UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

 

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2009

 

Commission file number: 000-52421

 

 

 

 

ADVANCED BIOENERGY, LLC

(Exact name of Registrant as Specified in its Charter)

 

 

10201 Wayzata Boulevard, Suite 250
Minneapolis, Minnesota 55305
(763) 226-2701
(Address, including zip code, and telephone number,
including area code, of Registrant’s Principal Executive Offices)

 

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

None

 

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

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o     No þ

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)  Yes o     No o

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

Our membership units are not publicly traded; therefore, our public float is not measurable.

 

As of December 26, 2009, the number of outstanding units was 17,814,180.

 

 

ADVANCED BIOENERGY, LLC
FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2009

 

INDEX

 

SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION

 

This Annual Report on Form 10-K contains forward-looking statements regarding our business, financial condition, results of operations, performance and prospects. All statements that are not historical or current facts are forward-looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks, uncertainties and other factors, many of which may be beyond our control that may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Certain of these risks and uncertainties are described in the “Risk Factors” section of this Annual Report on Form 10-K. These risks and uncertainties include, but are not limited to, the following:

 

 

You can identify forward-looking statements by terms such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would,” and similar expressions intended to identify forward-looking statements. Forward-looking statements reflect our current views with respect to future events, are based on assumptions, and are subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our estimates and assumptions only as of the date of this report. Except as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future. Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed from time to time with the Securities and Exchange Commission, which we refer to as the Commission, that advise interested parties of the risks and factors that may affect our business.

 

INTELLECTUAL PROPERTY

 

Advanced BioEnergy^tm, our logos and the other trademarks, trade names and service marks of Advanced BioEnergy mentioned in this report are our property. This report also contains trademarks and service marks belonging to other entities.

INDUSTRY AND MARKET DATA

 

We obtained the industry, market and competitive position data used throughout this report from our own research, studies conducted by third parties, independent industry associations, governmental associations or general publications and other publicly available information. In particular, we have based much of our discussion of the ethanol industry, including government regulation relevant to the industry and forecasted growth in demand, on information published by the Renewable Fuels Association, the national trade association for the U.S. ethanol industry. Because the Renewable Fuels Association is a trade organization for the ethanol industry, it may present information in a manner that is more favorable to that industry than would be presented by an independent source. Although we believe these sources are reliable, we have not independently verified the information. Forecasts are particularly likely to be inaccurate, especially over long periods of time.

 

ETHANOL UNITS

 

All references in this report to gallons of ethanol are to gallons of denatured ethanol. Denatured ethanol is ethanol blended with 2.0% to 2.5% denaturant, such as gasoline, to render it undrinkable and thus not subject to alcoholic beverage taxes.

 

 

COMPANY OVERVIEW

 

Advanced BioEnergy, LLC (“Company,” “we”, “Advanced BioEnergy” or “ABE”) was formed in 2005 as a Delaware limited liability company. Our business consists of producing ethanol and co-products, including wet, modified and dried distillers grains. Ethanol is a renewable, environmentally clean fuel source that is produced at numerous facilities in the United States, mostly in the Midwest. In the U.S., ethanol is produced primarily from corn and then blended with unleaded gasoline in varying percentages. The ethanol industry in the U.S. has grown significantly over the last few years as its use reduces harmful auto emissions, enhances octane ratings of the gasoline with which it is blended, offers consumers a cost-effective choice, and decreases the amount of crude oil the U.S. needs to import from foreign sources. Ethanol is most commonly sold as E10, the 10 percent blend of ethanol for use in all American automobiles. Increasingly, ethanol is also available as E85, a higher percentage ethanol blend for use in flexible fuel vehicles.

 

To execute our business plan, we entered into financial arrangements to build and operate ethanol production facilities in Fairmont, Nebraska, and we separately acquired Heartland Grain Fuels, LP (“HGF”) in November 2006, which owned existing ethanol production facilities in Aberdeen and Huron, South Dakota. Construction of our Fairmont, Nebraska plant began in June 2006, and operations commenced at the plant in November 2007. Construction of our expansion facility in Aberdeen, South Dakota began in April 2007, and operations commenced in January 2008. Our production operations are carried out primarily through our operating subsidiaries, ABE Fairmont, LLC (“ABE Fairmont”) which owns and operates the Fairmont, Nebraska plant and HGF, which owns and operates ethanol facilities in Aberdeen and Huron, South Dakota.

 

HGF has not made its scheduled principal and interest payments on its $88.0 million senior credit facility or interest payments on its outstanding $7.1 million working capital line since October 2008 during which time it has been operating under a bank suspension. In February 2009, HGF entered into a forbearance agreement with WestLB AG, New York Branch (“WestLB”), that expired on March 31, 2009, after which WestLB, as administrative agent for HGF’s senior credit facility, disclosed its intent to foreclose on 100% of ABE’s equity interest in HGF. At such time, ABE did not intend to object to the foreclosure. The Company’s Form 10-Q for the fiscal quarters ending March 30, 2009 and June 30, 2009 reflected HGF as discontinued operations.

 

In September 2009, HGF’s senior lenders commenced discussions with the Company to explore alternatives to foreclosing on ABE’s equity interest in HGF, including a restructuring of the terms of the current borrowing arrangements with those lenders. These discussions are ongoing, and we now intend to pursue with HGF’s senior lenders, as well as the subordinated revenue bond holders, a restructuring of the current lending arrangements for HGF that may permit the Company to maintain a significant portion of its ownership of those facilities. Accordingly, we are no longer reflecting HGF’s financial results as discontinued operations in our financial statements. Nonetheless, there can be no assurance that the Company will be successful in restructuring its current lending arrangements or, if an agreement is reached, whether the terms of any such agreement will permit the Company to retain a significant ownership interest in HGF. If we are unable to successfully restructure the obligations to HGF’s senior lenders, ABE may be obligated to transfer its equity interest in HGF to the senior lenders and subordinated revenue bond holders.

 

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 in assessing performance. The Company’s plants are managed and reported as one operating segment.

FACILITIES

 

The table below provides a summary of our dry mill ethanol plants in operation as of December 26, 2009:

 

 

 

 

We believe that the plants are in adequate condition to meet our current and future production goals. We believe that the plants are adequately insured for replacement cost plus related disruption expenditures.

 

The senior creditor of the Fairmont plant is secured by a first mortgage on the plant real estate and a security interest lien on the site’s personal property. We also granted a subordinate lien and security interest to the trustee of the subordinated exempt facilities revenue bonds used to finance the Fairmont plant. We pledged a first-priority security interest in and first lien on substantially all of the assets of the South Dakota plants to the collateral agent for the senior creditor of these plants and a continuing security interest in and lien on substantially all of the assets of our South Dakota plants to the trustee of the subordinated solid waste facilities revenue bonds used to finance the South Dakota plants.

 

HGF is currently in default under its senior and subordinated loan agreements, and is discussing with its lenders alternatives to foreclosing on the collateral securing its obligations under those agreements.

 

ETHANOL

 

Ethanol sales have represented 80.8%, 82.3% and 85.7% of our revenues in the years ended September 30, 2009, 2008 and 2007, respectively. In 2008, the United States consumed 9.6 billion gallons of ethanol representing 6.9% of the 137.8 billion gallons of finished motor gasoline consumed. The United States produced 9.0 billion gallons of ethanol in 2008 and imported the remainder. The United States consumed 7.8 billion gallons and produced 6.7 billion gallons of ethanol in the first nine months of 2009. Ethanol is currently blended with gasoline to meet regulatory standards as a clean air additive, an octane enhancer, a fuel extender and as a gasoline alternative. In recent years we have not seen seasonal demand trends that could influence quarterly pricing and financial results.

 

The Renewable Fuels Standard

 

The Renewable Fuels Standard (“RFS”) is a national program that imposes requirements with respect to the amount of renewable fuel produced and used. The RFS was revised by the Environmental Protection Agency (“EPA”) in May 2009 (“RFS2”) and applies to refineries, blenders, distributors and importers. We believe the RFS2 program will increase the market for renewable fuels, such as ethanol, as a substitute for petroleum-based fuels. The RFS2 requires that 11.1 billion gallons be sold or dispensed in 2009, increasing to 36 billion gallons by 2022, representing 11% of the anticipated gasoline and diesel consumption. In 2010, RFS2 requires refiners and importers to blend renewable fuels totaling at least 8.01% of total fuel volume, of which 6.65% of total fuel volume can be derived from corn-based ethanol.

The following chart illustrates the potential United States ethanol demand based on the schedule of minimum usage established by the program through the year 2022 (in billions of gallons).

 

 

The RFS2 program is expected to go into effect in 2010 and require certain gas emission reductions for the entire lifecycle production of fuels compared to petroleum fuels produced in 2005. The greenhouse gas reduction requirement generally doesn’t apply to facilities that commenced construction prior to December 2007. If this changes and our Fairmont plant must meet the standard, it may impact the way we procure feed stock and market and transport our products.

 

Clean Air Additive

 

A clean air additive is a substance that, when added to gasoline, reduces tailpipe emissions, resulting in improved air quality characteristics. Ethanol contains 35% oxygen, approximately twice that of MTBE, a historically used oxygenate. The additional oxygen found in ethanol results in more complete combustion of the fuel in the engine cylinder, which reduces tailpipe emissions by as much as 30%, including a 12% reduction in volatile organic compound emissions when blended at a 10% level. Pure ethanol, which is non-toxic, water soluble and biodegradable, replaces some of the harmful gasoline components, including benzene.

 

Octane Enhancer

 

Pure ethanol possesses an average octane rating of 113, enabling refiners to conform lower octane blend stock to gasoline standards, while also expanding the volume of fuel produced. In addition, ethanol is commonly added to finished regular grade gasoline at the wholesale terminal as a means of producing higher octane mid-grade and premium gasoline. At present, ethanol represents one of the few commercially viable sources of octane enhancer available to refiners.

 

Fuel Extender

 

Ethanol extends the volume of gasoline by the amount of ethanol blended with conventional gasoline, thereby reducing dependence on foreign crude oil and refined products. Furthermore, ethanol is easily added to gasoline after the refining process, reducing the need for large, capital intensive capacity expansion projects at refineries.

E85, a Gasoline Alternative

 

Ethanol is the primary blend component in E85. The number of service stations that sell E85 has grown rapidly, and, as of October 18, 2009, 1,934 retail stations currently supplied it in the U.S. The National Ethanol Vehicle Coalition estimates that six million U.S. vehicles are flexible fuel vehicles, or FFVs.

 

Blending Incentives

 

Under the Volumetric Ethanol Excise Tax Credit, known as VEETC, the full federal excise tax of 18.4 cents per gallon of gasoline is collected on all gasoline and allocated to the highway trust fund. In addition, a volumetric ethanol excise tax credit of 45.0 cents per gallon is provided for ethanol blended at 10% and expires on December 31, 2010. Refiners and gasoline blenders apply for this credit for all ethanol blended with all gasoline, diesel and ethyl tertiary butyl ether, known as ETBE, including ethanol in E85 (an 85% ethanol fuel blend) and E20 (a 20% ethanol fuel blend).

 

Imported Ethanol Tariffs

 

There is a 54.0 cent per gallon tariff on imported ethanol which expires on January 1, 2011. Ethanol imports from 24 countries in Central America and the Caribbean region are exempted from the tariff under the Caribbean Basin Initiative or CBI, which provides that specified nations may export an aggregate of 7% of U.S. ethanol production per year into the U.S., with additional exemptions from ethanol produced from feedstock in the Caribbean region over the 7% limit. Large ethanol producers, such as Cargill, Incorporated, have expressed interest in building dehydration plants in participating Caribbean basin countries, such as El Salvador, which would convert ethanol into fuel-grade ethanol for shipment to the U.S. Ethanol imported from Caribbean basin countries may be a less expensive alternative to domestically produced ethanol. The U.S. International Trade Commission announced the 2009 CBI import quota is 452 million gallons of ethanol.

 

Ethanol Competition

 

The ethanol we produce is similar to ethanol produced by other plants. The RFA reports that as of October 2009, current U.S. ethanol production capacity is 13.1 billion gallons per year. On a national level there are numerous other production facilities with which we are in direct competition, many of whom have greater resources than we do. The largest ethanol producers include Abengoa Bioenergy Corp., Archer Daniels Midland Company, Cargill, Incorporated, Green Plains Renewable Energy, Inc., Hawkeye Renewables, LLC, POET, LLC and Valero Renewable Fuels. Producers of this size may have an advantage over us from economies of scale and negotiating position with purchasers. We market our ethanol primarily on a regional and national basis. We believe that we are able to reach the best available markets through the use of experienced ethanol marketers and by the rail delivery methods we utilize. Our plants compete with other ethanol producers on the basis of price, and, to a lesser extent, delivery service. We believe that we can compete favorably with other ethanol producers due to our proximity to ample grain, natural gas, electricity and water supplies at favorable prices as well as unit train capability that can reach the west coast markets at favorable rates.

 

Competition from Alternative Fuels

 

Alternative fuels and alternative ethanol production methods are continually under development. The major oil companies have significantly greater resources than we have to develop alternative products and to influence legislation and public perception of ethanol. New ethanol products or methods of ethanol production developed by larger and better-financed competitors could provide them competitive advantages and harm our business.

 

Marketing

 

ABE Fairmont and HGF currently market and sell the ethanol they produce through ethanol product off-take agreements we entered into in 2008 with Gavilon, LLC (“Gavilon”). Under those agreements, we are required to sell the output of ethanol produced at our plants, less certain E-85 and local promotion retained product, at accepted bid prices per gallon less a commission. In accordance with the terms of these

agreements, ABE Fairmont notified Gavillon of its intent to terminate that agreement with respect to ABE Fairmont on December 31, 2009. On August 28, 2009, ABE Fairmont entered into a new marketing agreement with Hawkeye Gold, LLC (“Hawkeye Gold”) which will become effective on January 1, 2010. Hawkeye Gold is an affiliate of Hawkeye Energy Holdings, LLC (“Hawkeye”), a unitholder of the Company. The marketing agreement with Hawkeye Gold was entered into in connection with Hawkeye’s investment in the Company and requires, among other things, (1) that ABE Fairmont must sell, and Hawkeye Gold must purchase, all of the denatured fuel grade ethanol produced by ABE Fairmont, (2) a purchase and sale of ethanol under the agreement must be in the form of either a direct fixed price purchase order, a direct index price purchase order, a terminal storage purchase order, or a transportation swap or similar transaction that is mutually acceptable to the parties, (3) that ABE Fairmont will pay any replacement or other costs incurred by Hawkeye Gold as a result of any failure to deliver by ABE Fairmont, and (4) that, with certain exceptions, ABE Fairmont will sell ethanol it produces exclusively to Hawkeye Gold. The initial term of the agreement is for two years, and provides for automatic renewal for successive 18 month terms unless either party provides written notice of nonrenewal at least 180 prior to the end of any term.

 

CO-PRODUCT

 

Sales of distillers grains have represented 19.2%, 17.7% and 14.0% of our revenues for the years ended September 30, 2009, 2008 and 2007. When the plants are operating at capacity they produce approximately 592,000 tons of dried distillers grains equivalents per year, approximately 17 pounds per bushel of corn. Distillers grains are a high-protein, high-energy animal feed supplement primarily marketed to the dairy and beef industry, as well as the poultry and swine markets. Dry mill ethanol processing creates three forms of distillers grains: wet distillers grains with solubles, known as wet distillers grains, modified wet distillers grains with solubles, known as modified distillers grains, and dry distillers grains with solubles. Modified distillers grains have been dried to approximately 44% moisture, have a slightly longer shelf life of approximately 10 days and are often sold to nearby markets. Dried distillers grains have been dried to 13% moisture, have an almost indefinite shelf life and may be sold and shipped to any market regardless of its proximity to an ethanol plant.

 

Competition

 

We compete with other ethanol producers in the sales of distillers grains as well as a number of large and smaller suppliers of competing animal feed. We believe the principal competitive factors are price, proximity to purchasers and product quality. As of November 2009, Nebraska had 23 ethanol plants producing an aggregate of 1.6 billion gallons of ethanol per year, and South Dakota had 16 ethanol plants producing an aggregate of 1.0 billion gallons of ethanol per year, including our plants. Most of these plants produce distillers grains.

 

We currently sell 63% of our distillers grains production as dried which has an indefinite life and can be transported by truck or rail, 15% as modified distillers and 22% as wet. Wet and modified distillers grains can only be marketed locally and regionally through truck markets and have a shelf lives of 10 days and 3 weeks, respectively.

 

Marketing

 

ABE Fairmont is self-marketing the distillers grains it produces. HGF is party to a co-product marketing agreement with Dakotaland Feeds, LLC, whereby Dakotaland Feeds will market the local sale of ethanol co-products produced at the South Dakota plants to third parties for an agreed upon commission. Selling prices for distillers grains are seasonal, declining in the summer and fall seasons as cattle return to pasture grazing thereby decreasing demand for animal feed.

 

DRY MILL PROCESS

 

Dry mill ethanol plants produce ethanol by processing predominantly corn. Other possible feeds are sorghum, milo, or other cellulosic materials. The corn is received by truck, then weighed and unloaded in a

receiving building. It is then transported to storage silos. Thereafter, it is transferred to a scalper to remove rocks, cobs, and other debris before it is fed to a hammer mill where it is ground into flour and conveyed into a slurry tank. Water, heat and enzymes are added to the flour in the slurry tank to start the process of converting starch from the corn into sugar. The slurry is heated for sterilization and pumped to a liquefaction tank where additional enzymes are added. These enzymes continue the starch to sugar conversion. The grain slurry is pumped into fermenters, where yeast is added, to begin a batch fermentation process. Fermentation is the process of the yeast converting the sugar into alcohol and carbon dioxide. After the fermentation is complete, a vacuum distillation system removes the alcohol from the grain mash. The 95% (190 proof) alcohol from the distillation process is then transported to a molecular sieve system where it is dehydrated to 100% alcohol (200 proof). The 200 proof alcohol is then pumped to storage tanks and blended with a denaturant, usually gasoline. The 200 proof alcohol and 2-2.5% denaturant constitute denatured fuel ethanol.

 

Corn mash left over from distillation is pumped into a centrifuge for dewatering. The liquid from the centrifuge, known as thin stillage, is then pumped from the centrifuges to an evaporator where it is dried into thick syrup. The solids that exit the centrifuge, known as the wet cake, are conveyed to the dryer system. Syrup is added to the wet cake as it enters the dryer, where moisture is removed. The process produces distillers dried grains with solubles, which is used as a high protein/fat animal feed supplement.

 

RAW MATERIALS

 

Corn

 

In 2008, the ethanol industry consumed approximately 3.7 billion bushels of corn, which approximated 30.8% of the 12.0 billion bushels of 2008 domestic corn production. Our production facilities produce ethanol by using a dry-mill process, which yields approximately 2.8 gallons of denatured ethanol per bushel of corn. When our facilities are operating at capacity, they require approximately 69.6 million bushels of corn per year. At our Fairmont plant, we source our corn both directly from farmers located near our facilities and from local dealers. We have a grain origination agreement with South Dakota Wheat Growers Association to originate, store and deliver corn to the Aberdeen and Huron plants. The corn for the facilities is generally delivered to the facilities by truck from the local area.

 

We purchase corn through cash fixed-priced contracts and other physical delivery contracts. Our forward contracts specify the amount of corn, the price and the time period over which the corn is to be delivered. These forward contracts are at fixed-prices or prices based on the Chicago Board of Trade (“CBOT”) prices. The parameters of these contracts are based on the local supply and demand situation and the seasonality of the price. We purchase approximately 60% of the ABE Fairmont corn from commercial elevators and the remainder from local corn producers. Except for the HGF grain origination agreement with South Dakota Wheat Growers, we have no other significant contracts, agreements or understandings with any grain producer.

 

We intend to use forward contracting and hedging strategies to help guard against price movements that often occur in corn markets. Hedging means protecting the price at which we buy corn and the price at which we sell our products in the future. It is a way to reduce the risk caused by price fluctuation. The effectiveness of such hedging activities depends on, among other things, the cost of corn and our ability to sell enough ethanol and distillers grains to use all of the corn subject to the futures and option contracts we have purchased as part of our hedging strategy. Although we will attempt to link hedging activities to sales plans and pricing activities, hedging activities themselves can result in costs because price movements in corn contracts are highly volatile and are influenced by many factors that are beyond our control.

 

Natural Gas

 

When our facilities operate at capacity, they require approximately 5.3 mmbtu’s of natural gas per year. Natural gas prices and availability are affected by weather conditions and overall economic conditions. We have constructed our own natural gas pipelines for the Aberdeen and Fairmont plants. These pipelines originate at interstate transport pipelines and allow our plants to source gas from various national marketers without paying transportation cost to the local utility. We purchase natural gas from local utilities and national

suppliers for our Huron plant. We hedge a portion of our exposure to natural gas price risk from time to time by using fixed-price or futures contracts.

 

WORKING CAPITAL

 

The ethanol industry has experienced significant adverse conditions over the course of the last year, including prolonged negative operating margins that have impacted working capital. The spread, or crush margin, between ethanol and corn was thin for the first nine months of the fiscal year ending September 30, 2009, resulting in many plants not generating enough cash to make debt service payments.

 

We, too, have experienced these adverse conditions as well as working capital and liquidity shortages. ABE’s working capital consists primarily of cash, less current payments due to vendors and scheduled debt service payments. ABE’s net working capital improved from the capital raised in a private offering and the revised scheduled debt service payments under an Amended and Restated Secured Term Note issued by ABE to PJC Capital LLC (“PJC Capital”) on August 28, 2009 (the “PJC Capital Note”). In October 2007, the Company borrowed $10 million from PJC Capital, and issued a promissory note to PJC Capital which, among other terms, was secured by all of the equity in ABE Fairmont. In October 2008, the Company defaulted on its obligations under that promissory note, and the Company subsequently entered into a forbearance agreement with PJC Capital on June 1, 2009. Pursuant to the forbearance agreement, PJC Capital agreed to forbear from exercising its rights and remedies if among other things the Company was able to raise and remit at least $3 million in net proceeds from a private equity offering by October 1, 2009. We remitted $3.0 million in net proceeds from a private placement of newly issued units of ABE in August 2009 to PJC Capital to pay down a portion of our obligation. Our promissory note was amended and restated in its entirety in August 2009 (the PJC Capital Note). The PJC Capital Note had an outstanding balance of $9.8 million at September 30, 2009, accrues interest at 10%, requires monthly payments totaling $50,000 and matures on October 1, 2012. The Company also received $3.1 million from additional units issued or subscribed for at September 30, 2009 that were remitted to PJC Capital in October 2009. These funds are classified as restricted cash at September 30, 2009. The PJC Capital Note also requires the Company to forward future tax reimbursements from the Nebraska Tax Advantage Act as well as ABE Fairmont annual dividends to PJC Capital until the Note is paid in full.

 

Subsequent to September 30, 2009, the Company received an additional $1.3 million from the issuance of additional units and remitted these funds to PJC Capital to pay down a portion of our obligation. In October 2009, the Company remitted $1.7 million of funds previously used to collateralize a letter of credit to PJC Capital. Following these remittances, the PJC Capital Note has a balance of $3.7 million.

 

ABE Fairmont’s net working capital consists primarily of cash, accounts receivable and inventory less current payments due to vendors and scheduled principal payments due within the next twelve months. Net working capital was $8.0 million at September 30, 2009.

 

HGF has not made its scheduled principal and interest payments on its $88.0 million senior credit facility or interest payments on its outstanding $7.1 million working capital line since October 2008 during which time it has been operating under a bank suspension. In February 2009, HGF entered into a forbearance agreement with WestLB that expired on March 31, 2009, after which, WestLB, as administrative agent for HGF’s senior credit facility, disclosed its intent to foreclose on 100% of ABE’s equity interest in HGF. At such time, ABE did not intend to object to the foreclosure. The Company’s Form 10-Q for the fiscal quarters ending March 30, 2009 and June 30, 2009 reflected HGF as discontinued operations.

 

In September 2009, HGF’s senior lenders commenced discussions with the Company to explore alternatives to foreclosing on ABE’s equity interest in HGF, including a restructuring of the terms of the current borrowing arrangements with those lenders. These discussions are ongoing, and we now intend to pursue with HGF’s senior lenders, as well as the subordinated revenue bond holders, a restructuring of the current lending arrangements for HGF that may permit the Company to maintain a significant portion of its ownership of those facilities. Accordingly, we are no longer reflecting HGF’s financial results as discontinued operations in our financial statements. Nonetheless, there can be no assurance that the Company will be successful in restructuring its current lending arrangements or, if an agreement is reached, whether the terms

of any such agreement will permit the Company to retain a significant ownership interest in HGF. If we are unable to successfully restructure the obligations to HGF’s senior lenders, ABE may be obligated to transfer its equity interest in HGF to the senior lenders and subordinated revenue bond holders.

 

TECHNOLOGICAL IMPROVEMENTS

 

Most ethanol is currently produced from corn. The current trend in ethanol production research is to develop an efficient method of producing ethanol from cellulose-based biomass, such as agricultural waste, forest residue, and municipal solid waste and energy crops. This trend is driven by the environmental concerns regarding the carbon footprint of ethanol produced from corn and legislative supports within RFS2. Additionally, cellulose-based biomass is generally cheaper than corn, and producing ethanol from cellulose-based biomass would create opportunities to produce ethanol in areas that are unable to grow corn. If an efficient method of producing ethanol from cellulose-based biomass is developed, we may not be able to compete effectively. We do not believe it will be cost-effective to convert our existing plants into a cellulose-based biomass producing facilities.

 

ENVIRONMENTAL MATTERS

 

Our operations are subject to various federal, state and local laws and regulations with respect to environmental matters, including air and water quality and underground fuel storage tanks. We believe we are currently in substantial compliance with environmental laws and regulations. Protection of the environment requires us to incur expenditures for equipment, processes and permitting. If we were found to have violated federal, state or local environmental regulations, we could incur liability for cleanup costs, damage claims from third parties and civil or criminal penalties that could materially adversely affect our business.

 

EMPLOYEES

 

As of December 26, 2009, we had 124 full-time employees. None of our employees are covered by a collective bargaining agreement.

 

REPORTS

 

The Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports are available on the company’s website www.advancedbioenergy.com as soon as reasonably practicable after it electronically files such materials with the SEC.

 

 

RISKS RELATED TO OUR BUSINESS

 

HGF is currently not in compliance with its debt financing agreements with its lenders and ABE may lose its wholly owned equity interest in HGF.

 

HGF has not made its scheduled principal and interest payments on its $88.0 million senior credit facility or interest payments on its outstanding $7.1 million working capital line since October 2008 during which time it has been operating under a bank suspension. In February 2009, HGF entered into a forbearance agreement with WestLB that expired on March 31, 2009, after which, WestLB, as administrative agent for HGF’s senior credit facility, disclosed its intent to foreclose on 100% of ABE’s equity interest in HGF. At such time, ABE did not intend to object to the foreclosure. The Company’s Form 10-Q for the fiscal quarters ending March 30, 2009 and June 30, 2009 reflected HGF as discontinued operations.

 

In September 2009, HGF’s senior lenders commenced discussions with the Company to explore alternatives to foreclosing on ABE’s equity interest in HGF, including a restructuring of the terms of the current borrowing arrangements with those lenders. These discussions are ongoing, and we now intend to pursue with HGF’s senior lenders, as well as the subordinated revenue bond holders, a restructuring of the current lending arrangements for HGF that may permit the Company to maintain a significant portion of its ownership of those facilities. Accordingly, we are no longer reflecting HGF’s financial results as discontinued

operations in our financial statements. Nonetheless, there can be no assurance that the Company will be successful in restructuring its current lending arrangements or, if an agreement is reached, whether the terms of any such agreement will permit the Company to retain a significant ownership interest in HGF. If we are unable to successfully restructure the obligations to HGF’s senior lenders, ABE may be obligated to transfer its equity interest in HGF to the senior lenders and subordinated revenue bond holders.

 

Our PJC Capital Note is secured by a pledge of our membership units in ABE Fairmont and a default under the note could result in the loss of our units in ABE Fairmont.

 

In August 2009, we entered into the PJC Capital Note which requires payment of principal not later than October 1, 2012 and contains certain restrictive covenants, including restricting the ability of the Company to raise additional funds. Our failure to repay the PJC Capital Note or comply with other terms of the PJC Capital Note could result in the loss of our units in ABE Fairmont which would have a material adverse effect on our business, results of operations and financial condition. A default by ABE Fairmont under its existing debt financing agreements would cause a default under the PJC Capital Note which could result in all of the PJC Capital Note becoming immediately due and payable.

 

ABE Fairmont’s existing debt financing agreements contain restrictive covenants. The failure of ABE Fairmont to comply with applicable debt financing covenants and agreements could have a material adverse effect on our business, results of operations and financial condition.

 

The terms of ABE Fairmont’s existing debt financing agreements contain, and any future debt financing agreements we enter into may contain, financial, maintenance, organizational, operational or other restrictive covenants. If ABE Fairmont is unable to comply with these covenants or service its debt, we may lose control of ABE Fairmont and be forced to reduce or delay planned capital expenditures, sell assets, restructure our indebtedness or submit to foreclosure proceedings, all of which could result in a material adverse effect upon our business, results of operations and financial condition.

 

A default or acceleration of one debt agreement may result in the default and acceleration of our other debt agreements (regardless of whether we were in compliance with the terms of such other debt agreements), providing the lenders under such other debt agreements the right to accelerate the obligations due under such other debt agreements. Accordingly, a default, whether by us or ABE Fairmont, could result in all or a portion of our outstanding debt becoming immediately due and payable.

 

Our financial performance is highly dependent on commodity prices, which are subject to significant volatility, uncertainty, and supply disruptions, so our results may be materially adversely affected.

 

Our results of operations and financial condition are significantly affected by the cost and supply of corn and natural gas and by the selling price for ethanol, distillers grains, and gasoline, which are commodities. Changes in the price and supply of these commodities are subject to and determined by market forces over which we have no control. We purchase our corn in the cash market, and from time to time, hedge corn price risk through futures contracts, options and over-the-counter instruments to reduce short-term exposure to price fluctuations. We experienced aggregate corn-related hedging losses of $3.2 million in fiscal 2009 and these losses may be greater in the future.

 

Our revenues are exclusively dependent on the market prices for ethanol and distillers grains. These prices can be volatile due to a number of factors. These factors include the overall supply and demand, the price of gasoline, the level of government support and the availability and price of competing products. The price of ethanol tends to increase as the price of gasoline increases, and decrease as the price of gasoline decreases. Any lowering of gasoline prices will likely also lead to lower prices for ethanol, which may reduce revenues.

Certain members beneficially own a large percentage of our units, which may allow them to collectively control substantially all matters requiring member approval and, certain of our principal members, including Hawkeye and Ethanol Investment Partners, LLC, have been granted other unique rights.

 

In August 2009, the Company, each then director of the Company, South Dakota Wheat Growers Association, EIP and Hawkeye executed a Voting Agreement (the “Voting Agreement”). The Voting Agreement, among other things, requires the parties to (a) nominate for election to the board two designees of Hawkeye, two designees of EIP and the Chief Executive Officer of the Company, (b) recommend to the members the election of each of the designees, (c) vote (or act by written consent) all units (or other voting equity securities) of the Company they beneficially own, hold of record or otherwise control at any time, in person or by proxy, to elect each of the designees to the board, (d) not take any action that would result in (and take any action necessary to prevent) the removal of any of the designees from the board or the increase in the size of the board to more than nine members without the consent of the Hawkeye, EIP and Chief Executive Officer directors, and (e) not grant a proxy with respect to any units that is inconsistent with the parties’ obligations under the Voting Agreement. The Company has granted Hawkeye board observation rights under the Voting Agreement. At December 29, 2009, the parties to the Voting Agreement hold in the aggregate approximately 51% of the outstanding units of the Company.

 

As a result of the Voting Agreement, Hawkeye and EIP will significantly influence the outcome of any actions taken by our board of directors. In addition, given the large ownership of these two entities, they can significantly influence other actions, such as amendments to our operating agreement, mergers, going private transactions, and other extraordinary transactions, and any decisions concerning the terms of any of these transactions. The ownership and voting positions of these members may have the effect of delaying, deterring, or preventing a change in control or a change in the composition of our board of directors. These members may also use their contractual rights, including access to management, and their large ownership position to address their own interests, which may be different from those of our other members.

 

ABE Fairmont will be required to sell substantially all of its ethanol to Hawkeye Gold, LLC an affiliate of Hawkeye, which may place ABE Fairmont at a competitive disadvantage and reduce profitability.

 

As a condition to Hawkeye’s subscription for newly issued membership interests of the Company, ABE Fairmont was required, and has executed, an Exclusive Ethanol Marketing Agreement dated as of August 28, 2009 with Hawkeye Gold (the “Ethanol Agreement”) which will become effective on January 1, 2010. Hawkeye Gold is an affiliate of Hawkeye. The Ethanol Agreement requires, among other things, that (1) ABE Fairmont must sell, and Hawkeye Gold must purchase, all of the denatured fuel grade ethanol produced by ABE Fairmont, (2) a purchase and sale of ethanol under the Ethanol Agreement must be in the form of either a direct fixed price purchase order, a direct index price purchase order, a terminal storage purchase order, or a transportation swap or similar transaction that is mutually acceptable to the parties, (3) ABE Fairmont will pay any replacement or other costs incurred by Hawkeye Gold as a result of any failure to deliver by ABE Fairmont, and (4) with certain exceptions, ABE Fairmont will sell ethanol it produces exclusively to Hawkeye Gold. The initial term of the agreement is for two years, and provides for automatic renewal for successive 18 month terms unless either party provides written notice of nonrenewal at least 180 prior to the end of any term. Hawkeye Gold may offer its most competitive bid prices and delivery terms to its affiliated producers and may not be able to negotiate favorable terms with blenders and freight companies. Since ABE Fairmont is required to sell all of its denatured fuel grade ethanol exclusively to Hawkeye Gold, competition will be reduced and ABE Fairmont may not be able to get the best price for its ethanol. Hawkeye Gold may not effectively manage the logistics of ABE Fairmont’s rail cars to ensure ABE Fairmont will be able to continue producing ethanol without exceeding its storage capacity, resulting in unplanned slowdowns or shut downs. A default by Hawkeye Gold in its obligations to ABE Fairmont, ABE Fairmont’s failure to obtain the best price for its ethanol, or Hawkeye Gold’s failure to effectively manage logistics may negatively affect our profitability.

 

On December 21, 2009, Hawkeye Renewables, LLC, an affiliate of Hawkeye, filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code in Delaware. We are not aware of the degree to which the financial implications of such a filing will impact Hawkeye Gold, or how significant any such financial

implications might be with respect to the business of Hawkeye Gold. An adverse impact from this bankruptcy filing on the business of Hawkeye Gold could have a negative impact on Hawkeye Gold’s ability to market and sell the ethanol produced by ABE Fairmont, which is the primary means by which ABE Fairmont generates revenue, and could further increase the risks to which ABE Fairmont is exposed regarding payment for the ethanol it delivers to Hawkeye Gold for marketing and sale under the Ethanol Agreement. Further, if and to the extent to which this bankruptcy filing has an adverse effect on Hawkeye or its affiliates, it may negatively impact their ability to provide additional financial assistance to or investment in the Company, which may further hinder the Company’s operations.

 

We depend on others for sales of our products, which may place us at a competitive disadvantage and reduce profitability.

 

We currently have agreements with a third-party marketing firms (including Gavilon, LLC and Hawkeye Gold, an affiliate of Hawkeye) to market all of the ethanol we produce. We have a contract with a third party to locally market the sale of distillers grains produced at the South Dakota plants. If the ethanol or distillers grains marketers breach their contracts or do not have the ability, for financial or other reasons, to market all of the ethanol we produce or to locally market the distillers grains produced at the South Dakota plants, we will not have any readily available alternative means to sell our products. Our lack of a sales force and reliance on third parties to sell and market most of our products may place us at a competitive disadvantage. Our failure to sell all of our ethanol and distillers grains may result in lower revenues and reduced profitability.

 

We are exposed to credit risk resulting from the non-payment from significant customers.

 

We have a concentration of credit risk since our subsidiaries generally sell all of their ethanol to a single customer. We have increased in-house sales of distillers grains, which results in credit risks from new customers. Although payments are typically received within twenty days from the date of sale for ethanol and distillers grains, we continually monitor this credit risk exposure. In addition, we may prepay for or make deposits on undelivered inventories. Concentrations of credit risk with respect to inventory advances are primarily with a few major suppliers of petroleum products and agricultural inputs. The inability of a third party to make payments to us for our accounts receivable or to provide inventory to us on advances may cause us to experience losses and may adversely impact our liquidity and our ability to make our payments when due.

 

The spread between ethanol and corn prices can vary significantly and profitability is dependent on this spread.

 

Gross profit on gallons produced at our facilities, which accounts for the substantial majority of our operating income, is principally dependent on the spread between ethanol and corn prices. The ethanol industry has built an oversupply in production of ethanol over the existing demand for ethanol gallons according to the RFA. This has resulted in our ethanol selling prices being driven by the industry’s cost of ethanol production; more specifically, ethanol prices have been highly correlated to corn prices for the past eighteen months. The spread, or crush margin, between ethanol and corn was thin for the first nine months of the fiscal year ending September 30, 2009, resulting in many plants including HGF not generating enough cash to make debt service payments.

 

Any further reduction in the spread between ethanol and corn prices, whether as a result of an increase in corn prices or a reduction in ethanol prices, would adversely affect our financial performance. The price of corn is influenced by weather conditions (including droughts or over abundant rainfall) and other factors affecting crop yields, farmer planting decisions and general economic, market and regulatory factors, including government policies and subsidies with respect to agriculture and international trade, and global and local supply and demand.

The market for natural gas is subject to market conditions that create uncertainty in the price and availability of the natural gas that we use in our manufacturing process.

 

Natural gas costs represented approximately 6.1% of our cost of goods sold in the year ended September 30, 2009. We rely upon third parties for our supply of natural gas, which is consumed in the production of ethanol. The prices for and availability of natural gas are subject to volatile market conditions. These market conditions often are affected by factors beyond our control such as higher prices resulting from colder than average weather conditions, hurricanes in the Gulf of Mexico, and overall economic conditions. Significant disruptions in the supply of natural gas could impair our ability to produce ethanol. Furthermore, increases in natural gas prices or changes in our natural gas costs relative to natural gas costs paid by competitors may adversely affect our results of operations and financial position. The price fluctuations in natural gas prices over the period from January 1, 2001 through December 1, 2009, based on the New York Mercantile Exchange or NYMEX, daily futures data, has ranged from a low of $1.83 per million British Thermal Units, or mmbtu, on September 26, 2001 to a high of $15.38 per mmbtu on December 23, 2005. At September 30, 2009, the NYMEX price of natural gas was $4.84 per mmbtu.

 

We may engage in hedging transactions and other risk mitigation strategies that could harm our results.

 

We are exposed to a variety of market risks, including the effects of changes in commodity prices. We may engage in hedging activities using exchange traded futures contracts, OTC futures options or OTC swap agreements. Hedging activities can result in losses when a position is purchased in a declining market or a position is sold in a rising market. We experienced aggregate corn-related hedging losses of $3.2 million in fiscal 2009. There is no assurance that we will not experience greater hedging losses in the future. Hedging arrangements also expose us to the risk of financial loss in situations where the other party to the hedging contract defaults on its contract or, in the case of exchange-traded contracts, where there is a change in the expected differential between the underlying price in the hedging agreement and the actual prices paid or received by us. In addition, failure to have adequate capital to utilize various hedging strategies may result in a loss for our company or expose us to substantial risk of loss.

 

Our business is subject to seasonal fluctuations.

 

Our operating results are influenced by seasonal fluctuations in the price of our primary operating inputs, corn and natural gas, and the price of our primary products, ethanol and distillers grains. Historically, the spot price of corn tended to rise during the spring planting season in May and June and tended to decrease during the fall harvest in October and November. The price for natural gas however, tends to move opposite of corn and tends to be lower in the spring and summer and higher in the fall and winter. The price of distillers grains tends to rise during the fall and winter cattle feeding seasons and be lower in the spring and summer when pasture grazing is readily available.

 

Our lack of business diversification could result in adverse operating results if our revenues from our primary products decrease.

 

Our business consists of ethanol and distillers grains production and sales. We do not have any other lines of business or other potential sources of revenue. Our lack of business diversification could cause us to shut down operations and be unable to meet financial obligations if we are unable to generate positive cash flows from the production and sale of ethanol and distillers grains because we do not currently expect to have any other lines of business or alternative revenue sources.

 

Our operating results may fluctuate significantly, which makes our future results difficult to predict and could cause our operating results to fall below expectations.

 

Our operating results have fluctuated in the past and may fluctuate significantly in the future due to a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful, and our past results do not necessarily indicate our future performance.

We are dependent on certain key personnel, and the loss of any of these persons may prevent us from implementing our business plan in an effective and timely manner.

 

Our success depends largely upon the continued services of our chief executive officer and other key personnel. Any loss or interruption of the services of one of these key personnel could result in our inability to manage our operations effectively or pursue our business strategy.

 

We may be required to write down our long-lived assets and these impairment charges would adversely affect our operating results.

 

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount on the asset may not be recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows from operations are less than the carrying value of the asset group. An impairment loss would be measured by the amount by which the carrying value of the asset exceeds the fair value of the assets at the time of the impairment.

 

HGF has not made its scheduled principal and interest payments on its $88.0 million senior credit facility or interest payments on its outstanding $7.1 million working capital line since October 2008 during which time it has been operating under a bank suspension.

 

In March 2009, the Company recorded an impairment of $8.7 million against HGF assets. The Company performed a fair market value analysis of HGF to reconsolidate its results in our financial statements and recorded an additional $19.6 million impairment charge for the amount that the existing carrying value exceeded the estimated fair market value of the assets.

 

Future impairment could be significant and could have a material adverse effect on our reported financial results for the period in which the charge is taken.

 

RISKS RELATED TO OUR UNITS

 

We have placed significant restrictions on transferability of the units, no public trading market exists for our units and there is no assurance that unitholders will receive cash distributions.

 

Our units are subject to substantial transfer restrictions pursuant to our operating agreement. As a result, investors may not be able to liquidate their investments in the units and, therefore, may be required to assume the risks of investments in us for an indefinite period of time, which may be the life of our Company. We have not developed an exit strategy.

 

Further, there is currently no established public trading market for our units, and an active trading market is not anticipated for our units. In order for the Company to maintain its partnership tax status, unitholders may not trade the units on an established securities market or readily trade the units on a secondary market (or the substantial equivalent thereof).

 

To help ensure that a secondary market does not develop, our operating agreement prohibits transfers without the approval of our board of directors. The board of directors will not approve transfers unless they fall within “safe harbors” contained in the publicly traded partnership rules under the tax code, which include, without limitation, the following:

 

 

Distributions are payable at the sole discretion of our board of directors, subject to the provisions of the Delaware Limited Liability Company Act, our operating agreement and the requirements of our creditors. Cash distributions are not assured, and we may never be in a position to make distributions. Our board may elect to retain future profits to provide operational financing for the plants, debt retirement and possible plant

expansion, the construction or acquisition of additional plants or other company opportunities. This means that members may receive little or no return on their investment and be unable to liquidate their investment due to transfer restrictions and lack of a public trading market.

 

Our members may be diluted to raise funds required to maintain our equity interest in HGF.

 

The terms being negotiated with WestLB contemplate infusing additional equity into HGF. In the event the board elects to raise additional capital through the issuance of additional units of the Company, the interests of existing members may be diluted.

 

The presence of members holding only 25% of the outstanding units may take action at a meeting of our members.

 

In order to take action at a meeting, a quorum of members holding only 25% of the outstanding units must be represented in person, by proxy or by mail ballot. This means that the holders of a minority of outstanding units could pass a vote and take an action which would then bind all unitholders. The ability of the holders of a minority of outstanding units to pass a vote and take such action could materially adversely affect our business, results of operations or financial condition.

 

Our members have limited voting rights.

 

Members cannot exercise control over our daily business affairs. Subject to the provisions in our operating agreement, our board of directors may modify our business plans without the members’ consent.

 

In addition to the election of directors, members may vote only in a limited number of specific instances. These situations consist of the following matters, which require the affirmative vote of a majority of our membership voting interests:

 

 

Under our operating agreement, except for a decree of judicial dissolution, dissolution requires the vote of 75% of the membership voting interests and the following actions cannot be taken by our directors without the unanimous consent of the members:

 

 

Amendments to our operating agreement (other than amendments that would modify the limited liability of a member or alter the member’s economic interest, which requires a two-thirds vote of the membership interests adversely affected) require the affirmative vote of a majority of the membership voting interests constituting a quorum (with the minimum quorum being 25% of the membership voting interests).

The limitation on our ability to sell more than 20 million units without member consent may negatively impact our ability to raise financing through a sale of our equity.

 

Under our operating agreement, the Company may not issue in excess of a total of 20 million units without first obtaining a consent of our members. As of December 26, 2009, we had 17,814,180 units outstanding. Depending on the price per unit which the Company could receive in connection with any issuance and sale of its units in the future, the Company may be limited in the total proceeds it could generate from such a sale without first obtaining approval of its members. The time and cost required to obtain such approval may further inhibit the Company’s ability to generate proceeds from any such issuance and sale. Even if the Company determines to seek such approval, there can be no assurance that the Company’s members will authorize additional units, and that uncertainty can further limit the Company’s ability to raise financing from a sale of its equity, if at all. In the event the Company needs to generate financing, and is not otherwise able to obtain such financing through incurring additional indebtedness or otherwise, the limitations on its ability to sell newly issued units in excess of an aggregate of 20 million could negatively impact the Company’s ability to raise such financing.

 

RISKS RELATED TO THE ETHANOL INDUSTRY

 

If demand does not sufficiently increase and production capacity and imported ethanol increase, the current overcapacity state could continue.

 

According to the RFA, domestic ethanol production capacity has increased dramatically from 1.7 billion gallons per year in January of 1999 to 13.1 billion gallons per year as of October 15, 2009; however, 17 of the 201 plants in the United States are idle, reducing current operational output capacity to 11.9 billion gallons per year. In addition to this increase in supply, excess ethanol production capacity also may result from decreases in the demand for ethanol or increased imported supply, which could result from a number of factors, including but not limited to, regulatory developments and reduced gasoline consumption in the U.S. Reduced gasoline consumption could occur as a result of increased prices for gasoline or crude oil, which could cause businesses and consumers to reduce driving or acquire vehicles with more favorable gasoline mileage, or as a result of technological advances, such as the commercialization of engines utilizing hydrogen fuel-cells, which could supplant gasoline-powered engines. There are a number of governmental initiatives designed to reduce gasoline consumption, including tax credits for hybrid vehicles and consumer education programs.

 

Any increase in the supply of distillers grains, without corresponding increases in demand, could lead to lower prices or an inability to sell our distillers grains. A decline in the price of distillers grains, or the distillers grains market generally, could have a material adverse effect on our business, results of operations and financial condition.

 

Volatility in gasoline selling price and production cost may reduce our gross margins.

 

Ethanol is utilized both as a fuel additive to reduce vehicle emissions and as an octane enhancer to improve the octane rating of the gasoline with which it is blended. Therefore, the supply and demand for gasoline impacts the price of ethanol, and our business and future results of operations may be materially adversely affected if gasoline demand or price decreases.

 

The price of distillers grains is affected by the price of other commodity products; decreases in the price of these commodities could decrease the price of distillers grains.

 

Distillers grains compete with other protein-based animal feed products. The price of distillers grains may decrease when the price of competing feed products decrease. The prices of competing animal feed products are based in part on the prices of the commodities from which they are derived. Downward pressure on commodity prices, such as corn and soybean meal, will generally cause the price of competing animal feed products to decline, resulting in downward pressure on the price of distillers grains. Because the price of distillers grains is not tied to production costs, decreases in the price of distillers grains will result in us generating less revenue and lower profit margins.

Growth in the sale and distribution of ethanol is dependent on the changes in and expansion of related infrastructure which may not occur on a timely basis, if at all, and our operations could be adversely affected by infrastructure disruptions.

 

Ethanol is currently blended with gasoline to meet regulatory standards as a clean air additive, an octane enhancer, a fuel extender and a gasoline alternative. In 2008, the United States consumed 9.6 billion gallons of ethanol representing 6.9% of the 137.8 billion gallons of finished motor gasoline consumed according to the RFA. Ethanol plants in the United States produced 9.0 billion gallons in 2008 and the remainder was imported. Current federal blending laws restrict blending of ethanol to 10%, excluding specialty fuels such as E-85.

 

Current ethanol prices per gallon are approximately $.09 less than Reformulated Regular Gasoline Blendstock for Blending (“RBOB”) and the blenders receive the $.45 VEETC credit for each gallon of ethanol blended. In the areas of the United States that have adequate ethanol infrastructure, blenders are blending up to the 10% blend cap.

 

In March 2009, ethanol trade groups submitted a formal request to the U.S. Environmental Protection Agency to boost the allowed ethanol to gasoline blend rate to 15%. In December 2009, the EPA indicated they would need additional time to assess the impact that the higher blend rate would have on emission control systems, including catalytic converters, in vehicles and render a decision. Additional infrastructure will be required to handle the additional 5% of blending including:

 

 

Without passage of a federal increase in blending rates and required infrastructure investments by unrelated parties, the demand for ethanol may not increase which could have an adverse effect on our business.

 

Corn-based ethanol may compete with cellulose-based ethanol in the future, which could make it more difficult for us to produce ethanol on a cost-effective basis.

 

Approximately 91% of ethanol produced in the U.S. is currently produced from corn, according to the RFA. The current trend in ethanol production research is to develop an efficient method of producing ethanol from cellulose-based biomass, such as agricultural waste, forest residue, and municipal solid waste and energy crops. This trend is driven by governmental mandates including the Renewable Fuels Standard, as most recently amended (“RFS2”) and the fact that cellulose-based biomass would create opportunities to produce ethanol in areas that are unable to grow corn. Furthermore, ethanol produced from cellulose based biomass is generally considered to emit less carbon emission than ethanol produced from corn. If an efficient method of producing ethanol from cellulose-based biomass is developed, we may not be able to compete effectively. We do not believe it will be cost-effective to convert our existing plants into cellulose-based biomass facilities. If we are unable to produce ethanol as cost effectively as cellulose-based producers, our ability to generate revenue will be negatively impacted.

 

Competition from new or advanced technology may lessen the demand for ethanol and negatively impact our profitability.

 

Alternative fuels, gasoline oxygenates and ethanol production methods are continually under development. A number of automotive, industrial and power generation manufacturers are developing more efficient engines, hybrid engines and alternative clean power systems using fuel cells or clean burning gaseous fuels. Vehicle manufacturers are working to develop vehicles that are more fuel efficient and have reduced emissions using conventional gasoline. Vehicle manufacturers have developed and continue to work to improve hybrid

technology, which powers vehicles by engines that utilize both electric and conventional gasoline fuel sources. In the future, the emerging fuel cell industry will offer a technological option to address increasing worldwide energy costs, the long-term availability of petroleum reserves and environmental concerns. Fuel cells have emerged as a potential alternative to certain existing power sources because of their higher efficiency, reduced noise and lower emissions. Fuel cell industry participants are currently targeting the transportation, stationary power and portable power markets in order to decrease fuel costs, lessen dependence on crude oil and reduce harmful emissions. If the fuel cell and hydrogen industries continue to expand and gain broad acceptance, and hydrogen becomes readily available to consumers for motor vehicle use, we may not be able to compete effectively. This additional competition could reduce the demand for ethanol, which would negatively impact our profitability and reduce the value of your investment.

 

Competition in the ethanol industry could limit our growth and harm our operating results.

 

The market for ethanol and other biofuels is highly competitive. Our current and prospective competitors include many large companies that have substantially greater market presence, name recognition and financial, marketing and other resources than we do. We compete directly or indirectly with large companies, such as Abengoa Bioenergy Corp., Archer-Daniels-Midland Company, Cargill, Incorporated, Green Plains Renewable Energy, Inc., Hawkeye Renewables, LLC, POET, LLC and Valero Energy Corporation and with other companies that are seeking to develop large-scale ethanol plants and alliances. Pressure from our competitors could require us to reduce our prices or increase our spending for marketing, which would erode our margins and could have a material adverse effect on our business, financial condition and results of operations.

 

Imported ethanol may be a less expensive alternative to domestic ethanol, which would cause us to lose market share and reduce the value of your investment.

 

Brazil is currently the world’s second largest producer and exporter of ethanol. In Brazil, ethanol is produced primarily from sugarcane, which is less costly to produce than corn-based ethanol because of the higher sugar content of sugarcane. Ethanol imported from Brazil may be a less expensive alternative to domestically produced ethanol. The current 54 cent per gallon tariff imposed by the U.S. on ethanol imported from Brazil through December 31, 2010 significantly reduces competition from Brazilian ethanol producers for sales of ethanol in the U.S. In the event tariffs presently protecting U.S. ethanol producers are reduced or eliminated, a significant barrier to entry into the U.S. ethanol market would be removed or reduced. Competition from ethanol imported from Brazil may affect our ability to sell our ethanol profitably.

 

Ethanol produced or processed in certain countries in Central America and the Caribbean region is eligible for tariff reduction or elimination upon importation to the U.S. under a program known as the Caribbean Basin Initiative. Large ethanol producers, such as Cargill, have expressed interest in building dehydration plants in participating Caribbean basin countries, such as El Salvador, which would convert ethanol into fuel-grade ethanol for shipment to the U.S. Competition from ethanol imported from Caribbean basin countries may affect our ability to sell our ethanol profitably.

 

RISKS RELATED TO ETHANOL PRODUCTION

 

Operational difficulties at our plants could negatively impact our sales volumes and could cause us to incur substantial losses.

 

Our operations are subject to unscheduled downtime and operational hazards inherent to our industry, such as equipment failures, fires, explosions, abnormal pressures, blowouts, pipeline ruptures, transportation disruptions and accidents and natural disasters. We may have difficulty managing the process maintenance required to maintain our nameplate production capacities. If our ethanol plants do not produce ethanol and distillers grains at the levels we expect, our business, results of operations, and financial condition may be materially adversely affected.

Improperly trained employees may not follow procedures that could damage certain parts of the ethanol production facility which could negatively impact operating results if our plants do not produce ethanol and its by-products as anticipated.

 

The production of ethanol and distillers grains demands continuous supervision and judgments regarding mixture rates, temperature and pressure adjustments. Errors of judgment due to lack of training or improper manufacturer instructions could send chemicals into sensitive areas of production, which may reduce or halt ethanol or distillers grains production at our facilities.

 

We may have difficulty obtaining enough corn to operate the plants profitably.

 

There may not be an adequate supply of corn produced in the areas surrounding our plants to satisfy our requirements. Even if there is an adequate supply of corn and we make arrangements to purchase it, we could encounter difficulties finalizing the sales transaction and securing delivery of the corn. If we do not obtain corn in the quantities we plan to use, we may not be able to operate our plants at full capacity. If the price of corn in our local markets is higher due to lack of supply, drought, or other reasons, our profitability may suffer and we may incur significant losses from operations. As a result, our ability to make a profit may decline.

 

RISKS RELATED TO REGULATION AND GOVERNMENTAL ACTION

 

We are exposed to additional regulatory risk that may prevent the sale of our products to customers located in certain states or require us to change the way we operate.

 

Recent legislative acts by the State of California and the Environmental Protection Agency (i.e. RFS2) require cleaner emissions and reduced carbon footprints including effects caused by indirect land use. These acts, when implemented, may prohibit the sale of our products to certain customers which may materially impact our results from operations, or may require us to procure feedstock and market our products in a fashion that negatively impacts our financial performance.

 

The use and demand for ethanol and its supply are impacted by federal and state legislation and regulation, and any changes in legislation or regulation could cause the demand for ethanol to decline or its supply to increase, which could have a material adverse effect on our business, results of operations and financial condition, and the ability to operate at a profit.

 

Various federal and state laws, regulations and programs impact the demand for ethanol as a fuel or fuel additive. Tariffs generally apply to the import of ethanol from other countries. These laws, regulations and programs are constantly changing. Federal and state legislators and environmental regulators could adopt or modify laws, regulations or programs that could adversely affect the use of ethanol. The elimination or reduction of tax incentives for the ethanol industry, or the elimination or reduction of tariffs that apply to imported ethanol could reduce the market for ethanol generally or for domestically produced ethanol. Such changes could reduce prices and our revenues by making it more costly or difficult for us to produce and sell ethanol. If the federal tax incentives are eliminated or sharply curtailed, we believe that demand for ethanol could decrease, which could materially adversely affect our business, results of operations and financial condition.

 

The elimination or significant reduction in the federal ethanol tax incentive or the elimination or expiration of other federal or state incentive programs could have a material adverse effect on our business, results of operations and financial condition.

 

Currently, refiners and marketers receive a $0.45 per gallon tax incentive for each gallon of ethanol blended with gasoline. This incentive is scheduled to expire in December 2010. The federal ethanol tax incentives may not be renewed in 2010 or they may be renewed on different terms. In addition, the federal ethanol tax incentives, as well as other federal and state programs benefiting ethanol, generally are subject to U.S. government obligations under international trade agreements and may be subject to termination or reduction in scale. The elimination of or significant reduction in the federal ethanol tax incentives could have a material adverse effect on our business, results of operations and financial condition.

The State of Nebraska may not reimburse us for the tax incentives laid out in our Nebraska Advantage Act contract.

 

We anticipate receiving approximately $2.2 million from the State of Nebraska for reimbursement of sales taxes paid on construction bills related to our ABE Fairmont plant. We also anticipate receiving additional sales tax and employment credits over the next seven years. Any delay or termination of payments under the State of Nebraska’s Advantage Act could have a material adverse effect on our business, results of operations and financial condition. The PJC Capital Note requires all receipts from the Nebraska Advantage Act be remitted to PJC Capital until it is paid in full.

 

Current tariffs effectively limit imported ethanol into the U.S., and their reduction or elimination could undermine the ethanol industry in the U.S.

 

Imported ethanol is generally subject to a $0.54 per gallon tariff that was designed to offset the $0.45 per gallon ethanol incentive available under the federal excise tax incentive program for refineries that blend ethanol in their fuel. There is, however, a special exemption from this tariff for ethanol imported from 24 countries in Central America and the Caribbean Islands, which is limited to a total of 7% of U.S. ethanol production per year. Imports from the exempted countries may increase as a result of new plants in development. Since production costs for ethanol in these countries are significantly less than what they are in the U.S., the duty-free import of ethanol through the countries exempted from the tariff may negatively affect the demand for domestic ethanol and the price at which we sell our ethanol.

 

We do not know the extent to which the volume of imports would increase or the effect on U.S. prices for ethanol if the tariff is not renewed beyond its current expiration date of January 1, 2011. Any changes in the tariff or exemption from the tariff could have a material adverse effect on our business, results of operations and financial condition.

 

Various studies have criticized ethanol, which could lead to the reduction or repeal of incentives and tariffs that promote the use and domestic production of ethanol.

 

Although many trade groups, academics and governmental agencies have supported ethanol as a fuel additive that promotes a cleaner environment, others have criticized ethanol production as consuming considerably more energy and emitting more greenhouse gases than other biofuels. Other studies have suggested that corn-based ethanol is less efficient than ethanol produced from switch grass or wheat grain and that ethanol’s demand on corn has resulted in higher food prices and shortages. If these views gain acceptance, support for existing measures promoting use and domestic production of corn-based ethanol could decline, leading to reduction or repeal of these measures.

 

We may be adversely affected by environmental, health and safety laws, regulations and liabilities.

 

We are subject to extensive air, water and other environmental regulations, including those relating to the discharge of materials into the air, water and ground, the generation, storage, handling, use, transportation and disposal of hazardous materials, and the health and safety of our employees, and the plants we operate or manage need to maintain a number of environmental permits. Each ethanol plant we operate or manage is subject to environmental regulation by the state in which the plant is located and by the EPA. These laws, regulations and permits can often require expensive pollution control equipment or operational changes to limit actual or potential impacts on the environment. A violation of these laws and regulations or permit conditions can result in substantial fines, natural resource damages, criminal sanctions, permit revocations and/or facility shutdowns, liability for the costs of investigation and/or remediation and for damages to natural resources. Our operating subsidiaries may also be subject to related claims by private parties alleging property damage and personal injury due to exposure to hazardous or other materials from those plants, and ABE may have exposures to such claims arising from its management services.

 

Environmental issues, such as contamination and compliance with applicable environmental standards, could arise at any time during operation of an ethanol plant. If this occurs, our operating subsidiaries could be required to spend significant resources to remedy the issues and may limit operation of the ethanol plant. Our

operating subsidiaries may be liable for the investigation and cleanup of environmental contamination that might exist or could occur at each of the properties that they own or operate where they handle hazardous substances. If these substances have been or are disposed of or released at sites that undergo investigation and/or remediation by regulatory agencies, our operating subsidiaries may be responsible under the CERCLA or other environmental laws for all or part of the costs of investigation and/or remediation, and for damages to natural resources. Our operating subsidiaries may also be subject to related claims by private parties, including our employees and property owners or residents near their plant, alleging property damage and personal injury due to exposure to hazardous or other materials at or from those plants. Additionally, employees, property owners or residents near our ethanol plants could object to the air emissions or water discharges from our ethanol plants. Ethanol production has been known to produce an unpleasant odor. Environmental and public nuisance claims or toxic tort claims could be brought against us as a result of this odor or their other releases to the air or water. Some of these matters may require us to expend significant resources for investigation, cleanup, installation of control technologies or other compliance-related items, or other costs.

 

Additionally, the hazards and risks associated with producing and transporting our products (such as fires, natural disasters, explosions, abnormal pressures and blowouts) may also result in personal injury claims by third parties or damage to property owned by us or by third parties. We could sustain losses for uninsurable or uninsured events, or in amounts in excess of existing insurance coverage. Events that result in significant personal injury to third parties or damage to property owned by us or third parties or other losses that are not fully covered by insurance could have a material adverse effect on our business, results of operations and financial condition.

 

We also cannot assure that our operating subsidiaries will be able to comply with all necessary permits to continue to operate their ethanol plants. Failure to comply with all applicable permits and licenses could subject our operating subsidiaries to future claims or increase costs and materially adversely affect our business, results of operations and financial condition. Additionally, environmental laws and regulations, both at the federal and state level, are subject to change and such changes can be made retroactively. Consequently, even if our operating subsidiaries obtain the required permits, they may be required to invest or spend considerable resources to comply with future environmental regulations or new or modified interpretations of those regulations, which could materially adversely affect our business, results of operations and financial condition. Present and future environmental laws and regulations (and interpretations thereof) applicable to the operations of our operating subsidiaries, more vigorous enforcement policies and discovery of currently unknown conditions may require substantial expenditures that could have a material adverse effect on our business, results of operations and financial condition.

 

RISKS RELATED TO TAX ISSUES

 

The restructuring of HGF’s debt could cause investors to have taxable income without receiving cash distributions, which means investors could have to pay tax on their investment with personal funds.

 

HGF could recognize taxable income from cancellation of indebtedness as a result of the debt restructuring discussed above. That income would flow through to the owners of HGF, including ABE, and our unitholders would have to include their proportionate interests in that income on their individual tax returns (certain exceptions for insolvent unitholders could apply). HGF could elect to defer recognition of that income, which would result in a concurrent deferral to our unitholders. If HGF did so elect, the income would be recognized ratably over a five-year period beginning in 2014. In either case, ABE may not make distributions sufficient to pay tax on any income from cancellation of indebtedness that is recognized by an investor, which means that such an investor may have to pay tax on that income with personal funds.

 

IRS classification of the company as a corporation rather than as a partnership would result in higher taxation and reduced profits.

 

We are a Delaware limited liability company that has elected to be taxed as a partnership for federal and state income tax purposes, with income, gain, loss, deduction and credit passed through to the holders of the units. However, if for any reason the IRS successfully determines that we should be taxed as a corporation

rather than as a partnership, we would be taxed on our net income at rates of up to 35% for federal income tax purposes, and all items of our income, gain, loss, deduction and credit would be reflected only on our tax returns and would not be passed through to the holders of the units. If we were to be taxed as a corporation for any reason, distributions we make to investors will be treated as ordinary dividend income to the extent of our earnings and profits, and the payment of dividends would not be deductible by us, thus resulting in double taxation of our earnings and profits. If we pay taxes as a corporation, we will have less cash to distribute to our unitholders. Treatment of our company as a corporation for tax purposes could materially adversely affect our business and financial condition.

 

We might elect to convert our entity status from a limited liability company to a corporation, which would increase our tax burden.

 

Although we have no current plans to convert to a corporation, our company might elect in the future to convert to a corporation. If we convert to a corporation, no profits will be allocable to investors, there will be no tax liability to our shareholders unless we pay a dividend and our company, as a result, would not make tax distributions to our shareholders with respect to these allocable profits. Conversion to a corporation would require an approval by member vote pursuant to our operating agreement. If we elect to be organized as a corporation, we will be subject to Subchapter C of the Internal Revenue Code. We would be taxed on our net income at rates of up to 35% for federal income tax purposes, and all items of our income, gain, loss, deduction and credit would be reflected only on our tax returns and would not be passed through to the unitholders. Distributions, if made to investors, would be treated as ordinary dividend income to the extent of our earnings and profits, and the payment of dividends would not be deductible by us, resulting in double taxation of our earnings and profits. If we pay taxes as a corporation, we will also have less cash to distribute to our unitholders. Treatment of our company as a corporation for tax purposes could materially adversely affect our business and financial condition.

 

The IRS may classify your investment as a passive activity, resulting in the inability of unitholders to deduct losses associated with their investment.

 

It is likely that an investor’s interest in us will be treated as a “passive activity” for tax purposes. If an investor is an individual, estate, trust or a closely held corporation, and if the investor’s interest is deemed to be a “passive activity,” then the investor’s allocated share of any loss we incur will be deductible only against income or gains the investor has earned from other passive activities. Passive activity losses that are disallowed in any taxable year are suspended and may be carried forward and used as an offset against passive activity income in future years. These rules could restrict an investor’s ability to currently deduct any of our losses that are passed through to such investor.

 

Income allocations assigned to an investor’s units may result in taxable income in excess of cash distributions, which means unitholders may have to pay income tax on their investment with personal funds.

 

Investors will be required to pay tax on their allocated shares of our taxable income. It is likely that an investor will receive allocations of taxable income in certain years that result in a tax liability that is in excess of any cash distributions we may make to the investor. Among other things, this result might occur due to accounting methodology, lending covenants that restrict our ability to pay cash distributions, or our decision to retain the cash generated by the business to fund our operating activities and obligations. The PJC Capital Note requires that all permitted distributions from ABE Fairmont be paid to PJC Capital until the note is paid in full. Accordingly, investors are likely to be required to pay some or all of the income tax on their allocated shares of our taxable income with personal funds.

 

An IRS audit could result in adjustments to our allocations of income, gain, loss and deduction, causing additional tax liability to unitholders.

 

The IRS may audit our income tax returns and may challenge positions taken for tax purposes and allocations of income, gain, loss and deduction to investors. If the IRS were successful in challenging our

allocations in a manner that reduces loss or increases income allocable to investors, you may have additional tax liabilities. In addition, such an audit could lead to separate audits of an investor’s tax returns, especially if adjustments are required, which could result in adjustments on unitholders’ tax returns. Any of these events could result in additional tax liabilities, penalties and interest to unitholders, and the cost of filing amended tax returns.

 

 

The table below provides a summary of our ethanol plants in operation as of September 30, 2009 and December 28, 2009. We currently own each of these facilities.

 

 

 

 

Our corporate headquarters, located in Minneapolis, Minnesota, is approximately 5,300 square feet, under lease until November 2010. This building provides offices for our corporate and administrative staff. We believe this space will be sufficient for our needs until the end of the lease period.

 

 

We believe that each of the operating facilities is in adequate condition to meet our current and future production goals. We believe that these plants are adequately insured for replacement cost plus related disruption expenditures.

 

The senior creditor of the Fairmont plant is secured by a first mortgage on the plant real estate and a security interest lien on the site’s personal property. We also granted a subordinate lien and security interest to the trustee of the subordinated exempt facilities revenue bonds used to finance the Fairmont plant. We pledged a first-priority security interest and first lien on substantially all of assets of the South Dakota plants to the collateral agent for the senior creditor of these plants and a continuing security interest in and lien on substantially all of the assets of the South Dakota plants to the trustee of the subordinated solid waste facilities revenue bonds used to finance the South Dakota plants. HGF is currently in default under its senior and subordinated loan agreements, and is discussing with its lenders alternatives to foreclosing on the collateral securing its obligations under those agreements.

 

 

In June 2009, Revis Stephenson, the Company’s former director and chairman of the board and former chief executive officer, filed a demand for arbitration with the American Arbitration Association alleging that the Company breached its employment agreement with Mr. Stephenson when it terminated his employment in January 2009. Mr. Stephenson is seeking additional compensation, including but not limited to two years of

compensation and benefits. The Company filed an answer in July 2009 and discovery is ongoing. The arbitration has been scheduled for June 2010.

 

 

Our 2009 regular meeting of members was held on September 18, 2009. Of our 14,851,962 issued and outstanding membership units at that date, 11,377,726 membership units were present at the meeting in person or by proxy.

 

The following individuals were elected to serve on our board of directors until their successors are duly elected, with voting as follows:

 

 

The members cast the following number of votes in connection with the ratification of the selection of McGladrey & Pullen LLP as our independent registered public accounting firm for the fiscal year ending September 30, 2009.

 

 

The members cast the following number of votes in connection with the amendment of our operating agreement to permit the removal of former employee directors from the board.

 

 

 

The Company’s sole executive officer is:

 

 

Mr. Peterson joined our company as vice president of accounting and finance and chief financial officer in November 2006 and was named chief executive officer in October 2008. From July 2001 until November 2006, Mr. Peterson served as the director of finance, North American Operations for Nilfisk Advance, Inc., a manufacturer of commercial and industrial cleaning equipment. Prior to joining Nilfisk Advance, Mr. Peterson served as the chief financial officer for PPT Vision, Inc., a manufacturer of 2D and 3D vision inspection equipment from April 1999 to July 2001 and the chief financial officer of Premis Corporation, a point-of-sale software development company from December 1996 to April 1999.

 

 

Market Information

 

There is no established trading market for our membership units. Our membership units are subject to substantial transfer restrictions pursuant to our operating agreement, which prohibits transfers without the approval of our board of directors. The board of directors will not approve transfers unless they fall within

“safe harbors” contained in the publicly traded partnership rules under the tax code, which include, without limitation, the following:

 

 

Holders

 

There were 1,207 holders of record of our units as of December 26, 2009.

 

Issuer Purchases of Equity Securities

 

We did not make any purchases of our equity securities during the fourth quarter of fiscal 2009.

 

Distributions

 

We did not make any distributions in the years ended September 30, 2009 or 2008, nor did we receive a net cash flow from our operating plants in those years. Subject to any loan covenants or restrictions with any lenders, we may elect to make future distributions by distributing “net cash flow” to our members in proportion to the units that each member holds relative to the total number of units outstanding. “Net cash flow” means our gross cash proceeds less any portion, as determined by the board of directors in their sole discretion, used to pay or establish reserves for operating expenses, debt payments, capital improvements, replacements and contingencies. However, there can be no assurance that we will ever be able to pay any distributions to the unitholders. Our board may elect to retain future profits to provide operational financing for the plants, debt retirement, implementation of new technology and various expansion plans, including the possible construction of additional plants and development of new product lines. Additionally, our lenders may further restrict our ability to make distributions. Unitholders will be required to report on their income tax return their allocable share of the income, gains, losses and deductions we have recognized without regard to whether we make any cash distributions to our members.

 

Performance Graph

 

As disclosed above under “Market Information” and elsewhere in this Form 10-K, there is no established trading market for our membership units, which are subject to substantial transfer restrictions pursuant to our operating agreement. Given that our units are not publicly traded on an exchange or any over-the-counter market and we have very limited valuation data on our membership units, we have omitted the performance graph showing the change in our unitholder return.

 

Unregistered Sales of Equity Securities

 

We previously disclosed all sales of equity securities that were not registered under the Securities Act during the last fiscal year on Current Reports on Form 8-K dated as of August 28, 2009 and October 9, 2009.

 

Securities Authorized for Issuance under Equity Compensation Plans

 

There are no securities authorized for future issuance under equity compensation plans.

 

The following table presents selected consolidated financial and operating data as of the dates and for the periods indicated. The selected consolidated income statement data and other financial data for the years ended September 30, 2006 and 2005 and as of September 30, 2007, 2006 and 2005 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 September 30, 2009 and 2008 and the selected consolidated income statement data and other financial data for each of the three years in the period ended September 30, 2009 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.

 

 

 

 

 

 

GENERAL

 

The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of our consolidated financial condition and results of operations. This discussion should be read in conjunction with the consolidated financial statements included herewith and notes to the consolidated financial statements thereto and the risk factors contained herein.

 

OVERVIEW

 

Advanced BioEnergy was formed in 2005 as a Delaware limited liability company. Our business consists of producing ethanol and co-products, including wet, modified wet and dried distillers grains and providing management services to ethanol producers.

 

To execute our business plan, we entered into financial arrangements to build and operate ethanol production facilities in Fairmont, Nebraska, and we separately acquired HGF in November 2006, which owned existing ethanol production facilities in Aberdeen and Huron, South Dakota. Construction of our Fairmont, Nebraska plant began in June 2006 and operations commenced at the plant in November 2007. Construction of our expansion facility in Aberdeen, South Dakota began in April 2007, and operations commenced in January 2008. Our production operations are carried out primarily through our operating subsidiaries, ABE Fairmont which owns and operates the Fairmont, Nebraska plant and HGF.

 

HGF has not made its scheduled principal and interest payments on the $88.0 million senior credit facility or interest payments on the outstanding $7.1 million working capital line since October 2008, during which time it has been operating under a bank suspension. In February 2009, HGF entered into a forbearance agreement with WestLB that expired on March 31, 2009, after which,, WestLB, as administrative agent for HGF’s senior credit facility, disclosed its intent to foreclose on 100% of ABE’s equity interest in HGF. At such time, ABE did not intend to object to the foreclosure. The Company’s Form 10-Q for the fiscal quarters ending March 31, 2009 and June 30, 2009 reflected HGF as discontinued operations.

 

In September 2009, the senior lenders of HGF commenced discussions with the Company to explore alternatives to foreclosing on ABE’s equity interest in HGF, including a restructuring of the terms of the current borrowing arrangements with those lenders. These discussions are ongoing, and we now intend to pursue with HGF’s senior lenders, as well as the subordinated revenue bond holders, a restructuring of the current lending arrangements for HGF that will permit the Company to maintain a significant portion of its ownership of those facilities. Accordingly, we are no longer reflecting HGF’s financial results as discontinued operations in our financial statements. Nonetheless, there can be no assurance that the Company will be successful in restructuring its current lending arrangements or, if an agreement is reached, whether the terms of any such agreement will permit the Company to retain a significant ownership interest in HGF. If we are unable to successfully restructure the obligations to HGF’s senior lenders, ABE may be obligated to transfer its equity interest in HGF to the senior lenders and subordinated revenue bond holders.

 

 

 

We believe that each of the operating facilities is in adequate condition to meet our current and future production goals. We believe that these plants are adequately insured for replacement cost plus related disruption expenditures.

 

The senior creditor of the Fairmont plant is secured by a first mortgage on the plant real estate and a security interest lien on the site’s personal property. We also granted a subordinate lien and security interest to the trustee of the subordinated exempt facilities revenue bonds used to finance the Fairmont plant. We pledged a first-priority security interest and first lien on substantially all of assets of the South Dakota plants to the collateral agent for the senior creditor of these plants and a continuing security interest in and lien on substantially all of the assets of the South Dakota plants to the trustee of the subordinated solid waste facilities revenue bonds used to finance the South Dakota plants. HGF is currently in default under its senior and subordinated loan agreements, and is discussing with its lenders alternatives to foreclosing on the collateral securing its obligations under those agreements.

 

ABE Fairmont and HGF currently market and sell the ethanol they produce through an ethanol product off-take agreement it entered into in October 2008 with Gavilon. Under that agreement, ABE Fairmont and HGF are required to sell all of their output of ethanol produced at their plants, less certain E-85 and local promotion retained product, at accepted bid prices per gallon less a commission. In accordance with the terms of that agreement, ABE Fairmont has notified Gavillon of its intent to terminate that agreement with respect to ABE Fairmont as of December 31, 2009. On August 28, 2009, ABE Fairmont entered into a new marketing agreement with Hawkeye Gold which will become effective on January 1, 2010. The marketing agreement with Hawkeye Gold requires, among other things, (1) that ABE Fairmont must sell, and Hawkeye Gold must purchase, all of the denatured fuel grade ethanol produced by ABE Fairmont, (2) a purchase and sale of ethanol under the agreement must be in the form of either a direct fixed price purchase order, a direct index price purchase order, a terminal storage purchase order, or a transportation swap or similar transaction that is mutually acceptable to the parties, (3) that ABE Fairmont will pay any replacement or other costs incurred by Hawkeye Gold as a result of any failure to deliver by ABE Fairmont, and (4) that, with certain exceptions, ABE Fairmont will sell ethanol it produces exclusively to Hawkeye Gold. The initial term of the agreement is for two years, and provides for automatic renewal for successive 18 month terms unless either party provides written notice of nonrenewal at least 180 prior to the end of any term.

 

We currently sell 63% of our distillers grains production as dried which has an indefinite life and can be transported by truck or rail, 15% as modified distillers grains and 22% as wet. Wet and modified distillers grains can only be marketed locally and regionally through truck markets and have a shelf lives of 10 days and 3 weeks, respectively. ABE Fairmont is self-marketing the distillers grains it produces. HGF is party to a co-product marketing agreement with Dakotaland Feeds, LLC, whereby Dakotaland Feeds markets the local sale of ethanol co-products produced at the South Dakota plants to third parties for an agreed upon commission. Selling prices for distillers grains are seasonal, declining in the summer and fall seasons as cattle return to pasture grazing thereby decreasing demand for animal feed.

 

Our operations are highly dependent on commodity prices, especially prices for corn, ethanol, distillers grains and natural gas. As a result of price volatility for these commodities, our operating results may fluctuate substantially. The price and availability of corn are subject to significant fluctuations depending upon a number of factors that affect commodity prices in general, including crop conditions, weather, federal policy and foreign trade. Because the market price of ethanol is not always directly related to corn prices, at times ethanol prices may lag movements in corn prices and compress the overall margin structure at the plants. As a result, operating margins may become negative and we may be forced to shut down the plants.

 

We focus on locking in margins based on the cash flows approximating an “earnings before interest, taxes, depreciation and amortization (“EBITDA”)” model that continually monitors market prices of corn,

natural gas and other input costs against prices for ethanol and distillers grains at each of our production facilities. We create offsetting positions by using a combination of derivative instruments, fixed-price purchases and sales, or a combination of strategies in order to manage risk associated with commodity price fluctuations. Our primary focus is not to manage general price movements, for example minimize the cost of corn consumed, but rather to lock in favorable EBITDA margins whenever possible.

 

In particular, there has been a great deal of volatility in corn markets. The average corn price during calendar 2008 was $5.27 per bushel. In the first six months of calendar 2008, corn prices rose to nearly $8.00 per bushel, and retreated to $4.07 per bushel as of December 31, 2008. In 2009 corn rose to $4.49 in June and retreated to $3.00 in September before climbing back to $4.10 per bushel in December 2009. We believe that market volatility is attributable to a number of factors, including but not limited to export demand, speculation, currency valuation, ethanol demand and current production concerns. This corn market volatility poses a significant risk to our operations. The Company uses hedging strategies to lock in margins, leaving the Company less exposed to losses resulting from market fluctuations.

 

Historically, ethanol prices have tended to track the wholesale prices of gasoline. Ethanol prices can vary from state to state at any given time. During calendar year 2008, the average U.S. ethanol price, based on the Oil Price Information Service (“Opis”) Spot Ethanol Assessment, was $2.33 per gallon. For the same time period, the average U.S. gasoline price, based on New York Mercantile Exchange (“NYMEX”) reformulated blendstock for oxygen blending (“RBOB”) contracts was $2.49 per gallon, or approximately $0.16 per gallon above ethanol prices. We believe the higher ethanol prices were due to constraints in the ethanol blending and distribution infrastructure. For the fourth quarter of 2008, the average Opis Spot Ethanol Assessment was $1.77 per gallon and the average NYMEX RBOB was $1.34 per gallon, or approximately $0.43 per gallon below ethanol prices. During the fourth quarter of 2008, gasoline prices fell at a faster rate than ethanol prices. As a result, discretionary blending slowed because ethanol traded at or above the blender’s credit value.

 

In the first eleven months of 2009, the average Opis Spot Ethanol Assessment was $1.70 per gallon and the average NYMEX RBOB was $1.67 per gallon. We believe additional ethanol supply from existing plants that were temporarily taken off-line may come on-line in the near future and blenders will approach the 10% federal blend wall,which may reduce wholesale ethanol prices compared to gasoline.

 

Federal policy has a significant impact on ethanol market demand. Ethanol blenders benefit from incentives that encourage usage and a tariff on imported ethanol supports the domestic industry. Additionally, the renewable fuels standard (“RFS”) mandates increased level of usage of both corn-based and cellulosic ethanol. The RFS policies were challenged in a proceeding at the EPA by the State of Texas. The State of Texas sought a waiver of 50 percent of the RFS mandate for the production of ethanol derived from grain, citing the adverse economic impact due to higher corn, feed and food prices. The EPA denied this request in early August 2008. Any adverse ruling on, or legislation affecting, RFS mandates in the future could have an adverse impact on short-term ethanol prices and our financial performance in the future. Growth Energy, an ethanol industry trade organization, has requested a waiver from the EPA to increase the amount of ethanol blended into gasoline from the 10 percent blend up to a 15 percent blend (E15). We feel there is a strong possibility to see increased blends without having to increase the RFS mandate. We believe such a waiver, if granted, would have a positive and material impact on our business.

 

We believe the ethanol industry will continue to expand due to these federal mandates and policies. However, we expect the rate of industry expansion to slow significantly because of the amount of ethanol production added during the past two years or to be added by plants currently under construction or brought back into operation. This additional supply, along with a compressed margin structure, has resulted in reduced availability of capital for additional ethanol plant construction or expansion.

 

The ethanol industry and our business depend upon continuation of the federal and state ethanol supports such as RFS and VEETC. These government incentives have supported a market for ethanol that might disappear without the incentives. Alternatively, the government incentives may be continued at lower levels than those at which they currently exist. The elimination or reduction of the federal ethanol supports would make it more costly for us to sell our ethanol and would likely reduce our net income.

PLAN OF OPERATIONS THROUGH SEPTEMBER 30, 2010

 

Our primary focus throughout our last fiscal year, and on which we anticipate continuing to focus throughout the next twelve months, is continuing with operational improvements at each of our operating facilities. These operational improvements include exploring methods to improve ethanol yield per bushel and byproduct production, increasing production capacity at each of our plants, continuing our emphasis on safety and environmental regulation, reducing our operating costs and optimizing our margin opportunities through prudent risk management policies.

 

Another primary focus for the Company will be to finalize and complete a restructuring of our current loans with the senior and subordinate lenders to our subsidiary, HGF. HGF is in default under its credit agreements with our senior and subordinated lenders. In September 2009, the senior lenders of HGF commenced discussions with the Company to explore alternatives to foreclosing on ABE’s equity interest in HGF, including a restructuring of the terms of the current borrowing arrangements with those lenders. These discussions are ongoing, and we now intend to pursue with HGF’s senior lenders, as well as the subordinated revenue bond holders, a restructuring of the current lending arrangements for HGF that may permit the Company to maintain a significant portion of its ownership of those facilities. Accordingly, we are no longer reflecting HGF’s financial results as discontinued operations in our financial statements. Nonetheless, there can be no assurance that the Company will be successful in restructuring its current lending arrangements or, if an agreement is reached, whether the terms of any such agreement will permit the Company to retain a significant ownership interest in HGF. If we are unable to successfully restructure the obligations to HGF’s senior lenders, ABE may be obligated to transfer its equity interest in HGF to the senior lenders and subordinated revenue bond holders.

 

RESULTS OF OPERATIONS

 

Year Ended September 30, 2009 Compared to Year Ended September 30, 2008

 

The following table reflects quantities of our products sold at average net prices as well as bushels of corn ground and thermos of gas burned at average costs for fiscal 2008 and fiscal 2009:

 

 

Net Sales

 

Net sales for fiscal 2009 were $355.7 million, compared to $394.4 million for fiscal 2008, a decrease of $38.6 million or 9.8%. The decrease is due in large part to the decline in the net price of ethanol and dried distillers grains sold in fiscal 2009 of 28.8% and 15.4%, respectively from the prior fiscal year period. These price declines are due to the rapid expansion of ethanol plants in the United States over the past three years resulting in supply capacity exceeding demand for the products we produce. The price decreases were partially offset by an increase in quantities sold as a result of our Fairmont and Aberdeen expansion plants operating for the entire year in fiscal 2009. Ethanol revenues were offset by ethanol-related hedging losses of $2.6 million in fiscal 2008. During fiscal 2009 and 2008, 80.8% and 82.3%, respectively, of our net sales were derived from the sale of ethanol and our remaining net sales were derived from the sale of distillers grains.

Cost of Goods Sold

 

Cost of goods sold for fiscal 2009 were $345.7 million, compared to $389.5 million for fiscal 2008, a decrease of $43.8 million or 11.2%. Cost of goods sold included corn-related hedging losses of $3.2 million in fiscal 2009 and $478,000 in fiscal 2008. Corn costs represented 75.9% of cost of goods sold for fiscal 2009 and 72.6% for fiscal 2008. Physically delivered corn costs decreased 26.0% from $5.12 per bushel in fiscal 2008 to $3.79 per bushel for fiscal 2009 as a result of a strong growing season and less worldwide demand stemming from the current economic recession. Natural gas costs represented 6.1% of cost of sales for fiscal 2009 and 9.9% for 2008. Our average gas prices decreased from $8.66 per mmbtu in fiscal 2008 to $4.14 per mmbtu in fiscal 2009 due to a reduction in demand from the recession and mild hurricane season.

 

Gross Profit

 

Our gross profit for fiscal 2009 was $10.0 million, compared to a gross profit of $4.9 million for fiscal 2008. The increase was primarily due to increased production from having the Fairmont and Aberdeen expansion plants operating for the entire twelve month period in fiscal 2009, the 52.2% drop in natural gas cost per mmbtu and our wet distillers grains selling prices remaining stable despite the 26% decline in average corn cost per bushel.

 

Selling, General, and Administrative Expenses

 

Selling, general, and administrative expenses are comprised of recurring administrative personnel compensation, legal, technology, consulting, insurance and accounting fees as well as certain non-recurring charges. Overall selling, general and administrative costs declined approximately $3.6 million, or 25.9%, to $10.2 million for fiscal 2009. The prior year’s costs include the impairment of $750,000 of acquisition costs related to our acquisition of Indiana Renewable Fuels, LLC and a $1.5 million contract termination settlement paid to HGF’s former ethanol marketer. Selling, general and administrative expenses as a percentage of sales have declined from 3.5% in fiscal 2008 to 2.9% in fiscal 2009.

 

HGF Asset Impairments

 

Despite HGF’s efforts to increase capacity and replace ethanol marketers, HGF was unable to generate positive cash flows and in October 2008 HGF was not able to make an interest payment to its senior secured creditor. Additionally, the tightening credit markets, the ethanol industry’s capacity surplus, the narrow margins created by commodity movements and the global financial crisis, as well as liquidations of certain competitors have resulted in a significant decline in the market value of HGF. As a result, the Company recorded a non-cash charge of $29.1 million in September 2008, representing the full impairment of the carrying value of the goodwill recorded in connection with the purchase of HGF. In March 2009, upon determination that HGF would be foreclosed on by the senior creditor, the Company recorded an impairment of $8.7 million based on expected receipt of future cash flows. The Company reflected HGF results as discontinued operations for the quarterly reports filed on Form 10-Q for the quarters ending March 31, 2009 and June 30, 2009. In September 2009, the senior lenders of HGF commenced discussions with the Company to explore alternatives to foreclosing on ABE’s equity interest in HGF, including a restructuring of the terms of the current borrowing arrangements with those lenders. These discussions are ongoing, and we now intend to pursue with HGF’s senior lenders, as well as the subordinated revenue bond holders, a restructuring of the current lending arrangements for HGF that may permit the Company to maintain a significant portion of its ownership of those facilities. Accordingly, we are no longer reflecting HGF’s financial results as discontinued operations in our financial statements. The Company performed a fair market value analysis of HGF to reconsolidate its results in our financial statements and recorded an additional $19.6 million impairment charge for the amount that the existing carrying value exceeded the estimated fair market value of the assets.

Interest Expense

 

Interest expense for fiscal 2009 was $26.9 million, compared to $20.6 million for fiscal 2008, an increase of $6.3 million or 30.6%. The increase includes $4.2 million of additional expense recognized from the termination of our swap agreements with the HGF senior lenders, $4.9 million with respect to the write-off of deferred financing costs upon default by HGF and the additional 2% default interest on the HGF senior credit facility and subordinated revenue bonds for the entire year in fiscal 2009.

 

Year Ended September 30, 2008 Compared to Year Ended September 30, 2007

 

The following table reflects quantities of our products sold at average net prices as well as bushels of corn ground and thermos of gas burned at average costs for fiscal 2007 and fiscal 2008:

 

 

Net Sales

 

Net sales for fiscal 2008 were $394.4 million, compared to $58.4 million for fiscal 2007, an increase of $336.0 million or 581.7%. The increase is due in large part to the 110 million gallon annual production capacity added by the Fairmont plant completion in October 2007 and the 46 million gallon annual production capacity added by the Aberdeen plant expansion completed in January 2008. In addition to the increase in quantities of ethanol and distillers grains sold, the net price of ethanol, dried distillers grains and wet distillers grains sold in fiscal 2008 increased 13.2%, 43.1% and 74.7%, respectively from the prior fiscal year period. Ethanol revenues were offset by ethanol-related hedging losses of $2.6 million in fiscal 2008 and $18.5 million in fiscal 2007. During fiscal 2008 and 2007, 82.3% and 85.7%, respectively, of our net sales were derived from the sale of ethanol and our remaining net sales were derived from the sale of distillers grains.

 

Cost of Goods Sold

 

Cost of goods sold for fiscal 2008 were $389.5 million, compared to $67.4 million for fiscal 2007, an increase of $322.1 million or 478.1%. This increase is directly related to our increased capacity from the Fairmont plant completed in October 2007 and Aberdeen plant completed in January 2008. Cost of goods sold included corn-related hedging gains or losses of $(478,000) in fiscal 2008 and $1.0 million in fiscal 2007. Corn costs represented 72.6% of cost of sales for fiscal 2008. Physically delivered corn costs increased 45.8% from $3.51 per bushel in fiscal 2007 to $5.12 per bushel for fiscal 2008. Natural gas costs represented 9.9% of cost of goods sold for fiscal 2008 increasing from $29.9 million to $38.5 million in fiscal 2007. Our average gas prices increased from $8.24 per mmbtu in fiscal 2007 to $8.66 per mmbtu in fiscal 2008.

 

Gross Profit

 

Our gross profit for fiscal 2008 was $4.9 million, compared to gross loss of $9.0 million for fiscal 2007. The increase was primarily due to timing and capacity of plant openings and the reduction in hedging related losses described above.

 

Selling, General, and Administrative Expenses

 

Overall selling, general and administrative costs declined approximately $452,000, or 3.2%, to $13.8 million for fiscal 2008. The prior year costs included a $2.8 million intangible impairment related to the expiration of

the Indiana site methane agreement and a write-off of $1.4 million of previously capitalized offering costs related to a withdrawn public offering. The 2008 period costs included the impairment of $750,000 of additional acquisition costs related to our acquisition of Indiana Renewable Fuels, LLC, a $1.5 million contract termination settlement paid to HGF’s former ethanol marketer and $2.4 million of administrative costs for ABE Fairmont and the Aberdeen expansion plant that opened in 2008. Selling, general and administrative expenses as a percentage of sales have declined from 24.3% in fiscal 2007 to 3.5% in fiscal 2008.

 

Goodwill Impairment

 

Despite HGF’s efforts to increase capacity and replace ethanol marketers, HGF has been unable to generate positive cash flows and in October 2008 HGF was not able to make an interest payment to its senior secured creditor. Additionally, the tightening credit markets, the ethanol industry’s capacity surplus, the narrow margins created by commodity movements and the global financial crisis, as well as liquidations of certain competitors, have resulted in a significant decline in the market value of HGF. As a result, the Company recorded a non-cash charge of $29.1 million in September 2008, representing the full impairment of the carrying value of the goodwill recorded in connection with the purchase of HGF.

 

Interest Expense

 

Interest expenses for fiscal 2008 were $20.6 million, compared to $1.3 million for fiscal 2007, an increase of $19.3 million or 1,479.66%. The increase is related to the increased borrowings related to the completion of the Fairmont and Aberdeen plants. Total debt increased from $163.3 million at September 30, 2007 to $217.2 million at September 30, 2008. While the plants were being constructed interest costs were capitalized into property, plant and equipment.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Financing and Existing Debt Obligations

 

Our business activities and plant operations are conducted through Advanced BioEnergy, ABE Fairmont and HGF. The liquidity and capital resources for each entity are based on the entity’s existing financing arrangements and capital structure. ABE Fairmont and HGF both have traditional project financing in place including senior secured financing, working capital facilities and subordinate exempt facilities revenue bonds. There are provisions preventing cross default or collateralization between operating entities. Advanced BioEnergy is highly restricted in its ability to utilize the cash and other financial resources of each subsidiary for the benefit of Advanced BioEnergy or other subsidiaries with the exception of allowable distributions as defined in the separate financing agreements.

 

Advanced BioEnergy, LLC

 

The Company had cash and cash equivalents of $2.6 million and restricted cash of $5.7 million on hand at September 30, 2009.

 

The Company entered into a forbearance agreement with PJC Capital on June 1, 2009. Pursuant to the forbearance agreement, PJC Capital agreed to forbear from exercising its rights and remedies if among other things the Company was able to raise and remit at least $3 million in net proceeds from a private equity offering by October 1, 2009. We remitted $3.0 million in net proceeds from a private placement of newly issued units of ABE in August 2009 to PJC Capital to pay down a portion of our obligation. Our promissory note was amended and restated in its entirety in August 2009 (the PJC Capital Note). The PJC Capital Note had an outstanding balance of $9.8 million at September 30, 2009, accrues interest at 10%, requires monthly payments totaling $50,000 and matures on October 1, 2012. The Company also received $3.1 million from additional units issued or subscribed for at September 30, 2009 that were remitted to PJC Capital in October 2009. These funds are classified as restricted cash at September 30, 2009. The PJC Capital Note also requires the Company to forward any future tax reimbursements from the Nebraska Tax Advantage Act as well as ABE Fairmont annual dividends to PJC Capital.

Subsequent to September 30, 2009, the Company received an additional $1.3 million from the issuance of additional units and remitted these fundsto PJC Capital to pay down a portion of our obligation. In October 2009, the Company remitted $1.7 million of funds previously used to collateralize a letter of credit to PJC Capital. Following these remittances, the PJC Capital Note has a balance of $3.7 million. The Company believes it can service the remainder of the obligation through Nebraska Advantage Act tax refunds, cash on hand and/or distributions from ABE Fairmont.

 

ABE Fairmont

 

ABE Fairmont had cash and cash equivalents of $14.4 million and restricted cash of $1.4 million on hand at September 30, 2009. The restricted cash is held in escrow for future debt service payments. As of September 30, 2009, ABE Fairmont had $75.5 million in senior secured credit and $7.0 million of subordinate exempt facilities revenue bonds outstanding. ABE Fairmont is required to make monthly interest payments on its senior secured credit and semi-annual interest payments on its outstanding subordinate exempt revenue bonds. ABE Fairmont is required to make quarterly principal payments of $2.6 million on its senior secured credit. Annual principal payments of $815,000 on the subordinate exempt facilities revenue bonds commence in December 2010.

 

ABE Fairmont anticipates using available cash to fund current operations and working capital, invest in capital equipment and make required debt service payments on its debt. ABE Fairmont is allowed to make cash distributions to its parent company (Advanced BioEnergy, LLC) if ABE Fairmont meets all conditions required in its senior secured credit agreement at the end of a fiscal year. This annual distribution is limited to 40% of net income calculated in accordance with generally accepted accounting principals and other terms contained in its senior secured credit agreement. The distribution is subject to the completion of ABE Fairmont’s financial statement audit and upon making any distribution, ABE Fairmont must remain in compliance with all loan covenants and terms and conditions of the senior secured credit agreement. ABE Fairmont’s senior secured credit agreement also requires an annual cash sweep subject to a free cash flow calculation as defined in its senior secured credit agreement. This cash sweep requires ABE Fairmont for each fiscal year ending in 2009 through 2012, to make a payment equal to the lesser of $8.0 million or 75% of its free cash flow after distributions, not to exceed $16.0 million in the aggregate for all of these cash flow payments.

 

We believe ABE Fairmont has sufficient financial resources available to fund current operations and capital expenditure requirements for at least the next 12 months. In addition to the cash on hand, ABE Fairmont has a $6.0 million revolving credit facility for financing eligible grain inventory and equity in Chicago Board of Trade futures positions, which expires in February 2010. The Company has drawn $3 million on the revolving credit facility at September 30, 2009 and had $3 million remaining available. ABE Fairmont also has a $2.0 million revolving credit facility for financing third party letters of credit, which expires in February 2012. ABE Fairmont issued a letter of credit in connection with a rail car lease reducing the financing available from the $2.0 million revolving credit facility by $911,000.

 

ABE Fairmont’s senior secured credit facility agreement contains financial and restrictive covenants including limitations on additional indebtedness, restricted payments, the incurrence of liens, transactions with affiliates and sales of assets. In addition, the senior secured credit facility requires ABE Fairmont to comply with certain financial covenants, including maintaining monthly minimum working capital, monthly minimum net worth and annual debt service coverage ratios and capital expenditure limitations. ABE Fairmont was in compliance with all covenants at September 30, 2009.

 

Heartland Grain Fuels

 

HGF had cash and cash equivalents of $9.3 million and $801,000 of cash restricted for debt service payments. HGF has not made its scheduled principal and interest payments on the $88.0 million senior credit facility or interest payments on the outstanding $7.1 million working capital line since October 2008. In February 2009, HGF entered into a forbearance agreement with WestLB that expired on March 31, 2009. In March 2009, WestLB disclosed its intent to foreclose on 100% of ABE’s equity interest in HGF.

During the default period, HGF has been accruing interest at the default rate of 8.5% and had $9.9 million of unpaid interest at September 30, 2009. As a result of the defaults all principal amounts owed on the senior credit facility have been classified as current debt in this report.

 

HGF previously entered into interest rate swaps with a notional amount of $66.0 million to lock in interest rates on its floating rate debt. As a result of the defaults on the senior credit facility, the interest rate swaps were terminated in December 2008 and the fair value of the swaps were recorded as a note payable which continues to accrued interest at 8.27%.

 

The $19.0 million Brown County Revenue Bonds were issued pursuant to a bond trust indenture with maturities of $5.8 million in January 2016, $6.3 million in January 2017, and $6.9 million in January 2018 with an interest rate of 8.25%. In the year ended September 30, 2009, the scheduled semi-annual interest payments were made from established debt service accounts.

 

The revenue bonds are secured by a pledge to the trustee of a continuing security interest in HGF. In addition, HGF has granted a subordinate mortgage lien and security interest in its existing facilities to the trustee to secure the payment of the obligations of HGF.

 

The defaults on the senior credit facility also represented a default on the revenue bonds and all principal amounts owed on the revenue bonds have been classified as current debt in this report.

 

HGF has not made its scheduled principal and interest payments on its $88.0 million senior credit facility or interest payments on its outstanding $7.1 million working capital line since October 2008 during which time it has been operating under a bank suspension. In February 2009, HGF entered into a forbearance agreement with WestLB that expired on March 31, 2009, after which, WestLB, as administrative agent for HGF’s senior credit facility, disclosed its intent to foreclose on 100% of ABE’s equity interest in HGF. At such time, ABE did not intend to object to the foreclosure. The Company’s Form 10-Q for the fiscal quarters ending March 30, 2009 and June 30, 2009 reflected HGF as discontinued operations.

 

In September 2009, HGF’s senior lenders commenced discussion with the Company to explore alternatives to foreclosing on ABE’s equity interest in HGF, including a restructuring of the terms of the current borrowing arrangements with those lenders. These discussions are ongoing, and we now intend to pursue with HGF’s senior lenders, as well as the subordinated revenue bond holders, a restructuring of the current lending arrangements for HGF that will permit the Company to maintain a significant portion of its ownership of those facilities. Accordingly, we are no longer reflecting HGF’s financial results as discontinued operations in our financial statements. Nonetheless, there can be no assurance that the Company will be successful in restructuring its current lending arrangements or, if an agreement is reached, whether the terms of any such agreement will permit the Company to retain a significant ownership interest in HGF. If we are unable to successfully restructure the obligations to HGF’s senior lenders, ABE may be obligated to transfer its equity interest in HGF to the senior lenders and subordinated revenue bond holders.

CREDIT ARRANGEMENTS

 

Long-term debt consists of the following at September 30, 2009 and September 30, 2008 (in thousands, except percentages):

 

 

The estimated maturities of debt at September 30, are as follows (in thousands):

 

 

CONTRACTUAL OBLIGATIONS

 

The following table summarizes our contractual obligations as of September 30, 2009.

 

 

 

 

SUMMARY OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Note 1 to our consolidated financial statements contains a summary of our significant accounting policies, many of which require the use of estimates and assumptions. Accounting estimates are an integral part of the preparation of financial statements and are based upon management’s current judgment. We used our knowledge and experience about past events and certain future assumptions to make estimates and judgments involving matters that are inherently uncertain and that affect the carrying value of our assets and liabilities. We believe that of our significant accounting policies, the following are noteworthy because changes in these estimates or assumptions could materially affect our financial position and results of operations:

 

Revenue Recognition

 

Revenue from the production of ethanol and related products is recorded when title transfers to customers. Ethanol and related products are generally shipped free on board (FOB) shipping point. Interest income is recognized as earned. 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 sale price at the time of payment.

 

Fair Value of Financial Instruments

 

Financial instruments include cash and cash equivalents, interest rate swaps, derivative financial instruments, accounts receivable, accounts payable, accrued expenses and long-term debt. Management believes the fair value of each of these financial instruments approximates their carrying value as of the balance sheet date. The fair value of derivative financial instruments is based on quoted market prices. The fair value of the long-term debt is estimated based on anticipated interest rates which management believes would currently be available to the Company for similar issues of debt, taking into account the current credit risk of the Company and other market factors. The Company believes the carrying value of the debt instruments at ABE Fairmont and the PJC Capital Note approximate fair value. The Company believes it is not practical to estimate the fair value of the HGF debt instruments due to their default status. The fair value of all other financial instruments is estimated to approximate carrying value due to the short-term nature of those instruments.

 

Inventories

 

Corn, chemicals and supplies, work in process, ethanol and distillers grains inventories are stated at the lower of cost or market on the weighted average cost method.

 

Deferred Income

 

The Company recorded the net funds received from the Village of Fairmont, Nebraska tax incremental financing as deferred income, and this deferred income is amortizing against property tax expense over the life of the process equipment.

 

Property and Equipment

 

Property and equipment is carried at cost less accumulated depreciation computed using the straight-line method over the estimated useful lives:

 

 

Maintenance and repairs are charged to expense as incurred; major improvements and betterments are capitalized. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount on the asset may not be recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows from operations are less than the carrying value of

the asset group. An impairment loss would be measured by the amount by which the carrying value of the asset exceeds the estimated fair market value.

 

INTEREST RATE/FOREIGN EXCHANGE RISK

 

Our future earnings may be affected by changes in interest rates due to the impact those changes have on our interest expense on borrowings under our credit facility. As of September 30, 2009, we had $58.5 million of outstanding borrowings with variable interest rates. With each 1% increase in interest rates we will incur additional annual interest charges of $584,500.

 

We have no international sales. Substantially all of our purchases are denominated in U.S. dollars.

 

IMPACT OF INFLATION

 

We believe that inflation has not had a material impact on our results of operations since inception. We cannot assure you that inflation will not have an adverse impact on our operating results and financial condition in future periods.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

We have no off-balance sheet arrangements.

 

GOVERNMENT PROGRAMS, TAX CREDITS AND TAX INCREMENT FINANCING

 

We have applied for income and sales tax incentives available under a Nebraska Advantage Act Project Agreement. We anticipate recovery of certain sales taxes paid on construction costs, and up to 10% of the cost of the Fairmont plant construction pursuant to reductions in income taxes over the next 13 years. Under the Nebraska Advantage Act, we also anticipate recovery of 5% of the annual costs of the newly created employment positions, pursuant to offsets to future payroll taxes. Although we may apply under several programs simultaneously and may be awarded grants or other benefits from more than one program, some combinations of programs are mutually exclusive. Under some state and federal programs, awards are not made to applicants in cases where construction on the project has started prior to the award date. There is no guarantee that applications will result in awards of grants or credits or deductions.

 

In December 2006 we received net proceeds of $6.7 million from tax incremental financing from the Village of Fairmont, Nebraska. We anticipate paying off the outstanding obligation with future property tax payments, assessed on the Fairmont plant.

 

The State of South Dakota pays an incentive to operators of ethanol plants to encourage the growth of the ethanol industry. The Huron plant is eligible to receive an aggregate of $10 million, payable up to $1 million per year. The amounts are dependent on annual allocations by the State of South Dakota and the number of eligible plants. HGF generally received a payment between $700,000 and $800,000 for the Huron plant per year and expects this incentive to terminate for the plant in 2011.

 

 

We consider market risk to be the impact of adverse changes in market prices on our results of operations. We are subject to significant market risk with respect to the price of ethanol and corn. For the year ended September 30, 2009, sales of ethanol represented 80.8% of our total revenues and corn costs represented 75.9% of total cost of goods sold. In general, ethanol prices are affected by the supply and demand for ethanol, the cost of ethanol production, the availability of other fuel oxygenates, the regulatory climate and the cost of alternative fuels such as gasoline. The price of corn is affected by weather conditions and other factors affecting crop yields, farmer planting decisions and general economic, market and regulatory factors. At September 30, 2009, the price per gallon of ethanol and the price per bushel of corn on the Chicago Board of Trade, or CBOT, were $1.78 and $3.44, respectively.

We are also subject to market risk on the selling prices of our distillers grains, which represent 19.2% of our total revenues. These prices fluctuate seasonally when the price of corn or other cattle feed alternatives fluctuate in price. The dried distillers grains spot for local customers was $90 per ton at September 30, 2009.

 

We are also subject to market risk with respect to our supply of natural gas that is consumed in the ethanol production process. Natural gas costs represented 6.1% of total cost of sales for the year ended September 30, 2009. The price of natural gas is affected by weather conditions and general economic, market and regulatory factors. At September 30, 2009, the price of natural gas on the NYMEX was $4.84 per mmbtu.

 

To reduce price risk caused by market fluctuations in the cost and selling prices of related commodities, we have entered into forward purchase/sale contracts and derivative transactions. We entered into off-take agreements which guaranteed prices on 48.8% of our ethanol gallons sold through December 2009. At September 30, 2009 we had entered into forward sale contracts representing 35.1% of our expected distillers grains production and we had entered into forward purchase contracts representing 10.4% of our current corn requirements through December 2009. At September 30, 2009, we had not entered into any transactions in an effort to mitigate risks associated with changes in the price of natural gas usage.

 

The following represents a sensitivity analysis that estimates our annual exposure to market risk with respect to our current corn and natural gas requirements and ethanol sales. Market risk is estimated as the potential impact on operating income resulting from a hypothetical 10% change in the fair value of our current corn and natural gas requirements and ethanol sales, net of corn and natural gas forward contracts used to hedge market risk with respect to our current corn and natural gas requirements. The results of this analysis, which may differ from actual results, are as follows:

 

 

 

 

 

 

To the Board of Directors and Members
Advanced BioEnergy, LLC

 

We have audited the accompanying consolidated balance sheets of Advanced BioEnergy, LLC & subsidiaries as of September 30, 2009 and 2008, and the related consolidated statements of operations, changes in members’ equity and cash flows for each of the three years in the period ended September 30, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the auditing 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 Advanced BioEnergy, LLC & subsidiaries as of September 30, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2009 in conformity with United States generally accepted accounting principles.

 

We were not engaged to examine management’s assessment of the effectiveness of Advanced BioEnergy, LLC’s internal control over financial reporting as of September 30, 2009, included in Item 9A(T) of Form 10K and, accordingly, we do not express an opinion thereon.

 

 

Des Moines, Iowa
December 29, 2009

ADVANCED BIOENERGY, LLC & SUBSIDIARIES

 

Consolidated Balance Sheets

 

 

See notes to consolidated financial statements.

ADVANCED BIOENERGY, LLC & SUBSIDIARIES

 

Consolidated Statements of Operations and Comprehensive Loss

 

 

See notes to consolidated financial statements

ADVANCED BIOENERGY, LLC & SUBSIDIARIES

 

Consolidated Statements of Changes in Members’ Equity

For the Years Ended September 30, 2008 and 2009