern United States and our largest customers were Georgia Power, South
Carolina Public Authority (Santee Cooper) and East Kentucky Power, representing
approximately 35%, 26% and 10% of our revenues, respectively.

Substantially all of our revenues come from the sale of coal we
produce. We also sell coal that we purchase from third party coal producers on a
case by case basis. Additionally, when capacity is available, we charge third
party coal producers a negotiated price per ton for their use of our rail
load-out facilities. These rail load-out facilities allow easy, direct access to
load previously mined coal onto rail cars for shipment to customers.

Our revenues depend largely on the price at which we are able to sell
our coal. We believe that the current pricing environment in the United States
is strong. Any decrease in coal prices due to, among other things, the demand
for electricity and the price and availability of alternative fuels for
electricity generation, and the supply of domestic and foreign coal, could
adversely affect our revenues and our ability to generate cash flows in the
future.

Our long-term sales agreements generally require our customers to buy
coal from us at prices averaging over $50 per ton, subject to customary quality
adjustment provisions. Two of our contracts, pursuant to which we sold 36% of
our coal in the twelve months ended December 31, 2005, and which expire in 2007
and 2008, provide for adjustment of coal purchase prices based on market
conditions. We plan to continue to capitalize on the currently strong pricing
environment by pursuing additional long-term contracts and selling coal on the
spot market for the remainder of our uncommitted planned production.

Our revenues also depend on our coal production capacity. We intend to
further expand our production from our current reserves and increase production
by opening new mines. In Tennessee, we plan on making $7 million of major
improvements to our infrastructure through the purchase of a 42-mile short line
railroad and the modernization of a large preparation plant and rail loadout
facility. In February 2006, we purchased a short line railroad for approximately
$2 million which will connect our owned reserves to the Norfolk-Southern
Railroad at Oneida, Tennessee. We will spend an additional $1-1.5

million to refurbish the line and make it operational. We also acquired the
Baldwin preparation plant and rail loadout facility in 2005 in return for the
assumption of certain reclamation liabilities and will spend $3 million to
update the plant. These investments will provide the capability to efficiently
mine our owned reserves and transport that coal, which is expected to be at a
lower operating cost per ton than our existing operation, to our Southeast U.S.
utility customers at an advantageous rate.

Our results of operations depend on the cost of coal production. Our
primary expenses are wages and benefits, repair and maintenance expenditures,
diesel fuel purchases, blasting supplies, coal transportation costs, cost of
purchased coal, freight and handling costs and taxes incurred in selling coal.
We expect that our exploration costs in the next few years will be relatively
significant but that our exploration costs will decline as a percentage of
revenues. Because of rising fuel costs, our transportation costs have increased
significantly. Given that the coal mining business is capital intensive, we
expect our depreciation expenses to increase in 2006 and beyond as we increase
our capital expenditures for mining and other equipment needed to expand our
business.

The coal industry has been highly competitive with very low margins
during the past several years. Recently, the surge in price for natural gas has
made coal more competitive with that alternative energy source, which has
enabled coal-fired power plants to be price competitive with natural gas-fired
power plants. We believe this has caused increased demand for coal and has
resulted in higher prices and improved margins for our product. However, the
price of coal is very volatile, and there can be no assurances that the price of
coal will maintain current levels. To reduce our exposure to fluctuations in the
price of coal, we intend to maintain long-term contracts with respect to a
majority of our coal production. For additional information regarding some of
the risks and uncertainties that affect us and our industry, see "Risk Factors."

Our historical operations prior to April 30, 2003 reflect only the
operations of National Coal Corporation, a Tennessee corporation. Prior to April
30, 2003, National Coal Corp., a Florida corporation formerly known as Southern
Group International, Inc., was a "blank check" company, which is a company that
has no specific business plan or purpose or has indicated that its business plan
is to engage in a merger or acquisition with an unidentified company or
companies. On April 30, 2003, National Coal Corp. consummated a reorganization
in which all of the outstanding shares of National Coal Corporation, a
privately-held Tennessee corporation, were exchanged for 8,549,975 shares of
National Coal Corp., a Florida corporation. National Coal Corporation was formed
in January 2003, and from inception through June 30, 2003, National Coal
Corporation was in the exploration stage with no operating revenue. During the
third quarter of 2003, we commenced coal mining operations and, accordingly, are
no longer in the exploration stage. As a result of the reorganization of the
group and the commencement of operating activities, our results for the eleven
months from inception (January 30, 2003) to December 31, 2003 are not comparable
to those for the twelve months ended December 31, 2005 and 2004.

CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES

The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these consolidated financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our
estimates, including those related to computing depreciation, depletion,
amortization, accretion, the basis of reclamation and workers compensation
liabilities, asset impairment, valuing non-cash transactions, and recovery of
receivables. Estimates are then based on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.

We believe our most critical accounting policies include revenue
recognition, the corresponding accounts receivable and the methods of estimating
depletion and reclamation expense of actual mining operations in relation to
estimated total mineable tonnage on our properties. We believe the following
accounting policies affect our more significant judgments and estimates used in
preparation of our consolidated financial statements.

REVENUE RECOGNITION. Under SEC Staff Accounting Bulletin No. 104,
REVENUE RECOGNITION, we recognize revenue when all of the following criteria are
met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred
or services have been rendered, (3) the seller's price to the buyer is fixed or
determinable, and (4) collectibility is reasonably assured. In the case of coal
we mine and sell, we negotiate a specific sales contract with each customer,
which includes a fixed price per ton, a delivery schedule, and terms for
payment. We recognize revenue from sales made pursuant to these contracts at the
time the coal is loaded onto rail cars at our load-out facilities.

ACCOUNTS RECEIVABLE. Trade accounts receivable are recorded at the
invoiced amount and do not bear interest. Customers are primarily investment
grade companies and quasi-governmental agencies. As a result, we have not
experienced any instances of non-payment and do not currently maintain an
allowance for doubtful accounts. Management monitors customers closely and will
record an allowance if trade account balances become potentially uncollectible.

ASSET RETIREMENT OBLIGATION. The Surface Mining Control and Reclamation
Act of 1977 and similar state statutes require that mine properties be restored
in accordance with specified standards and an approved reclamation plan.
Significant reclamation activities include reclaiming refuse and slurry ponds,
reclaiming the pit and support acreage at surface mines, and sealing portals at
deep mines. Reclamation activities that are performed outside of the normal
mining process are accounted for as asset retirement obligations in accordance
with the provisions of Statement of Financial Accounting Standards, or SFAS, No.
143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS. We record our reclamation
obligations on a mine-by-mine basis based upon current permit requirements and
estimated reclamation obligations for such mines as determined by the Office of
Surface Mining ("OSM") and/or the Kentucky Department for Natural Resources when
we post a predetermined amount of reclamation bonds prior to commencing mining
operations. OSM's and/or the Kentucky Department for Natural Resources'
estimates of disturbed acreage are determined based on approved mining plans and
related engineering data. Cost estimates are based upon estimates approved by
OSM based on historical costs. In accordance with SFAS No. 143, we determine the
fair value of our asset retirement obligations using a discounted cash flow
methodology based on a discount rate related to the rates of US treasury bonds
with maturities similar to the expected life of a mine, adjusted for our credit
standing.

On at least an annual basis, we review our entire reclamation liability
and make necessary adjustments for permit changes granted by state authorities,
additional costs resulting from accelerated mine closures, and revisions to cost
estimates and productivity assumptions, to reflect current experience. At
December 31, 2005, we had recorded asset retirement obligation liabilities of
approximately $6.7 million. While the precise amount of these future costs
cannot be determined with certainty, as of December 31, 2005, we estimate that
the aggregate undiscounted cost of final mine closure and reclamation is
approximately $12,268,000. Our recorded liability represents the estimated
future cost of final mine closure and reclamation discounted at our credit
adjusted risk-free rate.

STOCK-BASED COMPENSATION. We account for stock-based compensation using
Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK ISSUED
TO EMPLOYEES. Under APB No. 25, compensation expense is recognized for stock
options with an exercise price that is less than the market price on the grant
date of the option. For stock options granted employees or directors with
exercise prices at or above the market value of the stock on the grant date, we
have adopted the Financial Accounting Standards Board ("FASB") disclosure-only
provisions of Statement of Financial Accounting Standards No. 123, ACCOUNTING
FOR STOCK-BASED COMPENSATION ("SFAS No. 123"). Except for the issuance of
1,237,500 options granted to directors and officers in March 2004, we have not
recorded any compensation costs for these types of option grants.

We currently use a standard option pricing model to measure the fair
value of stock options granted to employees. In December 2004, the FASB issued
Statement No. 123(revised 2005), SHARE-BASED PAYMENTS, ("SFAS No. 123(R)") which
amends FASB Statement Nos. 123 and 95. SFAS No. 123(R) requires all companies to
measure compensation cost for all share-based payments, including employee stock
options, at fair value and is effective for interim or annual periods beginning
after December 15, 2005. We adopted this standard effective January 1, 2006 and
have elected the modified prospective application transition method. Under the
modified prospective application transition method, awards that are granted,
modified, repurchased, or cancelled after the date of adoption should be
measured and accounted for in accordance with the provisions of SFAS No. 123(R).
Awards granted prior to the effective date should continue to be accounted for
in accordance with the provisions of SFAS No. 123 with the exception that
compensation expense related to unvested options must be recognized in the
income statement based on the fair value of the options on the date of grant.
SFAS No. 123(R) also requires the benefits of tax deductions in excess of
recognized compensation cost to be reported as a financing cash flow, rather
than as an operating cash flow as required under current literature. This
requirement will reduce net operating cash flows and increase net financing cash
flows in periods after adoption. We expect that adoption of the standard will
reduce fiscal 2006 net income.

BENEFICIAL CONVERSION FEATURE OF DEBT AND PREFERRED STOCK. In
accordance with Emerging Issues Task Force No. 98-5, ACCOUNTING FOR CONVERTIBLE
SECURITIES WITH BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY ADJUSTABLE
CONVERSION RATIOS, and No. 00-27, APPLICATION OF ISSUE NO. 98-5 TO CERTAIN
CONVERTIBLE INSTRUMENTS, we recognize the value of conversion rights attached to
convertible debt and equity instruments. These rights give the instrument holder
the immediate ability to convert debt or preferred equity into common stock at a
price per share that is less than the trading price of the common stock to the
public. The beneficial value is calculated based on the market price of the
stock at the commitment date in excess of the conversion rate of the debt and
related accruing interest or preferred stock and is recorded as a discount to
the related debt or constructive dividend to preferred stockholders and an
addition to additional paid-in capital. The debt discount is amortized and
recorded as interest expense over the remaining outstanding period of related
debt.

MINERAL RESERVES. We amortize our acquisition costs, development costs,
capitalized asset retirement costs and some plant and equipment using the
units-of-production method and estimates of recoverable proven and probably
reserves. We review these estimates on a regular basis and adjust them to
reflect our current mining plans. The rate at which we record depletion also
depends on the estimates of our reserves. If the estimates of recoverable proven
and probable reserves decline, the rate at which we record depletion increases.
Such a decline in reserves may result from geological conditions, coal quality,
effects of governmental, environmental and tax regulations, and assumptions
about future prices and future operating costs.

RECENT ACCOUNTING PRONOUNCEMENTS

In November 2004, the FASB issued Statement No. 151, INVENTORY COSTS AN
AMENDMENT OF ARB NO. 43, CHAPTER 4, which revised ARB No.43, relating to
inventory costs. This revision is to clarify the accounting for abnormal amounts
of idle facility expense, freight, handling costs and wasted material
(spoilage). This Statement requires that these items be recognized as a current
period charge regardless of whether they meet the criterion specified in ARB 43.
In addition, this Statement requires the allocation of fixed production
overheads to the costs of conversion be based on normal capacity of the
production facilities. This Statement is effective for financial statements for
fiscal years beginning after June 15, 2005. Earlier application is permitted for
inventory costs incurred during fiscal years beginning after the date this
Statement is issued. Management believes this Statement will have no impact on
our financial statements once adopted.

In December 2004, the FASB issued Statement No. 153, EXCHANGES OF
NONMONETARY ASSETS AN AMENDMENT OF APB OPINION NO. 29. This Statement addresses
the measurement of exchanges of nonmonetary assets. The guidance in APB Opinion
No. 29, ACCOUNTING FOR NONMONETARY TRANSACTIONS, is based on the principle that
exchanges of nonmonetary assets should be measured based on the fair

value of the assets exchanged. The guidance in that Opinion, however, included
certain exceptions to that principle. This Statement amends Opinion No. 29 to
eliminate the exception for nonmonetary exchanges of similar productive assets
and replaces it with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. A nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. This Statement is effective for
financial statements for fiscal years beginning after June 15, 2005. Earlier
application is permitted for nonmonetary asset exchanges incurred during fiscal
years beginning after the date of this Statement is issued. Management believes
this Statement will have no impact on our financial statements once adopted.

In March 2005, the FASB issued Interpretation No. 47 ("FIN 47"),
ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT OBLIGATIONS, which clarifies that an
entity is required to recognize a liability for the fair value of a conditional
asset retirement obligation when incurred if the liability's fair value can be
reasonably estimated. A conditional asset retirement obligation is defined as a
legal obligation to perform asset retirement activity in which the timing and
(or) method of settlement are conditional on a future event that may or may not
be within the control of the entity. FIN 47 is effective no later than the end
of fiscal years ending after December 15, 2005. Our adoption of FIN 47 will not
result in a change to current practice.

At its March 30, 2005 meeting, the Financial Accounting Standards Board
("FASB") ratified the consensus reached by the Emerging Issues Task Force
("EITF") in Issue No. 04-6, ACCOUNTING FOR STRIPPING COSTS INCURRED DURING
PRODUCTION IN THE MINING INDUSTRY. Issue No. 04-6 requires that the costs of
removing overburden and waste materials to access mineral deposits during the
production phase of a mine, commonly referred to as STRIPPING COSTS, be included
in the costs of the inventory produced. EITF Issue No. 04-6 is effective for the
first fiscal period in fiscal years beginning after December 15, 2005, with
early adoption permitted. We have adopted the Issue effective January 1, 2006.
Management believes this EITF will have no impact on our financial statements.

In May 2005, the FASB issued Statement of Financial Accounting
Standards No. 154, ACCOUNTING CHANGES AND ERROR CORRECTIONS A REPLACEMENT OF APB
OPINION NO. 20 AND FASB STATEMENT NO. 3, which changes the requirements for the
accounting for and reporting of a change in accounting principle. This statement
requires retrospective application to prior periods' financial statements of
changes in accounting principle, unless it is impracticable to determine the
period-specific effects or the cumulative effect of change. When it is
impracticable to determine the period-specific effects of an accounting change
on one or more individual prior periods presented, this Statement requires that
the new accounting principle be applied to the balances of assets and
liabilities as of the beginning of the earliest period for which retrospective
application is practicable and that a corresponding adjustment be made to the
opening balance of retained earnings for that period rather than being reported
in the income statement. Management believes this statement will have no impact
on our financial statements.

RESULTS OF OPERATIONS

The following table presents consolidated statement of operations data
for each of the periods indicated as a percentage of revenues.

ELEVEN
MONTHS
TWELVE MONTHS ENDED ENDED
DECEMBER 31, DECEMBER 31,
2005 2004 2003
-------- -------- --------

Revenues ............................... 100.0% 100.0% 100.0%
-------- -------- --------
Operating expenses:
Cost of sales ....................... 77.6 96.0 146.0
Depreciation, depletion and
amortization ..................... 15.3 14.6 51.8
General and administrative .......... 11.0 30.8 157.2
-------- -------- --------
Total operating expenses .......... 103.9 141.4 354.9
-------- -------- --------
Operating loss ......................... (3.9) (41.4) (254.9)
-------- -------- --------
Other income (expense):
Interest expense .................... (6.0) (19.7) (31.3)
Other income (expense), net ......... (0.4) (0.2) 6.3
-------- -------- --------
Net loss ............................... (10.3)% (61.4)% (279.9)%
======== ======== ========

COMPARISON OF TWELVE MONTHS ENDED DECEMBER 31, 2005 AND DECEMBER 31, 2004

REVENUES

TWELVE MONTHS PERCENT
ENDED DECEMBER 31 CHANGE
----------------------------- ---------
2005 2004

Coal sales .................... $65,258,071 $16,871,346 286.8%
Other revenue ................. 614,563 127,566 381.8%
----------- -----------
Total revenues ............. $65,872,634 $16,998,912 287.5%

For the twelve months ended December 31, 2005, our revenues were
derived from coal sales to fifteen customers, eight of which were utilities, six
of which were industrial customers and one of which was a coal reseller. Our
five largest customers represent 84% of our total revenue. For the twelve months
ended December 31, 2004, we had a total of twelve customers, two of which were
utilities that accounted for approximately 77% of our revenue. The 286.8%
increase in coal sales during the year ended December 31, 2005 is primarily
attributable to a 244% increase in production volume, the addition of 3 new
customers and a 15% increase in average sales prices. The significant increase
in production volume over 2004 is primarily the result of experiencing four full
quarters of operations in 2005 as compared to a single quarter in 2004 along
with the closure of two lower volume mines and commencement of operations at two
higher volume mines, one of which was a highwall mine.

During the two year period ended December 31, 2005, the market for
Central Appalachian coal experienced an increase in demand and strong pricing.
During the year ended December 31, 2004, 28% of our sales were below $40 per
ton, 25.2% were between $40 and $50 per ton and 53.2% was sold above $50 per
ton. All sales under contract during 2005 were made at an average price above
$50 per ton. All average prices include premiums and penalties for coal quality
variances from contractual requirements.

The increase in other revenue is due to the receipt of TIPPLING FEES of
$250,610 from a coal company with property located adjacent to ours and a
negotiated termination of a sales contract of

$350,000. At December 31, 2005, the sales contract had thirteen months remaining
and required the delivery of 130,000 tons of coal through 2006. These increases
were offset by the elimination of $103,403 in royalty revenue during 2004.

OPERATING EXPENSES

TWELVE MONTHS
ENDED DECEMBER 31 PERCENT
2005 2004 CHANGE
---------------- -------------- ---------
Cost of sales............................... $ 51,115,116 $ 16,322,632 213.2%
General and administrative expenses......... $ 7,213,346 $ 5,242,437 37.6%
Depreciation, depletion, accretion and
amortization expense................... $ 10,107,723 $ 2,473,369 308.7%
----------------- --------------- ---------
Total operating expenses $ 68,436,185 $24,038,438 184.7%

COST OF SALES

Cost of sales consists primarily of salary, benefits, and other
compensation costs paid directly to miners, and direct costs paid to third party
vendors whose goods and services were directly used in the process of producing
coal inventory. Third party vendor costs include equipment leases and
maintenance costs, blasting costs, fuel costs, parts and supplies, coal
purchases, and transportation costs. The increase in cost of sales in the year
ended December 31, 2005 as compared to the year ended December 31, 2004 is
primarily due to a 241% increase in mined and purchased coal.

As the production of coal tons increases the cost per ton is
decreasing. Our cost of sales as a percentage of total revenue has improved
19.2% from 96.0% to 77.6% in the year ended December 31, 2004 and the year ended
December 31, 2005, respectively.

GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative expenses primarily include non-operations
salary, benefits and related expenses; consulting expenses; legal and
professional fees; insurance expenses; and travel and travel related expenses.
The change in general and administrative expenses was primarily attributable to
changes in six major components: 1) $710,335 increase in payroll, primarily due
to an increase in corporate personnel in 2005 and incurring a full year of
expense on eleven corporate employees hired in 2004, 2) $329,075 increase in
professional fees, primarily legal fees, 3) $367,000 increase in security costs
related to securing our mine sites and corporate offices against various
threats, 4) the addition of $187,500 in directors fees due to the addition of
independent directors, 5) $150,000 forfeited deposit on a real estate
transaction, and 6) a $118,000 increase in consultants, primarily financial
consultants.

As a percentage of revenues, general and administrative expenses have
decreased from 30.8% to 11.0% for the years ended December 31, 2004 and 2005,
respectively.

DEPRECIATION, DEPLETION, ACCRETION AND AMORTIZATION EXPENSE

The increase in depreciation, depletion, accretion and amortization
expense in the twelve month period ended December 31, 2005 compared to the
twelve month period ended December 31, 2004 is primarily attributable to a
493.3% increase in depreciation. This change was due to the acquisition of $19.3
million of fixed assets, primarily mining equipment, and a change in the
estimated useful lives of our mining equipment. On April 1, 2005, we changed our
policy for the depreciable life of mining equipment to three to five years from
seven years. Subsequently, most of our equipment was estimated to have a three
year useful life. This had the impact of increasing depreciation on mining
equipment by approximately $3.6 million during 2005. This adjustment was treated
as a change in accounting estimate and depreciation expense was adjusted on a
prospective basis.

OTHER INCOME (EXPENSE)

TWELVE MONTHS ENDED
DECEMBER 31, PERCENT
2005 2004 CHANGE
----------- ----------- -----------

Interest expense and financing fees ..... (3,966,715) (3,348,922) 18.4%
Other income (expense), net ............. $ (260,905) $ (40,682) 541.3%
----------- ----------- -----------
Total other income (expense) ......... (4,227,620) $(3,389,604) 24.7%

The increase in other income (expense), net, in the year ended December
31, 2005 compared to the year ended December 31, 2004 is primarily attributable
to an increase in interest expense of $617,793 and an increase in other expense
of $220,223. The increase in interest expense is due to added borrowings for
asset acquisitions made during calendar 2005 of approximately $16.8 million
offset by the $1.7 million interest expense recognized in 2004 as a result of
the beneficial conversion feature of $3.0 million of preferred shares issued in
August 2004. The added borrowings do not include the $55,000,000 10.5% Senior
Secured Notes due 2010, which were issued on December 29, 2005.

COMPARISON OF TWELVE MONTHS ENDED DECEMBER 31, 2004 AND ELEVEN MONTHS ENDED
DECEMBER 31, 2003

REVENUES

ELEVEN MONTHS ENDED
DECEMBER 31, PERCENT
2004 2003 CHANGE
----------- ----------- -----------

Coal sales ................... $16,871,346 $ 1,012,520 1566.3%
Royalties receipts ........... 103,403 178,123 (72.3%)
Other revenue ................ 24,163 -- --
----------- -----------
Total revenues ............ $16,998,912 $ 1,190,643 1327.7%

We commenced mining coal in July 2003, and therefore had limited coal
sales during the eleven months ended December 31, 2003. As such, it is not
meaningful to compare sales between the eleven months ended December 31, 2003
and the twelve months ended December 31, 2004. During the twelve months ended
December 31, 2004, we generated all of our coal sales from fourteen customers,
six of which were electric utilities (73.1% of sales, with our top two
representing 54.6% of total coal sales), six of which were industrial companies
(26.3% of sales), and two of which were coal resellers. All of our sales in 2003
and in the first nine months of 2004 were made pursuant to short term contracts
with our electric utility and industrial customers. Sales to coal resellers were
made on a spot basis. Most of our coal sales in the fourth quarter 2004 were
derived from long-term contracts. At December 31, 2004, we had six contracts of
one year or longer, pursuant to which we estimate delivering an aggregate of
984,000 tons of coal in calendar 2005. The royalty receipts for the eleven
months ended December 31, 2003 and for the twelve months ended December 31, 2004
were the result of the recognition of deferred revenue relating to our sale in
August 2003 of $250,000 of royalty rights relating to coal mined on the Smoky
Mountain portion of our New River Tract property. We will not recognize any more
royalty revenue pursuant to this transaction. Other revenue for the twelve
months ended December 31, 2004 was the result of tippling fees charged to third
party operators which leased one of our tipple facilities.

OPERATING EXPENSES

TWELVE MONTHS ELEVEN MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31, PERCENT
2004 2003 CHANGE
----------- ----------- -----------

Cost of sales ............................. $16,322,632 $ 1,737,937 839.2%
General and administrative expenses ....... $ 5,242,437 $ 1,871,414 180.1%
Depreciation, depletion, accretion, and
amortization expense .................. $ 2,473,369 $ 617,155 300.8%
----------- -----------
Total operating expenses .................. $24,038,438 $ 4,226,506 438.8%

COST OF SALES

For the twelve month period ended December 31, 2004, these expenses
consisted primarily of salary, benefits, workers' compensation and other
compensation costs directly attributable to the employment of miners of
approximately $4.33 million, and direct costs paid to third party vendors whose
goods and services were directly used in the process of producing coal
inventory, which included coal purchases of approximately $2.31 million,
$477,000 paid to a contract mining entity, equipment leases and maintenance
expenses of $1.13 million, blasting expenses of $448,000, fuel costs of
$878,000, parts and supplies of $1.40 million, hauling costs of $1.50 million,
and royalties and taxes of approximately $911,000. The gross profit margin for
calendar 2004 was approximately 5% which is generally below the operating
margins of our competitors. This below average operating margin is mainly
attributable to the ramp up phase of our mining operations as we went from
operating one mine in 2003 to operating six mines in 2004.

There was no cost of sales prior to the second quarter 2003. For the
eleven months ended December 31, 2003, our total cost of sales and selling
expenses consisted primarily of salary, benefits and other compensation costs
directly attributable to the employment of miners of approximately $441,000,
direct costs paid to third party vendors whose goods and services were directly
used in the process of producing coal inventory, which included equipment leases
and maintenance expenses of approximately $470,000, blasting expenses of
$159,000, fuel costs of $191,000, parts and supplies of $227,000, hauling costs
of $66,000, and royalties and taxes of approximately $96,000.

GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative expenses primarily include salary, benefits
and related expenses; consulting expenses; legal and professional fees;
insurance expenses; and travel and travel related expenses. The increase in
general and administrative expenses in the twelve month period ended December
31, 2004 compared to the eleven month period ended December 31, 2003 is
primarily attributable to an increase in salaries, benefits and related expenses
of $2.08 million, an increase of $903,000 related to the non-cash recognition of
compensation expense related to the issuance of options with strike prices below
market, an increase in insurance fees of $866,000 partially offset by a decrease
in consulting fees of $456,000. This occurred as we transitioned from our
initial start-up phase, which began in the calendar third quarter 2003, during
which we used consultants, to on-going operations conducted by employees in
2004.

DEPRECIATION, DEPLETION, ACCRETION AND AMORTIZATION EXPENSE

The increase in depreciation, depletion, accretion and amortization
expense in the twelve month period ended December 31, 2004 compared to the
eleven month period ended December 31, 2003 is primarily attributable to the
acquisition of fixed assets which resulted in an increase of approximately $1.28
million in depreciation expenses, an increase of $504,000 in adjustments and
revisions from annual re-costing of our asset retirement obligations as well as
an increase in the recognition of estimated depletion expenses of $115,000.

OTHER INCOME (EXPENSE)

TWELVE MONTHS ELEVEN MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31, PERCENT
2004 2003 CHANGE
----------- ----------- ---------

Other income (expense), net .......... $ (40,682) $ 75,437 (147.3%)
Interest expense and financing fees .. (3,348,922) (372,458) 799.1%
----------- -----------
Total other income (expense) ...... $(3,389,604) $ (297,021) 1,041.2%

The increase in other income (expense), net, in the twelve month period
ended December 31, 2004 compared to the eleven month period ended December 31,
2003 is primarily attributable to an increase in interest expense of
approximately $2,518,000 related to $1,700,000 of interest expense recorded
pursuant to the beneficial conversion feature of the $3.0 million convertible
debentures issued in August 2004, and added borrowings for asset acquisitions
made during calendar 2004, an increase of finance fees of $458,000 related to
the April debt offering and fees paid for a second amendment to our senior
credit facility, and an increase in property taxes of approximately $33,000.

RELATED TRANSACTIONS

See "Certain Relationships and Related Transactions" included elsewhere
in this report for a full description of transactions to which we were or will
be a party, in which the transaction involved exceeds a material amount, and in
which any director, executive officer, shareholder of more than 5% of our common
stock or any member of their immediate family had or will have a direct or
indirect material interest.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2005, we had cash and cash equivalents of
approximately $25.4 million and positive working capital of approximately $18.3
million. We expect to expend a significant portion of our cash during fiscal
2006 as we continue to expand our coal mining operations. Subject to our
performance, which if adversely affected could reduce available funds, we expect
to be able to meet our liquidity requirements for the foreseeable future through
current cash reserves, cash provided by operations and liquidity available
through any future revolving credit facility. However, in order to continue to
expand our operations, or in the case that we determine it is necessary to
expand our operations through acquisition of additional assets and/or mining
operations, it may be necessary for us to obtain additional financing in the
future. We cannot assure you that additional financing will be available when
needed or that if available, such financing will include terms as favorable as
current financings. If such financing is not available when required or is not
available on acceptable terms, we may be unable to take advantage of business
opportunitites or respond to competitive pressures, any of which could have a
material adverse effect on our business, financial condition and results of
operations.

DEBT OBLIGATIONS

The following table summarizes our debt obligations, excluding capital
leases, at December 31:

2005 2004
------------ ------------
10.5% Notes, due 2010 ........................ $ 55,000,000 --
Bank note (prime + 1%), due 2007 ............. 1,200,018 --
Equipment note (non-interest bearing),
due 2006 .................................. 280,000 --
Installment purchase obligations, due 2008 ... 5,270,611 --
Credit facility (prime + 5.75%) due 2006 ..... -- 15,000,000
7.25% bank loan, due 2006 .................... -- 532,908
Other ........................................ 19,931 --
Less unamortized discounts ................... (3,910,160) --
------------ ------------
57,860,400 15,532,908
Less current portion of long-term debt ....... (3,319,175) (329,511)
------------
Long-term debt ............................... $ 54,541,225 $ 15,203,397
============ ============

10.5% SENIOR SECURED NOTES DUE 2010

On December 29, 2005, the Company issued $55,000,000 in aggregate
principal amount of 10.5% Senior Secured Notes due 2010 (the "Senior Notes") and
55,000 warrants to purchase a total of 1,732,632 shares of the Company's common
stock (the "Warrants"). The Senior Notes and Warrants were sold in Units (the
"Units") consisting of one $1,000 principal amount Note and one Warrant, which
entitled the holder to purchase 31.5024 shares of Company common stock at an
exercise price of $8.50 per share, subject to adjustment. The warrants are
subject to mandatory conversion if the price the Company's common stock remains
above $12.50 for more than thirty days. The Units were sold in a private
placement exempt from the registration requirements under the Securities Act of
1933, as amended (the "Securities Act"). The Senior Notes are fully and
unconditionally guaranteed on a senior secured basis by all of our wholly-owned
subsidiaries and were offered and sold within the United States only to
qualified institutional buyers in reliance on Rule 144A under the Securities
Act.

The Senior Notes were issued pursuant to an indenture with Wells Fargo
Bank National Association, as trustee. Interest on the Senior Notes accrues from
the date of issuance or the most recent interest payment date, and is payable in
cash semi-annually in arrears on June 15th and September 15th of each year,
commencing on June 15, 2006. The warrants are exercisable on or after December
29, 2006 or earlier if the warrants are exchanged for registered warrants which
are detached from the Notes and the warrants will expire on December 15, 2010.
All of the securities in this offering were initially purchased by Jefferies
& Company, Inc.

The Senior Notes and the related guarantees are secured by a lien on
substantially all of our and the guarantors' property and assets, including a
pledge of 100% of the capital stock or other equity interests of our domestic
subsidiaries. The Senior Notes will mature on December 15, 2010. The Senior
Notes will be our senior secured obligations, and will rank equally with our
existing and future senior debt and senior to our existing and future
subordinated debt. The Notes provide for us to obtain a $10 million revolving
line of credit which will hold a first priority secured lien senior to the
Notes.

Before December 15, 2008, we may, at any time or from time to time,
redeem up to 35% of the aggregate principal amount of the Senior Notes with the
net proceeds of a public or private equity offering at 110.500% of the principal
amount of the Senior Notes, plus any accrued and unpaid interest, if at least
65% of the aggregate principal amount of the notes remains outstanding after
such redemption and the redemption occurs within 90 days of the date of the
closing of such equity offering.

In addition, the Senior Notes are redeemable, at our option, in whole
or in part, at any time on or after December 15, 2008, in each case at the
redemption prices described in the table below, together with any accrued and
unpaid interest to the date of the redemption.

TIME PERIOD PERCENTAGE
----------- ----------
December 15, 2008 - December 14, 2009 105.250%
December 15, 2009 - June 14, 2010 102.625
June 15, 2010 and thereafter 100.000%

The indenture governing the Senior Notes will, among other things and
subject to certain exceptions, limit our ability and the ability of our
subsidiaries to:

o incur or guarantee additional indebtedness or issue preferred
stock;
o pay dividends or distributions on, or redeem or repurchase,
capital stock;
o make investments;
o issue or sell capital stock of restricted subsidiaries;
o engage in transactions with affiliates;
o grant or assume liens; or
o consolidate, merge or transfer all or substantially all of our
assets.

Our failure to make required payments of interest and principal and to
comply with other covenants may result in the acceleration of the principal of
the Senior Notes.

We have agreed, pursuant to a registration rights agreement with the
initial purchaser, to use our commercially reasonable efforts to register with
the SEC a new issue of notes having substantially identical terms as the Senior
Notes in order to exchange freely tradable notes for the Senior Notes. The
Warrants and Warrant Shares have not been registered with the SEC and are
subject to transfer restrictions. Under the terms of the registration rights
agreement relating to the Warrants, we have agreed to file a shelf registration
statement with the SEC covering the resale of the Warrants and the Warrant
Shares, and to use our commercially reasonable efforts to cause that resale
registration statement to be declared effective within 240 days after the sale
date.

We immediately used approximately $22,100,000 of the proceeds of the
Senior Note offering to repay existing indebtedness. The remaining proceeds will
be used to collateralize reclamation bonds for new mining operations and for
equipment acquisitions.

EQUIPMENT NOTES

In November 2005, we purchased mining equipment for use in our Kentucky
operations from two former contract mining companies for approximately
$1,775,000. We financed the purchase with a $400,000, four month, non-interest
bearing note to one of the mining companies and a $1,300,000, twenty-four month
note with a bank at the prime rate plus 1%. Both notes are secured by the
purchased equipment. The $400,000 was repaid early in January 2006 at a $20,000
discount from the then outstanding obligation of $300,000.

During the final quarter of 2005, we entered into capital lease
agreements of approximately $2,400,000 with equipment suppliers for certain
mining equipment. These leases are for periods of six to thirty-six months and
provide for the transfer of ownership of the equipment to the Company at the end
of the lease term.

INSTALLMENT PURCHASE OBLIGATIONS

In August 2005, our wholly-owned subsidiary, National Coal Corporation,
entered into installment sale contracts with an equipment manufacturer,
effective in July 2005, pursuant to which National Coal Corporation purchased,
and financed or refinanced, certain equipment used in its coal mining
operations. Pursuant to the installment sale contracts, we financed or
refinanced approximately $7.3 million in equipment at the following rates with
respect to the following amounts:

Annual Percentage Rate Financed Amount
---------------------- -----------------
5.22% $ 879,010
6.11% 4,967,673
7.65% 870,967
-----------------
Total $6,717,650
=================

The total $6,717,650 principal balance of these contracts includes
refinancing obligations previously under capital leases of approximately
$2,937,000 at June 30, 2005 representing gross assets of approximately
$4,372,000. This resulted in the recognition of a gain of approximately
$328,000. The remaining $3,781,000 is related to the purchase of equipment
formerly under operating lease and new equipment. The installment sale contracts
require monthly payments of principal and interest through January 14, 2008. The
obligations under the installment sale contracts are secured by the equipment
purchased.

In April 2006, we entered into new installment sales contracts with an
equipment manufacturer pursuant to which we refinanced equipment with an
aggregate principal value of approximatley $2,729,000 formerly acquired under
various capital leases. These installment sales contracts require payments over
36 months at fixed interest rates ranging from 7.03% to 7.5%.

SENIOR SECURED CREDIT FACILITY

On November 26, 2004, our wholly-owned subsidiary, National Coal
Corporation, in connection with our acquisition of assets from Appalachian
Fuels, LLC entered into a credit agreement with D. B. Zwirn Special
Opportunities Fund, L.P., as Lender and administrative agent for the Lenders.
The credit agreement provided for an initial credit facility of $15 million with
a subsequent credit facility not to exceed $6 million. We exercised our right to
borrow $15 million on November 29, 2004, the proceeds of which were used to pay
the remaining $12,250,000 of acquisition costs related to the acquisition of
assets of Appalachian Fuels, LLC, pay transaction costs with respect to the
closing of the credit facility and asset purchase, and fund working capital. We
borrowed an additional $1.4 million in January 2005 to fund our acquisition of
mining equipment. Borrowings under the credit agreement bear interest at the
prime rate, plus 5.75%. The obligation under the credit agreement was secured by
substantially all of our assets and those of our subsidiaries. At December 29,
2005, we repaid and terminated this credit facility resulting in the write-off
of approximately $407,000 of deferred financing costs.

BANK LOAN

In July 2004, we borrowed approximately $663,300 on a 24-month term
with an interest rate of 7.25% from a local bank. Proceeds from the loan were
used to purchase mining and other vehicles. The remaining principal balance of
the loan was repaid on December 29, 2005

CASH FLOWS

We currently satisfy our working capital requirements primarily through
cash flows generated from operations and sales of debt and equity securities.
For the twelve months ended December 31, 2005, we had a net increase in cash of
approximately $25.1 million. Cash flows from operating, financing and

investing activities for the twelve months ended December 31, 2005 and 2004 and
the eleven months ended December 31, 2003 are summarized in the following table:

ACTIVITY ELEVEN MONTHS
TWELVE MONTHS ENDED ENDED
DECEMBER 31, DECEMBER 31,
2005 2004 2003
---------- ---------- ----------

Operating activities .................. $ 4,962 $ (4,342) $ (1,541)
Investing activities: ................. (21,505) (33,466) (1,991)
Financing activities .................. 41,675 38,111 3,533
---------- ---------- ----------
Net increase (decrease) in cash .... $ 25,132 $ 303 $ 222
========== ========== ==========

OPERATING ACTIVITIES

The net cash provided by operating activities of approximately $5
million during the twelve months ended December 31, 2005 was primarily the
result of an improving net loss. When the impact of depreciation is removed from
the net loss, there is an improvement of $11.3 million. The improvement in net
loss is due to a significant increase in coal sales and resulting improvements
in the percentage of cost of sales and general and administrative expenses.
Although many operating costs are variable, gross margin percentage improves as
volume increases due to utilization of fixed costs. Additionally, general and
administrative costs are not variable and growth in those costs is slowing
significantly relative to the increase in coal volumes as the securing of the
management team and related corporate costs is completed.

The net cash used in operating activities of approximately $4.34
million during the twelve months ended December 31, 2004 was primarily the
result of the net loss of approximately $10.43 million and an increase in
receivables of approximately $1.90 million, inventory of approximately $119,000,
deferred revenue of approximately $179,000, payments for reclamation obligations
of approximately $87,100 and prepaid and other of approximately $233,500 as we
increased coal production during the year, partially offset by an increase in
accounts payable and accrued liabilities of approximately $3.30 million and
non-cash expenses of approximately $5.20 million. The non-cash expenses recorded
during the period included $1,700,000 of interest expense related to the
beneficial conversion feature of the $3.0 million convertible debentures issued
in August 2004, $903,000 of non-cash compensation expense related to the
issuance of stock options with an exercise price below the closing price of our
common stock on the date of grant, $227,000 of non-cash compensation expense for
the issuance of common stock in consideration of salary, $165,000 of non-cash
interest expense for the issuance of common stock in lieu of interest payments,
and $49,000 of non-cash consulting expense for the Black-Scholes pricing model
valuation of warrants issued as consideration for consulting services rendered.

The net cash used in operating activities of approximately $1.54
million during the eleven months ended December 31, 2003 was primarily the
result of the net loss of approximately $3.33 million and increases in
receivables of approximately $19,000, inventory of approximately $146,000,
deferred revenue of approximately $179,000 and prepaid and other of
approximately $15,000 as we increased coal production during the year, partially
offset by an increase in accounts payable and accrued liabilities of
approximately $829,000 and non-cash expenses of approximately $962,000, of which
$191,000 was non-cash compensation to a related party, and $153,500 was non-cash
compensation expense for the issuance of common stock for services.

INVESTING ACTIVITIES

Cash used in investing activities of $21.5 million was primarily
related to capital expenditures of $19.3 million and an increase in cash
collateral supporting reclamation bonds of $2.1 million. The capital
expenditures were used to open two new mines, including a highwall mine, and to
acquire additional equipment for existing mines.

The approximately $33.4 million of cash used in investing activities
during the twelve months ended December 31, 2004 was due primarily to the
purchase of approximately $17.7 million of property, plant and equipment, $10.9
million for the purchase of coal and mineral assets, $4.3 million deposited with
a bank as collateral for OSM reclamation requirements, $150,000 in deposits for
a potential purchase of mining rights, and $392,000 of prepaid royalty in
advance of royalties to be paid on property we lease and expect to mine within a
few years.

For the eleven months ended December 31, 2003, $2.0 million of cash
used in investing activities resulted primarily from $1.3 million for the
acquisition of coal and mineral rights, $448,000 for the acquisition of mining
equipment offset by the receipt of $23,000 from the sale of equipment, and
$257,500 paid to OSM for reclamation bonds used for surface mine TN #2.

FINANCING ACTIVITIES

The net cash provided by financing activities of approximately $41.7
million during the twelve months ended December 31, 2005 was primarily the
result of $55.0 million raised from the issuance of Senior Secured Notes, offset
by the repayment of $22.1 million including our previous Senior Credit Facility
and certain other notes and leases. Additionally, approximately $5.1 million was
through the issuance of a note payable and approximately $3.8 million from
capital leases.

The net cash provided by financing activities of approximately $38.11
million during the twelve months ended December 31, 2004 was primarily the
result of $24.5 million raised from sales of debt securities net of $1.0 million
in fees, and $17.7 million raised from the sale of common stock and Series A
convertible preferred stock net of $1.0 million in fees, offset primarily by
$3.05 million paid to debt holders, $950,000 paid pursuant to capital leases and
a bank loan, $560,000 paid on related party debt and $281,000 paid as a dividend
to holders of our Series A preferred stock. The net cash provided by financing
activities of approximately $3.53 million during the eleven months ended
December 31, 2003 was primarily the result of $3.25 million raised from sales of
debt from outside parties net of approximately $412,000 financing fees, $560,000
from related party debt, and $287,500 from the sale of equity securities,
partially offset by payments of approximately $543,600 on notes payable and
capital leases.

OFF-BALANCE SHEET ARRANGEMENTS

At December 31, 2005, 2004 and 2003, we did not have any relationships
with unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance, variable interest or special purpose
entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited
purposes. As such, we are not exposed to any financing, liquidity, market or
credit risk that could arise if we had engaged in such relationships.

CONTRACTUAL OBLIGATIONS

The following summarizes our contractual obligations at December 31,
2005 and the effects such obligations are expected to have on liquidity and cash
flow in future periods:

PAYMENTS DUE BY PERIOD
-----------------------------------------------------
LESS THAN 1 1-3 3-5 AFTER
TOTAL YEAR YEARS YEARS 5 YEARS
----------- ----------- ----------- ----------- -----------
Notes payable .................... $61,770,560 $ 3,343,132 $ 3,447,428 $55,000,000 $ --
Operating leases ................. 354,992 263,155 91,837 -- --
Capital leases ................... 2,570,122 1,251,500 1,318,622 -- --
----------- ----------- ----------- ----------- -----------
Total contractual obligations $64,695,674 $ 4,857,787 $ 4,857,887 $55,000,000 $ --
=========== =========== =========== =========== ===========

In November 2004, pursuant to our signed asset purchase agreement with
Appalachian Fuels, LLC, we agreed to replace $6.1 million of their reclamation
bonds on the Straight Creek, KY mining operations upon the transfer to us of all
of the mining permits listed in the asset purchase agreement. These mining
permits were transferred to us and the bonds replaced in January 2006.

We rent mining equipment pursuant to operating lease agreements, and
made lease payments totaling $1,213,000 and $516,000 during the twelve months
ended December 31, 2005 and 2004, respectively.

In September 2004, we purchased an office building in Knoxville,
Tennessee for $690,000, which is the new location of our corporate operations.
The building has been pledged to satisfy certain OSM bonding requirements.

During the year ending December 31, 2005, we paid dividends to the
holders of our Series A convertible preferred stock in the aggregate amount of
$1,124,650 in semi-annual payments on June 30 and December 31.

In March 2005, we borrowed $5.14 million to purchase mining equipment.
The notes issued had an original maturity of August 10, 2005, which was
subsequently extended, were secured by the mining equipment purchased, and had a
rate of interest of eighteen percent (18%) per annum calculated from the 61st
day until maturity. We paid an origination fee of approximately $200,000 upon
the execution of the loan documents. The lenders were also issued 5-year common
stock purchase warrants to purchase up to 140,000 shares of our common stock at
an exercise price per share of $8.50. Crestview Capital Master, LLC participated
in this transaction. The notes were repaid on December 29, 2005 with an
additional fee of 3% or approximately $154,000.

During the final quarter of 2005, we entered into capital lease
agreements of approximately $2.4 million with equipment suppliers for certain
mining equipment. These leases are for periods of six to thirty-six months and
provide for the transfer of ownership of the equipment to us at the end of the
lease term. Management anticipates that these leases will be renegotiated with a
finance company later in 2006.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Market Risk is the risk of loss arising from adverse changes in market
rates and prices, such as interest rates, foreign currency exchange rates and
commodity prices.

INTEREST RATE RISKS

Our interest expense is sensitive to changes in the general level of
interest rates in the U.S. At December 31, 2005, we had $61.7 million aggregate
principal amount of debt under fixed rate instruments and $1.2 million of debt
under variable rate instruments, with equipment financing making up 100% of the
variable rate instruments. At December 31, 2004, we had $0 aggregate principal
amount of debt under fixed rate instruments and $19.7 million of debt under
variable rate instruments, with our Senior Credit Facility making up $15 million
of the variable rate instruments.

Under the terms of our equipment financing agreements, the interest
rate on borrowings there under was determined based on the prime rate. Based on
the variable rate debt outstanding as of December 31, 2005, a 100 basis point
increase in interest rates would increase annual interest expense by
approximately $12,000. Based on the variable rate debt outstanding as of
December 31, 2004, a 100 basis point increase in interest rates would increase
annual interest expense by approximately $197,000.

COMMODITY RISKS

We are subject to commodity price risk based on the fluctuating market
price of coal. We manage this risk through securing long-term coal supply
agreements rather than through use of derivative instruments. In the future, as
existing long-term contracts expire or become subject to repricing, our coal

sales will be made at then-current market prices. As a result, our revenues and
net income will be significantly affected by fluctuations in the price of coal.

Coal prices are influenced by a number of factors and vary dramatically
by region. The two principal components of the delivered price of coal are the
price of coal at the mine, which is influenced by coal quality, and the cost of
transporting coal from the mine to the point of use. Electricity generators
purchase coal on the basis of its delivered cost per million Btu. The price of
coal is generally in parity with oil and natural gas prices. As macroeconomic
factors affect these commodity prices, the price of coal will similarly be
impacted.

The cost of operating a mine is influenced by geological
characteristics such as seam thickness, overburden ratios and depth of
underground reserves. It is generally cheaper to mine coal seams that are thick
and located close to the surface than to mine thin underground seams. Typically,
coal mining operations will begin at the part of the coal seam that is easiest
and most economical to mine. In the coal industry, this surface mining
characteristic is referred to as low ratio. As the seam is mined, it becomes
more difficult and expensive to mine because the seam either becomes thinner or
extends more deeply into the earth, requiring removal of more overburden.
Underground mining is generally more expensive than surface mining as a result
of high capital costs including costs for modern mining equipment and
construction of extensive ventilation systems and higher labor costs, including
costs for labor benefits and health care.

In addition to the cost of mine operations, the price of coal at the
mine is also a function of quality characteristics such as heat value and
sulfur, ash and moisture content. Metallurgical coal has higher carbon and lower
ash content and is usually priced $4 to $10 per ton higher than steam coal
produced in the same regions. Coal used for domestic consumption is generally
sold free on board at a loading point, and the purchaser normally pays the
transportation costs. Export coal is usually sold at an export terminal, and the
seller is responsible for shipment to the export coal loading facility while the
purchaser pays the ocean freight. Most electric power generators arrange
long-term shipping contracts with rail or barge companies to assure stable
delivery costs. Transportation cost can be a large component of the purchaser's
cost. Although the customer pays the freight, transportation cost is still
important to coal mining companies because the customer may choose a supplier
largely based on the cost of transportation. Trucks and overland conveyors haul
coal over shorter distances, while lake carriers and ocean vessels move coal to
export markets. Some domestic coal is shipped over the Great Lakes. Railroads
move more coal than any other product, and in 1999, coal accounted for 22% of
total U.S. rail freight revenue and more than 44% of total freight tonnage.
Railroads typically handle approximately 60% of U.S. coal production, with CSX
and Norfolk Southern the dominant carriers in the eastern United States.

Some products used in mining activities, such as diesel fuel, are
subject to price volatility. We use short-term fuel contracts to manage the
volatility related to this exposure.

FOREIGN CURRENCY

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

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

PAGE
-------

Report of Independent Registered Public Accounting Firm................ 56

Consolidated Balance Sheets at December 31, 2005 and 2004.............. 57

Consolidated Statements of Operations for the Twelve Months
Ended December 31, 2005 and 2004 and the
Eleven Months Ended December 31, 2003............................... 58

Consolidated Statements of Cash Flows for the Twelve Months
Ended December 31, 2005 and 2004 and the
Eleven Months Ended December 31, 2003............................... 59

Consolidated Statements of Changes in Stockholders' Equity from
Inception (January 30, 2003) to December 31, 2005................... 60

Notes to the Consolidated Financial Statements......................... 61

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors
National Coal Corp.
Knoxville, Tennessee

We have audited the consolidated balance sheets of National Coal Corp. (the
"Company," a Florida corporation) as of December 31, 2005 and 2004, and the
related consolidated statements of operations, cash flows and changes in
stockholders' equity for the years ended December 31, 2005 and 2004, and the
eleven month period from its inception (January 30, 2003) to December 31, 2003.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these 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. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of National Coal
Corp. at December 31, 2005 and 2004, and the consolidated results of its
operations and its cash flows for the years ended December 31, 2005 and 2004,
and the eleven month period from its inception to December 31, 2003, in
conformity with accounting principles generally accepted in the United States of
America.


Golden, Colorado
February 17, 2006


                                       56



                               NATIONAL COAL CORP.
                           CONSOLIDATED BALANCE SHEETS

                                                             DECEMBER 31,
                                                        2005            2004
                                                    ------------    ------------
ASSETS
Current assets
   Cash and cash equivalents ....................   $ 25,434,988    $    303,673
   Accounts receivable ..........................      2,929,735       2,091,698
   Inventory ....................................        360,614         264,873
   Other current assets .........................        274,591         230,735
                                                    ------------    ------------
      Total current assets ......................     28,999,928       2,890,980

Property, plant, equipment and mine
   development, net .............................     50,901,681      35,908,909

Deferred financing costs ........................      2,958,666         782,500
Restricted cash .................................      6,625,267       4,574,625
Other non-current assets ........................        921,876         393,500
                                                    ------------    ------------
      Total assets ..............................   $ 90,407,418    $ 44,550,513
                                                    ============    ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
   Current maturities of long-term debt .........      3,319,175         329,511
   Current installments of obligations under
      capital leases ............................        958,907       2,350,566
   Accounts payable and accrued expenses ........      6,390,626       4,131,596
                                                    ------------    ------------
      Total current liabilities .................     10,668,708       6,811,673

Long-term debt, less current maturities, net
   of discount ..................................     54,541,225      15,203,397
Obligations under capital leases, excluding
   current installments .........................      1,196,143       1,840,658
Asset retirement obligations ....................      7,228,232       2,093,759
Other noncurrent liabilities ....................        156,776            --
                                                    ------------    ------------
      Total liabilities .........................     73,791,084      25,949,487
                                                    ------------    ------------
Commitments and contingencies (Note 15)

Stockholders' equity
   Series A convertible preferred stock, $0.0001
      par value; 1,611 shares authorized;
      1,333.44 and 1,456.67 shares issued and
      outstanding at December 31, 2005 and 2004,
      respectively ..............................           --              --
   Common stock, $0.0001 par value, 80 million
      shares authorized; 13,977,217 and
      13,391,344 shares issued and outstanding
      at December 31, 2005 and 2004, respectively          1,398           1,300
   Additional paid-in-capital ...................     37,168,122      32,361,740
   Accumulated deficit ..........................    (20,553,186)    (13,762,015)
                                                    ------------    ------------
      Total stockholders' equity ................     16,616,334      18,601,026
                                                    ------------    ------------
      Total liabilities and stockholders' equity    $ 90,407,418    $ 44,550,513
                                                    ============    ============


The  accompanying  notes are an integral  part of these  consolidated  financial
statements.


                                       57



                               NATIONAL COAL CORP.
                      CONSOLIDATED STATEMENTS OF OPERATIONS

                                                                                ELEVEN MONTHS
                                                           YEAR ENDED               ENDED
                                                          DECEMBER 31,           DECEMBER 31,
                                                     2005            2004            2003
                                                 ------------    ------------    ------------
Revenues
   Coal sales ................................   $ 65,258,071    $ 16,871,346    $  1,012,520
   Other revenues ............................        614,563         127,567         178,123
                                                 ------------    ------------    ------------
      Total revenues .........................     65,872,634      16,998,912       1,190,643
                                                 ------------    ------------    ------------

Expenses
   Cost of sales .............................     51,115,116      16,322,632       1,737,937
   Depreciation, depletion, and amortization .     10,107,723       2,473,369         617,155
   General and administrative ................      7,213,346       5,242,437       1,871,414
                                                 ------------    ------------    ------------
      Total operating expenses ...............     68,436,185      24,038,438       4,226,506
                                                 ------------    ------------    ------------

Operating loss ...............................     (2,563,551)     (7,039,526)     (3,035,863)
                                                 ------------    ------------    ------------

Other income (expense)
   Interest income (expense) .................     (3,966,715)     (3,348,922)         75,437
   Other income (expense), net ...............       (260,905)        (40,682)       (372,459)
                                                 ------------    ------------    ------------
      Total other income (expense) ...........     (4,227,620)     (3,389,604)       (297,022)
                                                 ------------    ------------    ------------

Net (loss) ...................................     (6,791,171)    (10,429,130)     (3,332,885)

Preferred stock dividend .....................     (1,124,650)    (18,893,509)           --
                                                 ------------    ------------    ------------

Net (loss) attributable to common shareholders   $ (7,915,821)   $(29,322,639)   $ (3,332,885)
                                                 ============    ============    ============

Basic net (loss) per common share ............   $      (0.58)   $      (2.60)   $      (0.36)
                                                 ============    ============    ============

Diluted net (loss) per common share ..........   $      (0.58)   $      (2.60)   $      (0.36)
                                                 ============    ============    ============

Weighted average common shares ...............     13,712,813      11,261,800       9,137,630


The  accompanying  notes are an integral  part of these  consolidated  financial
statements.


                                       58



                               NATIONAL COAL CORP.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS


                                                                                   ELEVEN MONTHS
                                                        TWELVE MONTHS ENDED            ENDED
                                                            DECEMBER 31,            DECEMBER 31,
                                                        2005            2004            2003
                                                    ------------    ------------    ------------
Cash Flows from Operating Activities
Net (loss) ......................................   $ (6,791,171)   $(10,429,130)   $ (3,332,885)
Adjustments to reconcile net (loss) to net
cash provided by operating activites
   Depreciation, depletion, accretion and
      amortization ..............................     10,107,723       2,261,379         617,155
   Loss on disposal of assets ...................         29,991            --              --
   Loss on extinguishment of debt ...............        406,666            --              --
   Gain on extinguishment of debt ...............       (348,286)
   Beneficial conversion feature recorded as
      interest expense ..........................           --         1,700,000            --
   Issuance of stock/warrants in lieu of payment            --           440,647         153,500
   Stock option expense .........................        812,733         903,375            --
   Non-cash compensation ........................           --              --           191,000
   Changes in operating assets and liabilites:
   (Increase) in accounts receivable ............       (838,037)     (1,899,407)        (19,327)
   (Increase) in inventory ......................        (95,741)       (119,010)       (145,863)
   (Increase) in prepaid and other ..............       (388,232)       (233,502)        (15,197)
   Increase in accounts payable and accrued .....      2,259,030       3,299,551         831,158
   Increase (decrease) in deferred revenue ......           --          (179,050)        179,050
   Increase in other liabilites .................        156,776            --              --
   Settlement of asset retirement obligations ...       (349,950)        (87,090)           --
                                                    ------------    ------------    ------------
      Net cash flows provided by (used in)
         operating activities ...................      4,961,502      (4,342,237)     (1,541,409)
                                                    ------------    ------------    ------------

Cash Flows from Investing Activities
Capital expenditures ............................    (19,270,230)    (28,600,061)     (1,733,379)
(Increase) in restricted cash ...................     (2,050,642)     (4,317,125)       (257,500)
Deposits and prepaid royalties ..................       (184,000)       (548,500)           --
                                                    ------------    ------------    ------------
Net cash flows (used in) investing activities ...    (21,504,872)    (33,465,686)     (1,990,879)
                                                    ------------    ------------    ------------

Cash Flows from Financing Activities
   Proceeds from issuance of stock ..............             98      16,616,317         287,500
   Proceeds from exercise of warrants and options        792,779       1,109,001            --
   Proceeds from issuance of notes ..............     70,322,343      26,242,894       3,662,591
   Proceeds from capital leases .................      2,729,366            --              --
   Repayments of notes payable ..................    (23,388,017)     (3,255,301)       (226,500)
   Repayments of capital leases .................     (4,765,540)       (735,657)       (317,112)
   Deferred financing costs .....................     (2,958,666)     (1,025,424)       (412,235)
   Dividends paid ...............................     (1,057,678)       (281,117)           --
   Proceeds from (payment of) related party debt            --          (560,000)        560,000
   Repurchase and cancellation of common stock ..           --              --           (21,073)
                                                    ------------    ------------    ------------
      Net cash flows provided by financing
         activities .............................     41,674,685      38,110,713       3,533,171
                                                    ------------    ------------    ------------

NET INCREASE IN CASH ............................     25,131,315         302,790             883
Cash and Cash Equivalents at Beginning of Period         303,673             883            --
                                                    ------------    ------------    ------------
Cash and Cash Equivalents at End of Period ......   $ 25,434,988    $    303,673    $        883
                                                    ============    ============    ============

Supplemental Cash Flow Information
   Cash paid during the period for interest .....   $  2,825,233    $  1,190,735    $    270,862
Non-cash investing and financing:
   Issuance of stock for goods and services .....   $       --      $    577,573    $       --
   Conversion of debt ...........................           --        12,983,216            --
   Conversion of preferred dividends ............         18,198            --              --
   Beneficial conversion feature ................         66,972      18,612,392            --
   Constructive dividends .......................        (66,972)    (18,612,392)           --
   Issuance of warrants .........................      4,258,548          48,760            --



The  accompanying  notes are an integral  part of these  consolidated  financial
statements.


                                       59



                               NATIONAL COAL CORP.
           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY


                                        Preferred Stock             Common Stock            Additional
                                      --------------------  ----------------------------      Paid-in     Accumulated
                                       Shares      Amount      Shares          Amount         Capital       Deficit          Total
                                      --------    --------  ------------    ------------   ------------   ------------   ------------

Inception, January 30, 2003 .......       --      $   --            --      $       --     $       --     $       --     $       --
Reorganization April 2003
    Net liabilites of the Company .       --          --         471,844              47        177,176       (191,235)       (14,012)
    Issuance of shares to NCC (TN)
    shareholders for cash ($17,500)
    and services ($153,500) .......       --          --       8,549,975             855        (21,090)       191,235        171,000
Sale of stock for cash ............       --          --         337,500              34        269,966           --          270,000
Repurchase and cancellation .......       --          --        (105,363)            (10)       (21,062)          --          (21,072)
Net (loss) ........................       --          --            --              --             --       (3,332,885)    (3,332,885)
                                      --------    --------  ------------    ------------   ------------   ------------   ------------
Balance, December 31, 2003 ........       --          --       9,253,956             926        404,990     (3,332,885)    (2,926,969)


Conversion of notes payable and
    accrued interest ..............       --          --       1,769,897             177      3,558,039           --        3,558,216
Private placement of common stock .       --          --       1,250,000             125      2,749,875           --        2,750,000
Issuance for accrued officer salary       --          --          41,958               4        226,569           --          226,573
Issuance to acquire land ..........       --          --          75,000               7        350,993           --          351,000
Exercie of warrants ...............       --          --         867,200              48      1,108,953           --        1,109,001
Sale of preferred stock ...........     995.00        --            --              --       14,925,000           --       14,925,000
Conversion of debt ................     515.00        --            --              --        7,725,000           --        7,725,000
Preferred stock issuance costs ....       --          --            --              --       (1,058,683)          --       (1,058,683)
Conversion of preferred stock .....     (53.33)       --         133,333              13            (13)          --             --
Employee option expense ...........       --          --            --              --          903,375           --          903,375
Issuance of warrants for services .       --          --            --              --           48,760           --           48,760
Beneficial conversion debt discount       --          --            --              --        1,700,000           --        1,700,000
Beneficial conversion features ....       --          --            --              --       18,612,392           --       18,612,392
Contructive dividends .............       --          --            --              --      (18,612,392)          --      (18,612,392)
Preferred stock dividends .........       --          --            --              --         (281,117)          --         (281,117)
Net (loss) ........................       --          --            --              --             --      (10,429,130)   (10,429,130)
                                      --------    --------  ------------    ------------   ------------   ------------   ------------
Balance, December 31, 2004 ........   1,456.67        --      13,391,344           1,300     32,361,741    (13,762,015)    18,601,026


Exercise of warrants ..............      16.21        --            --              --          243,600           --          243,600
Conversion of preferred stock .....    (139.44)       --         349,429              75            (75)          --             --
Conversion of preferred dividends .       --          --           2,204            --           18,198           --           18,198
Beneficial conversion feature .....       --          --            --              --           66,972           --           66,972
Constructive dividend .............       --          --            --              --          (66,972)          --          (66,972)
Preferred stock dividends .........       --          --            --              --       (1,057,678)          --       (1,057,678)
Exercise of employee options ......       --          --         234,240              23        531,055           --          531,078
Employee option expense ...........       --          --            --              --          812,733           --          812,733
Issuance of warrants ..............       --          --            --              --        4,258,548           --        4,258,548
Net (loss) ........................       --          --            --              --             --       (6,791,171)    (6,791,171)
                                      --------    --------  ------------    ------------   ------------   ------------   ------------
Balance, December 31, 2005 ........   1,333.44    $   --      13,977,217    $      1,398   $ 37,168,122   $(20,553,186)  $ 16,616,334
                                      ========    ========  ============    ============   ============   ============   ============


The  accompanying  notes are an integral  part of these  consolidated  financial
statements.


                                       60



                               NATIONAL COAL CORP.

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

1.       BUSINESS OVERVIEW

         National Coal Corp. (the "Company") principally engages in the business
of mining high quality  bituminous steam coal in East Tennessee and Southeastern
Kentucky.  Its customers are electric  utilities and industrial  concerns in the
surrounding states.

         The Company owns the coal mineral rights to approximately  seventy-four
thousand  six  hundred   (74,600)  acres  of  land  and  leases  the  rights  to
approximately forty thousand nine hundred (40,900)  additional acres.  Currently
active mining complexes include three underground  mines, two surface mines, and
one highwall mine. Active support  facilities include two preparation plants and
two train loading  facilities.

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

         The accompanying  financial  statements reflect the Company's financial
position and results of operations on a  consolidated  basis.  All  intercompany
transactions and balances have been eliminated in consolidation.

USE OF ESTIMATES

         The  preparation of financial  statements in conformity with accounting
principles   generally  accepted  in  the  United  States  of  America  requires
management  to make  estimates,  judgments,  and  assumptions  that  affect  the
reported amounts and related disclosures of assets,  liabilities,  revenues, and
expenses at the date of the financial statements and for the periods then ended.
On an on-going basis,  management  evaluates the estimates used, including those
related to workers' compensation, reclamation and mine closure obligations, coal
reserve  values,  income  taxes,  and  contingencies.  Estimates  are  based  on
historical  experience,  actuarial  estimates,  current conditions,  and various
other   assumptions  that  management   believes  to  be  reasonable  under  the
circumstances. Actual results may differ from these estimates.

RECLASSIFICATIONS

         Certain  prior year  amounts have been  reclassified  to conform to the
current year's presentation.

CASH AND CASH EQUIVALENTS

         Cash and cash equivalents are stated at cost. Cash equivalents  consist
of  highly  liquid  investments  with  maturities  of three  months or less when
acquired.

ACCOUNTS RECEIVABLE

         Trade accounts  receivable  are recorded at the invoiced  amount and do
not bear interest.  Customers are primarily  quasi-governmental  agencies.  As a
result,  the Company has not  experienced  any instances of non-payment and does
not currently maintain an allowance for doubtful accounts.  Management  monitors
customers  closely and will record an allowance if trade account balances become
potentially uncollectible.


                                       61



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


INVENTORY

         Inventory  includes  mined coal  available  for delivery to  customers,
mined coal which has not yet been processed  through a wash plant, and purchased
coal.  Mined  coal  inventory  is  valued at the  lower of  average  cost or net
realizable value. Coal inventory costs include labor, fuel, equipment costs, and
operating  overhead.  Coal  is  classified  as  inventory  at  the  point  it is
extracted.  Purchased  coal  inventory  is  valued  at the  lower of cost or net
realizable value.


PROPERTY, PLANT, EQUIPMENT AND MINE DEVELOPMENT

         Property and equipment are stated at cost. Maintenance and repairs that
do not improve  efficiency  or extend  economic  life are  expensed as incurred.
Plant and  equipment are  depreciated  using the  straight-line  method over the
estimated  useful  lives of assets  which  generally  range from seven to thirty
years for  building  and plant and one to five years for  equipment.  On sale or
retirement, asset cost and related accumulated depreciation are removed from the
accounts and any related gain or loss is reflected in income.

         Leasing is used for certain  capital  additions  when  considered  cost
effective  relative to other  capital  sources.  All leases with an initial term
greater  than one year are  accounted  for under  SFAS No.  13,  ACCOUNTING  FOR
LEASES.   These  leases  are  classified  as  either  capital  or  operating  as
appropriate.  Leased equipment meeting the capital lease criteria of SFAS No. 13
is  capitalized  and the present value of the related lease payments is recorded
as a liability.  Amortization  of  capitalized  leased assets is computed on the
straight-line  method  over the  shorter  of the  estimated  useful  life or the
initial lease term.

         The Company  periodically  reviews the  estimated  useful  lives of its
fixed assets.  During the second quarter of 2005, this review indicated that the
estimated useful lives for certain asset categories were generally determined to
be less than those employed in calculating  depreciation  expense.  As a result,
the Company  revised the  estimated  useful lives of mining  equipment as of the
beginning  of the second  quarter.  The effect of this  revision was to increase
depreciation   expense  and  the  net  loss  by   approximately   $3,600,000  or
approximately ($0.26) per share for the year ended December 31, 2005.

         Reserves  and mine  development  costs are  recorded at cost or at fair
value in the case of  acquired  businesses.  The  Company's  coal  reserves  are
controlled either through direct ownership or through leasing arrangements which
generally  last  until the  recoverable  reserves  are  depleted.  Depletion  of
reserves  and  amortization  of mine  development  costs is  computed  using the
units-of-production method over the estimated recoverable tons. Costs related to
locating  coal  deposits and  determining  the  extractive  feasibility  of such
deposits are expensed as incurred.

         The Company reviews its long-lived assets for impairment when events or
changes in circumstances indicate that the carrying amount of the assets may not
be recoverable. If impairment indicators are present and the future undiscounted
cash flows are less than the carrying value of the assets,  the carrying  values
are reduced to the estimated fair value.

DEFERRED FINANCING COSTS

         The Company had deferred  financing costs of  approximately  $2,959,000
and approximately $782,000 at December 31, 2005 and 2004, respectively. Deferred
financing costs represent  capitalized  expenses associated with the issuance of
debt.  Deferred  financing  costs are amortized by the interest  method over the
life the  associated  debt.  The Company  recorded  approximately  $381,000  and
$243,000 of amortization  related to deferred  financing costs in 2005 and 2004,
respectively.


                                       62



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


RESTRICTED CASH

         Restricted   cash  at  December  31,  2005   represents   approximately
$6,143,000 in certificates of deposit supporting  irrevocable  letters of credit
written  in favor of the U.S.  Department  of the  Interior,  Office of  Surface
Mining  (the "OSM") for  reclamation  bonds,  approximately  $257,000 on deposit
directly  with the OSM, and  approximately  $225,000 in utility and  performance
bonds. Restricted cash at December 31, 2004 represents  approximately $4,270,000
in certificates of deposit supporting  irrevocable  letters of credit written in
favor  of the OSM for  reclamation  bonds,  approximately  $257,000  on  deposit
directly with the OSM, and approximately $48,000 in utility bonds.

PREPAID MINING ROYALTIES

         Coal leases  requiring  minimum or advance  payments  are  deferred and
charged to cost of sales as coal is extracted. The Company had prepaid royalties
of  approximately  $208,000  and  $392,000  at  December  31,  2005,  and  2004,
respectively, included in other non-current assets.

RECLAMATION AND ASSET RETIREMENT OBLIGATIONS

         The  Surface  Mining  Control and  Reclamation  Act of 1977 and similar
state  statutes  require  mine  properties  to be  restored in  accordance  with
specified standards.  Statement of Financial Accounting Standards No. 143 ("SFAS
No. 143") requires  recognition of an asset  retirement  obligation  ("ARO") for
eventual  reclamation  of  disturbed  acreage  remaining  after  mining has been
completed.  The Company  records its reclamation  obligations  based upon permit
requirements as determined by the OSM. A liability is recorded for the estimated
future cost that a third party would incur to perform the  required  reclamation
and mine closure discounted at the Company's  credit-adjusted  risk-free rate. A
corresponding increase in the asset carrying value of coal and mineral rights is
also recorded. The ARO asset is amortized on the units-of-production method over
the  estimated  recoverable  reserves  and the ARO  liability is accreted to the
expected reclamation date at the Company's credit-adjusted risk-free rate.

STOCK-BASED COMPENSATION

         The Company accounts for stock-based compensation under the recognition
and  measurement  principles  of  Accounting  Principles  Board  Opinion No. 25,
ACCOUNTING  FOR STOCK ISSUED TO  EMPLOYEES,  which  requires  that  compensation
expense be recognized for stock options with an exercise price that is less than
the  market  value of the  underlying  common  stock on the date of  grant.  The
Company  has  implemented  the  disclosure-only  provisions  of  SFAS  No.  123,
ACCOUNTING FOR STOCK-BASED COMPENSATION, ("SFAS No. 123") which requires the pro
forma disclosure of net income and earnings per share as if the fair value based
accounting method had been used to account for stock-based compensation cost.

         Compensation  costs  recorded in relation to the  issuance of 1,237,500
options  granted to directors and officers in March 2004 with an exercise  price
less than the  market  value of the  Company's  stock on the date of grant  were
approximately $813,000 and $903,000 for 2005 and 2004, respectively.

         If the  Company had adopted  the fair value  method of  accounting  for
stock-based compensation under SFAS No. 123, compensation costs which would have
been  recognized  and pro forma net income and earning per share for the periods
ending December 31 would have been as follows:


                                       63



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


                                                2005            2004             2003
                                           --------------  --------------   --------------
Net income (loss) attributable to common
shareholders, as reported ...............  $   (7,915,821) $  (29,322,639)  $   (3,332,885)
   Add: Stock-based compensation expense
   recognized under the intrinsic method          812,733         903,000             --
   Deduct: Total stock-based compensation
   expense for stock options determined
   under the Black-Scholes option pricing
   model ................................      (1,564,371)     (1,283,927)            --
                                           --------------  --------------   --------------
Pro forma net income (loss) .............  $   (8,667,459) $  (29,703,566)  $   (3,332,885)
                                           ==============  ==============   ==============

Income (loss) per share:
Basic - as reported .....................  $        (0.58) $        (2.60)  $        (0.36)
Basic - pro forma .......................  $        (0.63) $        (2.64)  $        (0.36)
Diluted - as reported ...................  $        (0.58) $        (2.60)  $        (0.36)
Diluted - pro forma .....................  $        (0.63) $        (2.64)  $        (0.36)


WORKERS' COMPENSATION

         The Company provides for income  replacement and medical  treatment for
work  related  injury and  occupational  disease  resulting  from coal  workers'
pneumoconiosis  (Black  Lung  Disease),  as  required  by federal and state law,
through insurance  policies with high deductibles.  Loss funding  provisions for
deductibles  are based on  determinations  by  independent  actuaries  or claims
administrators.

REVENUE RECOGNITION

         The Company  recognizes revenue when title and risk of loss pass to the
customer.  This  generally  occurs when coal is loaded onto trains at one of our
loading  facilities.  In most cases,  the Company  negotiates  a specific  sales
contract with each customer, which specifies a fixed price per ton, premiums and
penalties  for  quality  variances,  a delivery  schedule,  and  payment  terms.
Contracts range in duration from one to three years.

         Revenue  is also  earned  from  charging  TIPPLING  fees to other  coal
producers to use the Company's loading facilities in Kentucky and from royalties
based on coal mined by lessees.

INCOME TAXES

         The Company  recognizes  deferred  tax assets and  liabilities  for the
future tax  consequences  attributable  to  differences  between  the  financial
statement  carrying  amounts  of  existing  assets  and  liabilities  and  their
respective tax bases in accordance  with FASB Statement of Financial  Accounting
Standards  No. 109,  "Accounting  for Income  Taxes".  A valuation  allowance is
provided  when it is more likely than not that some portion or all of a deferred
tax asset will not be realized.  The ultimate realization of deferred tax assets
depends on the  generation of future  taxable  income during the period in which
related  temporary  differences  become  deductible.  Management  considers  the
scheduled reversal of deferred tax liabilities,  projected future taxable income
and tax  planning  strategies  in  this  assessment.  Deferred  tax  assets  and
liabilities  are  measured  using the  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


                                       64



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


effect  on  deferred  tax  assets  and  liabilities  of a change in tax rates is
recognized  in income in the period that  includes  the  enactment  date of such
change.

RECENT ACCOUNTING PRONOUNCEMENTS

         In November 2004, the Financial Accounting Standards Board (the "FASB")
issued Statement No. 151, INVENTORY COSTS AN AMENDMENT OF ARB NO. 43, CHAPTER 4,
which  revised  ARB No.43,  relating to  inventory  costs.  This  revision is to
clarify the accounting for abnormal amounts of idle facility  expense,  freight,
handling costs and wasted  material  (spoilage).  This  Statement  requires that
these items be recognized as a current period charge  regardless of whether they
meet the criterion specified in ARB 43. In addition, this Statement requires the
allocation of fixed production  overheads to the costs of conversion be based on
normal  capacity of the production  facilities.  This Statement is effective for
financial  statements for fiscal years  beginning  after June 15, 2005.  Earlier
application  is permitted  for  inventory  costs  incurred  during  fiscal years
beginning  after the date this  Statement is issued.  Management  believes  this
Statement  will have no impact on the  financial  statements of the Company once
adopted.

         In December  2004,  the FASB issued  Statement of Financial  Accounting
Standards No. 123 (revised 2005), SHARE-BASED PAYMENT, ("SFAS No. 123(R)") which
amends FASB Statement Nos. 123 and 95. SFAS No. 123(R) requires all companies to
measure compensation cost for all share-based payments, including employee stock
options,  at fair value and is effective for interim or annual periods beginning
after December 15, 2005. The Company will adopt this standard  effective January
1, 2006 and will elect the modified prospective  application  transition method.
Under the modified prospective  application  transition method,  awards that are
granted, modified,  repurchased,  or cancelled after the date of adoption should
be measured and  accounted  for in  accordance  with the  provisions of SFAS No.
123(R).  Awards  granted  prior to the  effective  date  should  continue  to be
accounted  for in  accordance  with  the  provisions  of SFAS  No.  123 with the
exception  that  compensation  expense  related  to  unvested  options  must  be
recognized in the income statement based on the fair value of the options on the
date of grant.  SFAS No. 123(R) also requires the benefits of tax  deductions in
excess of recognized  compensation cost to be reported as a financing cash flow,
rather than as an operating cash flow as required under current literature. This
requirement will reduce net operating cash flows and increase net financing cash
flows in periods after adoption. The Company expects adoption of the standard to
reduce fiscal 2006 net income by an amount  consistent with amounts shown in pro
forma disclosures at Note 15, STOCK-BASED COMPENSATION PLANS.

         In December  2004,  the FASB issued  Statement  No. 153,  EXCHANGES  OF
NONMONETARY ASSETS AN AMENDMENT OF APB OPINION NO. 29. This Statement  addresses
the measurement of exchanges of nonmonetary  assets. The guidance in APB Opinion
No. 29, ACCOUNTING FOR NONMONETARY TRANSACTIONS,  is based on the principle that
exchanges of  nonmonetary  assets should be measured  based on the fair value of
the assets exchanged.  The guidance in that Opinion,  however,  included certain
exceptions to that principle.  This Statement amends Opinion No. 29 to eliminate
the  exception  for  nonmonetary  exchanges  of  similar  productive  assets and
replaces it with a general exception for exchanges of nonmonetary assets that do
not have commercial  substance.  A nonmonetary exchange has commercial substance
if the future cash flows of the entity are expected to change significantly as a
result of the exchange. This Statement is effective for financial statements for
fiscal years beginning after June 15, 2005. Earlier application is permitted for
nonmonetary  asset  exchanges  incurred  during fiscal years beginning after the
date of this Statement is issued.  Management  believes this Statement will have
no impact on the financial statements of the Company once adopted.

         In March  2005,  the FASB  issued  Interpretation  No.  47 ("FIN  47"),
ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT OBLIGATIONS, which clarifies that an
entity is required to recognize a liability  for the fair value of a conditional
asset  retirement  obligation when incurred if the liability's fair value can be


                                       65



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


reasonably estimated.  A conditional asset retirement obligation is defined as a
legal  obligation to perform asset  retirement  activity in which the timing and
(or) method of settlement are  conditional on a future event that may or may not
be within the control of the entity.  FIN 47 is  effective no later than the end
of fiscal  years  ending  after  December  15,  2005.  Adoption of FIN 47 by the
Company will not result in a change to current practice.

         At its March 30, 2005 meeting,  the FASB ratified the consensus reached
by the Emerging  Issues Task Force ("EITF") in Issue No. 04-6,  "ACCOUNTING  FOR
STRIPPING COSTS INCURRED DURING  PRODUCTION IN THE MINING  INDUSTRY."  Issue No.
04-6  requires  that the costs of removing  overburden  and waste  materials  to
access mineral deposits during the production phase of a mine, commonly referred
to as STRIPPING COSTS, be included in the costs of the inventory produced.  EITF
Issue No.  04-6 is  effective  for the  first  fiscal  period  in  fiscal  years
beginning  after December 15, 2005, with early adoption  permitted.  The Company
has elected to adopt the Issue effective  January 1, 2006.  Management  believes
this EITF will have no impact on the  financial  statements  of the Company once
adopted.

         In  May  2005,  the  FASB  issued  Statement  of  Financial  Accounting
Standards No. 154, ACCOUNTING CHANGES AND ERROR CORRECTIONS A REPLACEMENT OF APB
OPINION NO. 20 AND FASB STATEMENT NO. 3, which changes the  requirements for the
accounting for and reporting of a change in accounting principle. This Statement
requires  retrospective  application to prior periods'  financial  statements of
changes in accounting  principle,  unless it is  impracticable  to determine the
period-specific  effects  or  the  cumulative  effect  of  change.  When  it  is
impracticable to determine the  period-specific  effects of an accounting change
on one or more individual prior periods presented,  this Statement requires that
the  new  accounting  principle  be  applied  to  the  balances  of  assets  and
liabilities as of the beginning of the earliest  period for which  retrospective
application is practicable  and that a  corresponding  adjustment be made to the
opening balance of retained  earnings for that period rather than being reported
in the income statement.  Management  believe this Statement will have no impact
on the financial statements of the Company once adopted.

3.       PROPERTY, PLANT, EQUIPMENT AND MINE DEVELOPMENT

         Property,  plant,  equipment and mine  development at December 31 is as
follows:

                                                     2005              2004
                                                 ------------      ------------
Furniture and office equipment .............     $    220,663      $    123,991
Mining equipment and vehicles ..............       36,509,990        16,935,087
Land and buildings .........................        6,721,858         6,650,285
Mine development ...........................       18,311,553        14,047,227
                                                 ------------      ------------
   Total property, plant, equipment
      and mine development .................       61,764,064        37,756,590

Less accumulated depreciation,
   depletion and amortization ..............      (10,862,383)       (1,847,681)
                                                 ------------      ------------
   Property, plant, equipment and
      mine development, net ................     $ 50,901,681      $ 35,908,909
                                                 ============      ============

         Depreciation,  depletion and  amortization  expense for the years ended
December  31,  2005 and 2004,  was  approximately  $10,108,000  and  $2,473,000,
respectively.

         Mining equipment includes  approximately  $11,440,000 and $4,470,000 of
gross assets under capital leases at December 31, 2005 and 2004, respectively.


                                       66



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


4.       OTHER NON-CURRENT ASSETS

         Other non-current assets at December 31 include:

                                                    2005         2004
                                                  --------     --------
         Deposits and prepaid royalties .....     $225,820     $393,500
         Workers' compensation loss fund ....      696,056         --
                                                  --------     --------
         Total other non-current assets .....     $921,876     $393,500
                                                  ========     ========

5.       ACCOUNTS PAYABLE AND ACCRUED EXPENSES

         Accounts payable and accrued expenses at December 31 are as follows:

                                                          2005         2004
                                                       ----------   ----------
         Accounts payable ..........................   $4,409,005   $3,029,298
         Accrued payroll and related taxes .........      383,642      272,269
         Accrued interest ..........................       47,466         --
         Accrued insurance premiums ................      789,810      475,826
         Royalty obligations .......................      204,433       54,203
         Accrued federal, state and local taxes ....      556,270      300,000
                                                       ----------   ----------
         Total accounts payable and accrued expenses   $6,390,626   $4,131,596
                                                       ==========   ==========

6.       DEBT AND FINANCING ARRANGEMENTS

              SENIOR SECURED PROMISSORY NOTES AND WARRANTS

         In April and May 2004,  the Company sold one-year  promissory  notes in
the  aggregate  principal  amount of $7.5  million with  three-year  warrants to
purchase up to an aggregate of 625,000 shares of its common stock at an exercise
price of $4.00 per share.  The Company sold these  securities  to  institutional
investors and individual accredited  investors,  with the largest investor being
Crestview Capital Master, LLC, for aggregate proceeds of $7.5 million. In August
2004,  certain holders of this debt agreed to cancel $4.725 million of principle
in exchange for the Company's  Series A  convertible  preferred  stock,  and the
Company repaid the remaining $2.775 million from the proceeds raised pursuant to
the issuance of additional  shares of Series A convertible  preferred  stock and
retired the debt.

              CONVERTIBLE PROMISSORY NOTES

         On August 31,  2004,  the  Company  issued  $3,000,000  of  convertible
promissory  notes to Crestview  Capital  Master,  LLC, an entity  controlled  by
Crestview  Capital Funds and SDS Capital Group SPC, Ltd. Prior to maturity,  the
promissory  notes may be converted into units consisting of the Company's Series
A convertible  preferred stock and common stock purchase  warrants at a price of
$15,000  per unit.  Each  unit  consists  of one  share of Series A  convertible
preferred  stock and  two-year  warrants  to purchase up to 500 shares of common
stock at an exercise price of $8.40 per share.  In December 2004, both Crestview
and SDS exercised their rights and converted their  respective  promissory notes
into units of the Series A convertible preferred stock and common stock purchase
warrants. On August 31, 2004, the closing price of the Company's common stock on
the NASDAQ  Over-the-Counter


                                       67



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


Bulletin Board exceeded the $6.00 per share common stock conversion price of the
promissory notes. Accordingly, the Company recorded a beneficial conversion debt
discount  of $1.7  million  for the  issuance  of the debt  below fair value and
commenced  amortization  over the nine-month term of the notes. The amortization
of the debt discount is recorded as interest expense. When the $3.0 million debt
was  converted to preferred  stock in December  2004,  the Company  expensed the
remaining  discount,  thus  recognizing  a total  of $1.7  million  of  non-cash
interest expense during 2004.

              SENIOR SECURED CREDIT FACILITY

         On November 26, 2004, the Company's Tennessee subsidiary, National Coal
Corporation,  in  connection  with its  acquisition  of assets from  Appalachian
Fuels,   LLC,  entered  into  a  credit  agreement  with  D.  B.  Zwirn  Special
Opportunities  Fund, L.P., as Lender and  administrative  agent for the Lenders.
The  Company  and  its  subsidiary,  NC  Transportation,  Inc.,  a  wholly-owned
subsidiary of the Tennessee corporation,  guaranteed the obligations of National
Coal Corporation under the credit agreement.  The credit agreement  provides for
an initial credit  facility of $15 million with a subsequent  additional  credit
facility not to exceed $6 million. The Company exercised its right to borrow $15
million  on  November  29,  2004,  the  proceeds  of which  were used to pay the
remaining  $12,250,000 of acquisition costs related to the acquisition of assets
of Appalachian  Fuels, LLC, pay transaction costs with respect to the closing of
the credit facility and asset purchase,  and fund working  capital.  The Company
borrowed an additional  $1.4 million in January 2005 to fund its  acquisition of
mining  equipment.  Borrowings  under the credit  agreement bear interest at the
prime rate plus 5.75%.  On December  29,  2005,  we repaid and  terminated  this
credit  facility  resulting  in  the  write-off  of  approximately  $407,000  of
remaining deferred financing costs.

              BANK LOAN

         In July 2004, the Company borrowed approximately $663,300 on a 24-month
term and an  interest  rate of 7.25% from a local bank.  Proceeds  from the loan
were used to purchase mining and other vehicles. The remaining principal balance
of the loan was repaid on December 29, 2005.

              NOTE PAYABLE

         In January 2005, the Company signed an agreement committing the Company
to the purchase of a highwall miner for a total purchase price of  approximately
$5,500,000,  and paid a $500,000  deposit  toward that purchase  commitment.  In
March 2005, the Company borrowed  approximately  $5,140,000  pursuant to certain
note and warrant  purchase  agreements and completed the purchase of this mining
equipment.  The  Company  issued  notes in the  aggregate  principal  amount  of
approximately  $5,140,000  to  three  purchasers,  including  Crestview  Capital
Master,  LLC. The notes had an original  maturity date of August 10, 2005,  were
secured by the highwall  miner,  and have an interest  rate of eighteen  percent
(18%).  The Company paid an origination fee of  approximately  $200,000 upon the
execution of the loan document.  The note purchasers were also issued  five-year
common stock purchase warrants to purchase up to 140,000 shares of the Company's
common stock at an exercise  price per share of $8.50.  The notes were repaid on
December 29, 2005.

              INSTALLMENT PURCHASE OBLIGATIONS

         In August 2005, the Company's  wholly-owned  subsidiary,  National Coal
Corporation,   entered  into   installment  sale  contracts  with  an  equipment
manufacturer,   effective  in  July  2005,   pursuant  to  which  National  Coal
Corporation purchased, and financed or refinanced, certain equipment used in its
coal mining operations.  Pursuant to the installment sale contracts, the Company
financed or refinanced  approximately $7.3 million in equipment at the following
rates with respect to the following amounts:


                                       68



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


                Annual Percentage Rate           Financed Amount
               ----------------------           ---------------
                        5.22%                       $  879,010
                        6.11%                        4,967,673
                        7.65%                          870,967
                                                ---------------
                        Total                       $6,717,650
                                                ===============

         The total  $6,717,650  principal  balance of these  contracts  includes
refinancing   obligations  previously  under  capital  leases  of  approximately
$2,937,000  at  June  30,  2005  representing   gross  assets  of  approximately
$4,372,000.  This  resulted  in  the  recognition  of a  gain  of  approximately
$328,000.  The  remaining  $3,781,000  is related to the  purchase of  equipment
formerly under operating lease and new equipment. The installment sale contracts
require monthly payments of principal and interest through January 14, 2008. The
obligations  under the  installment  sale contracts are secured by the equipment
purchased.

              EQUIPMENT NOTES

         In November 2005, the Company  purchased mining equipment to be used in
the Company's Kentucky  operations from two former contract mining companies for
approximately  $1,775,000.  The Company  financed the purchase  with a $400,000,
four month, non-interest bearing note payable to one of the mining companies and
a $1,300,000,  twenty-four  month note at the prime rate plus 1%. Both notes are
secured by the  purchased  equipment.  The  $400,000  note was  repaid  early in
January  2006 at a $20,000  discount  from the then  outstanding  obligation  of
$300,000.

              10.5% SENIOR SECURED NOTES DUE 2010

         On December 29, 2005,  the Company  issued  $55,000,000 of 10.5% Senior
Secured Notes.  The issue consisted of 55,000 units due 2010 and 55,000 warrants
to purchase a total of 1,732,632 shares of the Company's common stock. Each Unit
consists of one $1,000 principal amount note and one warrant, which entitles the
holder to purchase 31.5024 shares of Company's common stock at an exercise price
of $8.50 per share, subject to adjustment. The warrants are subject to mandatory
conversion if the price the Company's common stock remains above $12.50 for more
than thirty days. The warrants will be exercisable at any time on or after their
first  anniversary date and will expire on December 15, 2010. The estimated fair
value  of  the  warrants,   determined  using  the   Black-Scholes   model,  was
approximately  $3,911,000.  Net  proceeds  from  this  sale  were  approximately
$52,100,000.  The Company  immediately  used  approximately  $22,100,000  of the
proceeds to repay existing indebtedness.  The remaining proceeds will be used to
collateralize  reclamation  bonds for new mining  operations  and for  equipment
acquisitions.

         The indenture  allows the Company to incur a first lien credit facility
in  the  amount  of  $10.0  million  but  restricts  the  Company  from  further
indebtedness unless certain fixed charge coverage ratios are maintained on a pro
forma basis. To incur additional indebtedness, the Company must maintain a fixed
charge coverage ratio of 2.0 to 1 for the first year of the notes, 2.25 to 1 for
the second year, and 2.5 to 1 for the remaining term of the notes. The indenture
also restricts payment of dividends on the Company's common stock.

         In connection with the December 29, 2005 issuance of notes, the Company
entered  into a separate  registration  rights  agreement  with the  purchasers.
Pursuant to the separate  registration  rights agreement,  the Company agreed to
file an exchange  offer  registration  statement  registering  the resale by the
purchasers  of all of the notes and attached  warrants.  If the  exchange  offer
registration  statement is not declared  effective  within 240 days of the issue
date of the notes,  the Company must pay each of the purchasers  additional cash
interest  at the rate of 0.25% per annum for each  ninety day  period  following
default  up  to  a  maximum  of  1.00%  per  annum.  Pursuant  to  the  separate
registration rights  agreement,


                                       69



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


the Company  intends to file  registration  statements  with the  Securities and
Exchange Commission in April 2006.


         The  following  table  summarizes  debt  obligations  of  the  Company,
excluding capital leases, at December 31:

                                                       2005            2004
                                                   ------------    ------------
10.5% Notes, due 2010 ..........................   $ 55,000,000    $       --
Bank note (prime + 1%), due 2007 ...............      1,200,018            --
Equipment note (non-interest bearing), due 2006         280,000            --
Installment purchase obligations, due 2008 .....      5,270,611            --
Credit facility (prime + 5.75%) due 2006 .......           --        15,000,000
7.25% bank loan, due 2006 ......................           --           532,908
Other ..........................................         19,931            --
Less unamortized discounts .....................     (3,910,160)           --
                                                   ------------    ------------
                                                     57,860,400      15,532,908
Less current portion of long-term debt .........     (3,319,175)       (329,511)
                                                   ------------    ------------
Long-term debt .................................   $ 54,541,225    $ 15,203,397
                                                   ============    ============


         Maturities  of  long-term  debt for the next five years and  thereafter
follow:

         Fiscal year
         2006                                      $   3,319,175
         2007                                          3,227,288
         2008                                            224,097
         2009                                               --
         2010                                         55,000,000
         Thereafter                                         --
                                                   -------------
                                                     61,770,560
                                                   --------------
         Less unamortized discounts                  (3,910,160)
                                                   -------------
                                                      57,860,400
         Less current portion of long-term debt      (3,319,175)
                                                   -------------
         Long-term debt                            $  54,541,225
                                                   ==============


7.       LEASES

         The  Company   leases   mining  and  certain  other   equipment   under
noncancelable  lease agreements  ranging in initial term from six months to five
years.  Rental  expense for equipment  under  operating  lease  agreements  with
initial  lease  terms  of one  year or  greater  was  approximately  $1,213,000,
$516,000  and $307,000  for the years  ending  December 31, 2005,  2004 and 2003
respectively.


                                       70



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


         During the final  quarter of 2005,  the Company  entered  into  capital
lease  agreements  of  approximately  $2,400,000  with  equipment  suppliers for
certain  mining  equipment.  These  leases are for periods of six to  thirty-six
months and provide for the transfer of ownership of the equipment to the Company
at the end of the lease term.

         During the fourth  quarter of 2004,  the Company  entered into multiple
capital lease agreements with an equipment supplier for various mining equipment
with  a  combined  estimated  fair  value  of  approximately  $4,470,000,  which
approximated  the present  value of minimum lease  payments at inception.  These
capital lease agreements were replaced with installment  sales contracts with an
equipment manufacturer in August 2005

         Depreciation  expense  related to equipment  under  capital  leases was
approximately $1,079,000,  $149,000 and $65,000 for the years ended December 31,
2005, 2004 and 2003, respectively.

         Future  minimum lease  payments for  noncancelable  leases with initial
terms of one year or greater in effect at December 31, 2005 are as follows:

                                               Capital           Operating
                                               Leases              Leases
                                             -----------         ----------

2006                                         $ 1,251,500         $  263,155
2007                                           1,123,500             91,837
2008                                             195,122               --
2009                                                --                 --
2010                                                --                 --
Thereafter                                          --                 --
                                             -----------         ----------

Total minimum lease payments                   2,570,122         $  354,991
                                                                 ==========
Imputed interest                               (415,072)
                                             -----------

Present value of minimum capital
   lease payments                              2,155,050
Current portion                                 (958,907)
                                             -----------
Long-term obligations                        $ 1,196,143
                                             ===========


8.       ASSET RETIREMENT OBLIGATIONS

         In accordance with SFAS No. 143, the Company recognizes a liability for
the fair value of asset retirement  obligations associated with mine reclamation
in the period in which the obligations  are incurred or acquired.  The liability
is accreted to the expected  reclamation  date at the Company's  credit-adjusted
risk-free rate.

         The  following  table  describes  the  changes to the  Company's  asset
retirement obligations for the years ended December 31:


                                       71



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


                                                  2005           2004           2003
                                              -----------    -----------    -----------
Obligation at January 1 ...................   $ 2,093,759    $    64,359    $      --
Accretion expense .........................       347,671         34,604          7,047
Additions resulting from property additions     4,646,328      1,790,179         57,312
Adjustments from annual recosting .........       490,424        503,697           --
Obligations settled .......................      (349,950)       (87,090)          --
                                              -----------    -----------    -----------
Obligation at December 31 .................     7,228,232      2,305,749         64,359
Current portion included in accrued expenes          --         (211,990)          --
                                              -----------    -----------    -----------
Long-term liability .......................   $ 7,228,232    $ 2,093,759    $    64,359
                                              ===========    ===========    ===========

9.       STOCKHOLDERS' EQUITY

         In  January  2003,  a total of  7,674,978  shares of common  stock were
granted to the four founding  officer/directors of the Company for services. The
stock was valued at $153,500 ($0.04 per share) based on stock  transactions  for
cash with unrelated individuals

         In January and February 2003, a total of 874,997 shares of common stock
were sold to individuals for $17,500 ($0.04 per share). In June and July 2003, a
total of 337,500 shares were sold to investors for $270,000 ($0.80 per share).

         On March 28, 2003,  National Coal Corporation  (Tennessee) entered into
an Agreement and Plan of  Reorganization  to acquire 8.55 million  shares of the
Company's  common  stock  for all of  National  Coal  Corporation  (Tennessee)'s
outstanding  common  stock.  The  shares  were  exchanged  on  April  30,  2003.
Immediately  after  the  transaction,   the  former  National  Coal  Corporation
(Tennessee)  shareholders  owned  approximately  94.8% of the  Company's  common
stock.

         The  reorganization  was recorded as a  recapitalization  effected by a
reverse  merger  wherein the Company was treated as the acquiree for  accounting
purposes,  even  though  it was the legal  acquirer.  Since  the  Company  was a
non-operating entity with limited business activity, goodwill was not recorded.

         In June  2003,  105,363  shares  of the  Company's  common  stock  were
re-purchased for $21,073 and cancelled.

         During 2003, the Company raised gross proceeds of $198,000  pursuant to
a series of private  placements of unsecured  promissory notes to four unrelated
parties.  Each of the notes had an interest rate of 10% per annum and was due in
March 2004. In November  2003,  these note holders agreed to extend the terms of
the notes to November 2004 in  consideration of the issuance to them of warrants
to purchase an  aggregate  of 41,250  shares of our common stock at a conversion
price of $2.20  per  share.  In  January  2004,  these  four  unrelated  parties
exercised the warrants by converting their entire then outstanding principal and
accrued  interest into shares of common stock.  The Company issued 92,099 shares
of common  stock,  90,000 shares of which were issued in repayment of principal,
and 2,099 shares of which were issued in repayment of accrued interest.

         In February 2004,  Crestview Capital Master,  LLC, an entity controlled
by Crestview  Capital Funds,  purchased four of the Company's  outstanding notes
payable  from  an  unrelated  party  in  the  aggregate   principal   amount  of
approximately $3,465,200. Concurrent with its purchase of these notes, Crestview
agreed to extend the  maturity  date on all four notes to March 25,  2005 and to
modify certain  provisions.  Two of the notes, in the aggregate principal amount
of approximately $3.2 million, are


                                       72



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


convertible  into the  Company's  common  stock at a price of $2.00  per  share.
Crestview also purchased  common stock purchase  warrants from the original debt
holder which warrants had been issued by the Company as additional consideration
for the  convertible  notes.  The  warrants  allow  Crestview  to purchase up to
399,312 shares of the Company's  common stock at a price of $2.20 per share, and
expire on March 25, 2005. In March 2004,  the Company  issued  Crestview  80,347
shares of common stock upon conversion of $160,693 of accrued interest. In April
2004,  the  Company  issued  Crestview  250,000  shares  of  common  stock  upon
conversion  of $500,000  of  principal.  In October  2004,  the  Company  issued
Crestview  1,347,451  shares of common stock upon  conversion  of the  remaining
$2,694,903 of principal of the convertible  debentures.  The remaining two notes
in the  aggregate  principal  amount of $270,314,  were paid in full in December
2004.

         In February 2004, the Company sold an aggregate of 1,250,000  shares of
its  common  stock in a private  placement  at a price of $2.20 per share to one
institutional investor and three accredited investors.

         In March 2004, a total of 41,958 shares of common stock were granted to
the then Chairman of the Board in lieu of cash  compensation  for services.  The
stock was valued at $226,573 or $5.40 per share,  which was the closing price of
the Company's common stock on the date the stock was granted.

         In May 2004, the Company purchased from Cumberland Timber Company, LLC,
1,738 acres of land in East  Tennessee for a total  purchase  price of $631,000,
which  consisted of $280,000 cash and 75,000 shares of common stock.  The 75,000
shares were valued at a price per share of $4.68, which was the closing price of
the  Company's  common  stock  on May 14,  2004,  the date of  closing  for this
transaction.

         In August 2004,  the Company sold  $16,030,000  of Series A convertible
preferred stock and common stock purchase warrants in separate private placement
transactions.  The  Company  issued  a total  of  1,068.67  shares  of  Series A
convertible  preferred  stock, at $15,000 per share,  for cash  consideration of
$11.305  million  and  cancellation  of $4.725  million  of its  senior  secured
promissory  notes  issued  in  April  and May  2004.  Each  share  of  Series  A
convertible  preferred  stock is convertible  into 2,500 shares of common stock.
For each share of Series A convertible  preferred stock, the investors also were
issued  two-year  warrants to purchase 500 shares of common stock at an exercise
price of $8.40 per share.

         On August 31,  2004,  the  Company  issued  $3,000,000  of  convertible
promissory notes (see Note 6). The convertible promissory notes may be converted
prior to maturity into units  consisting  of our Series A convertible  preferred
stock and common stock  purchase  warrants at a price of $15,000 per unit.  Each
unit consists of one share of Series A convertible  preferred stock and two-year
warrants to purchase  up to 500 shares of common  stock at an exercise  price of
$8.40 per share.  In December  2004, the holders of the  convertible  promissory
notes converted the $3,000,000 principle into 200 shares of Series A convertible
preferred stock and warrants to purchase up to 100,000 shares of common stock.

         Investors  who  paid  cash   consideration   in  either  the  Series  A
convertible  preferred  stock  financing  or  convertible  debt  financing  also
received  the  right  to  purchase  additional  units of  Series  A  convertible
preferred stock and common stock purchase warrants.  Each of these investors can
purchase,  at a price of  $15,000  per  unit,  up to a number  of units  with an
aggregate  purchase price equal to 33.33% of the amount  invested in the initial
financing.  Each unit  consists of one share of Series A  convertible  preferred
stock and  two-year  warrants to purchase up to 500 shares of common stock at an
exercise  price of $8.40 per share.  The  purchase  rights must be  exercised no
later than April 28,  2005.  The  holders of  convertible  promissory  notes may
exercise this  additional  purchase right only if they convert their  promissory
note in full. In December 2004, the Company issued 241.33 shares of its Series A
convertible  preferred  stock and  warrants  to purchase  482,660  shares of its
common stock upon the exercise by certain holders of these purchase rights.  The
Company received gross proceeds of  approximately  $3,620,000 in connection with
the sale of these securities.


                                       73



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


         In connection  with the August 31, 2004 private  placement  financings,
the Company  entered  into  separate  registration  rights  agreements  with the
investors.  Pursuant to the separate registration rights agreements, the Company
filed  a Form  SB-2 on  November  1,  2004  with  the  Securities  and  Exchange
Commission, and such registration statement was declared effective by the SEC on
January 28, 2005 registering 17,587,730 shares of common stock for resale by the
selling shareholders

         During 2004,  the Company  issued an aggregate of 867,200 shares of its
common stock upon the exercise of warrants,  of which 389,139 shares were issued
pursuant to cashless exercises and 478,061 shares were issued for cash of $1.109
million.

         At the close of business on January 12,  2005,  the Company  affected a
1-for-4 reverse split of its issued and  outstanding  common stock as previously
approved on October 12, 2004 by its board of  directors  and  stockholders.  All
share and per share  amounts  have been  retroactively  restated for all periods
presented to reflect the effect of the reverse split.

         On May 6, 2005,  the Company  filed with the  Securities  and  Exchange
Commission,  a  post  effective  amendment  #1  to  Form  SB-2  on  a  Form  S-3
registration  statement  to  register  the  resale by the  selling  stockholders
identified therein, of an aggregate of 17,188,996 shares of the Company's common
stock  which was then  outstanding  or which  could be  acquired  by the selling
stockholders  from the  Company  upon the  conversion  or  exercise  of options,
warrants,  and Series A convertible  preferred stock. The amendment was declared
effective by the United  States  Securities  and Exchange  Commission on May 12,
2005.

         On December 29, 2005, the Company issued 55,000  Warrants to purchase a
total of 1,732,632  shares of the Company's common stock in conjunction with the
issue of  $55,000,000  of 10.5% Senior  Secured  Notes.  The issue  consisted of
55,000 units which will entitle the holder to purchase 31.5024 shares of Company
common stock at an exercise price of $8.50 per share, subject to adjustment. The
warrants are subject to mandatory  conversion if the price the Company's  common
stock  remains  above  $12.50 for more than thirty days.  The  Warrants  will be
exercisable at any time on or after their first anniversary date and will expire
on December 15, 2010.

         During  2005 and 2004,  holders of 139.44 and 53.33  shares of Series A
convertible preferred stock with liquidation  preferences totaling approximately
$2,100,000 and $800,000  converted  their shares into 351,633 and 133,333 shares
of common stock, respectively.

         During  2005,  the Company  issued  234,240  shares of common stock and
received  gross  proceeds of  approximately  $531,000 upon the exercise of stock
options by  employees.  No employee  stock  options were  available for exercise
during 2004.

10.      FAIR VALUE OF FINANCIAL INSTRUMENTS

         The  following  methods  and  assumptions  were used by the  Company in
estimating its fair value disclosures for financial  instruments at December 31,
2005, and 2004, respectively:

         CASH AND ACCOUNTS  RECEIVABLE:  The carrying amount  approximates  fair
         value because of the short maturity of these instruments.

         DEBT: The fair value of the Company's long-term debt is estimated based
         on the quoted  market  prices for  similar  issues or on the  estimated
         current  rate of  incremental  borrowing  available  to the Company for
         similar  liabilities.  At December 31, 2005 the  carrying  value of the
         Company's  10.5% Senior Secured Notes  approximated  fair value because
         the Notes were issued on December 29, 2005.


                                       74



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


         CAPITAL  LEASE  OBLIGATIONS:  The fair value of the  Company's  capital
         lease obligations is based on the estimated current rate of incremental
         borrowing available to the Company for similar liabilities.

         The estimated  fair values of the Company's  financial  instruments  at
December 31 are as follows:

                                          2005                       2004
                               -------------------------   -------------------------
                                 Carrying       Fair        Carrying         Fair
                                  Amount        Value        Amount          Value
                               -----------   -----------   -----------   -----------
Financial assets
   Cash and cash equivalents   $ 5,434,988   $ 5,434,988   $   303,673   $   303,673
   Accounts receivable .....     2,929,735     2,929,735     2,091,698     2,091,698
   Restricted cash .........     6,625,267     6,625,267     4,574,625     4,574,625

Financial liabilites
   Long-term debt ..........   $ 7,860,400   $57,478,632   $15,532,908   $14,084,578
   Capital lease obligations     2,155,050     2,280,683     4,191,224     4,362,213


11.      CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS

         Financial   instruments  which  potentially   subject  the  Company  to
concentrations of credit risk consist primarily of accounts receivable. Accounts
receivable  are from brokers or purchasers  of the  Company's  coal with payment
terms that  typically  do not exceed 20 days.  The  Company  routinely  performs
credit  evaluations  of customers  purchasing on account and generally  does not
require collateral.

         During the period ended December 31, 2005, the Company  derived revenue
from fifteen  customers,  eight of which were electric  utilities,  six of which
were  industrial  companies  and one of which was a coal  reseller.  The Company
derived  revenue in excess of  ten-percent  (10%) of total coal sales from major
customers as follows:

                                                 Customer
                              -----------------------------------------------
                                 A         B        C         D         E
                              --------  --------  -------  --------  --------
Period ended December 31:
2005                            35%       26%      10%        *         *
2004                            28%       27%      16%        *         *
2003                            27%        *        *        52%       15%
* Less than 10%


         At December  31,  2005,  the Company had six  contracts  of one year or
longer.  The following  table  summarizes,  as of December 31, 2005, the tons of
coal that the Company is committed to deliver at prices


                                       75



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


determined  under  existing  long-term  contracts,  which  prices are subject to
annual  adjustment  pursuant to the terms of the contracts,  during the calendar
years 2006 through 2010:

Calendar Year                   Tons          Avg. $ / Ton        Dollar Value
                          ---------------    --------------    -----------------
2006                         1,429,000          $  52.16         $ 74,532,250
2007                         1,230,000             52.02           63,985,500
2008                           300,000             51.35           15,403,500
2009                            60,000             59.48            3,568,500
2010                            15,000             69.45            1,041,750
                          ---------------    --------------    -----------------
Total                        3,034,000          $  52.25         $158,531,500
                          ===============    ==============    =================


12.      INCOME TAXES

         At December  31, 2005,  and 2004,  the Company had net  operating  loss
carry forwards of approximately  $17,960,000 and $9,600,000,  respectively  that
may be offset against future taxable income. These carry forwards are subject to
review by the Internal Revenue Service and begin to expire in 2023.

         The Company  records a valuation  allowance when it is more likely than
not that some  portion or all of the  deferred  tax assets will not be realized.
The ultimate  realization  of the deferred tax assets  depends on the ability to
generate  sufficient taxable income of the appropriate  character in the future.
Accordingly,  the Company has fully  reserved the  approximately  $7,300,000 tax
benefit of the operating loss carry forward by a valuation allowance of the same
amount  because the  likelihood  of  realization  of the tax  benefit  cannot be
determined.  There was an increase of approximately  $3,500,000,  $2,600,000 and
$1,200,000 in 2005, 2004 and 2003, respectively.

         Temporary  differences  between the time of reporting certain items for
financial  statement and tax reporting purposes consists primarily of beneficial
conversion  feature interest expense,  stock-based  compensation,  depreciation,
depletion and accrued reclamation expenses.  The Company's effective tax rate of
approximately  38.3% is a function  of the U.S.  statutory  rate of 34% plus the
effect of state taxes, net of the federal tax benefit, of approximately 4.3%.

13.      EARNINGS PER SHARE

         Basic earnings or loss per share are computed by dividing net income by
the  weighted  average  number of common  shares  outstanding  during  the year.
Diluted  earnings per share are computed  similarly to basic  earnings per share
except that they  reflect the  potential  dilution  that could occur if dilutive
securities  or other  obligations  to  issue  common  stock  were  exercised  or
converted  into  common  stock.  Diluted  earnings  or loss per  share  includes
dilutive common stock equivalents,  using the treasury stock method, and assumes
that the potentially  dilutive  instruments  were converted into common stock at
the beginning of the year or upon issuance.  Stock options with exercise  prices
greater than the average  fair market  price for a period,  which are defined as
anti-dilutive,  are not  included  in the  diluted  earnings  (loss)  per  share
calculations  because  of their  anti-dilutive  effect.  In  periods  of losses,
diluted  loss per share is computed on the same basis as basic loss per share as
the inclusion of any other potential shares outstanding would be anti-dilutive.

         For the years ended  December  31, 2005 and 2004 and the eleven  months
ended December 31, 2003, 6,024,642,  2,105,554 and 0 potentially dilutive shares
of the Company from warrants, convertible preferred stock and stock options were
not included in the computation of diluted  earnings (loss) per share because to
do so would be anti-dilutive.


                                       76



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


         The  computations  for  basic  and  diluted  earnings  per  share  from
continuing operations for the period ending December 31 are as follows:

                                                 2005            2004            2003
                                             ------------    ------------    ------------
Numerator:
Net (loss) ...............................   $ (6,791,171)   $(10,429,130)   $ (3,332,885)
Preferred dividends ......................     (1,124,650)    (18,893,509)           --
                                             ------------    ------------    ------------
Numerator for basic and diluted ..........   $ (7,915,821)   $(29,322,639)   $ (3,332,885)

Denominator:
Weighted average shares - basic ..........     13,712,813      11,261,800       9,137,630
                                             ------------    ------------    ------------
   Effect of warrants ....................      1,122,399         267,751            --
   Effect of convertable preferred shares       3,528,233         780,663            --
   Effect of stock options ...............      1,374,010       1,057,140            --
                                             ------------    ------------    ------------
Adjusted weighted average shares - diluted     19,737,455      13,367,354       9,137,630
                                             ============    ============    ============

Net income (loss) per share - basic ......   $      (0.58)   $      (2.60)   $      (0.36)

Net income (loss) per share - diluted ....   $      (0.58)   $      (2.60)   $      (0.36)


14.      STOCK-BASED COMPENSATION PLANS

         The Company's 2004 Option Plan (the "Plan") was authorized by the Board
of Directors of the Company in March 2004,  and amended in January  2005.  Under
the terms of the Plan,  stock  options  may be granted to  officers,  directors,
employees,  and others.  At December 31, 2005,  2,750,000 shares of common stock
were  authorized  for  issuance  under the Plan.  Shares  subject to awards that
expire  unexercised  or are  otherwise  terminated,  again become  available for
awards.  Upon exercise,  stock is issued from unissued or treasury  shares.  The
grant price of an option under the Plan  generally may not be less than the fair
market  value of the common  stock  subject to such option on the date of grant.
Options  have a maximum life of ten years and vest 25% per year over a four year
period commencing on January 1 following the Date of Grant.

         The  estimated  fair  value  of  options  granted  under  the  Plan  is
determined using the  Black-Scholes  option-pricing  model. The Company uses the
simplified method to estimate the expected option term whereby the expected term
is  calculated  as the average of the vesting term and original  contract  term.
Because of an insufficient  trading  history,  the Company bases its estimate of
expected  volatility on the  historical  volatility of similar  publicly  traded
entities.  The  risk-free  rate for  periods  within the  estimated  term of the
options is based on the yield of U.S.  Treasury  securities.  The estimated fair
value as of the date of grant for  options  granted  under the Plan  during  the
years ended  December 31, 2005 and 2004 was  determined  based on the  following
assumptions:


                                       77



                               NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


                                                    Year Ended
                                     ----------------------------------------
                                      December 31, 2005    December 31, 2004
                                     -------------------  -------------------
    Expected term (years)                          6.25                  4.0
    Risk-free interest rates              3.79% - 4.55%        3.23% - 4.37%
    Expected dividend yield                        0.0%                 0.0%
    Expected volatility                   47.6% - 48.0%        48.4% - 48.7%
    Weighted-average volatility                   47.8%                48.6%


         A summary of stock option  activity  under the Plan for the years ended
December 31, 2005 and 2004 is as follows:

                                                                 WEIGHTED       WEIGHTED
                                                               AVERAGE FAIR     AVERAGE
                                              COMMON SHARES        VALUE     EXERCISE PRICE
                                              -------------    ------------  --------------
 Options outstanding at January
   1, 2004
     Granted ..............................      1,448,750      $    3.54     $    2.65
     Exercised
     Forfeited
Options outstanding at December
   31, 2004: ..............................      1,448,750

Vested ....................................        362,188           3.54          2.65
Unvested ..................................      1,086,562           3.54          2.65
                                                 ---------
Total options outstanding at
   December 31, 2004 ......................      1,448,750      $    3.54     $    2.65
                                                 ---------

     Granted ..............................        631,000           3.41          6.50
     Exercised ............................        234,240           3.65          2.27
     Forfeited ............................        306,875           3.59          3.02
Options outstanding at December
   31, 2005: ..............................      1,538,635

Vested (8.68 year weighted average
   remaining contractual term) ............        509,448           3.50          3.73
Unvested (9.02 year weighted
   average remaining contractual
   term) ..................................      1,029,188           3.49          4.25
                                                 ---------
 Total options outstanding at
   December 31, 2005 ......................      1,538,635      $    3.49     $    4.08
                                                 =========
Options available for grant at
   December 31, 2005 ......................        977,125
                                                 =========


                                       78



                              NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


         Exercise  prices for stock options  outstanding as of December 31, 2005
range from $2.20 to $7.02 summarized as follows:

----------------------------- ------------------------- ----------------------------- ---------------------------
  Range of exercise prices        Number of shares       Weighted-average remaining   Weighted-average exercise
                                 underlying options       contractual life (years)              price
----------------------------- ------------------------- ----------------------------- ---------------------------
       $2.00 - $4.00                 765,760                        8.3                           $2.20
----------------------------- ------------------------- ----------------------------- ---------------------------
       $4.00 - $6.00                 251,875                        8.5                           $5.39
----------------------------- ------------------------- ----------------------------- ---------------------------
       $6.00 - $8.00                 521,000                        9.8                           $6.60
----------------------------- ------------------------- ----------------------------- ---------------------------
                                   1,538,635                        8.8                           $4.21
----------------------------- ------------------------- ----------------------------- ---------------------------

         The  Company  intends  to adopt the  provisions  of SFAS No.  123(R) on
January 1, 2006 using the modified prospective application transition method and
anticipates a reduction in fiscal 2006 net income by an amount  consistent  with
the pro forma disclosures shown above.

15.      COMMITMENTS AND CONTINGENCIES

         In December 2004,  the Company  succeeded to a permit for a coal mining
operation in Campbell County, Tennessee and in so doing became the real party in
interest  in  a  pending  civil  action  filed  by  a  group  of   environmental
organizations  in the United States  District Court for the Eastern  District of
Tennessee.  Plaintiffs  alleged that issuance of the original  permit was flawed
because the OSM, the federal  agency  which issued the permit,  had not complied
with the  requirements  of the  National  Environmental  Policy Act ("NEPA") and
asked that the permit be revoked by the Court.  The District Court dismissed the
plaintiffs' action and the plaintiffs subsequently appealed to the Sixth Circuit
Court. Hearings are scheduled for 2006. Concurrently,  the same plaintiffs filed
a  similar  action  alleging  NEPA  violation  regarding  OSM's  approval  of an
application for a revision of the same permit. An unfavorable  outcome of either
action would not involve direct monetary damages;  however significant financial
losses could result from curtailed mining operations.  The Company believes that
these matters will be resolved  favorably  and without a material  impact on its
cash flows, results of operations or financial condition.

         During  2005,  we were audited by our  previous  workers'  compensation
insurance provider who informed us that we owed an additional approximately $1.4
million  in  premiums  for the  policy  year ended  April 15,  2005.  The matter
primarily  involves the  application  of premium  rates to employees  performing
certain job  functions.  In January  2006, we attempted to settle the dispute by
submitting  a full  accounting  of the matter  with a payment  of  approximately
$427,000 to the previous insurance provider.  Currently, the matter has not been
resolved nor has any legal action been pursued by either party.

         The Company  becomes party to other legal action,  claims,  arbitration
and  administrative  proceedings  from  time to time in the  ordinary  course of
business.  Management  does not  expect the  outcome  of  pending or  threatened
proceedings to have a material  impact on its cash flows,  results of operations
or financial condition.

16.      RELATED PARTY TRANSACTIONS

         On July 1, 2003, the Company sold mineral royalty rights for coal mined
on the Patterson Mountain portion of its New River Tract property for $75,156 to
Jenco Capital  Corporation  ("Jenco"),  an entity owned by the  Company's  Chief
Executive  Officer and  President.  The Company was obligated to pay Jenco $2.00
per mined ton on the  property.  During 2003 and 2004,  the  Company  paid Jenco
$59,572 and $15,584, respectively, in accordance with the agreement. The Company
has no further obligation to Jenco pursuant to this royalty agreement.

         On August 1, 2003,  the Company  sold its  interest in mineral  royalty
rights that it received from U.S. Coal,  Inc. for coal mined on a section of the
Smokey Mountain portion of its New River Tract property.  The Company sold these
royalty rights for $250,000 to Jenco. The Company recorded the proceeds from the
sale as deferred revenue and recognized  revenue each month based on U.S. Coal's
production.  During 2003 and 2004, the Company  recognized the royalty  revenue,
$146,597 and $103,403,  respectively, and as of December 31, 2004 had no further
obligation pursuant to this agreement.

         These transactions were completed with Jenco, a related party,  because
(i) the Company needed a prompt capital infusion to ramp up its coal production,
(ii) Jenco had available cash for the  transaction,  (iii) the Company could not
have developed another independent source for the capital without


                                       79



                              NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


considerable  time  delay  due to lack of a  production  history,  and  (iv) the
Company had no knowledge of any outside  sources for such capital at the time of
the  transactions.  The Company believes that given the time delay to search for
capital and the cost of lost opportunity,  the terms of these  transactions were
acceptable  because it afforded the Company  immediate  liquidity  for operating
purposes.

         On June 30,  2003,  the  Company  assigned  a  ten-year,  $0.25 per ton
royalty interest on all the coal sold from its New River Tract property, to both
the then  Chairman  of the Board and its  current  Chief  Executive  Officer and
President.  The agreement provided that in the event any mineral properties were
sold prior to the end of the ten-year period, the obligation would be settled by
paying 12 1/2% of the sales  price to each  individual.  Pursuant to the sale of
mineral  property rights to Jenco in July and August 2003, the Company paid both
the Chairman of the Board and Chief  Executive  Officer and President 12 1/2% of
the sales price,  for an aggregate  payment of $81,289.  In February  2004,  the
Chairman of the Board and Chief  Executive  Officer and President each agreed to
permanently  cancel  all  future  royalty  payments  pursuant  to  this  royalty
agreement.

         In 2003,  the Company  acquired  mining  equipment  and  certain  other
intangible  mining rights and  information  from Strata Coal, LLC ("Strata") for
$47,000 ($7,000 cash and a non-interest  bearing promissory note) and assumption
of promissory notes payable to unrelated parties totaling $174,000.  The Company
also  assumed  $14,875  of  Strata's  accounts  payable.  Strata is owned by the
Chairman of the Board and the  CEO/President  of the  Company.  Since the Strata
transaction  involved related parties,  primarily for intangible  consideration,
the $205,875 purchase price (exclusive of the mining equipment subsequently sold
-see below),  was expensed in 2003.  Subsequent to March 31, 2003 the promissory
notes  (totaling  $214,000) were paid and on June 11, 2003 the mining  equipment
was sold to Jenco for $30,000.

         In March  2003,  the  Company  paid the  Chairman  of the Board and the
CEO/President $150,000 each for corporate organization and promotion activities.

         In October 2003, the Company loaned its current Chief Financial Officer
$15,000 with an annual  interest  rate of 3 1/2% and a maturity of 1 year.  This
loan was made to this  individual  before he became the Company's  full time CFO
and before he was an officer of the Company.  In February 2004,  this loan, plus
accrued interest, was paid in full.

         During  2003 and 2004,  the  Company  paid the law firm of Kite,  Bowen
&   Associates,   PA,  $45,000 and  $10,000,  respectively,   for   professional
services   rendered.  Mr.  Kite  was the  managing   partner  of Kite,  Bowen  &
Associates,  PA, and previously  served on the Company's Board of Directors.  In
May 2004,  Mr.  Kite  joined the  Company  on a full time  basis as its  General
Counsel.

         The Company  borrowed an aggregate  of $305,000  from Jenco from August
2003 through  January 2004, and borrowed  $105,000 from the President and CEO in
December  2003.  Each of these  loans were  evidenced  by a note  payable  which
accrued simple interest at an annual rate of 8% and was payable on demand. These
loans were paid in full during the first six months of 2004.

         In September  2004,  the Company  repaid a $150,000 note payable to the
former  Chairman.  During  2004 the  Company  paid a total of  $18,833  interest
pursuant to the note. This debt was outstanding since February 2003.

         In October 2004, the Company  borrowed $10,000 from its Chief Financial
Officer and $40,000 from its  Operations  Manager,  which amounts were repaid in
December 2004. These loans accrued simple interest at an annual rate of 8%.


                                       80



                              NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


         In October 2004, the Company  revised the  employment  contracts of its
Chief Executive Officer,  its Chief Financial Officer and its Operations Manager
such that each individual is entitled to additional  monthly  compensation in an
amount  equal to five  cents  ($0.05)  per ton of coal sold each month from coal
mined from all of the Company's owned and leased properties.

         In March 2005,  the Company  borrowed  approximately  $5,140,000 at 18%
interest with five-year common stock purchase warrants to purchase up to 140,000
shares of the Company's  common stock at an exercise price per share of $8.50 by
issuing notes to three  purchasers,  including  Crestview  Capital Master,  LLC,
which  is a  significant  shareholder  of  the  Company.  The  Company  paid  an
origination  fee of  approximately  $200,000  upon  the  execution  of the  loan
document. The notes were repaid on December 28, 2005 with an additional 3% fee.

17.      EVENTS SUBSEQUENT TO DECEMBER 31, 2005 (UNAUDITED)

         In February  2006, the Company  formed a  wholly-owned  subsidiary,  NC
Railroad,  Inc., which subsequently  purchased forty-two miles of railroad track
between  Oneida  and  Devonia,  Tennessee  from  Norfolk-Southern  Railroad  for
approximately $1,960,000.  The rail line gives access from the Company's Baldwin
preparation facility in the New River tract to  Norfolk-Southern's  rail yard in
Oneida, Tennessee.

         In March 2006, the Company was named as defendant in a complaint  filed
in the United States District Court for the Eastern  District of Kentucky by the
sublessor of certain coal mining rights at the Company's operations in Kentucky.
The  Company  is  the  sublessee  of  these  rights  as  the  result  of a  2004
acquisition.  The complaint alleges that the sublease  agreement does not convey
rights to the coal seams in question and the Company  extracted coal during 2005
without right or interest.  Management  believes that the complaint  lacks merit
and this matter will be resolved favorably without a material impact on its cash
flows, results of operations or financial condition.

         In February  2006,  the Company  purchased a second  highwall miner for
approximately $6,500,000 which was immediately placed in service on the Straight
Creek tracts in  Southeastern  Kentucky.  In March 2006, this highwall miner was
damaged by a rock  collapse  which is  expected to result in  approximately  two
months of lost service.  Insurance in place will cover the cost of returning the
highwall miner to working condition less a $50,000 deductible.

         In April 2006, the Company  entered into  installment  sales  contracts
with a manufacturer  pursuant to which the Company refinanced  equipment with an
aggregate  principal value of approximately  $2,729,000  formerly acquired under
various capital leases. The installment sales contracts require payments over 36
months at interest rates ranging from 7.03% to 7.5%.


                                       81



                              NATIONAL COAL CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED


18.      SUMMARY QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

         Quarterly  financial  data for 2005  and  2004 is as  follows  (certain
reclassifications have been made to conform to the annual presentation):

                                                      Three Months Ended
                                 ------------------------------------------------------------
                                   March 31,       June 30,      September 30,   December 31,
                                     2005            2005            2005            2005
                                 ------------    ------------    ------------    ------------

Total revenues ...............   $ 11,866,566    $ 15,574,119    $ 18,274,700    $ 20,157,249
Income (loss) from operations      (1,514,906)       (212,856)        337,851      (1,173,640)
Net (loss) available to common
   shareholders ..............     (2,482,229)     (1,533,942)       (654,973)     (3,244,677)
(Loss) per share:
Basic ........................   $      (0.18)   $      (0.11)   $      (0.05)   $      (0.24)
Diluted ......................   $      (0.18)   $      (0.11)   $      (0.05)   $      (0.24)


                                                      Three Months Ended
                                 ------------------------------------------------------------
                                   March 31,       June 30,      September 30,   December 31,
                                     2004            2004            2004            20054
                                 ------------    ------------    ------------    ------------

Total revenues ...............   $  1,064,903    $  4,528,695    $  4,410,287    $  6,995,027
(Loss) from operations .......       (918,762)       (649,472)     (2,896,787)     (2,574,505)
Net (loss) available to common
   shareholders ..............     (1,066,208)     (1,187,470)    (14,045,326)    (13,023,635)
(Loss) per share:
Basic ........................   $      (0.11)   $      (0.11)   $      (1.27)   $      (1.11)
Diluted ......................   $      (0.11)   $      (0.11)   $      (1.27)   $      (1.11)


                                                                 Three Months    Three Months
                                  Two Months     Three Months        Ended          Ended
                                 ended March      Ended June     September 30,   December 31,
                                   31, 2003        30, 2003          2003            2003
                                 ------------    ------------    ------------    ------------

Total revenues ...............   $       --     $     17,275   $    274,363   $    899,005
(Loss) from operations .......       (782,469)      (584,660)      (904,680)      (764,054)
Net (loss) available to common
   shareholders ..............       (794,458)      (618,484)    (1,051,888)      (868,055)
(Loss) per share:
Basic ........................   $      (0.02)  $      (0.02)  $      (0.03)  $      (0.29)
Diluted ......................   $      (0.02)  $      (0.02)  $      (0.03)  $      (0.29)


                                       82



ITEM 9.  CHANGES  IN  AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
         FINANCIAL DISCLOSURE.

         Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES.

CONTROLS AND PROCEDURES

         Members of our management,  including our Chief  Executive  Officer and
President, Jon Nix, and Chief Financial Officer, T. Michael Love, have evaluated
the  effectiveness  of our  disclosure  controls and  procedures,  as defined by
paragraph  (e) of Exchange Act Rules 13a-15 or 15d-15,  as of December 31, 2005,
the end of the  period  covered  by this  report.  Based  upon that  evaluation,
Messrs.  Nix and Love concluded that our disclosure  controls and procedures are
effective.

INTERNAL CONTROL OVER FINANCIAL REPORTING

         There were no changes in our internal control over financial  reporting
or in other factors  identified in connection  with the  evaluation  required by
paragraph  (d) of Exchange Act Rules 13a-15 or 15d-15 that  occurred  during the
fourth quarter ended  December 31, 2005 that have  materially  affected,  or are
reasonably  likely to materially  affect,  our internal  control over  financial
reporting.

ITEM 9B. OTHER INFORMATION.

         None.


                                       83



                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

                                   MANAGEMENT

         The  following  table sets forth the name,  age and position of each of
our executive  officers and directors as of December 31, 2005. As noted, some of
our executive officers are employed by our operating  subsidiary,  National Coal
Corporation.

NAME                     AGE                      POSITION HELD
----                     ---                      -------------

Jon E. Nix.               36     President and Chief Executive Officer, Director
                                 and Chairman of the Board
Kenneth F. Hodak          50     Executive Vice President and Chief Operating
                                 Officer, National Coal Corporation
T. Michael Love.          40     Senior Vice President, Chief Financial Officer
                                 and Director
Charles Kite              61     Senior Vice President and General Counsel
Jeanne Bowen Nix          35     Secretary
William R. Snodgrass      42     Operations Manager, National Coal Corporation
Joseph A. Davis, Jr       58     Vice President-Sales, National Coal Corporation
Robert Heinlein           42     Director
Kenneth Scott.            63     Director
Scott Filstrup            63     Director


         JON E. NIX, one of our founders,  has served as our President and Chief
Executive Officer and as a director since January 2003 and Chairman of the Board
since  March  2004.  Mr. Nix has over eight years  experience  in the  financial
industry. He is the founder of Jenco Capital Corporation, a Tennessee consulting
and  holding  corporation  ("Jenco").  He  is  also  a  co-founder  of  Medicine
Arm-In-Arm,  Inc., a nonprofit children's charity that provides medical services
to  underprivileged  children  around the  world.  Mr. Nix has over six years of
experience  in the coal  industry.  Mr. Nix holds a Bachelor  of Arts  degree in
Economics  from the  University of  Tennessee.  Jon Nix and Jeanne Bowen Nix are
married. Charles Kite is Jeanne Bowen Nix's stepfather.

         KENNETH F.  HODAK has  served as  Executive  Vice  President  and Chief
Operating Officer of our subsidiary,  National Coal  Corporation,  since October
2005. Prior to joining us, Mr. Hodak was a mine manager for Arch Coal, Inc. from
1996 to 1999, a General  Manager of Arch West  Virginia,  Inc., a subsidiary  of
Arch Coal,  Inc., from 1999 to 2002, and then Senior Vice President of Sales for
Arch Coal,  Inc. from 2002 through 2005.  From 1981 until 1993, Mr. Hodak served
at various  positions at Ashland Coal,  Inc. Mr. Hodak served as a mine engineer
at  Northern  Coal  Company  from 1979 to 1981.  Mr.  Hodak has over 25 years of
experience in the coal industry.  Mr. Hodak received a dual Bachelor's Degree in
mining and engineering,  and arts and sciences in 1979 from  Pennsylvania  State
University and his Juris Doctorate degree from West Virginia University in 1996.

         T. MICHAEL LOVE has served as Senior Vice President and Chief Financial
Officer  since  November  2005 and has worked with us as a financial  consultant
since June 2005.  Prior to being  engaged by us, Mr.  Love owned Love  Financial
Services,  a consulting  company  which  performed  various  financial  services
including contract executive and compliance work for public companies located in
South  Florida.  From 2002  through  2004,  Mr. Love  served as Chief  Financial
Officer of Air  Jamaica  Vacations,  a division of Air  Jamaica  Ltd.  From 1997
through 2002, Mr. Love was vice president of mergers and acquisitions for


                                       84



Gerald Stevens,  Inc., a NASDAQ company  engaged in the retail floral  industry.
From 1995 through 1997,  Mr. Love was director of mergers and  acquisitions  for
Blockbuster Entertainment. From 1988 to 1995, Mr. Love served as an auditor with
the firm of KPMG,  LLP. Mr. Love has been a Certified  Public  Accountant  since
1994 and earned  Bachelor of Science  degrees in  accounting  and  finance  from
Florida State University in 1987.

         CHARLES  KITE has served as our  General  Counsel  since May 2004,  and
served as a director from  February  2003 until May 2004.  Prior to becoming our
General  Counsel,  Mr. Kite, an attorney since 1973,  was our outside  corporate
counsel, and since 1990 has engaged in general legal practice with the Tennessee
law  firm   of  Kite,  Bowen  &  Associates,  P. A.,  where  he  specialized  in
commercial business  representation,  tax representation and litigation,  estate
planning, and probate matters. Mr. Kite served as Senior Trial Attorney with the
Chief  Counsel's  Office of the Internal  Revenue  Service from 1977 to 1983. He
graduated from Carson Newman College in 1967 with a Bachelor of Arts degree, and
received his Juris  Doctorate  degree from the  University of Tennessee in 1973.
Charles Kite is Jeanne Bowen Nix's stepfather.

         JEANNE  BOWEN  NIX has  served as our  Secretary  and  Treasurer  since
January 2003 and as Associate Counsel since May 2004. From 1997 to May 2004, Ms.
Bowen   Nix was a  partner   in  the  Tennessee  law  firm  of   Kite,  Bowen  &
Associates,  P. A., where she  specialized in general  corporate and real estate
matters. She graduated cum laude from the University of Tennessee in May of 1993
with a Bachelor of Arts degree in  Psychology  and received her Juris  Doctorate
degree from  Louisiana  State  University Law School in May of 1997. Jon Nix and
Jeanne Bowen Nix are married. Charles Kite is Jeanne Bowen Nix's stepfather. Ms.
Nix resigned her position as an officer and employee in February  2006  pursuant
to  the  terms  of a  Separation  Agreement,  but  continues  to  serve  us on a
consulting basis as needed.

         WILLIAM R.  SNODGRASS has served as our  Operations  Manager since July
2003. Mr.  Snodgrass  also served as our  consultant  from February 2003 to July
2003.  Prior to joining  us, Mr.  Snodgrass  served as  superintendent  and area
manager for Tennessee Mining, Inc., a subsidiary of Addington Enterprises, Inc.,
one of the largest coal  companies  in the nation,  a position he held from 1994
until February 2003. Mr. Snodgrass has extensive  knowledge and expertise in the
coal mining  industry and has been involved in numerous  mining  projects in the
Kentucky and Tennessee  areas.  Mr. Snodgrass has over 20 years of experience in
the coal industry.

         JOSEPH A. DAVIS JR. has served as our Vice President, Sales since April
2004. Prior to joining us, Mr. Davis served as Senior Vice President,  Sales and
Marketing,  and a Director for Pen Coal Corporation.  During his twenty years at
Pen Coal  Corporation,  he was responsible for domestic and  international  coal
sales and transportation.  Mr. Davis has over 30 years of experience in the coal
industry.  Mr. Davis  earned his  Bachelor of Arts degree from Western  Kentucky
University in political science and history.

         ROBERT  HEINLEIN  has served as a director  since April 1, 2005.  Since
2003  Mr.  Heinlein  has  worked  as  a  business  consultant  with  respect  to
Sarbanes-Oxley  regulations.  From August 2000 through 2003, Mr.  Heinlein was a
private  investor.  From June 1994 through August 2000, Mr.  Heinlein  served in
various  management  positions  with  Boca  Research,  Inc.,  including  as Vice
President of Finance and Chief Financial Officer from August 1999 to August 2000
and as Vice  President,  Corporate  Comptroller  and Treasurer from July 1998 to
August 1999.  Prior to joining Boca Research,  Inc.,  Mr.  Heinlein was a Senior
Audit Manager  with  the firm of  Deloitte  &  Touche,  LLP. Mr.  Heinlein  is a
Certified Public  Accountant.  Mr. Heinlein has a Bachelor's and Master's degree
in accounting from Florida Atlantic University.

         KENNETH SCOTT has served as a director  since April 1, 2005.  Mr. Scott
has been a partner with Colonnade  Strategies,  LLC, a business consulting firm,
since 2002. Prior to joining Colonnade Strategies,


                                       85



LLC, Mr. Scott was the Executive Vice  President for Europe and Vice  President,
Energy Industry, for Perot Systems Corporation,  which provides technology-based
business solutions to help  organizations  worldwide control costs and cultivate
growth.  Mr. Scott worked for Perot Systems  Corporation from 1998 through 2002.
Mr. Scott has  BBA and  MBA  degrees from Texas A&M University.   Mr. Scott also
serves as a director of North American Technologies Group, Inc.

         SCOTT FILSTRUP has served as a Director since February 16, 2005.  Since
1987, Mr. Filstrup has served as President of The Consultants  Limited of Tulsa,
Oklahoma,   a  professional   services  firm  offering  strategic  planning  and
management  consulting  services to  business  organizations  and  entrepreneurs
including  creation of new  businesses  and products.  Prior to The  Consultants
Limited,  Mr. Filstrup was a director for strategic  planning of MAPCO, Inc., an
energy company.  Before that, he held various executive and management positions
in planning and marketing with The Williams Companies,  an energy firm operating
in  Tulsa,  and  Monsanto  Company  of St.  Louis,  Missouri.  He has also  held
executive and board of director  positions  with emerging  energy and technology
firms. Mr. Filstrup is a member of multiple  professional  organizations  and is
currently a board member of various investment,  medical and technology firms in
Oklahoma  and  Illinois.  Mr.  Filstrup  has a B.S.  in Civil  Engineering  from
Northwestern  University and an MBA degree from the Kellogg School of Management
at  Northwestern.  He is currently a Board Member of The Kellogg School and is a
former Trustee of Northwestern University at Evanston, Illinois.

AUDIT COMMITTEE; AUDIT COMMITTEE FINANCIAL EXPERT

         We currently  have a separately  designated  standing  Audit  Committee
established  in  accordance  with Section  3(a)(58)(A)  of the Exchange Act. The
Audit  Committee is chaired by Mr.  Heinlein and  currently  consists of Messrs.
Heinlein,  Filstrup and Scott,  all of whom are considered  "independent"  under
Rule  4200(a)(15)  of the National  Association  of Securities  Dealers  listing
standards.  The Board of Directors  has  determined  that Robert  Heinlein is an
"audit committee  financial  expert," as defined in Item 401(h)(2) of Regulation
S-K.

COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

         Section 16(a) of the Securities  Exchange Act of 1934 requires that our
executive officers and directors, and persons who own more than ten percent of a
registered class of our equity securities, file reports of ownership and changes
in ownership with the SEC. Executive  officers,  directors and  greater-than-ten
percent  stockholders  are  required by SEC  regulations  to furnish us with all
Section  16(a) forms they file.  Based solely on our review of the copies of the
forms received by us and written  representations from certain reporting persons
that they have complied with the relevant filing requirements,  we believe that,
during  the  year  ended  December  31,  2005,  all of our  executive  officers,
directors and greater-than-ten  percent  stockholders  complied with all Section
16(a) filing requirements, except for the following: (i) an Initial Statement of
Beneficial  Ownership of Securities on Form 3 was filed late by Scott  Filstrup;
(ii) one Statement of Changes in Beneficial  Ownership on Form 4,  reporting two
separate transactions, was filed late by Jon Nix; (iii) one Statement of Changes
in  Beneficial  Ownership on Form 4,  reporting two separate  transactions,  was
filed late by Jeanne  Bowen Nix;  (iv) one  Statement  of Changes in  Beneficial
Ownership on Form 4,  reporting  one  transaction,  was filed late by William R.
Snodgrass;  (v) one  Statement  of Changes in  Beneficial  Ownership  on Form 4,
reporting one  transaction,  was filed late by Charlie Kite, and (vi) one Annual
Statement of Changes in Beneficial  Ownership on Form 5,  reporting two separate
transactions  that were not timely  filed on Form 4, was filed by Jenco  Capital
Corporation.


                                       86



ITEM 11. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

         The following table sets forth,  as to the Chief Executive  Officer and
Chief Operating Officer and as to each of the other four most highly compensated
executive officers whose  compensation  exceeded $100,000 during the last fiscal
year (our "Named Executive Officers"),  information  concerning all compensation
paid for services to us in all capacities for our fiscal year which commenced on
January  30, 2003  (inception)  and ended  December  31, 2003 and for our fiscal
years which ended December 31, 2005 and 2004.


                                                                                                 LONG-TERM
                                                                                               COMPENSATION
                                                                 ANNUAL COMPENSATION*             AWARDS
                                                      -------------------------------------    ------------
                                                                                                 NUMBER OF
                                      FISCAL YEAR                              OTHER ANNUAL     SECURITIES
NAME AND                                 ENDED        SALARY        BONUS      COMPENSATION     UNDERLYING
PRINCIPAL POSITION                    DECEMBER 31,      ($)          ($)            ($)          OPTIONS**
------------------                    -----------    ---------    ---------    ------------    ------------
Jon Nix.........................         2005         408,000       76,515      161,536 (1)         --
   President and Chief                   2004         298,077      111,934           --           625,000
   Executive Officer                     2003         161,538      150,000           --             --

Kenneth Hodak (2)........                2005          60,000       96,000           --           100,000
   Executive Vice President
   and Chief Operating Officer

Charles Kite (3)................         2005         180,900        9,000           --             --
   General Counsel                       2004          97,500       28,000           --           125,000
                                         2003           --            --             --             --

William R. Snodgrass (4)........         2005         119,999       61,914           --            50,000
   Operations Manager                    2004         116,192       16,898       30,675 (5)        50,000
                                         2003          29,915       15,800       35,900 (6)         --

T. Michael Love (7).............         2005          34,375        1,500      146,573 (8)       100,000
   Chief Financial Officer

Mark Oldham (9).................         2005         142,500         --             --            15,000
   Former Chief Financial
   Officer


*    Refer to  "Employment  Contracts"  below for a  discussion  of 2005  salary
     information.
**   Option  issuances  that  occurred  prior to  January  12,  2005,  have been
     adjusted  to reflect the 1-for-4  reverse  stock split of our common  stock
     which took effect on such date.
(1)  Represents  the value of personal  security  services  provided for Mr. Nix
     upon the  recommendation of our Board of Directors.  Such security services
     are considered to be corporate  business expenses and are not treated by us
     as compensation.
(2)  Mr.  Hodak's  employment as Executive  Vice  President and Chief  Operating
     Officer  commenced  in  September  2005.   $85,000  of  Mr.  Hodak's  bonus
     compensation is  attributable to a signing bonus accrued upon  commencement
     of his employment.
(3)  Mr. Kite's employment as General Counsel commenced in May 2004.
(4)  Mr. Snodgrass' employment as Operations Manager commenced in July 2003. Mr.
     Snodgrass served as a consultant to us from February 2003 to July 2003.
(5)  Represents the value of a year-end bonus gift.
(6)  Represents consulting fees paid to Mr. Snodgrass for services rendered from
     February 2003 to July 2003,  before he became our employee.
(7)  Mr. Love's  employment as Senior Vice President and Chief Financial Officer
     commenced in November  2005.  $10,000 of Mr. Love's bonus  compensation  is
     attributable   to  a  signing  bonus  accrued  upon   commencement  of  his
     employment.
(8)  Represents  consulting  fees paid to Love  Financial  Services,  Mr. Love's
     consulting firm, for consulting  services  rendered prior to service as our
     employee.
(9)  Mr. Oldham's  employment as Chief Financial Officer commenced in March 2005
     and terminated in October 2005.


                                       87



OPTION GRANTS IN 2005

         The following table presents information  regarding stock option grants
during 2005 to our Named Executive Officers.


                                        Percent of
                                          Total
                          Number of      Options                              Potential Realizable Value at
                          Securities    Granted To                            Assumed Annual Rates of Stock
                          Underlying   Employees In   Exercise               Appreciation for Option Term
                           Options        Fiscal      Or Base   Expiration   ------------------------------
NAME                     Granted (1)     Year(2)      Price (3)    Date            5%($)          10%($)
----------------------   -----------   -----------    -------    ---------   -------------    -------------
Kenneth Hodak.........      100,000        28.9%      $7.00      9/21/15       $440,230.00    $1,115,590.00
T. Michael Love.......      100,000        28.9%      $7.02      11/14/15      $441,487.80    $1,118,777.40
William R. Snodgrass..       50,000        14.5%      $5.86      6/07/15       $184,267.70    $  466,954.10
Mark A. Oldham........       15,000         4.3%      $6.25      4/01/15       $ 58,959.38    $  149,409.38

----------
(1)  All of these options were granted under our 2004 Option Plan,  vest in four
     equal annual  installments  of 25% each  commencing on January 1, 2006, and
     have a term of 10 years.
(2)  Options  covering an aggregate of 346,000  shares were granted to employees
     during fiscal 2005. (3) The exercise price and tax withholding  obligations
     related to exercise may be paid by delivery of already
     owned shares, subject to certain conditions.


AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES

         The  following  table  sets  forth,  for  each of the  Named  Executive
Officers,  certain  information  regarding the exercise of stock options  during
fiscal 2005, the number of shares of common stock  underlying stock options held
at fiscal  year-end and the value of options held at fiscal  year-end based upon
the last reported  sales price of the common stock on The NASDAQ  Capital Market
on December 30, 2005 ($6.90 per share).

                                                    Number of Shares
                                                 Underlying Unexercised        Value of Unexercised
                         Shares                  Options at Fiscal Year      In-The-Money Options at
                         Acquired     Value                End                 Fiscal Year End (1)
Name                   On Exercise   Realized   Exercisable/Unexercisable   Exercisable/Unexercisable
--------------------   -----------   --------   -------------------------   -------------------------

Jon E. Nix               156,250     $734,375          0 / 468,750               $0 / $2,203,125

Kenneth Hodak               0            -             0 / 100,000                      -

Charles Kite                0            -           31,250 / 31,250            $66,875 / $200,625

William R. Snodgrass        0            -             0 / 87,500                 $0 / $228,250

T. Michael Love             0            -             0 / 100,000                      -

Mark A. Oldham              0            -             0 / 15,000                  $0 / $9,750


                                       88



DIRECTOR COMPENSATION

         Prior to  April  2005,  our  outside  directors  did not  receive  cash
compensation  for their  services,  but were  reimbursed  for  their  reasonable
expenses incurred on our behalf or in attending meetings.  Each outside director
received  $37,500 for services  rendered from April 1, 2005 through December 31,
2005.  Each director  that served as a  chairperson  of a committee of the board
also  received  $25,000  for  their  services  as a  committee  chairperson.  In
addition,  each  outside  director  received  a  non-qualified  stock  option to
purchase  75,000  shares of our common stock at the  then-current  market price,
pursuant  to our 2004 Stock  Option  Plan.  Each  option  issued to the  outside
directors is exercisable in four equal annual installments on each of January 1,
2006, 2007, 2008 and 2009.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION.

     The Compensation  Committee of our Board of Directors currently consists of
Messrs. Filstrup,  Heinlein and Scott. None of these individuals served us as an
officer  or  employee  at any  time  during  fiscal  2005.  None of our  current
executive  officers  has  served  as a  member  of the  board  of  directors  or
compensation  committee  of any  entity  for  which a  member  of our  Board  of
Directors or Compensation Committee has served as an executive officer.

EMPLOYMENT CONTRACTS

         Other than William R. Snodgrass,  each of our Named Executive  Officers
not only  serves as an officer of National  Coal,  but also as an officer of our
wholly-owned subsidiary National Coal Corporation. Mr. Snodgrass is an executive
officer of National Coal Corporation only. Each of the named Executive  Officers
is party to an employment agreement with National Coal Corporation.

         JON E. NIX. In July 2004, our  wholly-owned  subsidiary,  National Coal
Corporation, entered into an employment agreement with Mr. Nix, as President and
Chief Executive Officer,  which agreement was subsequently  amended and restated
effective  as of October 1, 2004.  Under his  employment  agreement,  Mr. Nix is
entitled to an initial salary of $408,000 per year and a cash bonus in an amount
to be determined in good faith by the Board of National Coal  Corporation  on an
annual or quarterly  basis, as approved by the Board.  As further  compensation,
Mr. Nix also is  entitled  to monthly  compensation  in an amount  equal to five
cents ($.05) per ton of coal (calculated upon "clean" tonnage sold as opposed to
"raw" tonnage mined) sold by National Coal  Corporation each month that is mined
from all of its owned and leased properties.  Annual increases in Mr. Nix's base
salary are determined in good faith by the Board at the beginning of each fiscal
year. The initial term of Mr. Nix's employment is two years,  which term will be
automatically renewed for successive two-year terms unless the Board of National
Coal  Corporation  provides Mr. Nix written  notice of non-renewal no later than
120 days prior to the expiration of the  then-current  term. In August 2005, Mr.
Nix  voluntarily  accepted  a notice  of  non-renewal.  As a result,  Mr.  Nix's
employment  agreement  will expire as of October 1, 2006.  Mr. Nix's base salary
for 2005 is  $408,000.  Mr.  Nix's  termination  and  severance  provisions  are
described  below  in  "--Termination  and  Severance  Under  Certain  Employment
Agreements."  Pursuant  to  Mr.  Nix's  employment   agreement,   National  Coal
Corporation  maintains key man life  insurance for Mr. Nix. Any proceeds of this
policy would be  distributed  50% to National  Coal  Corporation  and 50% to Mr.
Nix's heirs.

         KENNETH  F.  HODAK.  In  October  2005,  our  wholly-owned  subsidiary,
National Coal Corporation,  entered into an employment  agreement with Mr. Hodak
to serve as Executive  Vice  President and Chief  Operating  Officer.  Under his
employment agreement, Mr. Hodak is entitled to an initial salary of $240,000 per
year,  and an annual cash bonus in an amount to be  determined  in good faith by
the Board of National Coal  Corporation.  Annual  increases in Mr.  Hodak's base
salary are determined in good faith by the Board at the beginning of each fiscal
year. Mr. Hodak is also entitled to one year of severance pay in


                                       89



the event of termination without cause or as a result of a change in control, if
either  of  these  events  occur  during  the  first  year  of  his  employment.
Thereafter, Mr. Hodak is entitled to six months of severance pay in the event of
termination  without cause or as a result of a change in control.  Mr. Hodak was
granted  100,000  stock  options at the then  current  market value of $7.00 per
share. These options vest in four equal annual  installments on each of his next
four anniversary dates.

         T.  MICHAEL  LOVE.  In  November  2005,  our  wholly-owned  subsidiary,
National Coal Corporation, entered into an employment agreement with Mr. Love to
serve as Chief Financial Officer.  Under his employment  agreement,  Mr. Love is
entitled to an initial  salary of $275,000  per year.  Annual  increases  in Mr.
Love's base salary are determined in good faith by the Board at the beginning of
each fiscal year.  Mr. Love is also entitled to one year of severance pay in the
event of termination without cause any time before January 1, 2009. Mr. Love was
granted  100,000  stock  options at the then  current  market value of $7.02 per
share. These options vest in four equal annual installments, starting on January
1, 2006.

         CHARLES KITE. In May 2004, our wholly-owned  subsidiary,  National Coal
Corporation,  entered  into an  employment  agreement  with Mr.  Kite as General
Counsel,  which agreement was subsequently  amended and restated effective as of
September 16, 2004. Under his employment  agreement,  Mr. Kite is entitled to an
initial salary of $180,000 per year, and an annual cash bonus in an amount to be
determined  in good  faith by the Board of  National  Coal  Corporation.  Annual
increases in Mr. Kite's base salary are determined in good faith by the Board at
the beginning of each fiscal year. The initial term of Mr. Kite's  employment is
two years,  which term will be  automatically  renewed for  successive  two-year
terms unless the Board of National  Coal  Corporation  provides Mr. Kite written
notice of  non-renewal  no later  than 120 days prior to the  expiration  of the
then-current  term. In August 2004,  Mr. Kite  voluntarily  accepted a notice of
non-renewal.  As a result,  Mr. Kite's  employment  agreement  will expire as of
September  16, 2006.  Mr.  Kite's base salary for 2005 is $180,000.  Mr.  Kite's
termination and severance  provisions are described below in  "-Termination  and
Severance Under Certain Employment  Agreements." Under his employment agreement,
Mr.  Kite was granted an  immediately  exercisable  option to  purchase  100,000
shares of our common  stock at an  exercise  price of $5.40 per share  under the
terms and  conditions  set forth in the 2004  National  Coal Corp.  Option Plan.
Pursuant to the 2004  Option  Plan,  Mr.  Kite's  options  vest  ratably  over a
four-year period beginning  January 1, 2005.  Pursuant to Mr. Kite's  employment
agreement,  National Coal  Corporation  maintains key man life insurance for Mr.
Kite.  Any proceeds of this policy  would be  distributed  50% to National  Coal
Corporation and 50% to Mr. Kite's heirs.

         WILLIAM R.  SNODGRASS.  In October 2004, our  wholly-owned  subsidiary,
National Coal  Corporation,  entered into an amended  employment  agreement with
William R.  Snodgrass  as  Operations  Manager of Mining  Operations.  Under his
employment agreement, Mr. Snodgrass is entitled to an initial salary of $120,000
per year and an annual cash bonus in an amount to be determined in good faith by
the Board of National Coal  Corporation.  After two years of employment,  annual
increases in Mr.  Snodgrass's  base salary are  determined  in good faith by the
Board at the beginning of each fiscal year. The initial term of Mr.  Snodgrass's
employment is two years, which term will be automatically renewed for successive
two-year  terms  unless the Board of  National  Coal  Corporation  provides  Mr.
Snodgrass  written  notice of  non-renewal  no later  than 120 days prior to the
expiration of the then-current  term. In August 2004, Mr. Snodgrass  voluntarily
accepted a notice of  non-renewal.  As a result,  his employment  agreement will
expire in October  2007.  Mr.  Snodgrass  will  remain  employed  in his current
position  without a contract.  Mr.  Snodgrass' base salary for 2005 is $120,000.
Mr.  Snodgrass's  termination  and severance  provisions are described  below in
"--Termination and Severance Under Certain Employment Agreements." In June 2005,
we granted  50,000 stock options to Mr.  Snodgrass at an exercise price of $5.86
per share.  These options vest in four equal  installments  starting annually on
January 1, 2006.


                                       90



TERMINATION AND SEVERANCE UNDER CERTAIN EMPLOYMENT AGREEMENTS

         Our employment  agreements (except for those of Messrs. Hodak and Love,
with respect to whom the  termination  and  severance  provisions  are described
above in "Employment  Contracts") provide that the employee may be terminated in
the case of any of the following events:

o    by the employee's death;
o    by the Board,  if due to  physical  or mental  disability  the  employee is
     unable to  adequately  perform  his or her  material  duties on a full-time
     basis for a period of four months  (whether  consecutive or not) within any
     twelve (12) months;
o    by a majority  vote of the Board,  if,  after  notice to the  employee  and
     advice of independent legal counsel, the Board determines that the employee
     has  engaged  in  misconduct  by  (i)  habitually  and  continuously  being
     unavailable  to act or  respond on our  behalf,  (ii)  engaging  in willful
     misconduct or fraud, (iii) being convicted of a felony,  (iv) willfully and
     continuously  materially failing to observe or perform the duties of his or
     her employment,  (v) willfully acting in a manner materially adverse to our
     best  interests,  or (vi)  willfully or habitually  neglecting the faithful
     performance of his or her duties;
o    by either  party in the event of a change in  control  (as  defined in each
     employment agreement) of National Coal Corporation (a "Change of Control"),
     or upon any other material  change in the financial  condition or ownership
     of us;
o    by the employee if there is a material  change in the employee's  function,
     authority,  duties,  title,  compensation or responsibilities,  without the
     employee's consent;
o    by the employee if substantial differences of opinion between such employee
     and the Board or the shareholders, or other circumstances should arise that
     such employee,  in good faith,  no longer feels that he or she can function
     effectively in his or her employment;
o    by the employee if there is a significant  increase in the amount of travel
     required  for  the  employee  to  perform  his or  her  job,  without  such
     employee's consent;
o    by the  employee  upon  our  material  failure  to  comply  with any of the
     provisions of the subject employment agreement; or
o    by the employee,  if the Board  requests any other matter or  circumstances
     made with the intent of, or having the result of,  hindering  such employee
     in his or her duties or creating an incentive  for the employee to exercise
     his or her rights to terminate his or her employment.

     If the employment of any of the Executive  Officers is terminated for "Good
Reason" (i.e.,  any of the last six reasons  listed above),  or we terminate the
employee  for reasons  other than  misconduct,  upon  execution  of a release of
claims in the form attached to the subject  employment  agreement (except in the
case of  termination  due to death of the  employee),  he or she is  entitled to
receive an amount  equal to his or her base  salary for a period of twenty  four
(24) months after termination (unless his or her termination is within 12 months
of a Change in Control) (the  "Severance  Period"),  insurance  coverage for the
same period,  and a prorated cash bonus payment for the year in which his or her
employment is terminated. In addition, during such period, such employee's stock
options shall  continue to vest in accordance  with the terms of the  employee's
stock option  agreement  for a period of up to 48 months,  and such employee may
exercise  his or her vested  options  for a period  commencing  with the date of
termination and expiring 120 days following the end of the Severance  Period. If
any of the Executive Officers voluntarily  terminates his or her employment with
us without  "Good  Reason,"  upon  execution  of a release of claims in the form
attached to the subject employment agreement, he or she is entitled to insurance
coverage  for one month and may only  exercise  any vested but  exercised  stock
options within 120 days of the effective date of termination.


                                       91



CHANGE IN CONTROL

         In  the  event  of  a  Change  in  Control,   the  Board  must  make  a
determination, within six months of the effective date of the Change in Control,
to either terminate any particular  executive  officer's  employment or continue
his or her  employment.  If the  employment of any of the Executive  Officers is
terminated for any reason other than misconduct within twelve months of a Change
in Control,  he or she is entitled to receive an amount equal to his or her base
salary  for a total of 36 months  after  termination  (the  "Extended  Severance
Period"),  insurance  coverage  for the same period,  and a prorated  cash bonus
payment for the year in which such employment is terminated. In addition, during
any Extended  Severance Period,  such employee's stock options shall continue to
vest in accordance with the terms of the employee's stock option agreement for a
period of up to forty eight  months,  and such  employee may exercise his or her
vested options for a period commencing with the date of termination and expiring
one hundred and twenty (120) days  following  the end of the Extended  Severance
Period.


                        REPORT OF COMPENSATION COMMITTEE

         The  Compensation  Committee  of the Board of  Directors  is  primarily
responsible  for  determining  the annual  salaries  and other  compensation  of
executive  officers  and  administering  the  Company's  stock  option and stock
purchase  plans.  During  fiscal  2005,  the  Committee  was  comprised of three
members,  all of whom were independent  directors  pursuant to applicable NASDAQ
rules.  In connection with its  deliberations,  the Committee seeks the views of
the Chief Executive Officer with respect to appropriate  compensation  levels of
the other officers.

COMPENSATION PHILOSOPHY

         The Compensation  Committee believes that our future success depends in
large part on retaining and motivating our executive officers.  As a result, the
Compensation Committee has adopted a general approach of compensating executives
with  cash  salaries  commensurate  with the  experience  and  expertise  of the
executive and competitive  with median salaries paid to executives at comparable
companies.  To reward  executives for their  contributions to the achievement of
Company-wide  performance  goals,  incentive  bonus awards are  established at a
level  designed  to ensure that when such  payouts are added to the  executive's
base salary,  the total  compensation for above-average  performance will exceed
the average compensation level at comparable  companies.  In addition,  to align
its executives' compensation with our business strategies, values and management
initiatives,  both short and long term,  executive  officers are  provided  with
long-term performance incentives.  It is our policy to encourage share ownership
through the grant of stock option awards under our 2004 Stock Option Plan.

         The Compensation  Committee also considers the  compensation  levels of
executive  officers  at  other  publicly  traded  and  private  companies.   The
Compensation  Committee has collected information regarding  compensation levels
at other  companies  over the last  several  years  from a variety  of  sources,
including proxy  statements and  compensation  reports and surveys  published or
prepared by respected consulting firms. Using this information, the Compensation
Committee  generally  establishes  base  compensation  levels  (including  stock
options)  comparable to the median  compensation levels of their counterparts at
comparable companies.

COMPENSATION ELEMENTS

         The Company's compensation package for executive officers consists of a
base salary,  performance-based  cash bonuses and stock  options.  The executive
officers are also  eligible to  participate  in most of the  Company's  employee
benefit plans.


                                       92



         BASE SALARIES.  Base salaries are initially  targeted at average levels
of comparable  companies and then adjusted  based on an assessment of individual
performance and contributions.

         BONUSES. We reward executives with cash bonuses for their contributions
to the achievement of Company-wide  performance  goals. Most of our officers and
certain other key employees selected by the Compensation Committee receive bonus
payouts  established  at a level  designed to ensure that when such  payouts are
added to a participant's  base salary,  the total compensation for above-average
performance will exceed the average compensation level at comparable  companies.
Awards are generally made when we, on the whole, exceed planned operating income
goals.  However,  certain  executive  officers are occasionally  awarded bonuses
based on attaining personal objectives set by the Compensation  Committee and/or
the Chief Executive Officer.

         STOCK  OPTION  PLANS.  The Company  uses stock  option plans to provide
employees with an opportunity  to share with the  stockholders  in the long-term
performance of the Company. The Compensation Committee grants stock options on a
periodic basis to certain  eligible  employees.  Grants are also made to certain
employees  upon  commencement  of  employment  and,  occasionally,  following  a
significant  change  in job  responsibility,  scope or  title or a  particularly
noteworthy  achievement.  Beginning in 2004,  stock options  generally vest with
respect to 25% of the stock  option award amount on January 1 of each year after
the grant,  and expires ten years from the date of grant.  The exercise price is
generally 100% of the market value of a share of Common Stock at the time of the
grant.

         The  Compensation  Committee has  established  general  guidelines  for
determining the size of periodic stock option grants based upon several factors,
including the salary and performance of the recipient at the time of grant.  The
size of the grants are targeted at competitive levels.

COMPENSATION OF CHIEF EXECUTIVE OFFICER

         Mr. Nix's  compensation for 2005 was based entirely on the terms of his
Amended  Employment  Agreement dated October 1, 2004,  which is due to expire on
October 1, 2006.  The Committee  has initiated the process of conducting  market
research and  considering  various  factors in anticipation of the expiration of
Mr. Nix's Amended Employment Agreement.

COMPENSATION OF OTHER EXECUTIVE OFFICERS

         The Compensation  Committee considered various factors to determine any
additional compensation for other Executive Officers.  These factors include (1)
the  successful  attainment of Company performance goals,  (2)  evaluations  and
recommendations of the Chief Executive  Officer,  (3) initiatives taken over and
above  the  regular  duties  of  the  other  Executive  Officers,  and  (4)  the
achievement  of  extraordinary  accomplishments  (which  may or may  not  affect
operating earnings or stock value).



                                            COMPENSATION COMMITTEE

                                            Kenneth Scott (Chairman)
                                            Robert Heinlein
                                            Scott Filstrup


                                       93



               STOCK PRICE PERFORMANCE COMPARISON SINCE INCEPTION

         The  following   Performance   Graph  compares  the  cumulative   total
stockholder return on the Company's common stock from May 18, 2004 (the date our
common stock was first  listed on the NASDAQ  Over-the-Counter  Bulletin  Board)
through December 31, 2005, with the cumulative total return over the same period
of the Russell 2000 index,  and a peer group index which  consists of Arch Coal,
Inc.,  CONSOL  Energy Inc.,  Massey Energy Co., and Peabody  Energy Corp.  These
comparisons  assume an initial investment of $100 and reinvestment of dividends.
On  April  22,   2005,   our  common   stock   listing  was   transferred   from
Over-the-Counter  Bulletin Board to The NASDAQ Capital Market (formerly known as
The Nasdaq SmallCap Market) under the symbol "NCOC".  The information  presented
below has been  adjusted to reflect a  one-for-four  reverse  stock split of our
common stock which took effect at the close of business on January 12, 2005.

                      COMPARISON OF CUMULATIVE TOTAL RETURN
                           Among National Coal Corp.,
                     Russell 2000 Index and Peer Group Index


                          [PERFORMANCE GRAPH OMITTED]


                                                 Cumulative Total Return
                            ---------------------------------------------------------------
                              5/04    6/04    9/04   12/04    3/05    6/05    9/05   12/05


NATIONAL COAL CORPORATION   100.00  105.26  218.42  289.47  142.54  125.88  154.39  151.32
RUSSELL 2000                100.00  109.18  106.06  121.01  114.55  119.49  125.10  126.52
PEER GROUP                  100.00  122.91  124.57  151.75  175.78  196.67  285.89  269.74


                                       94



ITEM 12. SECURITY  OWNERSHIP OF CERTAIN  BENEFICIAL  OWNERS AND  MANAGEMENT  AND
         RELATED STOCKHOLDER MATTERS

EQUITY COMPENSATION PLAN INFORMATION

         The following  table sets forth certain  information as of December 31,
2005 regarding  equity  compensation  plans (including  individual  compensation
arrangements) under which our equity securities are authorized for issuance:

                                  NUMBER OF SECURITIES TO BE                                  NUMBER OF SECURITIES
                                    ISSUED UPON EXERCISE OF    WEIGHTED AVERAGE EXERCISE    REMAINING AVAILABLE FOR
                                    OUTSTANDING OPTIONS AND       PRICE OF OUTSTANDING       FUTURE ISSUANCE UNDER
PLAN CATEGORY                               RIGHTS                 OPTIONS AND RIGHTS      EQUITY COMPENSATION PLANS
Equity compensation plans
approved by security holders..            1,538,635                      $4.48                      977,125

         The only equity  compensation  plan  maintained by us is our 2004 Stock
Option Plan.

BENEFICIAL OWNERSHIP TABLE

         The following  table  presents  information  regarding  the  beneficial
ownership of our common stock as of March 1, 2006 by:

         o        our Named Executive Officers;

         o        all of our directors and executive officers as a group; and

         o        each  shareholder  known by us to be the  beneficial  owner of
                  more than 5% of our common stock.

         Beneficial  ownership is determined in accordance with the rules of the
SEC  and  generally   includes  voting  or  investment  power  with  respect  to
securities.  Unless otherwise indicated below, to our knowledge, the persons and
entities  named in the table  have sole  voting and sole  investment  power with
respect to all shares  beneficially  owned,  subject to community  property laws
where  applicable.  Shares of our  common  stock  subject  to  options  that are
currently  exercisable or exercisable within 60 days of March 1, 2006 are deemed
to be outstanding and to be beneficially owned by the person holding the options
for the purpose of computing the percentage ownership of that person but are not
treated as outstanding for the purpose of computing the percentage  ownership of
any other person.

         Pursuant  to the  terms of  Series A  convertible  preferred  stock and
warrants held by certain of the 5% or more  shareholders,  the maximum number of
shares  that may be acquired by any such  shareholder  upon any  exercise of its
warrant or conversion of its preferred shares is limited to the extent necessary
to ensure that,  following such  exercise,  the total number of shares of common
stock then beneficially owned by such selling shareholder and its affiliates and
any other persons whose beneficial ownership of common stock would be aggregated
with the selling  shareholder for purposes of Section 13(d) of the Exchange Act,
does not exceed 4.99% or, in the case of Crestview Capital Master LLC, 9.99%, of
the  total  number of  issued  and  outstanding  shares  of  common  stock  then
outstanding.  The  information  presented  in this table is based on  14,140,245
shares of our common  stock  outstanding  on March 28,  2006.  Unless  otherwise
indicated, the address of each of the executive officers and directors and 5% or
more  shareholders  named below is c/o National Coal Corp., 8915 George Williams
Road, Knoxville, Tennessee 37923.


                                       95



                                                                    PERCENTAGE
                                             NUMBER OF SHARES        OF SHARES
NAME OF BENEFICIAL OWNER                    BENEFICIALLY OWNED      OUTSTANDING
---------------------------------------     ------------------     ------------

EXECUTIVE OFFICERS AND DIRECTORS:
  Jon Nix (1)                                   6,181,138               44.1%
  Kenneth Hodak                                     1,750                 *
  T. Michael Love (2)                              25,000                 *
  Charles Kite (3)                                181,250               1.3%
  William R. Snodgrass (4)                         37,500                 *
  Mark A. Oldham(5)                                15,000                 *
  Scott Filstrup(6)                                43,750                 *
  Robert Heinlein (7)                              43,750                 *
  Kenneth Scott (8)                                43,750                 *

DIRECTORS AND EXECUTIVE OFFICERS                6,559,638               46.2%
   AS A GROUP (9 PERSONS)

5% SHAREHOLDERS:
  Big Bend XII Investments, LP (9)                770,539               5.4%
  Crestview Capital Master LLC (10)             3,839,860               25.8%
  Stewart & Jennifer Flink (11)                 3,791,958               27.4%
  Jenco Capital Corporation (12)                2,161,138               15.6%
  Nancy Hoyt Revocable Trust (13)               3,829,440               27.5%
  North Sound Legacy International
     Ltd. (14)                                  2,075,373               14.3%
----------
    *  Less than 1%
       (1) Consists of (i)  3,568,750  shares of common  stock,  (ii)  2,161,138
shares of common stock held by Jenco Capital  Corporation over which Mr. Nix has
voting and investment power, (iii) 82,500 shares of common stock held by Perdase
Holdings,  Inc. over which Mr. Nix has voting and investment power, (iv) 181,250
shares of common stock beneficially owned by Mr. Nix's spouse, Jeanne Bowen Nix,
and (v) 187,500  shares of common stock  reserved for issuance  upon exercise of
stock  options held by Mr. Nix and Mr.  Nix's  spouse,  Jeanne Bowen Nix,  which
currently  are  exercisable  or will become  exercisable  on or before April 30,
2006.
       (2) Consists of 25,000 shares of common stock  reserved for issuance upon
exercise  of stock  options  which  currently  are  exercisable  or will  become
exercisable on or before April 30, 2006.
       (3)  Consists  of (i)  130,000  shares of common  stock,  and (ii) 62,500
shares of common  stock  reserved for issuance  upon  exercise of stock  options
which  currently are  exercisable or will become  exercisable on or before April
30, 2006.
       (4) Consists of (i) 12,500 shares of common stock, and (ii) 25,000 shares
of common stock  reserved  for issuance  upon  exercise of stock  options  which
currently  are  exercisable  or will become  exercisable  on or before April 30,
2006.
       (5) Consists of 15,000 shares of common stock  reserved for issuance upon
exercise  of stock  options  which  currently  are  exercisable  or will  become
exercisable on or before April 30, 2006.
       (6) Consists of (i) 25,000 shares of common stock, and (ii) 18,750 shares
of common stock  reserved  for issuance  upon  exercise of stock  options  which
currently  are  exercisable  or will become  exercisable  on or before April 30,
2006.
       (7) Consists of (i) 25,000 shares of common stock, and (ii) 18,750 shares
of common stock  reserved  for issuance  upon  exercise of stock  options  which
currently  are  exercisable  or will become  exercisable  on or before April 30,
2006.
       (8) Consists of (i) 25,000 shares of common stock, and (ii) 18,750 shares
of common stock  reserved  for issuance  upon  exercise of stock  options  which
currently  are  exercisable  or will become  exercisable  on or before April 30,
2006.
       (9)  Consists of (i) 314,711  shares of common  stock,  and (ii)  455,828
shares of common stock that may be acquired from the registrant upon exercise of
warrants and conversion of convertible preferred equity securities.
       (10) Consists of (i) 3,092,143 shares of common stock, (ii) 20,169 shares
of common stock held by Crestview Capital  Partners,  LLC, (iii) 1,975 shares of
common stock held by Dillon  Capital,  and (iv)  725,573  shares of common stock
that may be acquired from the registrant  upon exercise of outstanding  warrants
and conversion of outstanding convertible preferred equity securities.


                                       96



       (11) Consists of (i) 17,106 shares of common stock, (ii) 24,991 shares of
common stock that may be acquired from the registrant  upon exercise of warrants
and conversion of convertible  preferred equity securities,  and (iii) 3,739,860
shares of common stock  beneficially  owned by Crestview  Capital  Master,  LLC,
Dillon Capital and Crestview Capital Partners,  LLC over which Stewart Flink has
voting and investment power.
       (12) Jon Nix exercises  voting and  investment  authority over the shares
       held by this  shareholder.
       (13) Consists of  (i) 66,808 shares of common stock,  (ii) 105,000 shares
of common  stock that may be  acquired  from the  registrant  upon  exercise  of
warrants and conversion of convertible  preferred equity  securities,  and (iii)
3,739,860 shares of common stock beneficially owned by Crestview Capital Master,
LLC, Dillon Capital and Crestview Capital Partners,  LLC over which Robert Hoyt,
Nancy Hoyt's  husband,  has voting and  investment  power.  Nancy Hoyt exercises
voting and investment authority over the shares held by the Nancy Hoyt Revocable
Trust.
       (14) Consists of (i) 475,383  shares of common stock,  and (ii) 1,599,990
shares of common stock that may be acquired from the registrant upon exercise of
warrants and conversion of convertible preferred equity securities.


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         In March 2005, we borrowed  $5.14 million  pursuant to certain Note and
Warrant Purchase  Agreements.  We issued notes in the aggregate principal amount
of $5.14 million to three purchasers. The notes had an original maturity date of
August 10, 2005, are secured by certain mining  equipment,  and have an interest
rate of  eighteen  percent  (18%) per annum  calculated  from the 61st day until
maturity.  The note  purchasers  were also issued 5-year  common stock  purchase
warrants to purchase an aggregate of up to 140,000 shares of our common stock at
an  exercise  price  per  share  of  $8.50.   We  paid  an  origination  fee  of
approximately  $200,000  upon the  execution  of the loan  documents.  Crestview
Capital Master, LLC, a significant shareholder of ours, purchased a note in this
transaction in the principal amount of approximately $2.1 million and received a
warrant to purchase  approximately  56,000 shares of our common stock. In August
2005, the maturity date of the $5.14 million  indebtedness was extended to March
31,  2006,  and the notes were  amended to provide  that a 3% fee will be due on
each of December 15, 2005 and January 30, 2006 if the loan is not repaid in full
prior to  December 1, 2005 or January 16,  2006,  respectively.  Other terms and
conditions  of the notes remain  unchanged.  These loans will be repaid with the
proceeds of this offering.

         On March 21, 2005,  we and Robert  Chmiel,  our former chief  financial
officer,  entered into a Separation Agreement in connection with his resignation
as our chief financial  officer and as a director,  pursuant to which Mr. Chmiel
received  (i) an aggregate  severance  payment of  $145,000,  and (ii)  retained
56,250 of previously  issued but unvested stock options as consideration fro the
cancellation of his employment agreement.

         During  2005,  the Company  issued  234,240  shares of common stock and
received  gross  proceeds of  approximately  $531,000 upon the exercise of stock
options by employees.


ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

         Gordon, Hughes & Banks, LLP is  our  principal  independent  accounting
firm. All audit work was performed by the full time employees of Gordon,  Hughes
& Banks, LLP.  Generally,  the  Audit Committee  approves  in advance audit and
non-audit  services  to be  provided by  Gordon,  Hughes & Banks, LLP.  In other
cases, in accordance with Rule 2-01(c)(7) of Securities and Exchange  Commission
Regulation S-X, the Audit Committee has delegated  pre-approval authority to the
Chairman of the Audit  Committee  for matters  which arise or otherwise  require
approval between regularly  scheduled meetings of the Audit Committee,  provided
that the  Chairman  reports such  approvals  to the Audit  Committee at the next
regularly  scheduled  meeting of the Audit  Committee.  The Audit  Committee has
considered  whether the  provision  of  non-audit  services is  compatible  with
maintaining  the  principal  accountant's  independence,  and has approved  such
services.


                                       97



     AUDIT FEES

         Fees for audit  services  totaled  approximately  $82,000,  $53,100 and
$46,700 for the years ended  December  31,  2005,  2004 and 2003,  respectively,
including fees  associated  with the annual audit,  and reviews of our quarterly
reports on Form 10-QSB.

     AUDIT-RELATED FEES

         Fees for audit-related services totaled approximately  $23,000,  $2,600
and $9,500 for the years ended December 31, 2005,  2004 and 2003,  respectively.
Audit-related  services  principally  include due diligence in  connection  with
acquisitions, financing transactions, and accounting consultations.

     TAX FEES

         Fees were incurred totaling  approximately $7,000, $5,500 and $0 during
the years ended December 31, 2005, 2004 and 2003, respectively for tax services,
including for tax compliance, tax advice and tax planning.

     ALL OTHER FEES

         No other fees were incurred  during the years ended  December 31, 2005,
2004 and 2003 for  services  provided  by  Gordon,  Hughes & Banks, LLP,  except
as described above.


                                       98



                                     PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

         The following exhibits are filed herewith:

  EXHIBIT
   NUMBER                                   EXHIBIT TITLE
-------------

    2.1           Agreement  and Plan of  Reorganization  dated as of April  11,
                  2003 among Southern Group  International,  Inc., National Coal
                  Corp., and certain  subscribing  shareholders of National Coal
                  Corp. (1)

    2.2           Share  Purchase  Agreement  dated as of March 28,  2003 among,
                  Surinder  Rametra,  Southern  Group  International,  Inc., and
                  National Coal Corporation. (1)

    3.1           Articles of  Incorporation of National Coal Corp. dated August
                  8, 1995. (2)

   3.1.1          Articles of  Amendment  to the  Articles of  Incorporation  of
                  National Coal Corp. dated August 10, 1995. (2)

   3.1.2          Articles of  Amendment  to the  Articles of  Incorporation  of
                  National Coal Corp. dated January 4, 1996. (2)

   3.1.3          Articles of  Amendment  to the  Articles of  Incorporation  of
                  National Coal Corp. dated July 17, 2003, filed August 4, 2003.
                  (3)

   3.1.4          Articles of  Amendment  to the  Articles of  Incorporation  of
                  National  Coal Corp.  dated August 27, 2004,  filed August 31,
                  2004. (8)

   3.1.5          Articles of  Amendment  to the  Articles of  Incorporation  of
                  National Coal Corp.  dated January 10, 2005, filed January 12,
                  2005. (8)

    3.2           Amended and Restated Bylaws of National Coal Corp. (8)

    4.1           Amended and Restated  2004  National  Coal Corp.  Option Plan.
                  (8)*

    4.2           Indenture  dated as of December 29, 2005 among  National  Coal
                  Corp.,  its  subsidiaries,  and  Wells  Fargo  Bank,  National
                  Association, a national banking association, as trustee.

    4.3           Security Agreement dated as of December 29, 2005, by and among
                  National Coal Corp., its subsidiaries, in favor of Wells Fargo
                  Bank  National  Association,  in its capacity as trustee under
                  the Indenture dated December 29, 2005.

    4.4           Debt Registration  Rights Agreement,  dated as of December 29,
                  2005 by and between National Coal Corp., its subsidiaries, and
                  Jefferies & Company, Inc.

    4.5           Equity Registration Rights Agreement, dated as of December 29,
                  2005  by and  between  National  Coal Corp.  and  Jefferies  &
                  Company, Inc.

    4.6           Warrant  Agreement  dated  as of  December  29,  2005  between
                  National   Coal  Corp.,   and  Wells   Fargo  Bank,   National
                  Association as warrant agent.

    4.7           Intellectual  Property Security Agreement dated as of December
                  29, 2005 by and among National Coal Corp.,  its  subsidiaries,
                  in favor of Wells Fargo Bank, N.A. as collateral agent.

    10.1          Form of Indemnification Agreement of Registrant. (8)

    10.2          Asset Purchase and Sale Agreement  dated April 15, 2004 by and
                  among U.S. Coal, Inc., New River Processing, Inc. and National
                  Coal Corporation. (5)

    10.3          Asset  Purchase   Agreement  by  and  between   National  Coal
                  Corporation  and Robert Clear Coal  Corporation  dated October
                  26, 2004. (8)


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    10.4          Coal Supply Agreement by and between National Coal Corporation
                  and  East  Kentucky  Power  Cooperative,   Incorporated  dated
                  October 6, 2004.  Portions of this  exhibit  have been omitted
                  pursuant to a request for confidential treatment and have been
                  filed  separately  with  the  United  States   Securities  and
                  Exchange Commission. (7)

    10.5          Purchase and Sale Agreement by and between  Appalachian  Fuels
                  LLC and National Coal Corporation dated November 26, 2004. (8)

    10.6          Credit  Agreement by and between National Coal Corporation and
                  D.B. Zwirn Special  Opportunities  Fund,  L.P. as lender,  and
                  administrative  agent for the lenders dated November 26, 2004.
                  (8)

    10.7          First  Amendment to Credit  Agreement by and between  National
                  Coal  Corporation and D.B. Zwirn Special  Opportunities  Fund,
                  L.P.  as lender,  and  administrative  agent for the  lenders,
                  dated January 11, 2005.(10)

    10.8          Second  Amendment to Credit  Agreement by and between National
                  Coal  Corporation and D.B. Zwirn Special  Opportunities  Fund,
                  L.P.  as lender,  and  administrative  agent for the  lenders,
                  effective as of December 31, 2004.(10)

    10.9          Mineral  Rights  Purchase  and Sale  Agreement  by and between
                  National Coal Corporation and The Brimstone Co. dated December
                  6, 2004. (8)

   10.10          Form of Note and Warrant  Purchase  Agreements dated April 15,
                  2004,  including Form of Secured  Promissory  Note and Form of
                  Common Stock Purchase  Warrant  attached as exhibits  thereto.
                  (5)

   10.11          Security and Pledge  Agreement  dated April 15,  2004,  by and
                  among  National  Coal Corp.,  National  Coal  Corporation  and
                  Stewart Flink, as agent for himself and the holders of secured
                  promissory notes. (5)

   10.12          Subordination   Agreement   dated  April  15,  2004,  made  by
                  Crestview  Capital  Master,  LLC in favor of Stewart Flink, as
                  agent for himself and the holders of secured promissory notes.
                  (5)

   10.13          Preferred Stock and Warrant Purchase  Agreement by and between
                  National  Coal  Corp.  and the  persons  listed on  Schedule I
                  thereto,  with  respect to  Registrant's  Series A  Cumulative
                  Convertible  Preferred  Stock and Warrants to Purchase  Common
                  Stock dated August 31, 2004, including Form of Warrant. (8)

   10.14          Investor Rights  Agreement by and between  National Coal Corp.
                  and the Purchasers listed on Schedule I thereto,  dated August
                  31, 2004. (8)

   10.15          Preferred Stock and Warrant Purchase  Agreement by and between
                  National Coal Corp.  and CD Investment  Partners,  Ltd.,  with
                  respect  to  Registrant's  Series  A  Cumulative   Convertible
                  Preferred  Stock and  Warrants to Purchase  Common Stock dated
                  August 31, 2004. (8)

   10.16          Warrant,  dated August 31, 2004, issued by National Coal Corp.
                  to CD  Investment  Partners,  Ltd.  pursuant to the  Preferred
                  Stock and Warrant  Purchase  Agreement by and between National
                  Coal Corp and CD Investment  Partners,  Ltd.,  with respect to
                  Registrant's Series A Cumulative  Convertible  Preferred Stock
                  and  Warrants to Purchase  Common Stock dated August 31, 2004.
                  (8)

   10.17          Investor Rights  Agreement by and between  National Coal Corp.
                  and CD Investment Partners, Ltd. dated August 31, 2004. (8)


                                      100



   10.18          Note Purchase Agreement by and between National Coal Corp. and
                  the  persons  listed on  Schedule I thereto,  with  respect to
                  Registrant's 8% Convertible  Promissory Notes dated August 31,
                  2004,  including  Form of 8% Convertible  Promissory  Note and
                  Form of Common Stock Purchase Warrant. (8)

   10.19          Investor Rights  Agreement by and between  National Coal Corp.
                  and Crestview  Capital Master,  LLC and SDS Capital Group SPC,
                  Ltd. dated August 31, 2004. (8)

   10.20          Amended  Employment  Agreement  by and between  National  Coal
                  Corporation and Jon E. Nix dated October 1, 2004. (8)*

   10.21          Employment  Agreement by and between National Coal Corporation
                  and T. Michael Love, dated November 14, 2005.

   10.22          Employment  Agreement by and between National Coal Corporation
                  and Kenneth Hodak, dated September 20, 2005.

   10.23          Amended  Employment  Agreement  by and between  National  Coal
                  Corporation and Charles W. Kite dated September 16, 2004. (8)*

   10.24          Amended  Employment  Agreement  by and between  National  Coal
                  Corporation  and Jeanne L. Bowen-Nix dated September 16, 2004.
                  (8)*

   10.25          Amended  Employment  Agreement  by and between  National  Coal
                  Corporation and Joseph A. Davis, Jr. dated September 16, 2004.
                  (8)*

   10.26          Amended  Employment  Agreement  by and between  National  Coal
                  Corporation  and William R.  Snodgrass  dated October 1, 2004.
                  (8)*

   10.27          Form of Note  and  Warrant  Purchase  Agreements  by an  among
                  National Coal Corp.,  National Coal  Corporation,  and each of
                  Crestview Capital Master, LLC, Big Bend Investments, L.P., and
                  CCA (US) Fund I, L.P., dated March 10, 2005, including form of
                  Secured  Promissory  Note and form of  Common  Stock  Purchase
                  Warrant attached as exhibits thereto.(10)

   10.28          Form of Amendment Number One to Secured Promissory Note by and
                  between  National  Coal  Corporation,  and  each of  Crestview
                  Capital Master, LLC, Big Bend Investments,  L.P., and CCA (US)
                  Fund  I,   L.P.,   dated   August   10,   11  and  12,   2005,
                  respectively.(11)

   10.29          Security  Agreement by and between  National Coal  Corporation
                  and Crestview  Capital  Master,  LLC as agent for itself,  Big
                  Bend  Investment,  L.P. and CCA (US) Fund I, L.P., dated March
                  10, 2005.(10)

   10.30          Continuing and Unconditional  Guaranty of National Coal Corp.,
                  dated  March  10,   2005,   guaranteeing   full   payment  and
                  performance  of the Notes issued by National Coal  Corporation
                  and  the  Security   Agreement   executed  by  National   Coal
                  Corporation   pursuant  to  the  Note  and  Warrant   Purchase
                  Agreements dated March 10, 2005.(10)

   10.31          Installment   Sale  Contract  by  and  between  National  Coal
                  Corporation  and  Whayne  Supply  Company,  effective  July 1,
                  2005.(11)

   10.32          Installment   Sale  Contract  by  and  between  National  Coal
                  Corporation   and  Stowers   Machinery   Corporation   (twenty
                  vehicles), effective July 1, 2005.(11)

   10.33          Installment   Sale  Contract  by  and  between  National  Coal
                  Corporation   and   Stowers   Machinery   Corporation   (three
                  vehicles), effective July 1, 2005.(11)


                                      101



   10.34          Asset Purchase Agreement (Baldwin  Facility),  dated as of May
                  8, 2005,  by and between  National  Coal  Corporation  and LCC
                  Tennessee, LLC.(11)

   10.35          Separation  Agreement  by and  between  the Company and Robert
                  Chmiel, dated March 21, 2005. (10)

   10.36          Separation  Agreement  between National Coal Corp. and Mark A.
                  Oldham, dated November 14, 2005.

   10.37          Convertible   Promissory   Note   issued  by   National   Coal
                  Corporation to The Webb Group in the amount of  $1,503,016.67,
                  as amended, dated March 25, 2003. (6)

   10.38          Convertible   Promissory   Note   issued  by   National   Coal
                  Corporation  to The Webb Group in the amount of  $1,691,885.67
                  dated March 25, 2003. (6)

   10.39          Promissory  Note issued by National Coal  Corporation  to Webb
                  Group Financial Services, Inc. for $75,000 dated September 25,
                  2003. (6)

   10.40          Promissory  Note issued by National Coal  Corporation  to Webb
                  Group Financial Services, Inc. for $195,314.30 dated September
                  30, 2003. (6)

   10.41          Warrant to purchase  751,500  shares of common stock issued by
                  National Coal Corporation to Webb Financial Group,  Inc. dated
                  March 25, 2003. (6)

   10.42          Warrant to purchase  845,750  shares of common stock issued by
                  National Coal Corporation to Webb Financial Group,  Inc. dated
                  March 25, 2003. (6)

   10.43          Amendment  to Warrant  to  purchase  751,500  shares of common
                  stock issued by National Coal  Corporation  to Webb  Financial
                  Group, Inc. dated February 26, 2004. (6)

   10.44          Warrant to purchase  845,750  shares of common stock issued by
                  National Coal Corporation to Webb Financial Group,  Inc. dated
                  February 26, 2004. (6)

    14.1          National Coal Corp. Code of Ethical Conduct. (9)

    21.1          Subsidiaries of National Coal Corp. (8)

    23.1          Consent of Gordon, Hughes & Banks, LLP.

    31.1          Certification  of  Principal  Executive  Officer  pursuant  to
                  Securities  Exchange  Act Rules  13a-14(a)  and  15d-14(a)  as
                  adopted pursuant to section 302 of the  Sarbanes-Oxley  Act of
                  2002.

    31.2          Certification  of  Principal  Financial  Officer  pursuant  to
                  Securities  Exchange  Act Rules  13a-14(a)  and  15d-14(a)  as
                  adopted pursuant to section 302 of the  Sarbanes-Oxley  Act of
                  2002.

    32.1          Certification  of Principal  Executive  Officer and  Principal
                  Financial  Officer  pursuant  to 18 U.S.C.  Section  1350,  as
                  adopted pursuant to Section 906 of the  Sarbanes-Oxley  Act of
                  2002.

    99.1          Consolidated  Statements  of  Operations  (unaudited)  for the
                  three months ended December 31, 2005 and 2004.
----------
(1)  Incorporated  by reference  to our Current  Report on Form 8-K (dated April
     22, 2003), filed April 29, 2003.

(2)  Incorporated by reference to our Registration Statement on Form 10-SB filed
     June 25, 1999.

(3)  Incorporated  by reference to our Current  Report on Form 8-K (dated August
     7, 2003) filed August 7, 2003.

(4)  Incorporated  by  reference  to our  Quarterly  Report on Form 10-Q for the
     Quarterly Period ending June 30, 2004, filed August 13, 2004.

(5)  Incorporated  by reference  to our Current  Report on Form 8-K (dated April
     15, 2004), filed April 29, 2004.

(6)  Incorporated by reference to our Current Report on Form 8-K (dated March 1,
     2004), filed March 2, 2004.

(7)  Incorporated  by  reference  to our  Quarterly  Report on Form 10-Q for the
     Quarterly Period ending September 30, 2004, filed November 18, 2004.

(8)  Incorporated by reference to our Registration  Statement on Form SB-2 (File
     No. 333-120146).

(9)  Incorporated  by  reference  to our  Annual  Report on Form  10-KSB for the
     fiscal year ended December 31, 2004.

(10) Incorporated  by  reference  to our  Quarterly  Report on Form 10-Q for the
     Quarterly Period ending March 31, 2005, filed May 16, 2005

(11) Incorporated  by  reference  to our  Quarterly  Report on Form 10-Q for the
     Quarterly Period ending September 30, 2005, filed November 14, 2005

* Indicates a management contract or compensatory plan.


                                      102



                                   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.

                                       NATIONAL COAL CORP.


Date: April 10, 2006                     /s/ T. Michael Love
                                       -----------------------------------------
                                       By:   T. Michael Love
                                       Its:  Chief Financial Officer
                                             (Principal Financial and
                                             Accounting Officer)

                                POWER OF ATTORNEY

         The undersigned directors and officers of National Coal Corp. do hereby
constitute and appoint Jon Nix and T. Michael Love, and each of them,  with full
power of substitution and resubstitution, as their true and lawful attorneys and
agents,  to do any and all  acts  and  things  in our  name  and  behalf  in our
capacities as directors and officers and to execute any and all  instruments for
us and in our names in the capacities  indicated below,  which said attorney and
agent, may deem necessary or advisable to enable said corporation to comply with
the Securities  Exchange Act of 1934, as amended and any rules,  regulations and
requirements of the Securities and Exchange Commission,  in connection with this
Annual Report on Form 10-K, including specifically but without limitation, power
and  authority  to  sign  for us or any of us in  our  names  in the  capacities
indicated below, any and all amendments  (including  post-effective  amendments)
hereto,  and we do hereby ratify and confirm all that said attorneys and agents,
or either of them, shall do or cause to be done by virtue hereof.

         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 and in the capacities and on the dates indicated.

          NAME                            TITLE                        DATE
          ----                            -----                        ----

     /s/ Jon Nix              President and Chief Executive       April 10, 2006
------------------------      Officer and Director
        Jon Nix               (Principal Executive Officer)


 /s/ T. Michael Love          Chief Financial Officer and         April 10, 2006
------------------------      Director  (Principal
    T. Michael Love           Financial and Accounting
                              officer)

 /s/ Scott Filstrup           Director                            April 10, 2006
------------------------
    Scott Filstrup

 /s/ Robert Heinlein          Director                            April 10, 2006
------------------------
    Robert Heinlein

  /s/ Ken Scott               Director                            April 10, 2006
------------------------
       Ken Scott


                                      103