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, 2006, our active mining complexes included two underground mines, two surface mines, and two highwall mines. 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 or re-open five new mines close to our current operations. As of December 31, 2006, we controlled approximately 36.2 million estimated recoverable tons of coal reserves. During the year ended December 31, 2006, we generated total revenues of $87.5 million, an EBITDA loss of $1.1 million, and sold approximately 1,643,000 tons of coal. Our goal is to acquire additional mines and increase production from existing reserves as market conditions allow.
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"), 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 2.5% per year. During the year ended December 31, 2006, approximately 84% of our revenue was generated from coal sales to electric utility companies in the Southeastern United States. Our largest customers were South Carolina Public Service Authority (Santee Cooper), Georgia Power, and Duke Power, representing approximately 32%, 25% and 18% of our revenues, respectively.
In the year ended December 31, 2006, our mines produced approximately 1,329,000 tons of coal. Approximately 51% of our production for 2006 was produced at underground mines and 49% was produced at our surface and highwall mine operations. We sell a majority of our coal pursuant to long-term contracts. We plan to pursue additional long-term contracts.
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 those regulations.
INCREASE PRODUCTION AND DEVELOP RESERVES. We have expanded our coal sales 35% from 1,216,000 tons in 2005 to 1,643,000 tons in 2006. We plan to expand coal production as market conditions allow. We hold permits allowing us to open three new mines and re-open two additional mines on our properties. We also have applied for permits to open and operate seven additional mines. At December 31, 2006, we controlled approximately 36.2 million estimated recoverable tons, and we believe that we have substantial unproven deposits which can be developed.
IMPROVE PRODUCTION EFFICIENCIES. We plan to continue to improve our operating efficiencies through greater economies of scale and capital improvements. As we expand our production capabilities, we plan to increasingly leverage our fixed cost infrastructure and reduce our per ton production costs. In order to achieve new efficiencies, we spent approximately $9.5 million to modernize our Baldwin preparation plant and rail load-out facility that will enable us to reduce cost and expand processing capacity in the southern portion of our Tennessee reserves. In February 2006, we purchased a forty-two mile railroad line that will enable us to transport coal from the Baldwin facility and further reduce our internal transportation costs from this area.
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. We intend to continue to develop strong relationships with our existing customers and new customers in order to enhance our market position and secure favorable long-term contracts.
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. We believe that opportunities may exist to acquire nearby reserves to further leverage our railroad access and preparation plant facilities.
HISTORY
Our operations prior to April 30, 2003 reflect only the start-up of National Coal Corporation, a Tennessee corporation, which consisted of the formation of the corporation and the purchase of the New River Tract discussed below in "Item 2. Properties". 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.
MINING OPERATIONS
Currently we are mining coal from two surface mines, two underground mines and one highwall mine.
UG=Underground HWM=Highwall Miner
TENNESSEE MINING AREAS
We have two mining areas in Tennessee characterized by proximity to a preparation plant and a rail loading facility:
SMOKY JUNCTION PREPARATION PLANT. The Northern portion of our Tennessee properties include Mine #7 and Mine #11. These mines utilize the Smoky Junction preparation plant, as necessary, and ship via rail or truck from the Turley load-out. Smoky Junction has an estimated processing capacity of 720,000 clean tons per year. Currently, the coal mined from #3 HWM is also being processed at Smoky Junction and shipped from Turley.
BALDWIN FACILITY. The Baldwin Facility, including the purchase of a 42-mile short line railroad, was refurbished at a cost of $9.5 million during 2006 for the purpose of providing robust processing and
loading facilities to support at least five separate mining opportunities in the adjacent area. The Baldwin Facility resides on the New River Tract, a 65,000 acre parcel of owned coal mineral rights. In December 2006 and January 2007, due to declining coal prices and growing coal stockpiles at utility companies, we have put our plans for the development of the Baldwin mining area on hold until such time as coal demand and pricing supports the effort.
KENTUCKY MINES
We acquired our Kentucky operations on the Straight Creek and Pine Mountain tracts from Appalachian Fuels, LLC ("Appalachian Fuels") in November 2004. We have two mining areas in Kentucky, each geographically separated and having access to a preparation plant and loading facility:
STRAIGHT CREEK. Currently, all of our mining in Kentucky is occurring on this tract of leased and owned mineral rights in Harlan, Bell and Leslie counties. All coal is processed at the Brittain preparation plant which has an estimated annual processing capacity of 1.8 million tons per year. All coal is loaded onto trains at the Viall rail loading facility which is located on the CSX railroad. We completely mined two separate permitted areas during 2006 and have currently idled two mines in Kentucky due to high cost in the case of mine KY#2 and in anticipation of additional permit approvals in the case of mine KY#6. Mine KY#6 is expected to re-open in the last half of 2007.
PINE MOUNTAIN. We are not mining on the Pine Mountain tracts at this time. The preparation plant in Pine Mountain, Kentucky, is not currently in use and would need capital improvements to become operational. We intend, subject to availability of funds, to improve the loading and preparation plant facility where necessary to serve our growing production needs.
PERMITTED NON-OPERATING MINES
Currently, we have three issued mining permits for mines that are not yet operating and two issued permits for mines which have been idled. Four of these permits are for mines located in Tennessee and one is in Kentucky. 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 Viall rail load-out facility located in Straight Creek, Kentucky 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 connects our Baldwin facility in Devonia, Tennessee to the Norfolk-Southern rail system in Oneida, Tennessee.
We use independent contractors to transport coal from the mine sites to our preparation plants and load-out facilities.
EMPLOYEES
At December 31, 2006, we had 279 full-time employees, of which 240 were engaged in direct mining or processing operations, 10 in mining supervision, 14 in other operating capacities, and 15 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, Chief Operating Officer, Chief Financial Officer and General Counsel are based in Knoxville, Tennessee. Additionally, we used
approximately 100-150 additional contracted employees for mining and hauling services in a typical month during 2006.
MARKETING AND SALES
Our marketing and sales efforts are performed by independent coal brokers. 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, 2006, we sold approximately 1,643,000 tons of coal at an average price of $52.86 per ton, resulting in approximately $86.8 million in coal sales. Of this, approximately 406,000 tons were sold in the fourth quarter at an average price of $51.90 per ton. Our top three customers, all electric utilities, represented approximately 76% of the tonnage relating to these coal sales.
CUSTOMERS
During the twelve months ended December 31, 2006, we generated all of our coal sales revenue from thirteen customers, four of which were electric utilities (84%), eight of which were industrial companies (16%) and one was a coal reseller (<1%). All of our sales 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 2006 were derived from contracts twelve months or greater. 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. At December 31, 2006, we had contracts with five customers with a term of one year or longer. The following table summarizes, as of December 31, 2006, 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 2007 through 2010:
------------- -- --------------- ---- --------------- CALENDAR YEAR TONS AVG. $/ TON DOLLAR VALUE ------------- --------------- ---------------
2007.................. 1,402,500 $50.86 $71,327,700 2008.................. 210,000 52.49 11,022,000 2009.................. 197,500 51.16 10,104,500 2010.................. 137,879 49.00 6,756,071 ------------- --------------- --------------- Total............. 1,947,879 $50.93 $99,210,271 ============= =============== ===============
COMPETITION
The coal industry is intensely competitive. We compete with numerous domestic coal producers and coal importers. We also compete with producers of other fuels used in electricity generation, including nuclear and natural gas. 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.
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, versus 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 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.
UNDERGROUND 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 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 coal shipments in the United States. 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 the coal mining 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 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 Surface Mining Control and Reclamation Act ("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 underground 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. Beginning on October 1, 2007, the fee drops to $0.315 per ton on surface-mined coal and $0.135 per ton on underground-mined coal. Since September 30, 2004, 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
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).
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.
FOSSIL FUEL. Fuel such as coal, petroleum or natural gas formed from the fossil remains of organic material.
OVERBURDEN. The layers of earth and rock covering a coal seam. In surface mining operations, overburden is removed prior to coal extraction.
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.
RESERVES. That part of a mineral deposit that could be economically and legally extracted or produced at the time of the reserve determination.
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. Pillars are areas of coal left between the rooms to support overlying strata and surface structures.
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. 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.
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.
ITEM 1A.
ITEM 1A. 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, 2006, we had approximately $63.0 million principal value of total senior debt. Subsequent to year-end, we incurred another $2.0 million in senior debt. 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. Although the terms of the 10.5% Senior Secured Notes and Term Loan 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 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 10.5% Senior Secured Notes indenture and Term Loan Credit Facility limit our ability to sell assets and also restrict the 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, 2006, we control approximately 36.2 million tons of proven and probable reserves that are recoverable at this time. We base our reserve estimates on engineering, economic and geological data assembled and analyzed by our staff and an independent mining engineering firm. Our estimates of our proven and probable reserves and our recoverable reserves, as well as the Btu or sulfur content of our reserves are revised and updated periodically to reflect the resolution of uncertainties and assumptions, the production of coal from the reserves and new drilling or other data received.
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. Although this petition was dismissed, management's time and company resources were used in the process. 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 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 contracts of twelve months or greater. For the year ended December 31, 2006, 98% of the coal we produced was sold under contracts of twelve months or greater. 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. Three of our contracts, representing 43% of our coal sales in the year ended December 31, 2006 and which expire during 2007 and 2010, contain provisions allowing the purchase price to be renegotiated or adjusted based on market prices at the time at periodic intervals. One of the contracts that is expiring in 2007, which represented approximately 9% of our coal sales, is not being renewed. 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, 2006, we derived approximately 75% of our coal revenues from sales to our three largest customers. At December 31, 2006, we had coal supply agreements with these customers that expire at various times throughout 2007. 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 the year ended December 31, 2006 were approximately $86.8 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.
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 CUMULATIVE 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 cumulative 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 cumulative 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.
In May 2006, Jon E. Nix announced he would be resigning as Chief Executive Officer. Our Board of Directors approved Daniel A. Roling's appointment in May 2006 in keeping with plans for succession of its senior management. Mr. Nix remains as Chairman and continues to be involved in setting the company's strategic direction. Mr. Roling officially began his responsibilities in August 2006.
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.
Our customers have had difficulty negotiating an agreeable transportation rate for coal to be shipped by a third-party carrier from our Baldwin rail load-out facility in Devonia, TN. However, we have had complications due to rail logistics and customer requirements that have hindered our ability to transport this coal on this rail line. If we are unable to achieve a solution to these issues, it may not be economically feasible for us to expand our operations in the New River Tract.
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. 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 REGULATES 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, 2006, $257,500 was on deposit with OSM for reclamation bonds related to our Patterson Mountain mining operations. In addition, we have approximately $14.4 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 Term Loan 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 former Chief Executive Officer. We have spent approximately $875,000 during the year ended December 31, 2006 on security measures. We have taken steps to reduce our security expenses going forward. 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 our Term Loan Credit facility 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 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. industry competition.
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 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 27, 2007, our officers and directors and their affiliates owned approximately 34.5% 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.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2.
ITEM 2. PROPERTIES.
Our executive offices are located at 8915 George Williams Road, Knoxville, Tennessee 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 10.5% Senior Secured Notes lender a security interest in all our owned and leased mining properties.
Additionally, we own, either fee simple or right-of-way, approximately 42 miles of a railroad track between Oneida, Tennessee and Devonia, Tennessee. The property is approximately 500 acres. The rail line gives access between the Baldwin preparation plant and load-out facility on the New River Tract in Devonia, Tennessee, and the Norfolk Southern main line in Oneida, Tennessee.
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 title insurance on our Tennessee properties obtained in conjunction with the issuance of our 10.5% Senior Secured Notes. We had a title examination made of the New River Tract when we purchased it from Cumberland Timber Company, LLC. We did not conduct a title review of the Straight Creek Tract we acquired from Appalachian Fuels, LLC, because title thereto was obtained by Appalachian Fuels, LLC in January 2004 pursuant to a sale and order from the United States Bankruptcy Court in the Eastern District of Kentucky.
GEOLOGY
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 nine coal 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.
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, 2006, 36.2 million tons of our proven and probable in-place reserves are recoverable. 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 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 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 2006 by Marshall Miller & Associates, Inc. (Marshall Miller). 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 defined 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 and coal seams as of December 31, 2006:
Note: Quality is provided on a "washed, dry basis" based on an average of samples taken and reported by Marshall Miller
A map showing the locations of National Coal's properties is included as Exhibit 99.1 to this Report on Form 10-K.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
In October 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 in the United States District Court for the Eastern District of Tennessee. Plaintiffs alleged that issuance of the original permit was flawed because the 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 U.S. Sixth Circuit Court. The dismissal of this action was upheld by final Order of the Sixth Circuit Court entered on January 3, 2007.
The same plaintiffs filed a similar action in U.S. District Court based on essentially the same facts alleging NEPA violations regarding OSM's approval of an application for a revision of the same permit. An unfavorable outcome of this action would not involve direct monetary damages; however significant financial losses could result from curtailed mining operations. We believe that the U. S. District Court will dismiss this action based upon the prior ruling in the similar case by the U.S. Sixth Circuit Court.
During 2005, we were audited by our previous workers' compensation insurance provider which contends that an additional approximately $1.4 million in premiums is owed 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 paid approximately $427,000 to the previous insurance provider representing additional premium for new employees about which there was no dispute. Currently, the matter has not been resolved and both parties have pursued legal action in the United States Dictrict Court of the Eastern District of Tennessee. While management believes legal reserves are sufficient for this matter, it is possible that the actual outcome of the matter could vary significantly from this amount. Management will continue to review the amount of the accrual and any adjustment required to increase or decrease the accrual based on development of the matter will be made in the period determined.
In March 2006, we were named as defendant in a complaint filed in the United States District Court for the Eastern District of Kentucky by the sublessee of certain coal mining rights concurrent with the Company's operations in Kentucky. We are the sublessee of the right to mine coal using the underground method on the property in question, as the result of a 2004 acquisition. The complainant claims that it possesses the right to mine the coal at this property through the surface mining method and that by mining the coal by the highwall mining method, we committed either an intentional or negligent trespass. The complainant seeks damages in the range of $1.2 million to $2.8 million, which it estimates to be the range of gross profits from the revenues of the coal mined. We acknowledge that we mined the coal in question, but contend that by using the highwall mining method, we mined the coal pursuant to the Lease by an underground mining method and therefore committed no trespass. As an additional defense, we have filed a third-party complaint against a consultant, who advised us that we had the right to mine the coal. This counterclaim could allow us to recover a portion of any amounts lost, if the original complainant is successful. A settlement was reached and documented for entry by Order of the Court in February 2007.
In February 2006, we 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 resulted in approximately three months of lost service. Repairs to the highwall miner have totaled approximately $1,934,000 and were recorded as a cost of sales in the first two quarters of 2006. The initial insurance claim was denied, and in April 2006, management threatened legal action against the insurance provider. In September 2006, the insurance provider agreed to the claim, and we received approximately $1,867,000, which has been recorded as a reduction of cost of sales in the third quarter of 2006. We were also in discussion with a second insurance provider on a related claim pertaining to a front-end loader that was destroyed in the same March 2006 rock collapse. We have agreed to a settlement and received compensatory proceeds of approximately $155,000 during the first quarter of 2007.
On April 12, 2006, we were named as a defendant in a suit by Appalachian Fuels, LLC (the "Plaintiff"), along with Calvary Coal Company, Inc. ("Calvary"), an independent contractor who was the Contract Miner for the Company's Kentucky operations during a portion of 2004 and 2005. The Plaintiff seeks to recover approximately $360,000, funds allegedly supplied to Calvary by the Plaintiff prior to the time of our purchase of the Kentucky operations from the Plaintiff. The purchase agreement relating to the Kentucky operations allows for the deduction of the funds in question from the payments to Calvary only upon Calvary's written consent, which the Plaintiff did not obtain. Because the required written consent was not obtained, we did not deduct the funds in question and submit them to the Plaintiff. This matter was dismissed by the Boyd County Kentucky Circuit Court in February 2007 and has not been appealed.
On September 1, 2006, the Tennessee Department of Environment and Conservation ("TDEC") issued a STOP WORK ORDER (the "Order") with respect to the operations at Mine # 7 in Tennessee. The Order alleged that we disturbed two unnamed streams outside of the permitted mining area. The Order sought the reclamation of the two streams and the assessment of penalties of approximately $173,000 if the various requirements sought by the Order were not satisfied. We filed an appeal of the Order and in November 2006 came to an agreement with TDEC, which requires reclamation of the area in question with no penalties to be assessed.
We are made a party to other legal actions, claims, arbitration and administrative proceedings from time to time in the ordinary course of business. Management regularly assesses the potential for these proceedings to have a material impact on our cash flows, results of operations or financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
None
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
COMMON STOCK
Our common stock is listed on the NASDAQ Global Market (formerly known as the NASDAQ National Market), trading under the symbol "NCOC".
From April 23, 2005 to April 20, 2006, our common stock traded on the NASDAQ Capital Market (formerly known as the NASDAQ SmallCap Market) under the symbol "NCOC". Prior to April 22, 2005, our common stock traded on the Over-the-Counter Bulletin Board 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, 2005 through December 31, 2006. 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, 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
YEAR ENDED DECEMBER 31, 2006 First Quarter........................ $ 7.01 $ 6.10 Second Quarter....................... 11.41 6.58 Third Quarter........................ 7.98 5.30 Fourth Quarter....................... 6.90 4.52
On March 27, 2007, the closing sales price of our common stock as reported on the NASDAQ Global Market was $4.70 per share. As of March 27, 2007, there were approximately 111 holders of record of our common stock.
DIVIDENDS
We are restricted from making cash dividend payments on our common stock under the terms of our Series A cumulative convertible preferred stock, our 10.5% Senior Secured Notes due 2010, and our Term Loan Credit Facility. We do not intend to pay dividends on our common stock.
Historically we have made semi-annual cash dividend payments to the holder of the Series A preferred stock on June 30 and December 31. The dividend rate of our Series A preferred stock increased from 5% to 8% on September 1, 2006. During the year ended December 31, 2006, we accrued dividends to the holders of our Series A cumulative convertible preferred stock in the aggregate of approximately $1,029,933. We paid approximately $362,886 in dividends to the holders of our Series A cumulative convertible preferred stock in June and July 2006, $413,567 in February 2007, and issued $118,567 in common shares in lieu of preferred dividends as a result of the conversion of shares of preferred stock to common stock and a covenant failure. At December 31, 2006, there were accrued but unpaid dividends on our Series A cumulative convertible preferred stock of $548,480.
PERFORMANCE GRAPH
The following performance graph compares the yearly percentage change in the cumulative total shareholder return on the common stock of National Coal Corp. to the cumulative shareholder return for the same period of a peer group and the Russell 2000 Stock Index. The peer group is comprised of National Coal Corp., CONSOL Energy, Arch Coal, Inc., and Peabody Energy Corp. The graph assumes that the value of the investment in National Coal Corp. common stock and each index was $100 at May 30, 2004. The graph also assumes that all dividends were reinvested and that the investments were held through December 31, 2006.
[PERFORMANCE GRAPH OMITTED]
MAY 30, DECEMBER 31, DECEMBER 31, DECEMBER 31, 2004 2004 2005 2006 ------------------------------------------------------ National Coal Corp. 100.0 289.5 151.3 131.6 Peer Group 100.0 151.8 269.7 241.8 Russell 2000 Stock Index 100.0 121.0 126.5 149.8
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
TWELVE MONTHS ENDED DECEMBER 31, ------------------------------------ 2006 2005 2004 -------- -------- -------- CONSOLIDATED STATEMENT OF INCOME DATA: (In thousands, except per share, per ton and number of employee amounts)
Coal Sales Revenue ................... $ 86,830 $ 65,258 $ 16,871 Total Revenue ........................ 87,517 65,873 16,999 Operating Loss ....................... (16,457) (2,564) (7,040) Net Loss ............................. (23,421) (6,791) (10,429) Net loss attributable to common shareholders per share - basic .... (1.59) (0.58) (2.60) Net loss attributable to common shareholders per share - diluted .. (1.59) (0.58) (2.60) Preferred Dividends Per Share ........ (0.07) (0.08) (0.02)
CONSOLIDATED BALANCE SHEET DATA: Working Capital (Deficit) ............ $ (9,450) $ 18,331 $ (3,921) Restricted Cash(1) ................... 17,247 7,323 4,527 Property, plant and equipment(2) ..... 55,838 50,902 35,909 Total assets ......................... 85,992 90,407 44,551 Long-term debt(3) .................... 67,487 60,015 19,724 Total Liabilities .................... 87,915 73,791 25,949 Shareholders' (deficit) equity ....... (1,923) 16,616 18,601
OTHER DATA: EBITDA(4) ............................ $ (1,094) $ 7,545 $ (4,566) Tons of coal sold .................... 1,643 1,216 357 Average cash cost per produced ton sold(5) ....................... $ 56.30 $ 44.29 $ 53.89 Coal revenue per ton sold ............ $ 52.84 $ 53.67 $ 47.32 Capital expenditures, net ............ $ 18,925 $ 19,853 $ 22,527 Number of Employees .................. 279 244 133
(1) Consists of certificates of deposit and other cash primarily serving as collateral for reclamation liabilities and an operating lease, deposits for worker's compensation liabilities, and utility and performance bonds.
(2) Includes coal mineral rights, net of accumulated amortization and depletion. Excludes assets held for sale.
(3) Includes obligations under capital leases.
(4) EBITDA is defined as net loss plus (i) other (income) expense, net, (ii) interest expense, (iii) depreciation, depletion, accretion and amortization minus (iv) interest income. We present EBITDA to enhance understanding of our operating performance. We use EBITDA as a criterion 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 is an operating performance measure that provides investors and analysts with a measure of our operating performance and permits them to evaluate our cost effectiveness and production efficiencies relative to competitors. In addition, our management uses EBITDA to monitor and evaluate our business operations. However, EBITDA is not a measurement 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 should not be considered as an alternative to cash flows from operating activities, determined in accordance with GAAP, as indicators of cash flows. The following reconciles our net loss to EBITDA:
TWELVE MONTHS ENDED DECEMBER 31, -------------------------------- 2006 2005 2004 -------- -------- -------- Net loss ................................... $(23,421) $ (6,791) $(10,429) Other (income) expense, net ................ 280 390 41 Interest expense ........................... 7,476 3,967 3,349 Interest income ............................ (792) (129) -- Depreciation, depletion, accretion and amortization .......................... 15,363 10,108 2,473 -------- -------- -------- EBITDA ..................................... $ (1,094) $ 7,545 $ (4,566) ======== ======== ========
(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:
ITEM 7.
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, 2006, 2005 and 2004. 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.
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, 2006, our active mining complexes included two underground mines, two surface mines, and two highwall mines. In addition, we have four preparation plants, two active and two inactive, and four unit train loading facilities, three active and one inactive, served by the CSX and Norfolk Southern ("NS") railroads. We hold permits that allow us to open or re-open five new mines close to our current operations. As of December 31, 2006, we controlled approximately 36.2 million estimated recoverable tons of coal reserves. During the year ended December 31, 2006, we generated total revenues of $87.5 million, an EBITDA (a reconciliation of non-GAAP figures is presented in footnote 4 of Item 6. Selected Financial Data) loss of $1.1 million, and sold approximately 1,643,000 tons of coal. Our goals continue to include expansion and increasing mine production, as market conditions allow.
The majority of our revenues have come from the sale of coal we produce. We have also sold coal that we purchase from third party coal producers, both on a contract and a case by case basis. Additionally, we charge third party coal producers a negotiated price per ton for coal loading services. For 2007, we expect our production to be be slightly lower than in 2006 due to business decisions to temporarily idle or delay the opening of certain mines, a preparation plant, and a load-out facility. We will resume and expand our production activities when economic conditions are favorable. We plan to increase the purchase of coal from third-party producers to fulfill contractual obligations as part of our business strategy in 2007.
Our revenues depend largely on the price at which we are able to sell our coal. Coal prices decreased between 2005 and 2006. Decreases in coal prices are primarily due to the supply and demand balance of coal in the market - both domestic and imported, as well as the price and availability of alternative fuels for electricity generation. Continued low prices could adversely affect our revenues and our ability to generate cash flows in the future. As a result of supply having exceeded demand during 2006, which resulted in the currently low coal price environment, we have idled certain operations.
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. Three of our contracts, pursuant to which we sold 43% of our coal in the twelve months ended December 31, 2006, and which expire in 2007 and 2010, provide for adjustment of coal purchase prices based on market conditions. One of the contracts expiring in 2007, which represented 9% of coal sales for the twelve months ended December 31, 2006, is not being renewed due to our inability to obtain a contract with an acceptable sales price. We plan to capitalize on upswings in the pricing environment, if such market conditions emerge, by pursuing additional long-term contracts when economically acceptable to us. In the interim, any uncommitted coal produced will be sold on the spot market for an economically acceptable price.
We have expanded our production capacity significantly. In Tennessee, we made $9.5 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 load-out facility. In February 2006, we purchased a short line railroad for approximately $2 million which connects our owned reserves to the Norfolk-Southern Railroad at Oneida, Tennessee. We spent an additional $0.5 million to refurbish the line and make it operational. We also acquired the Baldwin preparation plant and rail load-out facility in 2005 in return for the assumption of certain reclamation liabilities and spent $7.0 million during 2006 to refurbish and modernize the Baldwin Preparation plant and rail load-out facility. These investments will provide the capability to efficiently process and transport our coal produced from our owned reserves to market. In addition we spent $4.1 million on developing new mining operations in Tennessee during 2006. The capital expenditures on mines, processing, and transportation should help us lower our operating costs. Also, the expenditures made on our transportation infrastructure should help reduce delivery cost to our Southeast U.S. utility customers. When economically advantageous, we intend to utilize our increased production capacity by increasing our production. Longer term, we plan to permit and develop additional production capability from our current reserve base.
Our financial results from operations depends heavily upon the cost of producing coal. Our primary expenses are wages and benefits, repairs 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 2007 and beyond as we increase our capital expenditures for mining and other equipment needed to expand our business.
For additional information regarding some of the risks and uncertainties that affect us and our industry, see "Risk Factors."
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.
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. When applicable, freight costs billed to the customers as part of the contract price are included as coal sales with the offsetting expense included in cost of sales. We recognize revenue from sales made pursuant to these contracts at the time the coal is loaded onto rail cars and trucks at our load-out, mine, and processing plant facilities.
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 Statement of Financial Accounting Standards, or SFAS, 13, ACCOUNTING FOR LEASES. These leases are classified as either capital or operating as appropriate. Leased equipment meeting the capital lease criteria of SFAS 13 is capitalized and the present value of the related minimum 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.
Reserves and mine development costs are recorded at cost or at fair value in the case of acquired businesses. Our 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.
Exclusive of the approximately $55.8 million of property, plant, equipment and mine development, net we had as of December 31, 2006 is approximately $0.6 million of mining equipment classified as assets held for sale. This equipment was sold in January 2007 for a small gain.
We review our 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.
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 underground 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 SFAS 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS ("SFAS 143"). 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 engineering estimates. In accordance with SFAS 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. In estimating future cash flows, we consider third party profit and apply inflation factors as required by SFAS 143.
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.
STOCK-BASED COMPENSATION. We account for stock-based compensation using Statement of Financial Accounting Standards No. 123 (Revised 2004), SHARE-BASED PAYMENT ("SFAS 123(R)"). We currently use a standard option pricing model to measure the fair value of stock options granted to employees. SFAS 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 123(R). Awards granted prior to the effective date should continue to be accounted for in accordance with the provisions of SFAS 123(R) 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 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.
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 probable 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 March 2005, the Financial Accounting Standards Board ("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 did 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. We have adopted the EITF effective January 1, 2006. Adoption of this EITF has had no material 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.
In June 2006, the FASB issued Interpretation No. 48 ("FIN 48"), ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES--AN INTERPRETATION OF FASB STATEMENT NO. 109. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently assessing the potential impact of the interpretation on our financial position and results of operations.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, FAIR VALUE MEASUREMENTS ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective prospectively for fiscal years beginning after November 15, 2007 and interim periods within that fiscal year. We are still analyzing SFAS 157 to determine the impact of adoption.
RESULTS OF OPERATIONS
The following table presents consolidated statement of operations data for each of the periods indicated as a percentage of revenues.
TWELVE MONTHS ENDED DECEMBER 31 ------------------------------- 2006 2005 2004 ------- ------- -------
Revenues ................................... 100.0% 100.0% 100.0% ------- ------- ------- Operating expenses: Cost of sales ........................... 90.6 77.6 96.0 Depreciation, depletion amortization, and accretion ........................ 17.6 15.3 14.6 General and administrative .............. 10.6 11.0 30.8 ------- ------- ------- Total operating expenses .............. 118.8 103.9 141.4 ------- ------- ------- Operating loss ............................. (18.8) (3.9) (41.4) Other income (expense): Interest expense ........................ (8.6) (6.0) (19.7) Interest income ......................... 0.9 0.2 -- Other income (expense), net ............. (0.3) (0.6) (0.3) ------- ------- ------- Net loss ................................... (26.8)% (10.3)% (61.4)% ======= ======= =======
COMPARISON OF TWELVE MONTHS ENDED DECEMBER 31, 2006 AND DECEMBER 31, 2005
REVENUES TWELVE MONTHS PERCENT ENDED DECEMBER 31 CHANGE ------------------------- ----------- 2006 2005
Coal sales .......................... $86,830,095 $65,258,071 33.1% Other revenue ....................... 686,992 614,563 11.8% ----------- ----------- Total revenues ................... $87,517,087 $65,872,634 32.9% =========== ===========
For the twelve months ended December 31, 2006, our revenues were derived from coal sales to thirteen customers, four of which were utilities, eight of which were industrial customers and one of which was a coal reseller. Our five largest customers represent 92% of our total coal sales. 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 coal sales. The 33.1% increase in coal sales during the year ended December 31, 2006 is primarily attributable to a 35% increase in sales volume and the addition of a new customer partially offset by a 4% decrease in average net sales prices, including penalties and premiums.
In 2005, coal prices in Central Appalachia remained relatively unchanged despite unseasonable weather in the Southeast, however, a second year of cooler summer temperatures and warmer winter temperatures in 2006 did have a large negative impact on coal prices. Also, many producers increased production to meet the higher demand.
The increase in other revenues is due to the increase in receipts of loading fees of $288,000 from a coal company with property located adjacent to ours and approximately $77,000 of wheelage revenue under a lease agreement, offset by a prior year negotiated termination of a sales contract of $350,000.
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, 2006 as compared to the year ended December 31, 2005 is primarily due to a 39% increase in mined and purchased coal.
Cost of sales as a percentage of revenue increased from 77.6% in 2005 to 90.6% in 2006. This was primarily due to inefficiencies incurred during the early stages of opening three new mines and building significant inventories, operating the refurbished Baldwin wash plant (with insufficient volume to absorb fixed costs), and the start-up of our short-line railroad. Operating costs associated with these projects for the year totaled $4.7 million. A significant portion of the cost increase, about $2.2 million was associated with the three capital projects that were completed, but then idled. Those projects were Mine #17, the Baldwin preparation facility, and the shortline railroad. In addition to the above, three other events contributed to higher costs during the year: lost production from a highwall miner due to an accident in March 2006, higher costs associated with purchasing and processing coal from third parties, and a significant increase in our cost structure in Kentucky due to the termination of a subcontractor.
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 three major components: 1) $1,423,000 increase in stock option expense primarily due to our adoption of SFAS 123(R) and an accelerated vesting of executive stock options for the former CEO, the former General Counsel and Secretary (who is also the spouse of the former CEO), and the former COO, 2) $514,000 increase in professional fees, primarily legal fees, and 3) $274,000 increase in payroll, primarily due to an increase in corporate personnel in 2006.
As a percentage of revenues, general and administrative expenses have decreased from 11.0% in 2005 to 10.6% in 2006.
DEPRECIATION, DEPLETION, ACCRETION AND AMORTIZATION EXPENSE
The increase in depreciation, depletion, accretion and amortization expense in the twelve month period ended December 31, 2006 compared to the twelve month period ended December 31, 2005 is primarily attributable to a 56.1% increase in depreciation. This change was due to the acquisition of $28.0 million of fixed assets, primarily mining equipment, net of fixed asset disposals with a gross value of approximately $9.7 million and a change in the estimated useful lives of certain mining equipment at April 1, 2005. Had this revision been made as of January 1, 2005, the effect would have been to increase depreciation expense by approximately $1.6 million for the year ended December 31, 2005.
The 88.4% increase in interest expense for the twelve month period ended December 31, 2006 compared to the twelve month period ended December 31, 2005 is attributable to an increase in the average outstanding balance of our debt related primarily to the issuance of $55 million of 10.5% Senior Secured Notes obtained immediately prior to year-end 2005, partially offset by a decrease in financing fees of approximately $1.9 million related to our prior year bond offering and a decrease in our weighted average interest rate of approximately 2.3%. Interest income increased by 512.9% primarily due to larger average short-term deposit balances Other income (expense), net of $279,928 expense consists primarily of the write-off of acquisition costs and a rebate from a third-party railroad agreement in the current year versus a $390,106 expense in the prior year related primarily to a loss on the early extinguishment of notes payable.
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 ....................... 614,563 127,567 381.8% ----------- ----------- Total revenues ................... $65,872,634 $16,998,913 287.5% =========== ===========
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 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 three 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.
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 from 96.0% in 2005 to 77.6% in 2006.
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% in 2005 to 11.0% in 2006.
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.
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.
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
At December 31, 2006, we had cash and cash equivalents of approximately $2.2 million, negative working capital of approximately $9.5 million, and cash flows used in operations of approximately $3.8 million for the year then ended. In order to fund general operating and working capital needs, we entered into a Term Loan Credit Facility in October 2006 that provides borrowings of up to $10.0 million with Guggenheim Corporate Funding, LLC. We borrowed $5.0 million at closing, an additional $3.0 million in December 2006, and the the remaining $2.0 million subsequent to year-end.
As noted previously, we have made significant investments over the past three years to expand our production capacity significantly. We are now in a position to increase our production when doing so will be economically advantageous. We have no material capital projects planned for 2007 and our budgeted capital expenditures for the year are less than $3 million.
At December 31, 2006, we had a shareholders' deficit of $1.9 million and incurred net losses of $23.4 million (excluding preferred stock dividends) for the year then ended. We expect that we will continue to incur net losses into the foreseeable future which will increase our shareholders' deficit. On March 2, 2007 we sold 3 million shares of our common stock in a private sale. Two institutional investors purchased 2.8 million shares and our current CEO purchased the remaining 200,000 shares. Proceeds from the sale were approximately $14.0 million and will be used for potential internal and external growth opportunities and to fund general operating and working capital needs. We are required to file a registration statement to register the shares as early as practicable, but no later than April 30, 2007.
We expect to be able to meet our liquidity requirements for the foreseeable future through current cash reserves and cash provided by operations. If our operating plans for 2007 vary significantly from our expectations, we may have to seek additional financing sources. In the case that market conditions improve and we determine that it is economically advantageous to resume expansion plans, we may have to seek additional financing sources. There are no assurances that our efforts to raise additional financial resources will be successful.
DEBT OBLIGATIONS
The following table summarizes our long-term debt obligations, excluding capital leases:
DECEMBER 31, DECEMBER 31, 2006 2005 ------------ ------------ 10.5% Senior Secured Notes, due 2010 ........... $ 55,000,000 $ 55,000,000 Term Loan Credit Facility ...................... 8,000,000 -- Bank note (prime + 1%), due 2007 ............... 637,374 1,200,018 Installment purchase obligations, due 2009 ..... 3,200,286 -- Installment purchase obligations, due 2008 ..... 2,825,209 5,270,611 Equipment note (non-interest bearing), due 2006 -- 280,000 Equipment notes (8.39%-9.28%, due 2009-2011) ... 125,382 -- Equipment note (4.48%, due 2009) ............... 234,721 -- Other .......................................... 89,512 19,931 Less unamortized discounts ..................... (3,298,679) (3,910,160) ------------ ------------ 66,813,805 57,860,400 Less current portion of long-term debt ......... (4,720,671) (3,319,175) ------------ ------------ Long-term debt ................................. $ 62,093,134 $ 54,541,225 ============ ============
TERM LOAN CREDIT FACILITY
On October 12, 2006, our wholly-owned subsidiary, National Coal Corporation, entered into a Term Loan Credit Facility that provides for borrowings of up to $10.0 million with Guggenheim Corporate Funding, LLC in order to fund general operating and working capital needs. We borrowed $5.0 million at closing, an additional $3.0 million in December 2006, and the remaining $2.0 million subsequent to year-end.
Under this Credit Facility, our obligations are secured by a priority senior lien on substantially all of our assets. All amounts under the Credit Facility become due and payable in March 2010 and the interest under this facility is payable at a rate equal to, at our option, the Eurodollar Rate plus 3.5% or the Base Rate (which approximates the prime rate) plus 2.5%. The Term Loan Credit Facility contains financial covenants and default provisions including that the Company maintain minimum levels of EBITDA and liquidity, maintain minimum interest coverage ratios, not exceed maximum leverage ratios, and that it limit certain future categories of transactions such as the incurrence of additional indebtedness and the sale of assets. Subsequent to year-end, Guggenheim has agreed to amend the credit agreement and reset the financial covenants including: EBITDA, consolidated leverage, and consolidated interest coverage. As a result of the amendment, the applicable margin on the credit facility will increase by 1.0%. The applicable margin is the rate which is added to the Eurodollar Rate or Base Rate, to determine the full interest rate on the facility. The applicable margin increase will remain in effect until we are back in compliance with the original covenant schedule in the credit agreement.
10.5% SENIOR SECURED NOTES DUE 2010
On December 29, 2005, we issued $55,000,000 in aggregate principal amount of 10.5% Senior Secured Notes due 2010 (the "Senior Secured Notes") and 55,000 warrants to purchase a total of 1,732,632 shares of the Company's common stock (the "Warrants"). The Senior Secured 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 of the Company's common stock remains above $12.75 for more than twenty days out of a thirty-day period. 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 Secured Notes are fully and unconditionally guaranteed 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 Secured Notes were issued pursuant to an indenture with Wells Fargo Bank National Association, as trustee. Interest on the Senior Secured 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 and the warrants will expire on December 15, 2010. All of the securities in this offering were initially purchased by the underwriter.
The Senior Secured 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 Secured Notes will mature on December 15, 2010. The Senior Secured Notes are subordinated to our new $10 million Term Loan Credit Facility with Guggenheim Corporate Funding, LLC, which holds a first priority secured lien senior to the Notes, and ranks senior to our existing and future subordinated debt.
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 Secured Notes with the net proceeds of a public or private equity offering at 110.500% of the principal amount of the Senior Secured 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, up to 35% of the Senior Secured Notes are redeemable, at our option, in whole or in part, at any time up to December 15, 2008 at a redemption price of 110.500%. The remaining 65% of the Senior Secured Notes are redeemable, at our option, in whole or part, on or after December 15, 2008, in each case at the redemption prices described in the table below. All redemptions prices are in addition to 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 Secured Notes, among other things and subject to certain exceptions, limits 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 Secured Notes.
We agreed, pursuant to a registration rights agreement with the initial purchaser, to use our commercially reasonable efforts to (a) register with the SEC a new issue of notes having substantially identical terms as the Senior Secured Notes in order to exchange freely tradable notes for the Senior Secured Notes, and (b) file a shelf registration statement with the SEC covering the resale of the Warrants and shares of our common stock issuable upon exercise of the Warrants, 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 filed registration statements subject to our obligations under the registration rights agreement on May 15, 2006. Both registration statements were declared effective on July 28, 2006, and we issued $51.0 million in principal amount of freely tradable notes in exchange for the same principal amount of Senior Secured Notes.
We immediately used approximately $22.1 million of the proceeds of the Senior Secured Note offering to repay existing indebtedness. During the year ended December 31, 2006 we used approximately $2.0 million to purchase a forty-two mile rail line in Tennessee, approximately $8.3 million as collateral to support reclamation bonds, and $19.7 million to purchase other equipment, refurbish a preparation plant and rail load-out, and to use as working capital.
EQUIPMENT NOTES
In November 2005, we purchased mining equipment to be used 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 payable to one of the mining companies and a $1,300,000, twenty-four month bank 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.
In February and March 2006, we purchased service vehicles and mining equipment for approximately $478,000. We financed the purchases with interest bearing notes ranging in term from thirty-six to sixty months and with interest rates ranging from approximately 4.5% to 9.3%. All notes are secured by the purchased equipment.
INSTALLMENT PURCHASE OBLIGATIONS AND SALE-LEASEBACK
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 rates ranging from 5.22% to 7.65%.
The total $6,717,650 aggregate principal balance of these contracts included refinancing obligations previously under capital leases of approximately $2,937,000 at September 30, 2005 representing gross assets of approximately $4,372,000. This resulted in the recognition of a gain on extinguishment of debt 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.
In April 2006, we entered into new installment sale contracts with an equipment manufacturer pursuant to which we refinanced equipment with an aggregate principal value of approximately $2,729,000 formerly acquired under various capital leases resulting in a loss on extinguishment of debt of approximately $10,000. These installment sale contracts require payments over 36 months at fixed interest rates ranging from 7.03% to 7.50%. The obligations under the installment sale contracts are secured by the equipment purchased.
In August 2006 and September 2006, we entered into new installment sale contracts with an equipment manufacturer pursuant to which we refinanced equipment with an aggregate principal value of approximately $1,447,000. These installment sale contracts require payments over periods ranging from 30 to 36 months at fixed interest rates ranging from 7.42% to 8.10%. The obligations under the installment sale contracts are secured by the equipment purchased.
On September 18, 2006 we entered into a sale-leaseback transaction with First National Capital Corporation's assignee, GATX Financial Corporation, involving our highwall miner initially purchased in February 2006. We sold the highwall miner for approximately $6.4 million and recorded a deferred gain of approximately $875,000 which will be recognized over the forty-two month term of the operating lease. The lease is a "net" lease and requires that we maintain and insure the equipment as well as pay rental payments of $166,568 per month. As a condition of the lease, we provided two standby letters of credit totaling $1,288,883 in lieu of security deposits which are 100% collateralized with cash on deposit at two financial institutions.
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.
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, 2006, we had a net decrease in cash of approximately $23.3 million. Cash flows from operating, financing and investing activities for the twelve months ended December 31, 2006, 2005, and 2004 are summarized in the following table:
ACTIVITY TWELVE MONTHS ENDED DECEMBER 31, ---------------------------------- 2006 2005 2004 -------- -------- --------
Operating activities .................... $ (3,835) $ 6,040 $ (4,342 Investing activities .................... (26,364) (19,473) (33,466) Financing activities .................... 6,945 38,565 38,111 -------- -------- -------- Net increase (decrease) in cash ...... $(23,254) $ 25,131 $ 303 ======== ======== ========
OPERATING ACTIVITIES
The decrease in net cash provided by operating activities of approximately $9.4 million to $3.8 million used in operating activities during the year ended December 31, 2006 was primarily the result of an increase in net loss, net of depreciation, depletion, amortization and accretion and non-cash stock option expense, of $9.9 million. The increase was primarily due to lower contract prices, increased purchases of coal due in part to the highwall miner damage during the year, and the termination of a financially favorable agreement with a subcontractor for the management of our Kentucky properties, partially offset by increased non-cash stock option expenses of $1.4 million over prior year due to the adoption of SFAS123(R) and the accelerated vesting of certain executive options. Offsetting the overall decrease in cash flow from operations is a greater increase in accounts payable of $3.6 million primarily attributable to the refurbishment of our Baldwin preparation plant and load-out facility which has taken place in 2006 and increased interest due to higher debt balances. These and other expansion activities have also resulted in a greater increase in inventory of $1.7 million in current year and $1.1 million of asset retirement obligation settlements, both of which decreased cash from operations.
The net cash provided by operating activities of approximately $6.0 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 reduction of 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 the fixed mine operating 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 $4.3 million during the twelve months ended December 31, 2004 was primarily the result of the net loss of approximately $10.4 million and an increase in receivables of approximately $1.9 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.
INVESTING ACTIVITIES
Cash used in investing activities for the twelve months ended December 31, 2006 of $26.4 million was primarily related to net capital expenditures of approximately $16.3 million including the acquisition of a forty-two mile rail line in Tennessee and renovations to a processing facility in Tennessee along with an increase in cash collateral supporting reclamation bonds of approximately $9.9 million.
Cash used in investing activities for the twelve months ended December 31, 2005 of $19.5 million was primarily related to capital expenditures of $16.5 million and an increase in cash collateral supporting reclamation bonds of $2.8 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.
FINANCING ACTIVITIES
The decrease in net cash provided by financing activities of approximately $35.2 million to approximately $6.9 million during the twelve months ended December 31, 2006 was primarily the result of the Senior Notes issued in December 2005 which decreased the need for additional funding.
The net cash provided by financing activities of approximately $38.6 million during the twelve months ended December 31, 2005 was primarily the result of $55.0 million raised from the issuance of our 10.5% 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.
The net cash provided by financing activities of approximately $38.1 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 cumulative convertible preferred stock net of $1.0 million in fees, offset primarily by $3.1 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.
OFF-BALANCE SHEET ARRANGEMENTS
At December 31, 2006, 2005, and 2004, 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, 2006 and the effects such obligations are expected to have on liquidity and cash flow in future periods:
We rent mining equipment pursuant to operating lease agreements, and made lease payments totaling approximately $1,011,323 during the year ended December 31, 2006.
For the year ended December 31, 2006, we accrued dividends to the holders of our Series A cumulative convertible preferred stock in the aggregate of approximately $1,029,933, $118,567 of which we paid as common shares in lieu of preferred dividends as a result conversion of preferred shares to common stock and a covenant failure. Historically we have made semi-annual cash dividend payments to the holder of the Series A preferred stock on June 30 and December 31. Dividends accrued on our Series A cumulative convertible preferred stock of $362,886 were paid in June and July 2006 and $413,567 was paid in February 2007. At December 31, 2006, there were accrued but unpaid dividends on our Series A cumulative convertible preferred stock of $548,480. The dividend rate of our Series A preferred stock increased from 5% to 8% on September 1, 2006. We intend to make dividend payments going forward as long as (1) no default of our debt covenants has occurred, (2) we will be in pro-forma compliance with our debt agreements, and (3) the available credit and cash equivalents we have is not less than $1.5 million.
ITEM 7A.
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, 2006, we had $61.5 million aggregate principal amount of debt under fixed rate instruments and $8.6 million of debt under variable rate instruments, with our Term Loan Credit Facility making up 93% of the variable rate instruments and equipment financing making the remaining 7%. At December 31, 2005, we had $60.6 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.
Under the terms of our Term Loan Credit Facility and our equipment financing agreements, the interest rate on borrowings there under was determined based on the Eurodollar rate and the prime rate, respectively. We are able to lock in the existing interest rate on our Term Loan Credit Facility for periods of up to six months. Based on the variable rate debt outstanding as of December 31, 2006, a 100 basis point increase in interest rates would increase annual interest expense by approximately $83,000. 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.
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. 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ----
Reports of Independent Registered Public Accounting Firms............ 51
Consolidated Balance Sheets at December 31, 2006 and 2005............ 53
Consolidated Statements of Operations for the Years Ended December 31, 2006, 2005, and 2004................................. 54
Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005, and 2004................................. 55
Consolidated Statements of Changes in Stockholders' (Deficit) Equity for the Years Ended December 31, 2006, 2005, and 2004...... 57
Notes to the Consolidated Financial Statements....................... 58
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of National Coal Corp. Knoxville, Tennessee
We have audited the consolidated balance sheet of National Coal Corp. (the "Company") as of December 31, 2006 and the related consolidated statements of operations, stockholders' (deficit) equity and cash flows for the year then ended. 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 audit. The financial statements of the Company for the years ended December 31, 2005 and 2004 were audited by other auditors whose report dated February 17, 2006 expressed an unqualified opinion on those statements.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the 2006 financial statements referred to above present fairly, in all material respects, the consolidated financial position of National Coal Corp. at December 31, 2006, and the consolidated results of its operations and its cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for share-based payments in accordance with Statement of Financial Accounting Standards No. 123(R) on January 1, 2006.
/S/ ERNST & YOUNG LLP
Richmond, Virginia March 30, 2007
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors National Coal Corp. Knoxville, Tennessee
We have audited the consolidated balance sheet of National Coal Corp. (the "Company", a Florida corporation) as of December 31, 2005, and the related consolidated statements of operations, cash flows and changes in stockholders' equity for the years ended December 31, 2005 and 2004. 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 the consolidated results of its operations and its cash flows for the years ended December 31, 2005 and 2004, in conformity with accounting principles generally accepted in the United States of America.
/S/ GORDON, HUGHES & BANKS, LLP
Greenwood Village, Colorado February 17, 2006
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
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. As of December 31, 2006, active mining complexes include two underground mines, two surface mines, and two highwall mines. 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 amounts from the prior consolidated financial statements have been reclassified to conform to the 2006 presentation. These consist primarily of the reclassification of certain deposits from other non-current assets to restricted cash totaling $697,756 and the reclassification of certain other current assets to inventory of $57,500. The balance sheets and statements of cash flows presented reflect these changes.
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.
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTS RECEIVABLE
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Customers are primarily utility companies. 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 customer balances and will record an allowance if trade account balances become potentially uncollectible.
INVENTORY
Inventory includes mined coal available for delivery to customers, mined coal which has not yet been processed through a wash plant, purchased coal, and tires. Mined coal inventory is valued at the lower of average cost or net realizable value. Mined coal inventory costs include labor, fuel, equipment costs, and operating overhead. Mined coal is classified as inventory at the point it is extracted. Tires are classified as inventory when purchased. 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 Statement of Financial Accounting Standards (SFAS) 13, ACCOUNTING FOR LEASES (SFAS 13). These leases are classified as either capital or operating as appropriate. Leased equipment meeting the capital lease criteria of SFAS 13 are capitalized and the present value of the related lease minimum payments are 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.
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.
Exclusive of the approximately $55,838,000 of property, plant, equipment and mine development, net we had as of December 31, 2006 is approximately $641,000 of mining equipment classified as assets held for sale. This equipment was sold in January 2007 for a small gain. Assets with carrying amounts of $4,655,628 were temporarily idled at December 31, 2006
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.
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DEFERRED FINANCING COSTS
The Company had deferred financing costs of $2,856,534 and $2,958,666 at December 31, 2006 and 2005, 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 of the associated debt. The Company recorded approximately $607,000 and $381,000 of amortization related to deferred financing costs in 2006 and 2005, respectively.
RESTRICTED CASH
Restricted cash at December 31, 2006 represents approximately $14,439,000 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 $1,289,000 on deposit for collateral to an operating lease, approximately $257,000 on deposit directly with the OSM, $780,000 on deposit with the Company's workers' compensation administrator, and approximately $482,000 in utility and performance bonds and deposits. 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 OSM for reclamation bonds, approximately $257,000 on deposit directly with the OSM, $696,000 on deposit for worker's compensation and approximately $227,000 in utility and performance bonds and deposits.
PREPAID MINING ROYALTIES
Certain coal leases require minimum or advance payments which are deferred and charged to cost of sales as coal is extracted. The Company had prepaid royalties of approximately $331,000 and $208,000 at December 31, 2006, and 2005, 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. These expenses are included in depreciation, depletion, amortization, and accretion in the operating expenses section of the income statement.
STOCK-BASED COMPENSATION
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, 2006, 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
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
Prior to January 1, 2006, the Company accounted for stock-based compensation under Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS 123"). As permitted under this standard, compensation cost was recognized using the intrinsic value method described in Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25"). APB 25 does not require any compensation expense to be recorded in the consolidated financial statements if the exercise price of the award was equal to or more than the market price on the date of the grant.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123, SHARE-BASED PAYMENT ("SFAS 123(R)") using the modified-prospective transition method. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense in the consolidated financial statements based on their fair values. Under the modified-prospective transition method, the Company recognizes compensation expense for the unvested portion of all share-based payments granted on or prior to December 31, 2005 over the remaining service period based on the grant date fair value estimated in accordance with SFAS 123(R) and recognizes compensation cost for all share-based payments granted on or subsequent to January 1, 2006 over the service period based on grant date fair value estimated in accordance with SFAS 123(R). As permitted by SFAS 123(R), prior periods were not restated to reflect the impact of the new accounting standard.
As a result of adopting SFAS 123(R) on January 1, 2006, the Company's net loss for the year ended December 31, 2006 is $999,091 higher than if it had continued to account for share-based compensation under APB 25. Basic and diluted loss per share are each $(0.07) greater than if the Company had continued to account for share-based compensation under APB 25.
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
If the Company had adopted the fair value method of accounting for stock-based compensation in 2005 and 2004, compensation costs which would have been recognized and pro forma net loss and loss per share for the periods ending December 31 would have been as follows:
2005 2004 -------------- -------------- Net loss attributable to common shareholders, as reported ................................. $ (7,915,821) $ (29,322,638) 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 loss .......................... $ (8,667,459) $ (29,703,565) ============== ==============
Loss per share: Basic - as reported ......................... $ (0.58) $ (2.60) Basic - pro forma ........................... $ (0.63) $ (2.64) Diluted - as reported ....................... $ (0.58) $ (2.60) Diluted - pro forma ......................... $ (0.63) $ (2.64)
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 or risk of loss pass to the common carrier or customer. This generally occurs when coal is loaded onto trains or trucks 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.
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FREIGHT REVENUE AND COSTS
Shipping and handling costs paid to third-party carriers and invoiced to coal customers are included in cost of sales and coal sales, respectively.
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 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 March 2005, the Financial Accounting Standards Board ("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. The Company's adoption of FIN 47 did 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 adopted the EITF effective January 1, 2006. Adoption of this EITF has had no material impact on its 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
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the opening balance of retained earnings for that period rather than being reported in the income statement. The Company believes this statement will have no impact on its financial statements.
In June 2006, the FASB issued Interpretation No. 48 ("FIN 48"), ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES--AN INTERPRETATION OF FASB STATEMENT NO. 109. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the potential impact of the interpretation on its financial position and results of operations.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, FAIR VALUE MEASUREMENTS ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective prospectively for fiscal years beginning after November 15, 2007 and interim periods within that fiscal year. The Company is still analyzing SFAS 157 to determine the impact of adoption
3. INVENTORY
Inventory at December 31 is as follows:
2006 2005 ---------- ---------- Coal ..................... $2,014,710 $ 360,614 Tires .................... 207,032 57,500 ---------- ---------- Inventory ............. $2,221,742 $ 418,114 ========== ==========
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
4. PROPERTY, PLANT, EQUIPMENT, MINE DEVELOPMENT AND ASSETS HELD-FOR-SALE
Property, plant, equipment and mine development at December 31 is as follows:
2006 2005 ------------ ------------ Furniture and office equipment .... $ 345,554 $ 220,663 Mining equipment and vehicles ..... 48,864,201 35,781,704 Land and buildings ................ 6,674,027 6,721,858 Mineral rights .................... 11,911,309 12,046,106 Mine development .................. 10,003,328 6,265,447 Construction in progress .......... 854,399 728,286 ------------ ------------ Total property, plant, equipment and mine development ........ 78,652,818 61,764,064 Less accumulated depreciation, depletion and amortization ..... (22,815,191) (10,862,383) ------------ ------------ Property, plant, equipment and mine development, net ....... $ 55,837,627 $ 50,901,681 ============ ============
Mining equipment includes approximately $869,000 and $2,325,000 of gross assets under capital leases at December 31, 2006 and 2005, respectively.
Depreciation expense, which includes amortization of assets under capital leases, was approximately $13,888,816, $9,009,054, and $1,518,362 for the years ended December 31, 2006, 2005, and 2004, respectively. Depletion expense related to mineral rights and amortization of mine development costs was $997,949, $750,998, and $708,413 for the years ended December 31, 2006, 2005, and 2004, respectively.
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 less than those employed in calculating depreciation expense. As a result, the Company revised the estimated useful lives of mining equipment as of April 1, 2005. Had this revision been made as of January 1, 2005, the effect would have been to increase depreciation expense by an additional approximately $1,612,000 for the year ended December 31, 2005.
During the three months ended March 31, 2006, the Company adopted a plan to sell existing transportation and mining equipment to various outside contractors. In September 2006, the Company completed sales of the majority of this equipment to various outside parties, including two contractors who perform hauling services for the Company. The equipment sold had a net book value of $919,549 and the sales resulted in a net loss of $22,550, which is included in other income (expense), net in the consolidated statement of operations. The net book value of the remaining assets held for sale at December 31, 2006 approximates the fair value and is disclosed separately on the balance sheet. In January 2007, these assets were sold at a small gain.
On September 18, 2006 the Company entered into a sale-leaseback transaction with First National Capital Corporation's assignee, GATX Financial Corporation, involving the Company's highwall miner initially purchased in February 2006. The Company sold the highwall miner for approximately $6.4 million and recorded a deferred gain of approximately $875,000 which will be recognized over the forty-two month term of the operating lease. The lease is a "net" lease and requires that the Company maintain and insure the equipment as well as pay rental payments of $166,568 per month. As a condition of the lease, the Company provided two standby letters of credit totaling $1,288,883 in lieu of security deposits which are 100% collateralized with cash on deposit at two financial institutions.
At maturity, the Company has the option of purchasing the highwall miner or extending the lease for an additional twelve month term, both at the then fair market value, or allowing the lease to expire, at
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
4. PROPERTY, PLANT, EQUIPMENT, MINE DEVELOPMENT AND ASSETS HELD-FOR-SALE (CONTINUED)
which time the Company would be responsible for the expense of transporting the highwall miner to a lessor designated location within the Continental United States.
Buildings include capitalized interest of $252,867 and $0 as of December 31, 2006 and 2005, respectively.
5. OTHER NONCURRENT ASSETS
Other noncurrent assets at December 31 are as follows:
2006 2005 -------- --------
Prepaid royalties .................. $330,705 $224,120 Notes receivable ................... 96,811 -- -------- -------- Total other noncurrent assets ...... $427,516 $224,120 ======== ========
6. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at December 31 are as follows:
2006 2005 ----------- ----------- Accounts payable ............................... $ 9,944,033 $ 4,409,005 Accrued payroll and related taxes .............. 189,753 383,642 Accrued interest ............................... 379,581 47,466 Accrued insurance premiums ..................... 310,726 789,810 Accrued dividends .............................. 548,480 -- Royalty obligations ............................ 464,987 204,433 Accrued federal, state and local taxes ......... 143,935 556,270 ----------- ----------- Total accounts payable and accrued expenses .... $11,981,495 $ 6,390,626 =========== ===========
7. DEBT AND FINANCING ARRANGEMENTS
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 ("CCM, LLC"). CCM, LLC is a related party to the Company due to the significant number of shares it holds in the Company. The notes had an original maturity date of August 10, 2005, later extended to March 10, 2006, were secured by the highwall
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
7. DEBT AND FINANCING ARRANGEMENTS (CONTINUED)
miner, and had an interest rate of eighteen percent (18%) which began accruing from May 10, 2005. 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 with an additional 3% late payment penalty.
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 bank 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.
In February and March 2006, the Company purchased service vehicles and mining equipment for approximately $478,000. The Company financed the purchases with interest-bearing notes ranging in term from thirty-six to sixty months and with interest rates ranging from approximately 4.5% to 9.3%. All notes are secured by the purchased equipment.
10.5% SENIOR SECURED NOTES DUE 2010
On December 29, 2005, the Company issued $55.0 million of 10.5% Senior Secured Notes and Warrants to purchase a total of 1,732,632 shares of the Company's common stock. The issue consisted of 55,000 units, with each unit comprised of one $1,000 principal amount note due 2010 and one warrant, which entitles the holder to purchase 31.5024 shares of the 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 of the Company's common stock remains above $12.75 for more than nineteen days out of a consecutive thirty day trading period. The warrants will be exercisable at any time on or after their first anniversary date and will expire on December 15, 2010. Net proceeds from this sale were approximately $52.1 million. The Company immediately used approximately $22.1 million of the proceeds to repay existing indebtedness. During 2006, the Company used approximately $2.0 million to purchase a forty-two mile rail line in Tennessee, approximately $8.3 million as collateral to support reclamation bonds, and $19.7 million to purchase other equipment, refurbish preparation facilities and rail load-outs, and provide working capital.
The indenture allows the Company to incur a Term Loan Credit Facility in the amount of $10.0 million, but limits further indebtedness unless certain fixed charge coverage ratios are maintained on a pro forma basis. Please refer to the Term Loan Credit Facility note below for a discussion of our entrance into such a credit facility. The fixed charge coverage ratio is defined as the ratio of net income (loss) plus (i) fixed charges, (ii) depreciation, depletion and amortization, (iii) taxes, (iv) extraordinary losses, and (v) other non-cash income and expenses to fixed charges defined to include 25% of capital expenditures made by the Company and its subsidiaries. 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. Notes issued under the indenture are guaranteed fully and unconditionally as well as jointly and severally by the Company, which has no independent assets or operations, and each of its wholly-owned subsidiaries.
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
7. DEBT AND FINANCING ARRANGEMENTS (CONTINUED)
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. Pursuant to the separate registration rights agreement, the Company filed two registration statements with the Securities and Exchange Commission in May 2006, which were declared effective on July 28, 2006. On September 5, 2006, the Company exchanged $51 million of the total $55 million 10.5% Senior Secured Notes for $51 million in new Notes, dated August 31, 2006, which are registered for resale with the Securities and Exchange Commission. The new Notes are issued under substantially the same terms as the old Notes.
TERM LOAN CREDIT FACILITY
On October 12, 2006, the Company's wholly-owned subsidiary, National Coal Corporation, entered into a Term Loan Credit Facility that provides for borrowings of up to $10.0 million with Guggenheim Corporate Funding, LLC to fund general operating and working capital needs. The Company immediately borrowed $5.0 at closing, $3.0 million in December 2006, and $2.0 million subsequent to year-end.
Under this credit facility, the Company's obligations are secured by a priority senior lien on substantially all of the assets of the Company. All amounts under the credit facility become due and payable in March 2010 and the interest under this facility is payable at a rate equal to, at our option, the Eurodollar Rate plus 3.5% or the Base Rate (which approximates the prime rate) plus 2.5%. The term loan credit facility contains financial covenants and default provisions including that the Company maintain minimum levels of EBITDA and liquidity, maintain minimum interest coverage ratios, not exceed maximum leverage ratios, and that it limit certain future categories of transactions such as the incurrence of additional indebtedness and the sale of assets. Subsequent to year-end, the Company renegotiated the financial covenants in exchange for assuming a 1.0% increase in the previously agreed-upon interest rate.
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 rates ranging from 5.22% to 7.65%.
The total $6,717,650 aggregate principal balance of these contracts included refinancing obligations previously under capital leases of approximately $2,937,000 at September 30, 2005 representing gross assets of approximately $4,372,000. This resulted in the recognition of a gain on extinguishment of debt of approximately $328,000. The remaining $3,781,000 is related to the purchase of new equipment as well as equipment formerly under operating leases. The installment sale contracts require monthly payments of principal and interest through January 14, 2008.
In April 2006, the Company entered into new installment sale contracts with an equipment manufacturer pursuant to which the Company refinanced equipment with an aggregate principal value of approximately $2,729,000 formerly acquired under various capital leases resulting in a loss on extinguishment of debt of approximately $10,000. These installment sale contracts require payments over
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
7. DEBT AND FINANCING ARRANGEMENTS (CONTINUED)
36 months at fixed interest rates ranging from 7.03% to 7.50%. The obligations under the installment sale contracts are secured by the equipment purchased. In August 2006 and September 2006, the Company entered into new installment sale contracts with an equipment manufacturer pursuant to which the Company refinanced equipment with an aggregate principal value of approximately $1,447,000. These installment sale contracts require payments over periods ranging from 30 to 36 months at fixed interest rates ranging from 7.42% to 8.10%. The obligations under the installment sale contracts are secured by the equipment purchased.
The following table summarizes long-term debt obligations of the Company, excluding capital leases:
DECEMBER 31, ---------------------------- 2006 2005 ------------ ------------ 10.5% Senior Secured Notes, due 2010 ........... $ 55,000,000 $ 55,000,000 Term Loan Credit Facility ...................... 8,000,000 -- Bank note (prime + 1%), due 2007 ............... 637,374 1,200,018 Installment purchase obligations, due 2009 ..... 3,200,286 -- Installment purchase obligations, due 2008 ..... 2,825,209 5,270,611 Equipment note (non-interest bearing), due 2006 -- 280,000 Equipment notes (8.39%-9.28%, due 2009-2011) ... 125,382 -- Equipment note (4.48%, due 2009) ............... 234,721 -- Other .......................................... 89,512 19,931 Less unamortized discounts ..................... (3,298,679) (3,910,160) ------------ ------------ 66,813,805 57,860,400 Less current portion of long-term debt ......... (4,720,671) (3,319,175) ------------ ------------ Long-term debt ................................. $ 62,093,134 $ 54,541,225 ============ ============
Maturities of long-term debt for the next five years and thereafter follow:
Fiscal year 2007 ....................................... $ 4,720,769 2008 ....................................... 1,780,604 2009 ....................................... 590,371 2010 ....................................... 63,016,417 2011 ....................................... 4,323 Thereafter ................................. -- ------------ 70,112,484 Less unamortized discounts ................. (3,298,679) ------------ 66,813,805 Less current portion of long-term debt ..... (4,720,671) ------------ Long-term debt ............................. $ 62,093,134 ============
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
8. LEASES
The Company leases mining and certain other equipment under noncancelable lease agreements with terms up to five years. Rental expense for equipment under operating lease agreements with initial lease terms of one year or greater was approximately $1,011,323, $1,212,696, and $516,000 for the years ended December 31, 2006, 2005, and 2004, respectively.
During the first quarter of 2006, the Company entered into a capital lease agreement of $265,300 with an equipment supplier for mining equipment with a comparable value. The lease is for a period of twenty-four months and provides for a bargain purchase option at the end of the lease term.
During the third quarter of 2006, the Company entered into a capital lease agreement of $625,000 with an equipment supplier for mining equipment with a comparable value. The lease is for a period of twenty-six months.
Future minimum lease payments for noncancelable leases with initial terms of one year or greater in effect at December 31, 2006 are as follows:
Capital Operating Leases Leases ---------- ----------
2007 .............................................. $ 414,897 $2,090,226 2008 .............................................. 337,806 1,998,813 2009 .............................................. -- 1,998,813 2010 .............................................. -- 427,524 2011 .............................................. -- -- Thereafter ........................................ -- -- ---------- ----------
Total minimum lease payments ...................... 752,703 $6,515,376 ==========
Imputed interest .................................. (79,964) ----------
Present value of minimum capital lease payments ... 672,739 Current portion ................................... (351,668) ---------- Long-term obligations ............................. $ 321,071 ==========
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
9. ASSET RETIREMENT OBLIGATIONS
The following table describes the changes to the Company's asset retirement obligations for the years ended December 31:
2006 2005 ----------- ----------- Obligation at January 1 ........................ $ 7,228,232 $ 2,305,749 Accretion expense .............................. 476,064 347,671 Obligations acquired and incurred .............. 250,427 4,379,108 Adjustments from annual recosting .............. 350,175 490,424 Obligations settled ............................ (1,090,004) (294,720) ----------- ----------- Obligation at December 31 ...................... 7,214,894 7,228,232 Current portion included in accrued expenses ... (1,378,967) -- ----------- ----------- ong-term liability ............................ $ 5,835,927 $ 7,228,232 =========== ===========
The above table has been adjusted to reflect the correct opening balance and activity for 2005.
10. STOCKHOLDERS' (DEFICIT) EQUITY
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 modified certain provisions. Two of the notes, in the aggregate principal amount of approximately $3.2 million, were 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 allowed Crestview to purchase up to 399,312 shares of the Company's common stock at a price of $2.20 per share, and expired 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.
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
10. STOCKHOLDERS' (DEFICIT) EQUITY (CONTINUED)
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 cumulative 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 cumulative convertible preferred stock, at $15,000 per share, for cash consideration of approximately $11.3 million and cancellation of approximately $4.7 million of its senior secured promissory notes issued in April and May 2004. Each share of Series A cumulative convertible preferred stock is convertible into 2,500 shares of common stock. For each share of Series A cumulative 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 cumulative 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 cumulative 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 cumulative 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 cumulative convertible preferred stock financing or convertible debt financing also received the right to purchase additional units of Series A cumulative 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 cumulative 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 cumulative 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.
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
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
10. STOCKHOLDERS' (DEFICIT) EQUITY (CONTINUED)
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 cumulative 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 of 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 the year ended December 31, 2006 and 2005, 152,500 and 0 warrants were exercised with gross proceeds totaling $1,006,501 and $0, respectively. At December 31, 2006, warrants entitling the holders to purchase 1,872,632 shares of common stock at an exercise price of $8.50 per share were outstanding. The warrants are subject to mandatory conversion if the price of the Company's common stock remains above $12.50 for more than thirty days.
During the year ended December 31, 2006 and 2005, holders of 550.90 and 139.44 shares of Series A cumulative convertible preferred stock with liquidation preferences totaling $8,260,206 and $2,091,600 plus accrued dividends of $65,439 and $18,198, converted their shares into 1,386,128 and 351,633 shares of common stock, respectively.
During the year ended December 31, 2006 and 2005, the Company issued 712,510 and 234,240 shares of common stock and received gross proceeds of $1,651,122 and $531,078 respectively, upon the exercise of stock options by employees or former employees. Additionally, 101,503 shares of common stock were issued during the year ended December 31, 2006 for gross proceeds of $897,018, including 100,000 shares purchased by the Company's new Chief Executive Officer.
In October 2006, the Company determined that it had not complied with a preferred stock purchase agreement provision which resulted in the accrual of a dividend adjustment of $198,220. Therefore, the Company has reflected this accrual as a one-time adjustment to shareholders' equity during the third quarter of 2006 as it was not material to previous periods. In November 2006, a majority of the preferred shareholders voted to eliminate the provision which gave rise to this accrual. The Company also issued 10,886 shares of common stock in lieu of dividends as a result of the dividend adjustment.
11. 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, 2006, and 2005, respectively:
CASH AND ACCOUNTS RECEIVABLE: The carrying amount approximates fair value because of the short maturity of these instruments.
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
11. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
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.
The estimated fair values of the Company's financial instruments at December 31 are as follows:
12. 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, 2006, the Company derived revenue from thirteen customers, four of which were electric utilities, eight 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 -------- ------- -------- -------- Period ended December 31: 2006 .......................... 25% 32% 18% * 2005 .......................... 35% 26% * 10% 2004 .......................... 28% 27% * 16% * Less than 10%
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
13. INCOME TAXES
At December 31, 2006, the Company had federal and state net operating loss ("NOL") carryforwards of $33.5 million that will begin to expire in 2024. The use of deferred tax assets including federal net operating losses and credits are limited to future taxable earnings. Based on the required analysis of future taxable income under the provisions of SFAS 109, management believes that there is not sufficient evidence at December 31, 2006 indicating that the results of operations will generate sufficient taxable income to realize the net deferred tax asset in years beyond 2007. As a result, a valuation allowance has been provided for the entire net deferred tax asset related to future years, including loss and credit carryforwards.
The valuation allowance was $14,785,860 and $6,369,398 at December 31, 2006 and 2005, respectively. The valuation allowance increased by $8,413,451 and $2,542,404 in 2006 and 2005, respectively. The net deferred income taxes as of December 31 include the following amounts of deferred income tax assets and liabilities:
2006 2005 Deferred tax assets - current: ................. ------------ ------------ Inventory reserve ........................... $ 70,128 $ 27,847 Intangibles (tax basis difference) .......... 89,614 235,923 ------------ ------------ Total deferred tax assets - current ...... 159,742 263,770 ------------ ------------ Deferred tax assets - noncurrent: Net operating loss carryforwards ............ 12,823,594 5,392,048 Fixed assets (tax basis difference) ......... 1,886,181 468,736 Intangibles (tax basis difference) .......... 80,661 57,435 Deferred royalties .......................... 87,481 170,274 Charitable contribution carryforwards ....... 44,973 44,973 ------------ ------------ Total deferred tax assets - noncurrent ... 14,922,890 6,133,466 ------------ ------------ Total gross deferred tax assets ................ 15,082,632 6,397,236 Deferred tax liabilities ....................... (296,772) (27,838) Valuation allowance ............................ (14,785,860) (6,369,398) ------------ ------------ Net deferred tax assets ........................ $ -- $ -- ============ ============
The Company's deferred income taxes relate principally to deferred revenue, deferred compensation and federal and state net operating loss and credit carryforwards. The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before the provision for income taxes. The sources and tax effects of the differences are as follows:
2006 2005 2004 ----------- ----------- -----------
Federal and state income tax benefit at US statutory rates .. $(8,730,314) $(2,600,339) $(3,993,314) Permanent differences ............. 316,863 57,935 1,481,411 Change in valuation allowance ..... 8,413,451 2,542,404 2,511,903 ----------- ----------- ----------- Total income tax expense on continuing operations .......... $ -- $ -- $ -- =========== =========== ===========
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
14. 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, 2006, 2005, and 2004, 3,866,360, 6,024,642 and 2,105,554 potentially dilutive shares of the Company from warrants, convertible preferred stock and stock options were not included in the computation of diluted loss per share because to do so would be anti-dilutive.
The computations for basic and diluted loss per share from continuing operations for the period ending December 31 are as follows:
15. 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, 2006, 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.
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
15. STOCK-BASED COMPENSATION PLANS (CONTINUED)
During the year ended December 31, 2006, the Company recognized $2,235,224 of compensation expense related to stock options, including $941,961 related to the accelerated vesting of 400,000 options granted to the former CEO, the former General Counsel and Secretary (who is also the spouse of the former CEO), and the former COO in prior years. The former CEO continues as Chairman. During the years ended December 31, 2005 and 2004, Company recognized $812,733 and $903,375 of compensation expense related to stock options, respectively.
The fair value of each option was estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
Year Ended December 31, --------------------------------------------- 2006 2005 2004 ------------- ------------- ------------- Expected term (years) 6.25 6.25 4.0 Risk-free interest rates 4.36% - 5.19% 3.79% - 4.55% 3.23% - 4.37% Expected dividend yield 0.0% 0.0% 0.0% Expected volatility 50.3% - 54.0% 47.6% - 48.0% 48.4% - 48.7% Weighted-average volatility 52.2% 47.8% 48.6%
The risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant, volatility is based on the average long-term implied volatilities of peer companies as the Company's trading history is limited, and the expected term is determined using the SIMPLIFIED method as accepted under Securities and Exchange Commission Staff Accounting Bulletin No. 107 assuming a ten-year original contract term and graded vesting over four years. The weighted-average grant-date fair value of options issued during the years ended December 31, 2006, 2005, and 2004 were $3.16, $3.41, and $3.54, respectively. The total intrinsic value of options exercised during the years ended December 31, 2006, and 2005 was $2,450,313 and $1,104,780, respectively. No options were eligible for exercise in 2004.
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
15. STOCK-BASED COMPENSATION PLANS (CONTINUED)
The following table summarizes activity under the Plan for the year ended December 31, 2006:
As of December 31, 2006, there was $2,312,137 of total unrecognized compensation cost related to non-vested stock options granted under the Plan. That cost is expected to be recognized over a weighted average period of 2.7 years. The total fair value of shares vested during the years ended December 31, 2006, 2005, and 2004, was $2,762,529, $1,821,514, and $0, respectively.
Subsequent to year-end, the Board of Directors agreed to a modification of stock option agreements as they apply to independent directors. At such time as an independent director ceases to serve on the Board, his vested options outstanding at that time may be exercised for a period of 90 days. This survival period has been extended to 18 months. According to the requirements of SFAS 123(R), this constitutes a modification of existing awards requiring a re-measurement of those awards which will require the Company to recognize additional expense related to vested options in the first quarter of 2007.
16. COMMITMENTS AND CONTINGENCIES
In October 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 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 U.S. SixthCircuit Court. The dismissal of this action was upheld by final Order of the Sixth Circuit Court entered on January 3, 2007.
The same plaintiffs filed a similar action in U.S. District Court based on essentially the same facts alleging NEPA violations regarding OSM's approval of an application for a revision of the same permit.
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
16. COMMITMENTS AND CONTINGENCIES (CONTINUED)
An unfavorable outcome of this action would not involve direct monetary damages; however significant financial losses could result from curtailed mining operations. Management believes that the U. S. District Court will dismiss this action based upon the prior ruling in the similar case by the U.S. Sixth Circuit Court.
During 2005, the Company was audited by its previous workers' compensation insurance provider which contends that an additional approximately $1.4 million in premiums is owed 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, the Company paid $427,000 to the previous insurance provider. Currently, the matter has not been resolved and both parties have pursued legal action in the United States District Court of the Eastern District of Tennessee. While management believes legal reserves are sufficient for this matter, it is possible that the actual outcome of the matter could vary significantly from this amount. Management will continue to review the amount of the accrual and any adjustment required to increase or decrease the accrual based on development of the matter will be made in the period determined.
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 sublessee of certain coal mining rights concurrent with the Company's operations in Kentucky. The Company is the sublessee of the right to mine coal using the underground method on the property in question, as the result of a 2004 acquisition. The complainant claims that it possesses the right to mine the coal at this property through the surface mining method and that by mining the coal by the highwall mining method, the Company committed either an intentional or negligent trespass. The complainant seeks damages in the range of $1.2 million to $2.8 million, which it estimates to be the range of gross profits from the revenues of the coal mined. Management acknowledges that the Company mined the coal in question, but contends that by using the highwall mining method, the Company mined the coal pursuant to the Lease by an underground mining method and therefore committed no trespass. As an additional defense, the Company has filed a third-party complaint against a consultant, who advised the Company that it had the right to mine the coal. This counterclaim could allow the Company to recover a portion of any amounts lost, if the original complainant is successful. A settlement was reached with the opposing party and documented for entry by Order of the Court in February 2007.
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 resulted in approximately three months of lost service. Repairs to the highwall miner have totaled approximately $1,934,000 and were recorded as a cost of sales in the first two quarters of 2006. The initial insurance claim was denied, and in April 2006, management threatened legal action against the provider. In September 2006, the insurance provider agreed to the claim, and the Company received approximately $1,867,000, which has been recorded as a reduction of cost of sales in the third quarter of 2006. The Company was also in discussion with a second insurance provider on a related claim pertaining to a front-end loader that was destroyed in the same March 2006 rock collapse. The Company has agreed to a settlement and received proceeds of approximately $155,000 during the first quarter of 2007.
On April 12, 2006, the Company was named as a defendant in a suit by Appalachian Fuels, LLC (the "Plaintiff"), along with Calvary Coal Company, Inc. ("Calvary"), a former independent contractor who was our Contract Miner for the Kentucky operations during a portion of 2004 and 2005. The Plaintiff seeks to recover approximately $360,000, funds allegedly supplied to Calvary by the Plaintiff prior to the time of our purchase of the Kentucky operations from the Plaintiff. The purchase agreement relating to the Kentucky operations allows for the deduction of the funds in question from the payments to
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
16. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Calvary only upon Calvary's written consent, which the Plaintiff did not obtain. Because the required written consent was not obtained, the Company did not deduct the funds in question and submit them to the Plaintiff. This matter was dismissed by the Boyd County, Kentucky Circuit Court in February 2007 and has not been appealed.
On September 1, 2006, the Tennessee Department of Environment and Conservation ("TDEC") issued a STOP WORK ORDER (the "Order") with respect to the operations at Mine # 7 in Tennessee. The Order alleged that the Company disturbed two unnamed streams outside of the permitted mining area. The Order sought the reclamation of the two streams and the assessment of penalties of approximately $173,000 if the various requirements sought by the Order were not satisfied. The Company filed an appeal of the Order and in November 2006 came to an agreement with TDEC, which requires reclamation of the area in question with no penalties to be assessed.
The Company is made 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 these other pending or threatened proceedings to have a material impact on our cash flows, results of operations or financial condition.
17. RELATED PARTY TRANSACTIONS
During 2004, the Company paid the law firm of Kite, Bowen & Associates, PA, $10,000, 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 Capital Corporation, an investment Company controlled by the former President and former CEO, from August 2003 through January 2004, and borrowed $105,000 from the former President and former 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 former 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%.
In October 2004, the Company revised the employment contracts of its Chief Executive Officer, its former Chief Financial Officer and its Operations Manager such that each individual was entitled to additional monthly compensation in an amount equal to five cents ($0.05) per ton of coal sold or produced each month from coal mined from all of the Company's owned and leased properties. This additional compensation ceased at the end of May 2006.
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
17. RELATED PARTY TRANSACTIONS (CONTINUED)
In March 2005, the Company borrowed approximately $5,140,000 at 18% interest, accruing from May 2005, 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 in the form of an original issue discount upon the execution of the loan document. The notes were repaid on December 28, 2005 with an additional 3% fee.
On June 5, 2006 the Company sold 100,00 shares to Daniel Roling, the Company's President and CEO, for a total price of $888,000. On February 28, 2007, the Company signed definitive subscription agreements to sell three million shares of its common stock at the February 28, 2007 closing consolidated bid price of $4.65 per share. Daniel Roling purchased 200,000 of these shares for a total price of $930,000.
18. EVENTS SUBSEQUENT TO DECEMBER 31, 2006
On February 28, 2007, the Company signed definitive subscription agreements to sell three million shares of its common stock at the February 28, 2007 closing consolidated bid price of $4.65 per share. Daniel Roling, the Company's President and CEO, purchased 200,000 of these shares. Two institutional investors purchased 2,800,000 shares and the proceeds from the sale were $13,950,000. The Company has agreed to file a registration statement to register the shares as soon as practicable, but in any event, no later than April 30, 2007.
On March 1, 2007, the Company promoted Bill Snodgrass, for ten months its Chief Operating Officer (COO), to the newly created position of Senior Vice President of Business Development. In conjunction with Mr. Snodgrass's promotion, Ken Hodak, the Company's former COO, returned to the Company as COO.
From January 1, 2007 through March 16, 2007, holders of 80.0 shares of our Series A cumulative convertible preferred stock with liquidation preferences totaling $1,200,000 converted their shares into 200,000 shares of common stock.
NATIONAL COAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
19. SUMMARY QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial data for 2006 and 2005 is as follows:
In November 2006, the Company determined that during the first, second, and third quarters of 2006, shipping and handling costs paid to third-party carriers and invoiced to coal customers had not been properly reflected as cost of sales and coal sales, respectively, consistent with Emerging Issues Task Force Issue No. 00-10, ACCOUNTING FOR SHIPPING AND HANDLING FEES AND COSTS. The impact was to understate both coal sales and cost of sales by $445,174, $290,093, and $315,136 for the first, second, and third quarters of 2006, respectively. Total revenues as initially reported by the Company were $20,023,558, $23,835,062, and $21,113,745 for the first, second, and third quarters of 2006, respectively. Operating loss and net loss attributable to common shareholders were not impacted. The impact to 2005 was not material.
The Company has also determined that total revenues for the first and second quarter of 2005 as presented above are inconsistent with amounts previously reported in its 2006 first and second quarter filings on Form 10-Q due to the Company's failure to include certain reclassifications previously made for consistency of presentation in its 2005 Form 10-K. Total revenues as previously reported by the Company were $12,584,404 and $16,010,644 for the first and second quarters of 2005, respectively. As the overstatement of total revenues for both quarters is offset by a commensurate overstatement of cost of sales, operating loss and net loss attributable to common shareholders were not impacted.
In the fourth quarter of 2006, the Company determined that the weighted average shares used to calculate both the basic and diluted loss per common share during the first and second quarters of 2006 was incorrect. Both basic and diluted loss per common share as previously reported by the Company were $(0.57) and $(0.34) for the first and second quarters of 2006, respectively.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
CONTROLS AND PROCEDURES
Members of our management, including our President and Chief Executive Officer, Daniel A. Roling, 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, 2006, the end of the period covered by this report. Based upon that evaluation, Messrs. Roling and Love concluded that our disclosure controls and procedures were effective as of December 31, 2006.
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, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE.
The information required by this item is incorporated by reference to National Coal's Proxy Statement for its 2007 Annual Meeting of Shareholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2006.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to National Coal's Proxy Statement for its 2007 Annual Meeting of Shareholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2006.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated by reference to National Coal's Proxy Statement for its 2007 Annual Meeting of Shareholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2006.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated by reference to National Coal's Proxy Statement for its 2007 Annual Meeting of Shareholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2006.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to National Coal's Proxy Statement for its 2007 Annual Meeting of Shareholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2006.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
1. CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firms
Financial Statements Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Cash Flows Consolidated Statements of Changes in Stockholder's (Deficit) Equity Notes to the consolidated financial statements
2. FINANCIAL STATEMENT SCHEDULES
All financial schedules are not required under the related instructions, or are inapplicable and therefore have been omitted.
3. EXHIBITS. SEE ITEM 15(B) BELOW.
(b) EXHIBITS. We have filed, or incorporated into this Form 10-K by reference, the exhibits listed on the accompanying Index to Exhibits immediately following the signature page of this Form 10-K.
(c) FINANCIAL STATEMENT SCHEDULE. See Item 15(a) above.
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 2, 2007 /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 Daniel Roling 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/ DANIEL A. ROLING Chief Executive Officer, April 2, 2007 - --------------------------- President, and Director Daniel A. Roling (Principal Executive Officer)
/S/ T. MICHAEL LOVE Chief Financial Officer and April 2, 2007 - --------------------------- Director (Principal Financial T. Michael Love and Accounting Officer)
/S/ JON NIX Chairman of the Board April 2, 2007 - --------------------------- Jon Nix
/S/ SCOTT FILSTRUP Director April 2, 2007 - --------------------------- Scott Filstrup
/S/ ROBERT HEINLEIN Director April 2, 2007 - --------------------------- Robert Heinlein
/S/ GERALD MALYS Director April 2, 2007 - --------------------------- Gerald Malys
/S/ KEN SCOTT Director April 2, 2007 - --------------------------- Ken Scott
INDEX TO EXHIBITS
EXHIBIT NUMBER EXHIBIT TITLE - -------- ---------------------------------------------------------------
3.1 Articles of Incorporation of National Coal Corp. dated August 8, 1995. (1)
3.1.1 Articles of Amendment to the Articles of Incorporation of National Coal Corp. dated August 10, 1995. (1)
3.1.2 Articles of Amendment to the Articles of Incorporation of National Coal Corp. dated January 4, 1996. (1)
3.1.3 Articles of Amendment to the Articles of Incorporation of National Coal Corp. dated July 17, 2003, filed August 4, 2003. (2)
3.1.4 Articles of Amendment to the Articles of Incorporation of National Coal Corp. dated August 27, 2004, filed August 31, 2004. (3)
3.1.5 Articles of Amendment to the Articles of Incorporation of National Coal Corp. dated January 10, 2005, filed January 12, 2005. (3)
3.2 Amended and Restated Bylaws of National Coal Corp. (3)
4.1 Amended and Restated 2004 National Coal Corp. Option Plan. (3)*
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)
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)
4.4 Debt Registration Rights Agreement, dated as of December 29, 2005 by and between National Coal Corp., its subsidiaries, and Jefferies & Company, Inc. (4)
4.5 Equity Registration Rights Agreement, dated as of December 29, 2005 by and between National Coal Corp. and Jefferies & Company, Inc. (4)
4.6 Warrant Agreement dated as of December 29, 2005 between National Coal Corp., and Wells Fargo Bank, National Association as warrant agent. (4)
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. (4)
10.1 Form of Indemnification Agreement of Registrant. (3)
10.2 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. (3)
10.3 Investor Rights Agreement by and between National Coal Corp. and the Purchasers listed on Schedule I thereto, dated August 31, 2004. (3)
10.4 Amended Employment Agreement by and between National Coal Corporation and Jon E. Nix dated October 1, 2004. (3)*
EXHIBIT NUMBER EXHIBIT TITLE - -------- ---------------------------------------------------------------
10.4.1 Separation Agreement among National Coal Corp., National Coal Corporation and Jon E. Nix, dated September 11, 2006. (8)*
10.5 Employment Agreement by and between National Coal Corporation and T. Michael Love, dated November 14, 2005. (4)*
10.6 Employment Agreement by and between National Coal Corporation and Kenneth Hodak, dated September 20, 2005. (4)*
10.7 Amended Employment Agreement by and between National Coal Corporation and Charles W. Kite dated September 16, 2004. (3)*
10.8 Amended Employment Agreement by and between National Coal Corporation and Joseph A. Davis, Jr. dated September 16, 2004. (3)*
10.9 Amended Employment Agreement by and between National Coal Corporation and William R. Snodgrass dated October 1, 2004. (3)*
10.10 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. (5)
10.11 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. (6)
10.12 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. (5) 10.13 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. (5)
10.14 Installment Sale Contract by and between National Coal Corporation and Whayne Supply Company, effective July 1, 2005. (6)
10.15 Installment Sale Contract by and between National Coal Corporation and Stowers Machinery Corporation (twenty vehicles), effective July 1, 2005. (6)
10.16 Installment Sale Contract by and between National Coal Corporation and Stowers Machinery Corporation (three vehicles), effective July 1, 2005. (6)
10.17 Asset Purchase Agreement (Baldwin Facility), dated as of May 8, 2005, by and between National Coal Corporation and LCC Tennessee, LLC. (6)
10.18 Separation Agreement by and between the Company and Robert Chmiel, dated March 21, 2005. (5)*
10.19 Separation Agreement between National Coal Corp. and Mark A. Oldham, dated November 14, 2005. (4)*
10.20 Employment Agreement, dated May 25, 2006, by and among National Coal Corporation, National Coal Corp., and Daniel A. Roling. (7)*
EXHIBIT NUMBER EXHIBIT TITLE - -------- ---------------------------------------------------------------
10.21 Credit Agreement, dated October12, 2006, among National Coal Corp., National Coal Corporation, the Lenders, and Guggenheim Corporate Funding, LLC. (9)
10.22 Security and Guarantee Agreement, dated October 12, 2006, among National Coal Corporation, National Coal Corp., Subsidiary Grantors and Guggenheim Corporate Funding, LLC. (9)
10.23 Intercreditor Agreement, dated as of October 12, 2006, by and between Guggenheim Corporate Funding LLC, and Wells Fargo Bank, N.A., and acknowledged and agreed to by National Coal Corporation, National Coal Corp., and Guarantors. (9)
14.1 National Coal Corp. Code of Ethical Conduct. (10)
21.1 Subsidiaries of National Coal Corp. (3)
23.1 Consent of Gordon, Hughes & Banks, LLP.
23.2 Consent of Ernst & Young, 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 Map showing the locations of National Coal's properties.
- ---------- * Indicates a management contract or compensatory plan.
(1) Incorporated by reference to our Registration Statement on Form 10-SB filed June 25, 1999.
(2) Incorporated by reference to our Current Report on Form 8-K, dated August 7, 2003.
(3) Incorporated by reference to our Registration Statement on Form SB-2 (File No. 333-120146).
(4) Incorporated by reference to our Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
(5) Incorporated by reference to our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005.
(6) Incorporated by reference to our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2005.
(7) Incorporated by reference to our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006.
(8) Incorporated by reference to our Current Report on Form 8-K, dated September 11, 2006. (9) Incorporated by reference to our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2006.
(10) Incorporated by reference to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004.