Executive Overview

We operate coal mines and processing facilities in Central Appalachia, which generate revenues and cash flow through the mining, processing and selling of steam and metallurgical grade coal, primarily of a low sulfur content. We also generate income and cash flow through other coal-related businesses, including the management of material handling facilities and a synfuel production plant. Other revenue is obtained from royalties, rentals, gas well revenues, gains on the sale of non-strategic assets, and miscellaneous income. For the year ended December 31, 2006, approximately 71% of produced tons sold were to U.S. electricity generators, 20% were to steel manufacturers in the U.S. and abroad, and 9% were to the U.S. industrial sector.

We reported net income for the year ended December 31, 2006 of $41.0 million, or $0.50 per basic share, compared to net loss for 2005 of $101.6 million, or $1.33 per basic share. Net income in 2006 included pre-tax gains totaling approximately $30 million ($19 million after-tax or $0.24 per diluted share) related to the sale of our Falcon reserves. Included in the 2005 loss was an after-tax charge of $216.2 million, or $2.83 per basic share related to a capital restructuring. Results in 2005 also included gains totaling approximately $57.3 million after-tax or $0.74 per basic share related to the sale of our ownership interest in the property known as Big Elk Mining Company and a non-cash exchange of coal reserves.

Produced tons sold were 39.1 million in 2006, compared to 42.3 million in 2005. Shipments were negatively affected during the year by productivity issues at underground mines, including the loss of six months of production from our Logan County resource group's Aracoma longwall mine due to a fire in January 2006 and geological difficulties at several underground mines, especially at our Revolution and Rockhouse longwall mines (located at our Independence and Sidney resource groups, respectively). We also continued to experience railroad congestion due to heightened coal demand and a lack of rail cars and a tight labor market that lead to high turnover and inexperienced workers. We produced 38.6 million tons during 2006, compared to 43.1 million tons produced in 2005. Exports decreased to 4.2 million tons compared to 5.3 million tons exported in 2005. In an effort to better manage our production in 2006 to adjust to the changing coal markets, we closed several low-margin coal mines, including our Rockhouse longwall and replaced some of the production capacity by adding a dragline at our Twilight surface mine and purchasing new, more productive surface and underground mine equipment.

During 2006, Produced coal revenue increased by 7% over the prior year on fewer tons shipped as we benefited from higher prices secured in new agreements as lower-priced contracts expired. These higher priced contracts were negotiated during a period of strong economic growth in China, India, the U.S. and other regions of the world, during which a worldwide shortage of certain grades of coal existed, stockpile inventories at utilities were low, and the cost of natural gas and oil was high. As 2006 progressed, spot coal prices dropped as a warm winter and relatively mild summer weather in the U.S. allowed utilities to rebuild their stockpiles and lowered the price of natural gas, resulting in natural gas storage injections that reached record levels. Our average Produced coal revenue per ton sold in 2006 increased by 16% to $48.71 compared to $42.02 in 2005 and by 56% over a five-year period compared to $31.30 in 2002. Our average Produced coal revenue per ton in 2006 for metallurgical tons sold increased by 28% to $69.20 from $54.19 in 2005.

We experienced a significant increase in costs during the past 5-year period, with Average cash cost per ton sold increasing from $28.64 in fiscal 2002 to $42.33 in fiscal 2006 (a reconciliation of these non-GAAP figures is presented in footnote 3 of Item 6. Selected Financial Data). The increased cost level is mainly due to increased sales-related costs resulting from the growth in average per ton realization, materially higher supply costs, including diesel fuel, steel, copper and explosives, higher labor and benefit costs, and lower operating productivity, as discussed above.

In June 2006, Congress passed and President Bush signed the MINER Act, which, among other things, requires mine-specific emergency response plans, enhanced communication systems, and more available mine rescue teams, as well as larger penalties by MSHA for noncompliance by mine operators. In December 2006, MSHA similarly passed its final rule on Emergency Mine Evacuation, which includes requirements for increased availability and storage of SCSRs; improved emergency evacuation drills and SCSR training; and the installation and maintenance of lifelines in underground coal mines. Coal producing states, including West Virginia and Kentucky, passed similar legislation in 2006. While the full cost of compliance remains unknown, we spent over $3 million in 2006 and estimate that we will spend a total of $20 million to $25 million over two to three years to fully comply with these laws. These costs were capitalized in Net Property, Plant and Equipment for 2006.

Results of Operations

2006 Compared with 2005

Revenues

For the year ended December 31, 2006, produced coal revenue increased $124.6 million, or 7%, to $1,902.3 million compared with $1,777.7 million for the year ended December 31, 2005. The following is a breakdown, by market served, of the changes in produced tons sold and average produced coal revenue per ton sold for 2006 compared to 2005:

                                            Year Ended
                                           December 31,
                                                             Increase      % Increase
  (In millions, except per ton amounts)    2006     2005    (Decrease)     (Decrease)
  Produced tons sold:
  Utility                                   27.7     29.2         (1.5 )           (5 )%
  Metallurgical                              7.8      9.4         (1.6 )          (17 )%
  Industrial                                 3.6      3.7         (0.1 )           (3 )%

  Total                                     39.1     42.3         (3.2 )           (8 )%

  Produced coal revenue per ton sold:
  Utility                                 $42.37   $36.66       $ 5.71             16 %
  Metallurgical                            69.20    54.19        15.01             28 %
  Industrial                               53.13    53.19        (0.06 )            0 %
  Weighted average                         48.71    42.02         6.69             16 %

The improvement in our average per ton sales price was attributable to prices contracted during a period of increased demand for all grades of coal in the U.S. and for metallurgical coal worldwide, as our lower-priced sales contracts expired. Increased prices for alternative fuel sources such as oil and natural gas also resulted in higher demand for certain coals. Exports of metallurgical coal decreased by 1.0 million tons, or 19%, to 4.2 million tons for 2006 as compared to 2005 due to lower production.

Freight and handling revenue increased $5.6 million, or 4%, to $156.5 million for 2006 compared with $150.9 million for 2005, due to more shipments to customers where we paid for freight and handling.

Purchased coal revenue decreased $61.7 million, or 47%, to $70.6 million for 2006 from $132.3 million for 2005, mainly due to a decrease in purchased tons sold from 2.5 million in 2005 to 1.3 million in 2006, offset by a 3% increase in revenue per ton. We purchase varying amounts of coal to supplement produced coal sales.

Other revenue, which consists of royalties, rentals, earnings associated with coal handling facilities, gas well revenues, synfuel earnings, gains on the sale of non-strategic assets, contract settlement payments, and miscellaneous income, decreased $52.9 million, or 37%, to $90.4 million for 2006 from $143.3 million for 2005. Other revenue for 2006 includes a pre-tax gain of $30.0 million on the sale of our Falcon reserves (see Note 4 in the Notes to Condensed Consolidated Financial Statements for further discussion). Other revenue for 2005 includes a pre-tax gain of $45.9 million related to the sale of our ownership interest in Big Elk Mining Company and a pre-tax gain of $38.2 million on a coal reserves exchange (see Note 4 in the Notes to Condensed Consolidated Financial Statements for further discussion).

Costs

Cost of produced coal revenue increased approximately 11% to $1,599.1 million for 2006 from $1,438.5 million for 2005. Cost of produced coal revenue on a per ton of coal sold basis increased 19% in 2006 compared with 2005. This increase resulted from a variety of factors including higher labor and benefit costs, higher supply costs, including diesel fuel, explosives, copper and steel prices, productivity issues at several underground mines, including the Revolution and Rockhouse longwall mines, and difficulties encountered in the restart of the Aracoma mine in July 2006. A fire at the Aracoma mine, which occurred in January 2006, also contributed significantly to the increase in Cost of produced coal revenue. Also negatively impacting Cost of produced coal revenue were higher sales-related costs for production royalties and taxes, and severance and black lung excise taxes associated with the increase in average realized prices. Tons produced during 2006 were 38.6 million compared to 43.1 million during 2005.

Freight and handling costs increased $5.6 million, or 4%, to $156.5 million for 2006 compared with $150.9 million for 2005, due to more shipments to customers where we pay freight and handling.

Cost of purchased coal revenue decreased $50 million, or 44%, to $62.6 million for 2006 from $112.6 million for 2005, due to a slight decrease in purchased tons sold from 2.5 million in 2005 to 1.3 million in 2006, offset by a 7% increase in average cost of purchased coal per ton.

Depreciation, depletion and amortization decreased $4.1 million, or 2%, to $230.5 million in 2006 compared to $234.6 million in 2005.

Selling, general and administrative expenses decreased $14.5 million, or 21%, to $53.8 million for 2006 compared to $68.3 million for 2005. The decrease was primarily attributable to lower stock-based compensation accruals due to changes in the price of the Company's stock and lower performance-linked executive compensation accruals in 2006.

Other expense, which consists of costs associated with the generation of other revenue, such as costs to operate the coal handling facilities, gas wells, and other miscellaneous expenses, decreased from $8.0 million in 2005 to $6.2 million in 2006.

Interest

Interest income of $20.1 million in 2006 was greater than the $12.6 million earned in 2005 due to higher levels of cash reserves during 2006 and higher interest rates received on investments during 2006. Interest expense increased to $86.1 million for 2006 compared with $67.1 million for 2005. The higher interest expense was primarily a result of a debt restructuring that occurred in December 2005, which increased debt levels in 2006 compared to 2005, and resulted in a higher effective interest rate. Interest expense in 2005 included a $6.6 million write-off of previously unamortized debt issuance costs related to our debt restructuring.

Income Taxes

Income tax expense was $3.4 million for 2006 compared with a tax expense of $26.2 million for 2005. The income tax rate for 2006 was favorably impacted by percentage depletion allowances, the usage of a net operating loss carry forward and the adjustment of reserves in connection with the closing of a prior period audit by the IRS. The income tax rate for 2005 was negatively impacted by the non-deductibility on the early payout of deferred compensation ($7.5 million tax effect) and the non-deductibility on our debt repurchases and exchange offers during the fourth quarter. The tax rate for 2005 was favorably impacted by percentage depletion allowances, the usage of a net operating loss carry forward, the adjustment of reserves in connection with the closing of a prior period audit by state taxing authorities and the IRS and the closing of a federal statutory period. Because of the tax benefit recognized as a result of the closing of the statutory periods and other factors, the tax rate for 2005 and 2006 should not be considered indicative of future tax rates.

2005 Compared with 2004

Revenues

For the year ended December 31, 2005, produced coal revenue increased $321.0 million, or 22%, to $1,777.7 million compared with $1,456.7 million for the year ended December 31, 2004. The following is a breakdown, by market served, of the changes in produced tons sold and average produced coal revenue per ton sold for 2005 compared to 2004:

                                            Year Ended
                                           December 31,
                                                             Increase      % Increase
  (In millions, except per ton amounts)    2005     2004    (Decrease)     (Decrease)
  Produced tons sold:
  Utility                                   29.2     25.7          3.5             14 %
  Metallurgical                              9.4     10.4         (1.0 )           (1 )%
  Industrial                                 3.7      4.3         (0.6 )          (14 )%

  Total                                     42.3     40.4          1.9              5 %

  Produced coal revenue per ton sold:
  Utility                                 $36.66   $31.79       $ 4.87             15 %
  Metallurgical                            54.19    45.55         8.64             19 %
  Industrial                               53.19    38.21        14.98             39 %
  Weighted average                         42.02    36.02         6.00             17 %

The improvement in our average per ton sales price was attributable to a continuing global economic recovery, rapid economic expansion in China, and increased prices for alternative fuel sources such as oil and natural gas that resulted in shortages of certain coals and led to increases in the market prices of these coals. We were able to take advantage of the market situation during 2005 by negotiating higher prices as lower-priced sales contracts expired. Our exports of metallurgical coal decreased by 1.0 million tons, or 16%, to 5.1 million tons for 2005 as compared to 2004 due to lower production.

Freight and handling revenue increased $2.1 million, or 1%, to $150.9 million for 2005 compared with $148.8 million for 2004, due to more shipments to customers where we paid for freight and handling.

Purchased coal revenue increased $27.4 million, or 26%, to $132.3 million for 2005 from $104.9 million for 2004, mainly due to an 18% average increase in purchased coal revenue per ton. We purchase varying amounts of coal to supplement produced coal sales.

Other revenue, which consists of royalties, rentals, coal handling facility fees, gas well revenues, synfuel earnings, gains on the sale of non-strategic assets, and miscellaneous income, increased $87.1 million, or 155%, to $143.3 million for 2005 from $56.2 million for 2004. The increase was primarily due to $84.1 million related to the sale of our ownership interest in Big Elk Mining Company and a non-cash gain on the exchange of coal reserves.

Costs

Cost of produced coal revenue increased approximately 22% to $1,438.5 million for 2005 from $1,175.9 million for 2004. This increase resulted from a variety of factors including higher labor and supply costs, including diesel fuel, explosives and steel prices, productivity issues, and continuing costs to comply with regulatory requirements. Also negatively impacting cost of produced coal revenue were higher sales-related costs for production royalties and taxes associated with the increase in average realized prices. Tons produced during 2005, were 43.1 million compared to 42.0 million during 2004. As production was greater than shipped tons, coal inventories (in various stages of production) increased during 2005.

Freight and handling costs increased $2.1 million, or 1%, to $150.9 million for 2005 compared with $148.8 million for 2004, due to more shipments to customers where we paid for freight and handling.

Cost of purchased coal revenue increased $8.5 million, or 8%, to $112.6 million for 2005 from $104.1 million for 2004, due to a slight increase in purchased tons sold from 2.4 million in 2004 to 2.5 million in 2005, as well as a 1% increase in average cost of purchased coal per ton.

Depreciation, depletion and amortization increased $10.0 million, or 4%, to $234.6 million in 2005 compared to $224.6 million in 2004, due in part to a significant investment in new surface and underground mining equipment during 2005. DD&A in 2004 included the write-off of $6.1 million (pre-tax) of capitalized development costs at an idle mine and a gas well.

Selling, general and administrative expenses increased $10.8 million, or 19%, to $68.3 million for 2005 compared to $57.5 million for 2004. The increase was primarily attributable to higher stock-based compensation accruals based on the appreciation and higher average market price of Common Stock during 2005. In addition, SG&A in 2004 was positively impacted by a $4.3 million reduction in our bad debt reserves due to the re-evaluation of the total reserve, in light of improved market conditions for the steel industry and our tighter credit terms.

Other expense, which consists of costs associated with the generation of other revenue, such as costs to operate the coal handling facilities, gas wells, and other miscellaneous expenses, decreased from $9.5 million in 2004 to $8.0 million in 2005.

Interest

Interest income of $12.6 million in 2005 was greater than the $8.8 million earned in 2004 as we had higher levels of cash reserves on hand during 2005. Interest expense increased to $67.1 million for 2005 compared with $60.7 million for 2004. The higher interest expense was due in part to higher debt levels in 2005 compared to 2004 and to a $6.6 million write-off of previously unamortized debt issuance costs related to our debt restructuring during 2005.

Income Taxes

Income tax expense was $26.2 million for 2005 compared with a tax benefit of $19.5 million for 2004. The income tax rate for 2005 was negatively impacted by the non-deductibility on the early payout of deferred compensation ($7.5 million tax effect) and the non-deductibility on our debt restructuring during the fourth quarter. The tax rate for 2005 was favorably impacted by percentage depletion allowances and the adjustment of reserves in connection with the closing of a prior period audit by state taxing authorities and the closing of a federal statutory period. In 2004, the tax rate was favorably impacted by percentage depletion allowances, the closing of a prior period audit by the IRS, and the closing of a federal statutory period. In accordance with company policy, a reserve was released for the closed statutory periods. Because of the tax benefit recognized as a result of the closing of the statutory periods and other factors, the tax rate for 2005 and 2004 should not be considered indicative of future tax rates.

Liquidity and Capital Resources

At December 31, 2006, our available liquidity was $350.0 million, which consisted of cash and cash equivalents of $239.2 million and $110.8 million availability under the asset-backed liquidity facility.

Debt was comprised of the following:

                                                   December 31,       December 31,
                                                       2006               2005
                                                           (In Thousands)
  6.875% senior notes due 2013, net of discount   $      754,804     $      754,277
  6.625% senior notes due 2010                           335,000            335,000
  2.25% convertible senior notes due 2024                  9,647              9,647
  4.75% convertible senior notes due 2023                    730                750
  Capital lease obligations                               11,232             21,443
  Fair value hedge adjustment                             (6,506 )           (7,855 )

  Total debt                                           1,104,907          1,113,262
  Amounts due within one year                             (2,583 )          (10,680 )

  Total long-term debt                            $    1,102,324     $    1,102,582

Asset-Based Credit Facility

On August 15, 2006, we amended and restated our asset-based revolving credit agreement, which provides for available borrowings, including letters of credit, of up to $175 million, depending on the level of eligible inventory and accounts receivable. The previous credit limit was $130 million, including a $100 million sublimit for letters of credit. In addition, we achieved improved pricing and extended the facility's maturity to August 2011. As of December 31, 2006, there were $64.2 million of letters of credit issued and there were no outstanding borrowings under this facility.

Conversion of 4.75% Notes

In August 2006, $20,000 of principal amount of the 4.75% Notes was converted into 1,031 shares of Common Stock.

Debt Ratings

Moody's Investors Service ("Moody's") and Standard & Poor's Rating Services
("S&P") rate our long-term debt. As of December 31, 2006, our S&P outlook rating
is Developing. Moody's outlook on all of our notes is Stable; our Corporate
Family Rating is B1.



                          Current Ratings:   Moody's   S&P
                          6.875% Notes         B2      B+
                          6.625% Notes         B2      B+
                          2.25% Notes          B2      B+
                          4.75% Notes          B3      B-

Convertible Notes Threshold

Both the 4.75% Notes and 2.25% Notes are convertible by holders into shares of Common Stock during certain periods under certain circumstances. As of December 31, 2006, the price of Common Stock had reached the specified threshold for conversion for the 4.75% Notes. Consequently, the 4.75% Notes are convertible until March 31, 2007, the last day of our first quarter, however, the 2.25% Notes are not convertible during this period. The 4.75% Notes and the 2.25% Notes may be convertible in future periods if the specified threshold for conversion is met in subsequent quarters.

Cash Flow

Net cash provided by operating activities was $214.5 million for 2006 compared to $270.1 million for 2005. Cash provided by operating activities reflects Net
(loss) income adjusted for non-cash charges and changes in working capital requirements. In 2005, coal inventory increased by $85.9 million, mainly due to an increase of $55.8 million in Saleable coal (see Note 2 to the Notes to Consolidated Financial Statements for further discussion). Changes in deposits and inventory are included in Changes in operating assets and liabilities.

Net cash utilized by investing activities was $246.7 million and $273.0 million for 2006 and 2005, respectively. The cash used in investing activities reflects capital expenditures in the amount of $298.1 million and $346.6 million for 2006 and 2005, respectively. These capital expenditures are for replacement of mining equipment, the expansion of mining and shipping capacity, and projects to improve the efficiency of mining operations. Included in these capital expenditures are $25.3 million and $13.8 million of cash spent for the buyout of operating leases in 2006 and 2005, respectively. Additionally, 2006 and 2005 included $51.5 million and $73.5 million, respectively, of proceeds provided by the sale of assets. Proceeds from the sale of assets for 2006 included $30.8 million in cash related to the sale of our Falcon reserves (see Note 4 to the Notes to Consolidated Financial Statements for further discussion). Proceeds from the sale of assets for 2005 include $49.0 million for the sale of our ownership interest in Big Elk Mining Company to a privately held coal company (see Note 4 to the Notes to Consolidated Financial Statements for further discussion).

Financing activities primarily reflect changes in debt levels for 2006 and 2005, as well as the exercising of stock options and payments of dividends. Net cash utilized by financing activities was $48.0 million for 2006 while net cash provided by financing activities was $199.8 million for 2005. Net cash provided by financing activities for 2005 includes the proceeds of $742.8 million (after discount and fees) from the issuance of the 6.875% Notes, offset by the cash utilized for the debt repurchases and exchange offer of $562.6 million. Additionally, during 2005, we made open-market debt repurchases, retiring a total principal amount of $19.1 million of the 6.95% Notes at a cost of $19.8 million, plus accrued interest. Financing activities for 2006 included $50.0 million for the repurchase of 1.3 million shares of Common Stock under the share repurchase program discussed below. We generated $21.8 million from several sale-leaseback (operating leases) transactions of certain mining equipment in 2006, compared to $71.7 million of sale-leasebacks (capital leases) in 2005.

We believe that cash on hand, cash generated from operations and our borrowing capacity will be sufficient to meet our working capital requirements, anticipated capital expenditures (other than major acquisitions), scheduled debt payments, potential share repurchases, additional bonding requirements, requirements to secure additional obligations and anticipated dividend payments for at least the next few years. Nevertheless, our ability to satisfy debt service obligations, to fund planned capital expenditures, to repurchase shares or pay dividends will depend upon our future operating performance, which will be affected by prevailing economic conditions in the coal industry, debt covenants and financial, business and other factors, some of which are beyond our control. We frequently evaluate potential acquisitions. In the past, we have funded acquisitions primarily with cash generated from operations, but we may consider a variety of other sources, depending on the size of any transaction, including debt or equity financing. Additional capital resources may not be available to us on terms that we find acceptable, or at all.

Share Repurchases

On November 14, 2005, the Board of Directors authorized a stock repurchase program, authorizing us to repurchase shares of Common Stock. We may repurchase Common Stock from time to time, as determined by our authorized officers, up to an aggregate amount not to exceed $500 million (excluding commissions) with free cash flow as existing financing covenants may permit. Existing covenants currently allow for up to approximately $18.5 million of share repurchases. The stock repurchases may be conducted on the open market, through privately negotiated transactions, through derivative transactions or thorough purchases . . .