Item 1 - “Business - Supply of Ethanol.”
(5)
Construction of our Welcome facility began in late November 2006.
(6)
Construction of our Hartley facility began in late November 2006.
ITEM 3.
LEGAL PROCEEDINGS
From time to time in our normal course of business, we are a party to various legal claims, actions and complaints. Currently, we do not have any pending litigation that we consider material.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 4A.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets out the names and ages of, and positions and offices held by, each of our executive officers, followed by a description of their business experience. Executive officers are appointed annually by the Board of Directors.
Donald L. Endres has served as our Chief Executive Officer and a director since 2001, and has served as President since March 2007. He has more than 20 years of experience in investing in, building, operating and managing successful businesses.
Mr. Endres serves on the board of directors and on the executive committee of the Renewable Fuels Association and was awarded the 2005 Ernst & Young Entrepreneur of the Year Award for the Minnesota, South Dakota and North Dakota region. In 2000, he co-founded and served as vice-chairman of Glacial Lakes Energy, an ethanol producer in Watertown South Dakota, and he is an investor in and former board member of Badger State Ethanol, an ethanol producer in Monroe, Wisconsin.
Mr. Endres earned a bachelor of science degree in animal science with minors in computer science and economics from South Dakota State University. He was recognized by South Dakota State University’s College of Engineering as “Entrepreneur of the Year” in 2000.
Robert L. Antoine, Jr. serves as Senior Vice President, Human Resources and joined VeraSun August 2006. Mr. Antoine has more than 25 years of experience in human resources positions. Most recently, Mr. Antoine was head of human resources for Forward Air Corporation from 2002 to 2006. Previously, he served as Vice President of Human Resources for Laidlaw Transit Services, Inc, from 1995 to 2002.
Mr. Antoine graduated from the University of Kansas with a Bachelor of Science in Journalism.
Paul J. Caudill serves as Senior Vice President, Operations and joined VeraSun in late February 2006. He has over 25 years experience in architecture and engineering design, procurement and construction project management and has held senior-level positions with electric utilities in power generation plant operations. Prior to joining VeraSun, Mr. Caudill held a management position with Nebraska Public Power District from 1997 to 2006, where he was responsible for the company’s entry into the ethanol plant energy services market.
Mr. Caudill earned a bachelor of science degree in public management from the University of Arizona and in 2004 graduated from Northwestern University’s Kellogg Graduate School of Management with a masters of business administration.
Danny C. Herron serves as our Senior Vice President and Chief Financial Officer, and joined VeraSun in March 2006. Before joining the Company, Mr. Herron was executive vice president and chief financial officer of Swift & Company (an HM Capital Partners LLC portfolio company), a processor of fresh beef and pork products headquartered in Greeley, Colorado, from 2002 to 2006. He previously served as vice president and
senior financial officer of Conagra Beef Company, a beef products manufacturer headquartered in Greeley, Colorado, from 1998 to 2002.
Mr. Herron earned a masters degree in business administration from New Hampshire College and a bachelor of science degree in business administration and accounting from Valdosta State College.
William L. Honnef is one of our founders and serves as Senior Vice President, Sales and Marketing. He was president and co-founder of ExpressGold.com, Inc. until it merged with CyberSource Corporation in January 2000. Mr. Honnef served as sales director of CyberSource Corporation until leaving to start VeraSun in 2001. Mr. Honnef serves on the boards of directors of the American Coalition for Ethanol.
Mr. Honnef graduated from Indiana University of Pennsylvania with a bachelor of arts degree in information systems in 1988 and was recognized by the University as the “Eberly School of Business and Information 2000 Entrepreneur of the Year.”
Barry P. Schaps serves as Senior Vice President, Logistics and joined VeraSun in February 2007. Prior to joining VeraSun, he was General Manager, Planning and Portfolio Strategy of Motiva Enterprises, LLC, a joint venture company between affiliates of Shell Oil Company and Saudi Aramco from 2005 to 2007. Prior to that, he worked in roles of increasing responsibility with Motiva and Shell Oil Company, including as Manager Retail Logistics and Supply, Assistant to the CEO, Manager Marketing Ventures. Mr. Schaps has over 27 years experience in the petroleum industry with areas of focus in strategic planning, refining, retail marketing, supply and trading, risk management and logistics.
Mr. Schaps earned a BBA degree from the Bernard M. Baruch College of the City University of New York in 1975 majoring in accounting and an MBA in finance from Long Island University in 1980.
John M. Schweitzer serves as Senior Vice President, General Counsel and Secretary. Prior to joining VeraSun in September 2005, he had been a partner at Stoel Rives LLP for more than 25 years, where he acted as counsel to VeraSun since its organization in 2001.
Mr. Schweitzer earned a bachelor of arts degree in business administration from the University of Wisconsin - Milwaukee and masters and juris doctorate degrees from the University of Wisconsin - Madison.
Peter A. Atkins serves as Vice President, Mergers & Acquisitions and joined VeraSun July 2006. Mr. Atkins has over 25 years of regional banking and agriculture experience. Prior to joining VeraSun, Mr. Atkins was the Community Banking President/District President at Wells Fargo Bank from 2004 to 2006. Mr. Atkins managed multiple full-service locations in South Dakota and was a member of Wells Fargo’s corporate agriculture steering committee.
Mr. Atkins earned a degree in Animal Science from South Dakota State University.
Matthew K.R. Janes served as our Chief Operating Officer from January 2002 through September 2004 when he became Vice President, Technology. Mr. Janes served as a director from January 2003 to January 2005. Prior to joining VeraSun, Mr. Janes worked for 11 years with Commercial Alcohols Inc., or CAI, a manufacturer of industrial-grade alcohol and fuel-grade ethanol in Canada. He was CAI’s Vice President of Operations and Technology and was responsible for the design and start up of CAI’s 40 MMGY plant in Chatham, Ontario. Mr. Janes has also served as vice president of the Canadian Renewable Fuels Association and as a director of Agri-Development Kent, an advisory committee of the local municipal government.
Mr. Janes earned a bachelor of science degree in applied chemistry from the University of Waterloo and holds a diploma in business administration from Wilfred Laurier University. Mr. Janes has also completed both an Operations Management Program and a Financial Analysis for Executives Program at the Richard Ivey School of Business at the University of Western Ontario.
PART II
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
We completed an initial public offering, or “IPO”, of shares of our common stock in June, 2006. Our common stock trades on the New York Stock Exchange under the symbol “VSE.” The following table sets forth the high and low closing prices for the common stock as reported on the New York Stock Exchange for the quarterly periods since our IPO. These prices do not include retail markups, markdowns or commissions.
On March 13, 2007, the closing price of our common stock was $16.89. As of March 13, 2007, there were approximately 582 shareholders of record of our common stock. We believe the number of beneficial owners is substantially greater than the number of record holders because a large portion of our outstanding common stock is held of record in broker “street names” for the benefit of individual investors. As of March 13, 2007, there were 76,181,326 shares outstanding.
Dividend Policy
The payment of dividends is within the discretion of our Board of Directors and will depend upon our earnings, capital requirements and operating and financial position, among other factors. We expect to retain all of our earnings to finance the expansion and development of our business, and we have not paid, and we currently have no plans to pay, cash dividends to our shareholders. The indenture underlying our senior secured notes limits, and our future debt agreements may restrict, our ability to pay dividends.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information about compensation plans (including individual compensation arrangements) under which our equity securities are authorized for issuance to employees or non-employees (such as directors and consultants), at December 31, 2006.
Use of Proceeds from Registered Securities
On June 13, 2006, our Registration Statement on Form S-1 (Registration No. 333-132861) became effective. A total of 20,987,500 shares of our common stock were registered pursuant to the Registration Statement. The IPO of our shares was completed on June 19, 2006. An aggregate of 11,000,000 shares of common stock were sold by the Company and 9,987,500 shares were sold by certain shareholders of the Company, which included 2,737,500 shares sold pursuant to an option granted by the shareholders to the underwriters to cover over-allotments. The underwriters for the offering were Morgan Stanley & Co. Incorporated, Lehman Brothers Inc. and A.G. Edwards & Sons, Inc.
The IPO price was $23 per share. We and the selling shareholders received total proceeds of $235.9 million and $214.2 million, respectively, after deduction of underwriting discounts and commissions of $17.1 million and $15.5 million, respectively. Other expenses payable by us relating to the IPO were $2.8 million.
As of December 31, 2006, we had applied the $233.0 million of net proceeds we received from the IPO of our shares as follows (dollars in millions):
None of the foregoing payments were to our directors or officers, or their associates, or to our affiliates or persons owning ten percent or more of our common stock.
Performance Graph
The following graph compares the percentage change in our cumulative total shareholder return (as measured by dividing (1) the sum of the cumulative amount of dividends for the measurement period, if any, assuming dividend reinvestment, and the difference between our share price at the end and the beginning of the measurement period by (2) the share price at the beginning of the period) with the Russell 2000 Index and VSE Peer Group as defined below. The graph assumes a $100 investment at the closing price of our stock on June 30, 2006, the last trading day of the quarter in which we completed our initial public offering. The other data points are September 29, 2006, the last trading day in our third fiscal quarter, and December 29, 2006, the last trading day in 2006. The stock performance presented below covers only a six and one-half month period; historical stock performance may not be indicative of future performance.
*
The VSE Peer Group is comprised of: Pacific Ethanol, Inc. (“PEIX”) and Aventine Renewable Energy Holdings, Inc. (“AVR”).
ITEM 6.
SELECTED FINANCIAL DATA
The following table presents selected consolidated financial and operating data as of the dates and for the periods indicated. The selected consolidated balance sheet financial data as of December 31, 2004, 2003 and 2002 and the selected consolidated income statement data and other financial data for the years ended December 31, 2003 and 2002 have been derived from our audited consolidated financial statements that are not included in this Form 10-K. The selected consolidated balance sheet financial data as of December 31, 2006 and 2005 and the selected consolidated income statement data and other financial data for each of the three years in the period ended December 31, 2006 have been derived from the audited Consolidated Financial Statements included elsewhere in this Form 10-K. You should read the following table in conjunction with Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the accompanying notes included elsewhere in this Form 10-K. Among other things, those financial statements include more detailed information regarding the basis of presentation for the following consolidated financial data.
(1)
Income statement data reflects the financial impact of operations of our Aurora facility, which commenced operations in December 2003, and our Fort Dodge facility, which commenced operations in October 2005.
(2)
Interest expense includes changes in the fair value of a put warrant of $19,670 for the year ended December 31, 2006, $2,809 for the year ended December 31, 2005, $3,481 for the year ended December 31, 2004, and $566 for the year ended December 31, 2003. The put warrant is described under Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates - Put warrant.”
(3)
EBITDA is defined as earnings before interest expense, income tax expense, depreciation and amortization. Amortization of debt issuance costs and debt discount are included in interest expense. EBITDA is not a measure of financial performance under Generally Accepted Accounting Principles or, GAAP, and should not be considered an alternative to net income, or any other measure of performance under GAAP, or to cash flows from operating, investing or financing activities as an indicator of cash flows or as a measure of liquidity. EBITDA has its limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of the limitations of EBITDA are:
•
EBITDA does not reflect our cash used for capital expenditures;
•
Although depreciation and amortization are non-cash charges, the assets being depreciated or amortized often will have to be replaced and EBITDA does not reflect the cash requirements for replacements;
•
EBITDA does not reflect changes in, or cash requirements for, our working capital requirements;
•
EBITDA does not reflect the cash necessary to make payments of interest or principal on our indebtedness; and
•
EBITDA includes non-recurring payments to us which are reflected in other income.
Because of these limitations, EBITDA should not be considered as a measure of discretionary cash available to us to service our debt or to invest in the growth of our business. We compensate for these limitations by relying on our GAAP results as well as on our EBITDA. Management uses EBITDA as a measure of our performance and ability to generate cash necessary to meet our future requirements for debt service, capital expenditures, working capital and taxes.
The following table reconciles our EBITDA to net income for each period presented (dollars in thousands):
(4)
2006 capital expenditures includes $88.4 million spent from escrowed cash (including interest income) for construction of our Charles City, Iowa facility.
(5)
Average gross price of ethanol sold (dollars per gallon) does not include freight, commissions or other related costs, but does include related hedging gains or losses.
(6)
Total debt at December 31, 2006 and December 31, 2005 is shown before unaccreted discount of $1.1 million and $1.3 million, respectively.
(7)
NM - Not Meaningful
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the “Selected Financial Data” and the consolidated financial statements and accompanying notes included elsewhere in this Form 10-K. All references to years relate to the calendar year ended December 31 of the particular year.
Business Overview
We are one of the largest “pure-play” ethanol producers, with approximately 4% of the total production capacity in the United States, according to the RFA. We own and operate two of the largest ethanol production facilities in the United States, located in Aurora, South Dakota and Fort Dodge, Iowa, with a combined ethanol production capacity of 230 MMGY, and were the first to develop large-scale greenfield dry mill ethanol plants that exceed 100 MMGY of capacity. We were the first to create a branded E85 fuel, VE85tm, and to enter into strategic relationships with Ford Motor Company and General Motors Corporation to increase awareness of E85 and flexible fuel vehicles. We have continued to develop new partnerships to market VE85tm and have expanded to over 80 retail locations at the end of 2006, primarily throughout the Midwest.
We are developing and constructing additional facilities in Charles City, Iowa; Hartley, Iowa; and Welcome, Minnesota. We believe that we have adequate cash to completely fund these projects and expect to have an aggregate production capacity of 340 MMGY by the end of April 2007 and 560 MMGY by the end of the first quarter of 2008. We are also considering additional opportunities for growing our production capacity through the expansion of one or more of our existing facilities and through potential acquisitions.
We plan to continue to improve our operating efficiencies, customer and supplier relationships, as well as product and brand recognition. Our demonstrated capabilities in constructing, starting-up and operating large-scale ethanol production facilities, as well as continued study of new technologies, are expected to help drive long-term growth. We believe that our focused approach to our business and the value we bring to our customers and consumers will allow us to maintain an industry leadership position in a highly dynamic and competitive environment.
As announced in November 2006, we are developing a process to extract corn oil from distillers grains. The oil can be converted into biodiesel, thereby creating two biofuels from a single feedstock. We have also filed a provisional patent application for the extraction process. We are considering the sale of the extracted oil to others for feed or for biodiesel production. We are also considering the construction of our own biodiesel production facility.
Our financial strategy will continue to focus on maintaining strong earnings and cash flow. We believe our strategy of being a large and low-cost producer should sustain our growth and strong cash flows. We remain committed to building value for our shareholders through reinvesting in our business and continued focus on new technologies.
Executive Summary
Highlights for 2006 are as follows:
•
Total revenues increased 136.0% or $321.5 million compared to 2005.
•
Cash flows provided by operating activities were $97.3 million.
•
Earnings per diluted share increased from $0.01 for 2005 to $1.03 for 2006.
These improvements in our financial results were primarily driven by a 77.7% increase in ethanol gallons sold and a 37.1% increase in the net realized price per gallon for 2006 compared to 2005.
The following are significant factors affecting our financial results for 2006:
•
The IPO triggered accelerated vesting of stock-based compensation awards, and we issued stock awards to non-management employees. The aggregate charge for these awards was $18.2 million, or $12.8 million after tax or $0.17 per diluted share.
•
The increased value of a warrant resulted in a charge of $19.7 million to interest expense, or $0.27 per diluted share.
•
We received aggregate proceeds from an insurance settlement of $2.5 million, or $1.5 million after tax or $0.02 per diluted share.
Results of Operations
The following table sets forth, for the periods presented, revenues, expenses and net income, as well as the percentage relationship to total revenues of specified items in our condensed consolidated statements of operations (dollars in thousands):
The following table sets forth other key data for the periods presented (in thousands, except per unit data):
(1)
Includes gallons produced and used in VE85tm sales.
(2)
EBITDA is defined as earnings before interest expense, income tax expense, depreciation and amortization. Amortization of debt issuance costs and debt discount are included in interest expense.
Non-GAAP Financial Measures
Our Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, includes financial information prepared in accordance with GAAP, as well as another financial measure, EBITDA, which is considered a “non-GAAP financial measure.” Generally, a non-GAAP financial measure is a numerical measure of a company’s financial performance, financial position or cash flows that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP. The presentation of EBITDA information is intended to supplement an investor’s understanding of our operating performance and liquidity. Furthermore, this measure is not intended to replace net income, or any other measure of performance under GAAP, or to cash flows from operating, investing or financing activities as a measure of liquidity.
We believe that EBITDA is useful to investors and management in evaluating our operating performance in relation to other companies in our industry because the calculation of EBITDA generally eliminates the effects of financings and income taxes, which items may vary for different companies for reasons unrelated to overall operating performance. EBITDA has its limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our financial results as reported under GAAP. Some of the limitations of EBITDA are:
•
EBITDA does not reflect our cash used for capital expenditures;
•
Although depreciation and amortization are non-cash charges, the assets being depreciated or amortized often will have to be replaced and EBITDA does not reflect the cash requirements for replacements;
•
EBITDA does not reflect changes in, or cash requirements for, our working capital requirements;
•
EBITDA does not reflect the cash necessary to make payments of interest or principal on our indebtedness; and
•
EBITDA includes non-recurring payments to us which are reflected in other income.
Because of these limitations, EBITDA should not be considered as a measure of discretionary cash available to us to service our debt or to invest in the growth of our business. We compensate for these limitations by relying on our GAAP results, as well as on our EBITDA.
The following table reconciles our EBITDA to net income for the periods presented (in thousands):
Year Ended December 31, 2006 Compared to Year Ended December 31,
Total revenues. Total revenues increased by $321.5 million, or 136.0%, to $557.8 million from $236.4 million. The increase in total revenues was primarily the result of a 77.7% increase in ethanol volume sold and an increase in average ethanol prices of $0.59 per gallon, or 37.1%, compared to 2005. The additional ethanol sales volume was due to the Fort Dodge facility being operational for all of 2006 but for only three months in 2005. With the addition of our Fort Dodge facility, we produced a total of 226.2 million gallons of fuel ethanol in 2006, compared to 128.0 million gallons in 2005.
Net sales from ethanol increased $288.3 million, or 144.4%, to $488.0 million for 2006 from $199.7 million for 2005. The average price of ethanol sold was $2.18 per gallon for 2006, compared to $1.59 per gallon for 2005. Prices improved in 2006 primarily due to increased demand for ethanol as oil companies replaced a competitive product, MTBE, from the fuel stream in a relatively short time. We expect that ethanol prices may be lower in 2007 as a result of increases in production capacity during the year.
The net gain from derivatives included in net sales was $2.4 million for 2006, compared to a net loss of $3.9 million for 2005. See “Critical Accounting Policies and Estimates - Derivative instruments and hedging activities.”
Net sales from co-products increased $23.3 million, or 66.6%, to $58.3 million for 2006 from $35.0 million for 2005. Co-product sales increased primarily as a result of the additional production volume from the Fort Dodge facility, partially offset by a decrease in the average price per ton in 2006.
Net sales of VE85TM increased $6.8 million to $7.6 million for 2006 from $756,000 for 2005, primarily due to an increase in the number of retail outlets selling our product.
Cost of goods sold and gross profit. Gross profit increased $157.1 million to $192.7 million for 2006 from $35.5 million for 2005. The increase was the result of the additional gallons sold and the higher average net realized price per gallon of ethanol for 2006 compared to 2005. Ethanol production increased by 98.2 million gallons, or 76.7% primarily as a result of the Fort Dodge facility being operational for all of 2006 and the completion of the Aurora facility expansion project at the end of June 2005.
Corn costs increased $74.1 million to $173.5 million for 2006 from $99.4 million for 2005. Corn costs represented 47.5% of our cost of goods sold before taking into account our co-product sales and 31.5% of our cost of goods sold after taking into account co-product sales for 2006, compared to 49.5% of our cost of goods sold before taking into account our co-product sales and 32.1% of our cost of goods sold after taking into account co-product sales for 2005. The increase in total corn costs was primarily the result of increased production volume from the Fort Dodge facility and the Aurora facility expansion, along with an increase in the average price per bushel of corn in the 2006 period. Corn prices have increased significantly in 2007, which is expected to have an adverse effect on our margins during the
year. See Item 1A
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In addition to risks inherent in our operations, we are exposed to various market risks. As a commodity-based business, we are subject to a variety of market factors, including the price relationship between ethanol and corn. During 2006, we experienced strong ethanol demand due to the phase-out of MTBE, leading to tightened ethanol supply and favorable ethanol prices. In 2006, we experienced historically wide spreads between the price of ethanol and the price of corn, as shown in the following graph:
Ethanol and Corn Price Comparison
(1)
Ethanol prices are based on the monthly average of the daily closing price of U.S. average ethanol rack prices quoted by Bloomberg, L.P. (“Bloomberg”). The corn prices are based on the monthly average of the daily closing prices of the nearby corn futures quoted by the Chicago Board of Trade (“CBOT”) and assume a conversion rate of 2.8 gallons of ethanol produced per bushel of corn. The comparison between the ethanol and corn prices presented does not reflect the costs of producing ethanol other than the cost of corn, and should not be used as a measure of future results. This comparison also does not reflect the revenues that are received from the sale of distillers grains.
We consider market risk to be the potential loss arising from adverse changes in market rates and prices. We are subject to significant market risk with respect to the price of ethanol, our principal product, and the price and availability of corn, the principal commodity used in our ethanol production process. In general, ethanol prices are influenced by the supply and demand for gasoline, the availability of substitutes and the effect of laws and regulations. Higher corn costs result in lower profit margins and, therefore, represent unfavorable market conditions. Traditionally, we have not been able to pass along increased corn costs to our ethanol customers. The availability and price of corn are subject to wide fluctuations due to unpredictable factors such as weather conditions during the corn growing season, carry-over from the previous crop year and current crop year yield, governmental policies with respect to agriculture and international supply and demand. Corn costs represented approximately 47.5% of our total cost of goods sold for 2006, compared to 49.5% for 2005. Over the ten-year period from 1997 through 2006, corn prices (based on the CBOT daily futures data) have ranged from a low of $1.75 per bushel in 2000 to a high of $3.90 per bushel in 2006, with prices averaging $2.32 per bushel during this period. At December 31, 2006, the CBOT price per bushel of corn was $3.90.
We are also subject to market risk with respect to our supply of natural gas that is consumed in the ethanol production process and has been historically subject to volatile market conditions. Natural gas prices and availability are affected by weather conditions and overall economic conditions. Natural gas costs represented 15.9% of our cost of goods sold for 2006, compared to 18.5% for 2005. The price fluctuation in natural gas prices over the six-year period from December 31, 2000 through December 31, 2006, based on the NYMEX daily futures data, has ranged from a low of $1.83 per MMBTU in 2001 to a high of $15.38 per MMBTU in 2005, averaging $5.86 per MMBTU during this period. At December 31, 2006, the NYMEX price of natural gas was $6.30 per MMBTU.
We have prepared a sensitivity analysis to estimate our exposure to market risk with respect to our corn and natural gas requirements, ethanol contracts and the related exchange-traded contracts for 2006. Market risk related to these factors is estimated as the potential change in pre-tax income, resulting from a hypothetical 10% adverse change in the fair value of our corn and natural gas requirements and ethanol contracts (based on average prices for 2006) net of the corn and natural gas forward and futures contracts used to hedge our market risk with respect to our corn and natural gas requirements. The results of this analysis, which may differ from actual results, are as follows:
As of December 31, 2006, approximately 3.2% of our estimated ethanol sales for the next twelve months was subject to fixed price contracts. In addition, we had contracted forward on a fixed price basis the following quantities of corn and natural gas, which represent the indicated percentages of our estimated requirements for these inputs for the next twelve months:
(1)
Represents our net corn position, which includes exchange-traded futures and forward purchase contracts. Changes in the value of these contracts are recognized in current period income.
The extent to which we enter into these arrangements during the year may vary substantially from time to time based on a number of factors, including supply and demand factors affecting the needs of customers or suppliers to purchase ethanol or sell us raw materials on a fixed basis, our views as to future market trends, seasonable factors and the costs of futures contracts. For example, we would expect to purchase forward a smaller percentage of our corn requirements for the fall months when prices tend to be lower.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
To the Board of Directors
VeraSun Energy Corporation
Brookings, South Dakota
We have audited the consolidated balance sheets of VeraSun Energy Corporation and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, shareholders’ equity and comprehensive income and cash flows for each of the years in the three year period ended December 31, 2006. 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 standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of VeraSun Energy Corporation and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2006 in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company adopted Financial Accounting Standards Board Statement No. 123(R) Share-Based Payment in 2006.
/s/ McGladrey & Pullen, LLP
Sioux Falls, South Dakota
March 27, 2007
VERASUN ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2006 and 2005
See Notes to Consolidated Financial Statements.
VERASUN ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2006, 2005 and 2004
See Notes to Consolidated Financial Statements.
VERASUN ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
Years Ended December 31, 2006, 2005 and 2004
See Notes to Consolidated Financial Statements.
VERASUN ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2006, 2005 and 2004
See Note 18 for supplemental disclosures of cash flow information.
See Notes to Consolidated Financial Statements.
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
Note 1.
Nature of Business and Significant Accounting Policies
Nature of business: VeraSun Energy Corporation (“VEC” or “Parent”) is the parent corporation of the following wholly owned subsidiaries as of December 31, 2006: VeraSun Aurora Corporation (“VAC”), VeraSun Fort Dodge, LLC (“VFD”), VeraSun Marketing, LLC (“VM”), VeraSun Charles City, LLC (“VCC”), VeraSun Welcome, LLC (“VW”), VeraSun Hartley, LLC (“VH”), VeraSun Reynolds, LLC (“VRL”), VeraSun Granite City (“VGC”) and VeraSun BioDiesel, LLC (“VBD”).
VAC owns and operates an ethanol plant located near Aurora, South Dakota with an annual capacity of 120 million gallons. VFD owns and operates an ethanol plant located near Fort Dodge, Iowa with an annual capacity of 110 million gallons. VM markets and distributes E85 (an alternative fuel comprised of a blend of 85% ethanol and 15% gasoline) to gasoline retailers. VCC, VW and VH are development stage companies that are constructing ethanol plants near Charles City, Iowa; Welcome, Minnesota; and Hartley, Iowa; respectively, each with planned annual capacity of 110 million gallons. VH was formed in the second quarter of 2006. VRL and VGC were formed in the fourth quarter of 2006 and are development stage companies with no operations. VBD is also a development stage company that is researching the extraction of corn oil as an additional co-product in the ethanol production process. VEC and its subsidiaries are collectively referred to as the “Company”.
A summary of the Company’s significant accounting policies follows:
Principles of consolidation: The accompanying consolidated financial statements include the accounts of the Parent and its subsidiaries. All material intercompany accounts and transactions 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 and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue recognition: Revenues from the production of ethanol and related products are recorded when title transfers to customers. Ethanol and related products are generally shipped FOB shipping point. Shipping and handling charges to customers are included in revenues.
The Company receives incentives to produce ethanol from state and federal entities. In accordance with the terms of these arrangements, incentive income is recorded in revenues based on the production of ethanol or blending of E85.
In accordance with the Company’s agreements for the marketing and sale of ethanol and related products, commissions due to the marketers are deducted from the gross sales price at the time payment is remitted to the Company. Ethanol sales are recorded net of commissions of $981, $1,037 and $1,001 in 2006, 2005 and 2004, respectively.
Cost of goods sold primarily includes costs for raw material, inbound freight charges, purchasing and receiving costs, inspection costs, shipping costs, other distribution expenses, warehousing costs, plant management, certain compensation costs, and general facility overhead charges.
Selling, general, and administrative expenses consists primarily of salaries and expenses for employees located at the Company’s corporate headquarters, as well as fees paid to outside service providers such as legal, audit and consulting firms.
Cash and cash equivalents: For the purposes of reporting cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents,
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
except cash restricted for the construction of property and equipment. Cash and cash equivalents as of December 31, 2006, includes $324,889, which is not federally insured. Of these amounts, $19,825 is held by one commercial bank and $305,064 by several investment banks. Cash equivalents consist of commercial paper and money market mutual funds, among other short-term instruments.
Receivables: Receivables are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer’s financial condition, credit history and current economic conditions. Receivables are written off when deemed uncollectible. Recoveries of receivables previously written off are recorded when received. A receivable is considered to be past due if any portion of the receivable balance is outstanding for more than 90 days.
Inventories: Corn, chemicals, supplies and work in process inventories are stated at the lower of cost or market on the first-in first-out method. Ethanol and distillers grains are stated at the lower of average cost (determined quarterly) or market.
Derivatives and hedging activities: Derivatives are recognized on the balance sheet at their fair value and are included in the accompanying balance sheets as “derivative financial instruments”. On the date the derivative contract is entered into, the Company may designate the derivative as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow” hedge). Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a cash flow hedge are recorded in other comprehensive income, net of tax effect, until earnings are affected by the variability of cash flows (e.g., when periodic settlements on a variable rate asset or liability are recorded in earnings). Changes in the fair value of undesignated derivative instruments are reported in current period earnings. The Company may elect to create a hedging relationship for forward purchase contracts by selling an exchange traded futures contract as an offsetting position. In this situation, the forward purchase contract may be designated to be valued at market price until delivery is made against the contract. For the statement of cash flows, the Company categorizes the cash flows relating to hedging activities in the same category as the item being hedged.
The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedged transactions. This process includes linking all derivatives that are designated as cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items.
The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer effective in offsetting changes in the cash flows of a hedged item (including forecasted transactions); (2) the derivative expires or is sold, terminated, or exercised; or (3) the derivative is de-designated as a hedge instrument because it is unlikely that a forecasted transaction will occur or when management determines that designation of the derivative as a hedge instrument is no longer appropriate.
When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value, and gains and losses that were accumulated in other comprehensive income will be recognized immediately in earnings. In all other situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet, with subsequent changes in its fair value recognized in current-period income. The
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
Company’s derivative positions related to corn are undesignated instruments where changes in the fair value of these economic hedges are included in cost of goods sold in the income statements. The Company designates exchange traded futures transactions related to its position in unleaded gasoline and natural gas as cash flow hedges. Income statement effects of unleaded gasoline futures contracts and natural gas futures contracts are included in net sales and cost of goods sold, respectively.
Income taxes: VeraSun, LLC (“VSL”) and VFD’s operations were taxed as partnerships under the provisions of the Internal Revenue Code through September 30, 2005 and December 31, 2005, respectively. Under these provisions, their net income (loss) was reported on the individual income tax returns of their members. Accordingly, no provision/benefit or asset/liability for income taxes was reflected in these financial statements relative to the income or loss of VSL or VFD through those dates for interests in those activities held by members other than VAC. VSL was dissolved in December 2005. Effective with the Company’s reorganization in 2005, income taxes payable to (refundable from) the Internal Revenue Service are calculated based on the consolidated income of the Parent and all its subsidiaries. Prior to the reorganization, the income tax provision only related to the income of VAC.
Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Debt issuance costs: Debt issuance costs are stated at cost, less accumulated amortization. Debt issuance costs are amortized over the term of the related debt by a method which approximates the interest method. Amortization of debt issuance costs was $955, $278 and $97 during 2006, 2005 and 2004, respectively. Future amortization of debt issuance costs, based on debt outstanding as of December 31, 2006, is expected to be approximately $954 for each upcoming year until 2012. The amounts outstanding in relation to the existing debt at the time of the refinancing in December 2005 of $1,917 were fully expensed in 2005 as part of loss on extinguishment of debt in the statement of income.
Property and equipment: Property and equipment are stated at cost. Depreciation is computed by the straight-line method over the following estimated useful lives:
Maintenance, repairs and minor replacements are charged to operations while major replacements and improvements are capitalized.
Construction in progress as of December 31, 2006 primarily relates to the VCC facility and will be depreciated upon the commencement of operations of the Charles City ethanol plant, which is expected to occur in 2007.
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
Goodwill: Goodwill represents the excess of the purchase price of an acquired entity over the amounts assigned to assets acquired and liabilities assumed. Goodwill is not amortized, but is reviewed for impairment annually or more frequently if certain impairment conditions arise.
Long-lived assets: The Company records impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets.
Convertible put warrant: The value of the convertible warrant was adjusted to the formula based put value. Changes in the put price were recognized on the balance sheet in the period of change and were included in the Company’s statements of income as interest expense. The put warrant was exercised and the related shares were sold during 2006 (Note 8).
Deferred revenue: Proceeds received from the issuance of tax increment bonds are recorded as deferred revenue and are being amortized into income over the life of the related property and equipment, which is 21 years.
Earnings per common share (“EPS”): Basic EPS is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that would occur, using the treasury stock method, if securities or other obligations to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that shared in the Company’s earnings.
A reconciliation of the common stock share amounts used in the calculation of basic and diluted EPS is as follows for the years ended December 31:
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
Stock option awards outstanding for 1,426,640 shares of common stock at a weighted average exercise price of $23.04 were not included in diluted earnings per common share in 2006 as the awards were antidilutive.
Warrants outstanding for 1,475,681 shares of common stock at an exercise price of $0.52 were not included in the computation of diluted earnings per common share for the years ended December 31, 2005 and 2004, because the related performance conditions had not been met.
Performance stock option awards of 972,785 shares of common stock at a weighted average exercise price of $1.02 during 2004 and performance stock option awards of 912,078 shares of common stock at a weighted average exercise price of $1.94 during 2005 were not included in diluted earnings per common share since the accounting “grant date” had not yet occurred.
Stock-based compensation: Effective January 1, 2006, the Company adopted Financial Accounting Standards Board (“FASB”) Statement No. 123 (revised), Share-Based Payment (“Statement No. 123R”) utilizing the modified prospective application method. Prior to the adoption of FASB Statement No. 123R, the Company accounted for stock-based compensation in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations (the intrinsic value method).
For periods prior to January 1, 2006 under APB Opinion No. 25, no stock-based employee compensation was recognized for grants under fixed stock option awards for those awards that had an exercise price equal to the market value of the underlying common stock on the date of grant and, accordingly, stock-based compensation was only recognized in connection with the issuance of variable performance-based stock options and restricted stock. The Company recognizes compensation expense for awards with graded vesting using the straight line method over the entire vesting period for those awards.
The following table illustrates the pro forma effect on net income and per common share information had the Company accounted for stock-based compensation in accordance with FASB Statement No. 123R for the years ended December 31, 2005 and 2004:
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
Recent accounting pronouncements: In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. This interpretation provides that the financial statement effects of tax positions initially be recognized when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. This interpretation also may require additional disclosures relating to tax positions taken.
The provisions of FIN 48 are effective as of the beginning of the Company’s 2007 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to the opening balance of retained earnings. Management is currently evaluating the impact of adopting FIN 48, but does not expect the adoption of this statement to be significant to the Company’s consolidated financial statements.
In September 2006, the Securities and Exchange Commission (“SEC”) staff issued Staff Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 requires that public companies utilize a “dual-approach” to assessing the quantitative effects of financial misstatements. This dual approach includes both an income statement focused assessment and a balance sheet focused assessment. The Company adopted SAB 108 in the quarter ended December 31, 2006 without any impact on the Company’s consolidated financial statements.
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements. FASB Statement No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. Specifically, it sets forth a definition of fair value, and establishes a hierarchy prioritizing the inputs to valuation techniques, giving the highest priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable inputs. The provisions of FASB Statement No. 157 are generally required to be applied on a prospective basis, except to certain financial instruments accounted for under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, for which the provisions of FASB Statement No. 157 should be applied retrospectively. The Company will adopt FASB Statement No. 157 in the first quarter of 2008 and is evaluating the effect, if any, on its financial position or results of operations.
In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115, which provides all entities, including not-for-profit organizations, with an option to report selected financial assets and liabilities at fair value. The Company will adopt FASB Statement No. 159 in the first quarter of 2008 and is evaluating the effect, if any, on its financial position or results of operations.
Advertising costs: Advertising and promotion costs are expensed when incurred. Advertising costs during 2006, 2005 and 2004 were $1,250, $468 and $240, respectively.
Research and development costs: Research and development costs are expensed as incurred. Total research and development costs incurred in connection with the research of extracting corn oil as an additional co-product in the ethanol process were charged to selling, general and administrative expenses and were $657, $217 and $11 for 2006, 2005 and 2004, respectively.
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
Fair value of financial instruments: The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
Cash and cash equivalents: The carrying value of cash and cash equivalents was $318,049 and $29,714 at December 31, 2006 and 2005, respectively. The carrying amounts approximate fair values due to the relatively short maturity of these instruments.
Restricted cash held in escrow: The carrying value of restricted cash was $44,267 and $124,750 at December 31, 2006 and 2005, respectively. The carrying amounts approximate fair value due to the relatively short maturity of the instruments.
Long-term debt: The carrying value and fair value of long-term debt were $208,905 and $222,075, respectively, at December 31, 2006. The carrying value and fair value of long-term debt were $208,719 and $213,150, respectively, at December 31, 2005. The fair value of the Company’s long-term debt at December 31, 2006 and 2005 was estimated based on quoted market prices.
Derivatives and warrant: The carrying values of commodity derivatives were assets of $12,382 and liabilities of $11,331 at December 31, 2006 and assets of $1,382 and liabilities of $5,808 at December 31, 2005. The carrying values of the convertible put warrant were $0 and ($7,458), respectively, at December 31, 2006 and 2005. These instruments are recorded at fair value on the accompanying balance sheets, with such fair value determined based on quoted market prices or formula value.
Segment reporting: Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company’s operating segments are aggregated into the “Ethanol Production” and “All Other” reportable segments because the long-term financial performance of these reportable segments is affected by similar economic conditions. See Note 16.
Note 2.
Initial Public Offering
On June 13, 2006, the Company’s Form S-1 filed with the SEC became effective. A total of 20,987,500 shares of common stock were registered pursuant to the Form S-1. The initial public offering (“IPO”) was completed June 19, 2006. An aggregate of 11,000,000 shares of common stock were sold by the Company and 9,987,500 shares were sold by certain shareholders of the Company.
The IPO price was $23 per share. The Company and the selling shareholders received total proceeds of $235,923 and $214,207, respectively, after the deduction of underwriting discounts of $17,077 and $15,506, respectively. Net proceeds to the Company were $233,167, after the deduction of costs of raising capital of $2,756.
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
Note 3.
Receivables
A summary of receivables at December 31 is as follows:
Note 4.
Inventories
A summary of inventories at December 31 is as follows:
Note 5.
Property and Equipment
A summary of property and equipment at December 31 is as follows:
The Company incurred a loss on disposal of equipment during 2005 of $2,640 attributable to the VAC plant expansion.
Note 6.
Notes Payable
Credit facility: On December 21, 2005, the Company entered into a bank agreement for a $30,000 revolving credit agreement with a $10,000 sublimit for letters of credit. Loan advances under the agreement have a borrowing base limitation based on a percentage of eligible receivables and
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
outstanding inventory. As of December 31, 2006, funds of $30,000 were available to be drawn as computed under the borrowing base limitation, of which $3,679 in irrevocable stand-by letters of credit were outstanding, leaving $26,321 remaining unused borrowing capacity. The agreement bears interest at LIBOR plus the applicable margin of 2.5% as of December 31, 2006, for a total rate of 7.83%. The agreement has an expiration date of December 31, 2008 and is secured by a first priority lien on all of the Parent’s and certain of its subsidiaries’ accounts receivable, inventories and the cash proceeds therefrom (including amounts received from insurance policies in respect thereof and deposit and securities accounts into which such proceeds are deposited). The agreement contains restrictive covenants relating to certain financial measurements and ongoing financial reporting requirements to the lender. In addition, the agreement provides for an unused commitment fee ranging from 0.15% to 0.25% (based on working capital levels) of the average unused portion of the $30,000 commitment, after deducting any letters of credit outstanding under the agreement, and a letter of credit fee equal to 2.25% of the amount of outstanding letters of credit. As of December 31, 2006 and 2005, no loans were outstanding under the agreement.
Related party notes: On July 28, 2005, the Company entered into a line of credit agreement of $1,000 with its Chief Executive Officer. On November 14, 2005, the Company issued a secured promissory note of $1,300 to its Chief Executive Officer. On November 14, 2005, the Company also issued an unsecured promissory note of $800 to its Chief Executive Officer. All of these notes were paid in full by December 2005. Total interest incurred under the notes was $24 during 2005.
During 2004, the Company entered into a $1,000 unsecured line of credit promissory note and an unsecured term note with its Chief Executive Officer. These notes were paid in full in 2004. Total interest incurred under the notes was $32 during 2004.
During 2004, a related party loaned the Company $1,000. This loan was converted into shares of common stock during 2004. Total interest incurred under the loan was $22 during 2004.
Note 7.
Long-Term Debt and Restricted Cash
Long-term debt at December 31 consists of:
(a)
On December 21, 2005, the Company issued $210,000 of senior secured notes. The notes bear interest at a fixed rate of 9.875% and are net of unamortized debt discount of $1,095 and $1,281 at December 31, 2006 and 2005, respectively. Debt discount amortization recognized during 2006 and 2005 was $186 and $8, respectively. The notes mature in full on December 15, 2012 and may be prepaid prior thereto with a penalty. Interest is paid on a semi-annual basis in the amount of $10,369 on June 15 and December 15 of each year. The proceeds of the debt offering were used to refinance a portion of the Company’s existing debt and $125,000 was placed in escrow for the purpose of constructing a 110 million gallon per year ethanol plant near Charles City, Iowa. The indenture relating to the notes contains a number of restrictive covenants that limit the ability of the Parent and its subsidiaries to, among other things, incur additional indebtedness, pay dividends, make investments, and enter into
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
transactions with affiliates and other restrictions. The notes are collateralized by substantially all the assets of the Parent and certain of its subsidiaries, except for accounts receivable, inventory, commodities accounts and the cash proceeds therefrom and subject to various other exceptions. Certain registration rights were granted related to the notes and the notes were registered with the SEC in 2006. VAC, VFD, VM, VCC, VW, VH, VRL and VGC are all guarantors of the notes and each is a 100% wholly owned subsidiary of VEC.
The $44,267 restricted cash held in escrow as of December 31, 2006 consists of cash proceeds in one bank from the senior notes held for the construction of the VCC facility. The bank began releasing escrow funds upon the commencement of construction on the VCC facility in 2006.
In December 2005, the Company extinguished certain long-term debt with proceeds from the senior secured notes. The Company incurred prepayment penalties of $13,357 and expensed unamortized debt issuance costs and debt discount of $2,387, which are included as other interest expense, loss on extinguishment of debt, in the accompanying statement of income.
Note 8.
Convertible Put Warrant
The Company entered into a subordinated note purchase agreement in 2002, which provided for a commitment to issue subordinated secured notes in an aggregate principal amount of up to $20,000. During 2005, these notes were paid in full (Note 7). To induce the subordinated note holder (“SNH”) to enter into the note purchase agreement and to make extensions of credit hereunder, the Company granted warrants to acquire 1,180,000 shares of common stock at an exercise price of $0.01 per share. The computed value of the warrant was $7,458 at December 31, 2005, primarily based upon the estimated fair value of the related common stock. In connection with the completion of the IPO, the put feature was terminated and the warrant was exercised with the underlying shares sold; therefore, the liability related to the warrant of $27,128 at the time of the IPO was reclassified to additional paid-in capital in 2006. During 2006, 2005 and 2004, the change in the computed value of the warrant included in interest expense in the accompanying statements of income was $19,670, $2,809 and $3,481, respectively.
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
Note 9.
Income Tax Matters
Net deferred tax liabilities consist of the following components as of December 31, 2006 and 2005:
The components giving rise to the net deferred tax liabilities described above have been included in the accompanying balance sheets as of December 31 as follows:
The provision for income taxes charged to operations for the years ended December 31, 2006, 2005 and 2004 consists of the following:
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
The income tax provision differs from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income for the years ended December 31, 2006, 2005 and 2004, due to the following:
Note 10.
Tax Increment Financing
During the year ended December 31, 2003, the Company received a grant of $2,004 from the proceeds of tax increment financing bonds issued by Brookings County, South Dakota. Under South Dakota law, proceeds from tax increment financing are not a liability of the Company, but are an obligation of the taxing district issuing the bonds. The grant was provided to fund improvements to the property owned by the Company and the bonds will be repaid by Brookings County from the incremental increase in property taxes related to the improvement of the Company’s real property. The proceeds of the financing have been recorded as deferred revenue and are being amortized at approximately $96 per year into income, with such amortization amount based on the life of the related property and equipment. During 2006, 2005 and 2004, $96, $96 and $95, respectively, of amortization was included in income in the accompanying statements of income.
Note 11.
Risk Management
The Company’s activities expose it to a variety of market risks, including the effects of changes in commodity prices and interest rates. These financial exposures are monitored and managed by the Company as an integral part of its overall risk-management program. The Company’s risk-management program focuses on the unpredictability of financial and commodities markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results.
The manufacturing of the Company’s products requires substantial purchases of corn and natural gas. Price fluctuations in commodities cause firm commitments to purchase the commodities to develop unrealized appreciation or depreciation when compared with current commodity prices and actual cash outlays for the purchase of the commodities differ from anticipated cash outlays.
The Company seeks to mitigate its exposure to commodity price fluctuations by purchasing forward a portion of its corn requirements on a fixed price basis and by purchasing corn and natural gas futures
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
contracts. To mitigate ethanol price risk, the Company sells a portion of its production forward under fixed price and indexed contracts. The indexed contracts are typically referenced to a futures contract, such as unleaded gasoline on the NYMEX, and the Company may hedge a portion of the price risk associated with index contracts by selling exchange-traded unleaded gasoline contracts. The Company believes its strategy of managing exposure to commodity price fluctuations will reduce somewhat the volatility of its results, but will also reduce its ability to benefit from favorable changes in prices.
Exchange-traded futures contracts are valued at market price. Changes in market price are recorded in other comprehensive income, net of tax, until earnings are affected by the variability of cash flows for those highly effective contracts designated and that qualify as cash flow hedges. At December 31, 2006, the Company had hedged a portion of its exposure with forward and futures contracts through 2009. Unrealized gains and losses on forward contracts, in which delivery has not occurred, are deemed “normal purchases and normal sales” under FASB Statement No. 133, as amended (unless designated otherwise), and therefore are not marked to market in the Company’s financial statements. The Company may elect to create a hedging relationship for forward purchase contracts by selling an exchange traded futures contract as an offsetting position. In this situation, the forward purchase contract may be designated to be valued at market price until delivery is made against the contract. The Company formally assesses, both at the hedge’s inception and on an ongoing basis, whether its commodity hedges are highly effective in offsetting changes in cash flows of the hedged item.
The Company uses futures contracts to fix the purchase price of anticipated volumes of commodities to be purchased and processed in a future month, including the Company’s anticipated natural gas requirements for its production facilities. The Company hedges its exposure to natural gas price changes for up to six months. Accumulated other comprehensive loss as of December 31, 2006 and 2005 was $962 and $2,310, respectively, net of tax, relating to derivative financial instruments. The gains and losses arising from cash flow hedges will be recognized in the statement of income within the next 12 months. Hedging gains (losses) included in the statements of income consist of the following for the years ended December 31, 2006, 2005 and 2004:
By using derivative financial instruments to hedge exposures to changes in commodity prices, the Company exposes itself to credit risk and market risk. Credit risk is the risk of failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Company, which creates repayment risk for the Company. When the fair value of a derivative contract is negative, the Company owes the counterparty and, therefore, it does not have repayment risk. The Company reduces the credit (or repayment) risk in derivative instruments by entering into transactions with high-quality counterparties. Derivative contracts entered into by the Company are governed by an International Swap Dealers Association Master Agreement.
Market risk is the adverse effect on the value of a financial instrument that results from a change in commodity prices. The market risk associated with commodity-price contracts is managed by the establishment and monitoring of parameters that limit the types and degree of market risk that may be undertaken.
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
The components of other comprehensive income (loss) on hedging activities for the years ended December 31 are as follows:
Note 12.
Stock-Based Compensation and Equity-Based Awards
The Company has a Stock Incentive Plan (“Plan”), under which 4,791,811 common shares as of December 31, 2005, were reserved for grants to directors, employees, select non-employee agents and independent contractors of the Company in the form of service-based, performance-based or restricted stock awards. In 2006, the Company’s Board of Directors authorized, subject to shareholder approval, an additional 5,208,189 of common shares to be included in the Plan, for an aggregate of 10,000,000 awards authorized, which also includes a long-term incentive plan that was formed during 2006 and which provides for the grant of restricted stock awards and stock options to certain employees at a ratio of 25% restricted stock and 75% stock options of the total award. Such amounts vest 10% at the end of year one, 15% at the end of year two, 20% at the end of year three, 25% at the end of year four and 30% at the end of year five. As of December 31, 2006, there were 3,797,530 shares available to be awarded under the Plan. The Plan is administered by the Compensation Committee of the Board of Directors, which selects persons eligible to receive awards under the Plan and determines the number, terms, conditions, performance measures and other provisions of the awards.
Compensation expense charged against income for grants under the Plan was $22,452, $1,142 and $715 for the years ended December 31, 2006, 2005 and 2004, respectively, of which $20,571, $1,142 and $715, respectively, was charged to selling, general and administrative expenses and the remainder was charged to cost of goods sold. As a result of the Company’s IPO during 2006, options and warrants covering 3,516,338 shares and restricted stock covering 99,211 shares immediately vested due to accelerated vesting provisions within those instruments. In addition, performance-based awards for 620,041 shares for which a grant date had not occurred prior to the IPO immediately were “granted” for accounting purposes, vested and resulted in the recognition of stock-based compensation expense. Stock-based compensation expense was also recognized for a stock bonus to non-management employees that management awarded concurrently with the offering. Agreements for awards to two employees were modified during 2006 to shorten the vesting period from five years to three years for the related awards. The total incremental compensation cost related to such modifications was not significant. The total income tax benefit recognized in the consolidated statement of income for grants under the Plan was $6,155, $182 and $114 for the years ended December 31, 2006, 2005 and 2004, respectively. No compensation expense was capitalized during the three years ended December 31, 2006.
Net cash received from the exercise of options and awards under the Plan was $368, $0 and $0 for the years ended December 31, 2006, 2005 and 2004, respectively. The Company recognized an excess tax benefit of $1,320 in connection with related exercises in 2006 and no significant tax benefits were recognized in 2004 and 2005.
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
Under the modified prospective approach, FASB Statement No. 123R applies to new awards and to awards that were outstanding as of January 1, 2006 that are subsequently modified, repurchased or cancelled. Compensation expense recognized in 2006 included compensation expense for awards granted under the Plan prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of FASB Statement No. 123, and included compensation expense for awards granted under the Plan subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of Statement No. 123R. Prior periods were not restated to reflect the impact of adopting the new standard.
As a result of adopting Statement No. 123R on January 1, 2006, income before income taxes and minority interest, net income, cash flows from operating activities, cash flows from financing activities and basic and diluted EPS for the year ended December 31, 2006 were higher (lower) by $3,679, $2,868, ($1,320), $1,320, ($0.04) and ($0.04), respectively, than if the Company had continued to account for stock-based compensation under APB Opinion No. 25 for awards under the Plan.
Service-Based Awards
Service-based option awards (“Service Awards”) under the Plan are generally granted with an exercise price equal to the market price of the Company’s common stock at the date of grant; those awards generally vest based on five years of continuous service and have ten year contractual terms. These awards can only be exercised if the holder of the award is still employed or in the service of the Company at the time of exercise and for a specified period after termination of employment. Certain Service Awards granted under the Plan provide for accelerated vesting if there is a change in control as defined in the Plan.
The fair value of each Service Award is estimated on the date of grant using the Black-Scholes single option pricing model with the weighted average assumptions described below for the periods presented. Expected volatility was based on the stock volatility for a comparable publicly traded company for the period prior to the Company’s IPO and is based on the Company’s stock activity from the IPO date to December 31, 2006, considered collectively for the expected term of the award. The Company uses historical activity to estimate option exercise, forfeiture and employee termination assumptions within the valuation model. The expected term of options granted is generally derived using the mid-point between the date options become exercisable (generally five years) and the date at which they expire (generally ten years). The risk-free interest rate for periods within the contractual life of the Service Award is based on the U.S. Treasury yield curve in effect at the time of grant.
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
The following table lists Service Award activity under the Plan for the year ended December 31, 2006:
The Company applied a forfeiture rate of 3% when calculating the amount of options expected to vest as of December 31, 2006. This rate is based on historical activity and will be revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The weighted average grant date fair value of options granted during the years ended December 31, 2006, 2005 and 2004 was $14.35, $3.38 and $0.49 per share, respectively. The total intrinsic value of options exercised during the years ended December 2006, 2005 and 2004 was $4,854, $0 and $0, respectively.
Restricted stock awards (“Restricted Stock”) under the Plan generally vest over a period of five years. If the holder of Restricted Stock is no longer employed or in the service of the Company, nonvested shares are automatically forfeited. Certain Restricted Stock awards granted under the Plan provide for accelerated vesting if there is a change in control as defined in the Plan.
The following table shows the status of the Company’s nonvested Restricted Stock as of December 31, 2006 and changes during the year ended December 31, 2006:
As of December 31, 2006, there was $24,299 of total unrecognized compensation expense related to nonvested Service Awards and Restricted Stock granted under the Plan. This expense is expected to be recognized over a weighted average period of 2.5 years. The total fair value of service-based shares vested during the years ended December 31, 2006, 2005 and 2004 was $2,928, $386 and $10, respectively. The grant date fair value of nonvested shares was determined using the value of the Company’s common stock sold on or near the date of grant.
Performance-Based Awards
Performance-based option awards (“Performance Awards”) under the Plan are generally awarded at the January meeting of the Company’s Board of Directors. The vesting of Performance Awards is
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
contingent upon meeting various individual, departmental and company-wide goals. Performance Awards are generally granted with an exercise price equal to the market price of the Company’s common stock at the date of grant, contingently vest over a period of one year and have ten year contractual terms. These awards can only be exercised if the holder of the award is still employed or in the service of the Company at the time of exercise and for a specified period after termination of employment. Certain Performance Awards granted under the Plan provide for accelerated vesting if there is a change in control as defined in the Plan.
The fair value of each Performance Award was estimated at the date of grant using the same option valuation model used for Service Awards granted under the Plan and assumes that performance goals will be achieved at a rate of 97%. If such goals are not met, or are met at a rate less than 97%, compensation expense is adjusted to the appropriate amount to be recognized and any recognized compensation expense above that amount is reversed. The inputs for expected volatility, expected dividend yield, estimated forfeitures and risk-free interest rate used in estimating the fair value of Performance Awards are the same as those noted in the table described for Service Awards. The expected term for Performance Awards granted under the Plan during the years ended December 31, 2006, 2005 and 2004 was eight, eight - ten, and five - eight years, respectively.
The following table lists Performance Award activity under the Plan for the year ended December 31, 2006:
The weighted average grant date fair value of Performance Awards granted was $16.61, $3.39 and $0.44 per share for the years ended December 31, 2006, 2005 and 2004, respectively. The aggregate intrinsic value of Performance Awards exercised during the years ended December 31, 2006, 2005 and 2004 was $1,347, $0 and $0, respectively. The total fair value of Performance Awards vested during the years ended December 31, 2006, 2005 and 2004 was $14,770, $997 and $665, respectively. As of December 31, 2006, there was no unrecognized compensation expense related to Performance Awards because all outstanding Performance Awards vested upon completion of the IPO on June 19, 2006.
Other Share-Based Awards
Service-Based Awards: In connection with its service agreement with a third party financial advisor (“Advisor”), the Company granted a warrant to the Advisor to purchase 96,376 shares of common stock. The warrant was fully vested at December 27, 2002. The warrant has an exercise price of $0.52 per share and expires February 25, 2008. The warrant is not transferable, except to officers of the Advisor. The aggregate intrinsic value of this warrant as of December 31, 2006 was $1,853. Through December 31,
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
2006, no shares have been issued under the warrant and no expense had been recognized by the Company.
The Company granted warrants to certain employees in 2002 to purchase 578,258 shares of common stock which vest over a five year period. As of December 31, 2006, warrants for 455,733 shares were exercisable. The warrants have an exercise price of $0.52 per share and expire on the earliest of August 20, 2007, or the day of termination of the warrant holder’s employment with the Company for cause, or the day of voluntary termination of the warrant holder’s employment. As of December 31, 2006 30,000 shares have been issued under the warrants. For the years ended December 31, 2006, 2005 and 2004, compensation expense of $20, $0 and $0 was recognized by the Company in connection with these warrants. As of December 31, 2006, there was $9 of unrecognized compensation expense related to these warrants and the aggregate intrinsic value of the outstanding warrants was $10,543.
Performance- and Market-Based Awards: In 2002, the Company granted “claw back” warrants to purchase 1,475,681 shares of common stock to the Company’s initial common shareholders, who were also employees of the Company. The warrants were fully exercisable as of December 31, 2006 at an exercise price of $0.52 per share and expire on June 14, 2016. The total fair value of these warrants at the date of grant was $141, which the Company recognized as expense in the year ended December 31, 2006, when the performance conditions were met upon the completion of the IPO. The aggregate intrinsic value of these warrants as of December 31, 2006 was $28,377.
The Company issues new shares upon the exercise of options and warrants.
Note 13.
Employee Benefit Plan
The Company has a 401(k) plan. Employees who are at least 18 years of age are eligible to participate in the plan. Eligible employees may make elective deferral contributions to the plan. The Company’s matching contribution is 100% of the employee elective deferrals, not to exceed 3% of the employee’s eligible wages. During 2006, 2005 and 2004, the Company contributed approximately $289, $136 and $96, respectively, to the plan.
Note 14.
Commitments and Contingencies
The Company has entered into various contracts and agreements.
The Company leases railroad cars with terms ranging from 36 to 120 months following the receipt of the railroad cars. The total lease expense included in the statements of income for the years ended December 31, 2006, 2005 and 2004 relating to these leases is $3,351, $2,476 and $1,052, respectively. Future minimum lease payments on the railroad cars are as follows:
The Company accrues an estimate for repair expenses on railroad cars for damages in excess of normal wear and tear as provided by the lease agreement. As of December 31, 2006 and 2005, $448 and
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
$142, respectively, was included in accrued expenses in the accompanying balance sheets and $306, $142 and $0 was included in the accompanying statements of income during the years ended December 31, 2006, 2005 and 2004, respectively.
The Company has entered into agreements for the purchase of corn, electricity, natural gas, water and railroad transportation as follows:
Corn - Corn purchase obligations include corn commitments to purchase approximately 32.6 million bushels of corn under forward contracts, in which the related commodity had not been delivered, and a multi-year corn purchase agreement. To quantify the purchase obligations under certain of the Company’s corn contracts and its multi-year corn purchase agreement, the Company has used its December 31, 2006 published bid prices for corn.
Natural Gas - The agreements provide the Company with fixed rates for natural gas through various dates through 2019 from one vendor at each plant. The rates are based upon transportation rates or demand charges for the various agreements plus minimum monthly administrative charges. The agreements require varying annual minimum purchases of up to 3,000,000 MMBtu of natural gas at each plant.
Electricity - The agreements provide the Company with a fixed rate for electric service through various dates through 2012 from one vendor at each plant. The agreements require varying minimum purchases of up to 10,000 kilowatts of electricity each month plus a monthly facilities charge at each plant.
Water - The agreements provide the Company with fixed rates for water through various dates to 2009 from one vendor at each plant. The agreements require varying minimum purchases of up to 350 million gallons of water per year through 2019 at each plant.
Railroad transportation - The agreements provide the Company with a transportation route for outbound ethanol and distillers grain shipments and inbound corn shipments. These agreements are with one or two vendors per plant. The rates per the agreements are fixed, subject to semi-annual adjustment based on a national index of rail costs. These contracts do not have stated minimums and terminate on various dates through 2018, or upon notice.
Expenses related to the agreements for the purchase of natural gas, electricity, water and railroad transportation totaled $72,700, $48,107 and $24,392 for the years ended December 31, 2006, 2005 and 2004, respectively.
Minimum purchase amounts under these contracts are as follows:
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
The Company has agreements with Aventine Renewable Energy, Inc. (“Aventine”) for the marketing, billing, receipt of payment and other administrative services for substantially all ethanol produced by the Company. The Company pays fees that vary based on the number of gallons sold. In February 2006, formal notice was provided to terminate the Company’s agreements with Aventine on March 31, 2007. Sales to Aventine are recorded net of fees and such sales were $485,678, $203,550 and $155,439 for the years ended December 31, 2006, 2005 and 2004, respectively. At December 31, 2006 and 2005, $25,496 and $12,272, respectively, was due from Aventine and is included in receivables in the accompanying balance sheets. Management does not expect any significant adverse affects from the termination of these marketing agreements. A marketing department has been established to facilitate marketing ethanol directly to oil companies.
In March 2006, the Company entered into agreements for construction and engineering of the VCC plant. The Company anticipates that the amount held in escrow for the engineering and construction of the VCC facility will be adequate to pay amounts due under these contracts. In the event that the sum of the cost of the work and the flat fee under the agreement exceed the contracted cash amount for construction of the VCC plant, the Company has the option to pay the contractor any excess by either a payment of cash or by tendering to the contractor common stock of the Company with a value equal to the amount owed (valued at the time of issuance).
In September 2006, the Company entered into agreements for the construction and engineering of 110 million gallons per year facilities for VW and VH, as well as a third unspecified location that will begin construction in 2007. The Company began construction of the VW and VH facilities during the fourth quarter of 2006. The Company anticipates that the cash on hand will be adequate to pay amounts due for the construction of two of the plants and that the third plant will be funded from future cash flows.
In 2006, an agreement was entered into for the storage of ethanol effective April 1, 2007 with a monthly commitment of approximately $368 through March 2008.
The Company has an agreement with American Milling, LLP, a grain processing and transportation company, for the acquisition from time to time of rights to purchase or lease real property sites suitable for future construction and operation of 110 million gallons per year nameplate ethanol production facilities. American Milling has identified a number of potential sites and has acquired or is in the process of acquiring rights either to purchase or lease them. At the time it designates a site, American Milling will provide documentation about the site and the related property rights to assist the Company in deciding whether to accept it. Upon any acceptance, American Milling may elect to receive cash or shares of the Company’s common stock for the property rights. As of December 31, 2006, there was no liability to American Milling for accepted sites. On March 1, 2007, the Company agreed to accept a site located near Reynolds, Indiana. As consideration for the site, the Company is obligated to issue 300,000 shares of its common stock, of which 150,000 shares were issued to American Milling on March 15, 2007. The remaining 150,000 shares will be issued upon receipt of the required construction permits for the proposed ethanol facility, but no later than March 15, 2008.
The Company’s operations are subject to environmental laws and regulations adopted by various governmental authorities in the jurisdiction in which it operates. These laws require the Company to investigate and remediate the effects of the release or disposal of material at its locations. Accordingly, the Company has adopted policies, practices and procedures in the areas of pollution control, occupational health, and the production, handling, storage and use of hazardous materials to prevent environmental or other damage, and to limit the financial liability which could result from such events. Environmental liabilities are recorded when the Company’s liability is probable and the costs can be reasonably estimated. No such liabilities were recorded at December 31, 2006.
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
Note 15.
Insurance Proceeds
Other income for the year ended December 31, 2006 includes $2,475 of business interruption insurance proceeds with respect to a malfunction of a key piece of equipment in 2005 at VFD’s facility. In addition, insurance proceeds of $500 were recognized in the year ended December 31, 2005 which were included primarily in cost of goods sold as an offset to repair expenses incurred.
Note 16.
Segment Information
The Company’s reportable segments are distinguished by those business units that manufacture and sell ethanol and its co-products and business units that are engaged in other activities. The “Ethanol Production” segment includes the operations of VAC and VFD and ethanol plants under construction or in development of VCC, VW, VH, VRL and VGC. The Company’s remaining operations, including activities by the Parent corporation, are aggregated and classified as “All Other”. Financial performance is evaluated based on earnings before interest, taxes, depreciation and amortization (“EBITDA”), and the accounting policies are applied to the enterprise consistently. Companies combined as “All Other” function primarily for the purpose of research, providing management services or marketing of distillers grains and E85.
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
The following schedule is presented to reconcile EBITDA to income before income taxes and minority interest:
*
Amortization of debt issuance costs and debt discount are included in interest expense.
The components of revenues are as follows for the years ended December 31:
Revenue from one customer of the Ethanol Production segment was $485,678, $203,550 and $155,439 during the years ended December 31, 2006, 2005 and 2004, respectively. See Note 14.
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
Note 17.
Quarterly Financial Data (Unaudited)
The following table presents summarized quarterly financial data for the year ended December 31, 2006:
(a)
Includes $18,147 of stock-based compensation related to accelerated vesting and other stock-based compensation issued in connection with the IPO (Note 12)
(b)
Includes business interruption insurance proceeds of $2,475 (Note 15)
(a)
Includes loss on disposal of equipment of $2,640 (Note 5)
(b)
Includes loss on extinguishment of debt of $15,744 (Note 7)
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
Note 18.
Supplemental Cash Flow Information
Note 19.
Guarantors/Non-guarantors Consolidating Financial Statements
In accordance with the indenture governing the Company’s senior secured notes, certain wholly owned subsidiaries of the Company have fully and unconditionally guaranteed the notes on a joint and several basis. The following tables present condensed consolidating financial information for VEC (the issuer of the notes), subsidiaries that are guarantors of the notes and subsidiaries that are non-guarantors of the notes. VAC, VFD, VM, VH, VCC, VRL, VGC and VW are combined as guarantors, each of which is a 100% wholly owned subsidiary of VEC. Prior to 2005, VEC had no independent assets or operations and the non-guarantor subsidiaries were minor. Accordingly, consolidating financial information is not presented for periods prior to 2005.
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31, 2006
ASSETS
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
CONDENSED CONSOLIDATING STATEMENT OF INCOME
For the Year Ended December 31, 2006
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the Year Ended December 31, 2006
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31,
ASSETS
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
CONDENSED CONSOLIDATING STATEMENT OF INCOME
For the Year Ended December 31, 2005
VERASUN ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(dollars in thousands, except per share data)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the Year Ended December 31, 2005
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required financial disclosure.
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision of management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon such evaluation as of December 31, 2006, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were not effective because of the material weaknesses discussed below. To address those weaknesses, the Company preformed additional analyses and other post-closing procedures to ensure that our consolidated financial statements are prepared in accordance with generally accepted accounting principles. Accordingly, management believes that the financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented.
The aforementioned evaluation identified the following weaknesses:
1. Our post-closing processes discovered certain issues with respect to the accounting for derivative financial instruments and income taxes among certain other items, resulting in significant adjustments to our financial statements.
2. We also concluded that there were deficiencies in our financial closing process, the monitoring of accounting recognition matters and the calculation of certain estimates.
As noted above, the issues that resulted from these weaknesses were properly addressed before the completion of our consolidated financial statements. In addition, our management is working with our Audit Committee to identify and implement corrective actions where required to improve our internal controls, including the enhancement of our systems and procedures to assure that the weaknesses noted above are corrected.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred in the fiscal quarter ended December 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting, except as described above.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to directors of the Company is incorporated herein by reference to the section entitled “Election of Directors” in our proxy statement for our 2007 Annual Meeting of Shareholders (the “2007 Proxy Statement”), to be filed no later than 120 days after the end of the fiscal year ended December 31, 2006. Information with respect to our executive officers is set forth under Item 4A in Part I of this report.
Information with respect to compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to our 2007 Proxy Statement.
The Company has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. The Company has posted this Code of Business Conduct and Ethics on the VeraSun Energy Corporation website at www.verasun.com.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
Information regarding Executive Compensation, our Compensation Committee and the Compensation Committee Report are incorporated herein by reference to our 2007 Proxy Statement.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The section of our 2007 Proxy Statement entitled “Security Ownership of Certain Beneficial Owners and Management” is incorporated herein by reference. Information regarding our equity compensation plan is included in Item 5 of this Annual Report on Form 10-K.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information with respect to certain relationships and related transactions and director independence is incorporated herein by reference to our 2007 Proxy Statement.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
Information with respect to principal accounting fees and services is incorporated herein by reference to our 2007 Proxy Statement.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) and (a) (2) Financial statements. The Financial Statements of the Company filed as part of this Annual Report on Form 10-K are included in Item 8 of this Annual Report on Form 10-K.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(1)
Accounts charged off.
Report of Independent Registered Public Accounting Firm
To the Board of Directors
VeraSun Energy Corporation
Brookings, South Dakota
Our audits of the consolidated financial statements referred to in our report dated March 27, 2007, included elsewhere in this Annual Report on Form 10K, also included the financial statement Schedule II of VeraSun Energy Corporation and subsidiaries, listed in Item 15(a) of this From 10K. This schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion based on our audits of the consolidated financial statements.
In our opinion, the financial statement Schedule II, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ McGladrey & Pullen, LLP
Sioux Falls, South Dakota
March 27, 2007
(a)(3) Exhibits
(b)
See Exhibit Index beginning on page 81 for a description of the documents that are filed as Exhibits to this Annual Report on Form 10-K or incorporated herein by reference.
EXHIBIT INDEX
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, as of March 28, 2007.
VERASUN ENERGY CORPORATION
By:
/s/ Donald L. Endres
Donald L. Endres
Chief Executive Officer and President
SUBSIDIARIES
VERASUN AURORA CORPORATION
VERASUN FORT DODGE, LLC
VERASUN CHARLES CITY, LLC
VERASUN HARTLEY, LLC
VERASUN MARKETING, LLC
VERASUN WELCOME, LLC
VERASUN GRANITE CITY, LLC
VERASUN REYNOLDS, LLC
By:
/s/ Donald L. Endres
Donald L. Endres
Chief Executive Officer and President
POWER OF ATTORNEY
KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints, jointly and severally, Donald L. Endres and Danny C. Herron, and each of them, attorneys-in-fact for the undersigned, each with the power of substitution, for the undersigned in any and all capacities to sign any and all amendments to this Annual Report on Form 10-K for the year ended December 31, 2006, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may 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 by the following persons on behalf of the registrant and in the capacities indicated as of March 28, 2007.
POWER OF ATTORNEY
KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints, jointly and severally, Donald L. Endres and Danny C. Herron, and each of them, attorneys-in-fact for the undersigned, each with the power of substitution, for the undersigned in any and all capacities to sign any and all amendments to this Annual Report on Form 10-K for the year ended December 31, 2006, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may 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 by the following persons on behalf of the subsidiary registrants and in the capacities indicated as of March 28, 2007.