Attached files

file filename
EX-31.2 - EX-31.2 - Heron Lake BioEnergy, LLChlby-20160131ex31211ea16.htm
EX-32.1 - EX-32.1 - Heron Lake BioEnergy, LLChlby-20160131ex32195078e.htm
EX-32.2 - EX-32.2 - Heron Lake BioEnergy, LLChlby-20160131ex3224cbad3.htm
EX-31.1 - EX-31.1 - Heron Lake BioEnergy, LLChlby-20160131ex3118f0785.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

 

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

For the quarterly period ended January 31,  2016 

 

OR

 

 

 

Transition report under Section 13 or 15(d) of the Exchange Act.

 

For the transition period from                    to                  .

 

COMMISSION FILE NUMBER 000-51825

 

HERON LAKE BIOENERGY, LLC

(Exact name of Registrant as specified in its charter)

 

 

 

 

Minnesota

 

41-2002393

(State or other jurisdiction of organization)

 

(I.R.S. Employer Identification No.)

 

91246 390th Avenue, Heron Lake, MN 56137-1375

(Address of principal executive offices)

 

(507) 793-0077

(Issuer’s telephone number)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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    No

 

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes    No

 

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.

 

 

 

 

Large accelerated filer  

 

Accelerated filer 

 

 

 

Non-accelerated filer  

 

Smaller reporting company 

(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    No

 

As of March 16,  2016, there were 62,932,107 Class A units and 15,000,000 Class B units issued and outstanding.

 

 

 

 

 


 

 


 

PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

 

 

 

 

 

 

 

 

 

 

    

January 31, 2016

    

October 31, 2015

 

 

 

(Unaudited)

 

 

 

 

ASSETS

 

 

 

 

 

 

 

Current Assets

 

 

 

 

 

 

 

Cash

 

$

1,166,542

 

$

1,126,283

 

Restricted cash

 

 

363,291

 

 

 —

 

Accounts receivable

 

 

4,747,017

 

 

5,671,181

 

Inventory

 

 

5,492,522

 

 

5,259,346

 

Commodity derivative instruments

 

 

126,238

 

 

677,149

 

Prepaid expenses and other current assets

 

 

334,523

 

 

158,473

 

Total current assets

 

 

12,230,133

 

 

12,892,432

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

 

52,342,605

 

 

52,984,550

 

 

 

 

 

 

 

 

 

Other Assets

 

 

 

 

 

 

 

Other intangible assets, net

 

 

112,611

 

 

122,148

 

Other assets

 

 

697,254

 

 

697,254

 

Total other assets

 

 

809,865

 

 

819,402

 

 

 

 

 

 

 

 

 

Total Assets

 

$

65,382,603

 

$

66,696,384

 

 

 

 

 

 

 

 

 

LIABILITIES AND MEMBERS' EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities

 

 

 

 

 

 

 

Current maturities of long-term debt

 

$

584,674

 

$

517,957

 

Checks drawn in excess of bank balance

 

 

5,341,768

 

 

1,836,682

 

Accounts payable

 

 

2,056,012

 

 

3,913,714

 

Accrued expenses

 

 

254,435

 

 

187,750

 

Total current liabilities

 

 

8,236,889

 

 

6,456,103

 

 

 

 

 

 

 

 

 

Long-Term Debt, net of current maturities

 

 

7,536,806

 

 

6,711,975

 

 

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Members' Equity

 

 

 

 

 

 

 

Members' Equity attributable to Heron Lake BioEnergy, LLC consists of:

77,932,107 units issued and outstanding at both January 31, 2016 and October 31, 2015

 

 

48,524,340

 

 

52,446,500

 

Non-controlling interest

 

 

1,084,568

 

 

1,081,806

 

Total members' equity

 

 

49,608,908

 

 

53,528,306

 

 

 

 

 

 

 

 

 

Total Liabilities and Members' Equity

 

$

65,382,603

 

$

66,696,384

 

 

Notes to Condensed Consolidated Unaudited Financial Statements are an integral part of this Statement.

1


 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

Three Months Ended

 

 

 

January 31, 2016

 

 

January 31, 2015

 

    

 

(Unaudited)

    

 

(Unaudited)

Revenues

 

$

26,588,565

 

$

27,177,449

 

 

 

 

 

 

 

Cost of Goods Sold

 

 

25,730,984

 

 

25,330,399

 

 

 

 

 

 

 

Gross Profit

 

 

857,581

 

 

1,847,050

 

 

 

 

 

 

 

Operating Expenses

 

 

808,634

 

 

880,382

 

 

 

 

 

 

 

Operating Income

 

 

48,947

 

 

966,668

 

 

 

 

 

 

 

Other Income (Expense)

 

 

 

 

 

 

Interest income

 

 

253

 

 

 —

Interest expense

 

 

(58,674)

 

 

(48,066)

Other income

 

 

67,678

 

 

24,251

Total other income (expense), net

 

 

9,257

 

 

(23,815)

 

 

 

 

 

 

 

Net Income

 

 

58,204

 

 

942,853

 

 

 

 

 

 

 

Less: Net Income Attributable to Non-controlling Interest

 

 

(83,759)

 

 

(63,597)

 

 

 

 

 

 

 

Net Income (Loss) Attributable to Heron Lake BioEnergy, LLC

 

$

(25,555)

 

$

879,256

 

 

 

 

 

 

 

Weighted Average Units Outstanding—Basic and Diluted (Class A and B)

 

 

77,932,107

 

 

77,932,107

 

 

 

 

 

 

 

Net Income (Loss) Per Unit Attributable to Heron Lake BioEnergy, LLC - Basic and Diluted (Class A and B)

 

$

0.00

 

$

0.01

 

 

 

 

 

 

 

Distributions Per Unit (Class A and B)

 

$

0.05

 

$

0.12

 

Notes to Condensed Consolidated Unaudited Financial Statements are an integral part of this Statement.

2


 

HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

Three Months Ended

 

 

 

 

January 31, 2016

 

 

January 31, 2015

 

 

    

 

(Unaudited)

    

 

(Unaudited)

 

Cash Flow From Operating Activities

 

 

 

 

 

 

 

Net income

 

$

58,204

 

$

942,853

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

1,184,553

 

 

1,133,293

 

Change in fair value of commodity derivative instruments

 

 

(253,684)

 

 

(14,038)

 

Change in operating assets and liabilities:

 

 

 

 

 

 

 

Restricted cash

 

 

(363,291)

 

 

95,686

 

Accounts receivable

 

 

924,164

 

 

3,224,572

 

Inventory

 

 

(233,176)

 

 

(959,204)

 

Prepaid expenses and other current assets

 

 

(176,050)

 

 

(147,244)

 

Accounts payable

 

 

(1,672,711)

 

 

2,161,114

 

Accrued expenses

 

 

66,685

 

 

45,455

 

Commodity derivative instruments

 

 

804,595

 

 

93,838

 

Net cash provided by (used in) operating activities

 

 

339,289

 

 

6,576,325

 

 

 

 

 

 

 

 

 

Cash Flows from Investing Activities

 

 

 

 

 

 

 

Capital expenditures

 

 

(718,062)

 

 

(3,897,444)

 

Net cash used in investing activities

 

 

(718,062)

 

 

(3,897,444)

 

 

 

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

 

 

Checks drawn in excess of bank balance

 

 

3,505,086

 

 

3,425,828

 

Proceeds from long-term debt

 

 

4,613,122

 

 

3,354,979

 

Payments on long-term debt

 

 

(3,721,574)

 

 

(145,567)

 

Distributions paid to members

 

 

(3,896,605)

 

 

(9,351,850)

 

Distributions to non-controlling interest

 

 

(80,997)

 

 

 —

 

Net cash provided by (used in) financing activities

 

 

419,032

 

 

(2,716,610)

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash

 

 

40,259

 

 

(37,729)

 

 

 

 

 

 

 

 

 

Cash—Beginning of period

 

 

1,126,283

 

 

662,128

 

 

 

 

 

 

 

 

 

Cash—End of period

 

$

1,166,542

 

$

624,399

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

 

Interest expense

 

$

58,674

 

$

63,531

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Non-Cash Investing, Operating and Financing Activities

 

 

 

 

 

 

 

Capital expenditures and construction in process included in accounts payable

 

$

164,491

 

$

272,954

 

 

Notes to Condensed Consolidated Unaudited Financial Statements are an integral part of this Statement.

 

 

3


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2016

 

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation and Principles of Consolidation

 

The accompanying condensed consolidated unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations. These condensed consolidated unaudited financial statements and related notes should be read in conjunction with the financial statements and notes thereto included in the Company’s audited consolidated financial statements for the year ended October 31, 2015, contained in the Company’s annual report on Form 10-K.

 

In the opinion of management, the condensed consolidated unaudited financial statements reflect all adjustments consisting of normal recurring accruals that we consider necessary to present fairly the Company’s results of operations, financial position and cash flows. The results reported in these condensed consolidated unaudited financial statements should not be regarded as necessarily indicative of results that may be expected for any other quarter or for the fiscal year.

 

Nature of Business

 

The Company owns and operates an ethanol plan near the Heron Lake, Minnesota with a permitted capacity of approximately 72.3 million gallons per year of undenatured ethanol on a twelve month rolling sum basis.  In addition, the Company produces and sells distillers’ grains with solubles and corn oil as co-products of ethanol production.  Additionally, the Company, through a majority owned subsidiary, operates a natural gas pipeline that provides natural gas to the Company's ethanol production facility and other customers.

 

Principles of Consolidation

 

The condensed consolidated unaudited financial statements as of January 31,  2016 include the accounts of Heron Lake BioEnergy, LLC and its wholly owned subsidiary, HLBE Pipeline Company, LLC, collectively the Company. HLBE Pipeline Company, LLC owns 73% of Agrinatural Gas, LLC (Agrinatural). Given the Company’s control over the operations of Agrinatural and its majority voting interest, the Company consolidates the unaudited financial statements of Agrinatural with its consolidated unaudited financial statements, with the equity and earnings (loss) attributed to the remaining 27% noncontrolling interest identified separately in the accompanying condensed consolidated balance sheets and statements of operations.  All significant intercompany balances and transactions are eliminated in consolidation.

 

Accounting Estimates

 

Management uses estimates and assumptions in preparing these condensed consolidated unaudited financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses.  The Company uses estimates and assumptions in accounting for significant matters including, among others, the economic lives of property and equipment, the analysis of impairment of long-lived assets and valuation of commodity derivative instruments, inventory, and inventory purchase and sales commitments.  The Company periodically reviews estimates and assumptions, and the effects of revisions are reflected in the period in which the revision is made. Actual results could differ from those estimates.

 

Noncontrolling Interest

 

Amounts recorded as noncontrolling interest on the balance sheets relate to the net investment by an unrelated party in Agrinatural. Income and losses are allocated to the members of Agrinatural based on their respective percentage of membership units held. Agrinatural will provide natural gas to the plant with a specified price per MMBTU for an initial term of 5 years expiring October 31, 2016, with two automatic renewal options for five year periods.  On July 1, 2015, the Company entered into an amendment of its natural gas transportation agreement dated May 13, 2011 with Agrinatural, in which the Company agreed on an early exercise of one of the two automatic five-year term renewals thereby extending the term of the transportation agreement to October 31, 2021.

 

4


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2016

 

Revenue Recognition

 

The Company generally sells ethanol and related products pursuant to marketing agreements. Revenues from the production of ethanol and the related products are recorded when the customer has taken title and assumed the risks and rewards of ownership, prices are fixed or determinable and collectability is reasonably assured. Title is generally assumed by the buyer at the Company’s shipping point.

 

In accordance with the Company's agreements for the marketing and sale of ethanol and related products, marketing fees and commissions due to the marketers are deducted from the gross sales price as earned. These fees and commissions are recorded net of revenues as they do not provide an identifiable benefit that is sufficiently separable from the sale of ethanol and related products. Shipping costs incurred by the Company in the sale of ethanol are not specifically identifiable and as a result, are recorded based on the net selling price reported to the Company from the marketer. Shipping costs incurred by the Company in the sale of ethanol related products are included in cost of goods sold.

 

Inventory

 

Inventory is stated at the lower of cost or net realizable value in accordance with the Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2015-11 issued in July 2015.  Cost for all inventories is determined using the first in first out method (FIFO).  Net realizable value is the estimated selling prices in the ordinary course of business less reasonably predictable costs of completion, disposal, and transportation.  Inventory consists of raw materials, work in process, finished goods, and spare parts.  Corn is the primary raw material along with other raw materials.  Finished goods consist of ethanol, distillers' grains, and corn oil.

 

Correction Of An Immaterial Error

 

The Company revised the condensed consolidated unaudited statement of cash flows for the three months ended January 31, 2015, to correct for a non-cash acquisition of property and equipment resulting in an increase in cash provided by operating activities of approximately $3,359,225 and a corresponding decrease in net cash provided by investing activities.

 

 

2.RISKS AND UNCERTAINTIES

 

The Company has certain risks and uncertainties that it experiences during volatile market conditions. These volatilities can have a severe impact on operations. The Company’s revenues are derived from the sale and distribution of ethanol and distillers' grains to customers primarily located in the U.S. Corn for the production process is supplied to the plant primarily from local agricultural producers.  Ethanol sales average 75%-85% of total revenues and corn costs average 75%-90% of cost of goods sold.

 

The Company’s operating and financial performance is largely driven by the prices at which it sells ethanol and the net expense of corn. The price of ethanol is influenced by factors such as supply and demand, the weather, government policies and programs, unleaded gasoline prices and the petroleum markets as a whole. Excess ethanol supply in the market, in particular, puts downward pressure on the price of ethanol. The largest cost of production is corn. The cost of corn is generally impacted by factors such as supply and demand, the weather, government policies and programs, and a risk management program used to protect against the price volatility of these commodities. Market fluctuations in the price of and demand for these products may have a significant adverse effect on the Company’s operations, profitability and the availability and adequacy of cash flow to meet the Company’s working capital requirements.

 

5


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2016

 

3.INVENTORY

 

Inventory consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

January 31, 2016

 

 

October 31, 2015

 

 

    

 

(Unaudited)

    

 

 

 

Raw materials

 

$

1,279,422

 

$

1,800,320

 

Work in process

 

 

695,199

 

 

693,844

 

Finished Goods

 

 

2,652,533

 

 

1,829,311

 

Supplies

 

 

865,368

 

 

935,871

 

Totals

 

$

5,492,522

 

$

5,259,346

 

 

The Company performs a lower of cost or net realizable value analysis on inventory to determine if the market values of certain inventories are less than their carrying value, which is attributable primarily to decreases in market prices of corn and ethanol. Based on the lower of cost or net realizable value analysis, the Company recorded a loss on ethanol inventories of approximately $261,000 and $0 for the three month periods ended January 31, 2016 and 2015, respectively.

 

4.DERIVATIVE INSTRUMENTS

 

As of January 31,  2016, the total notional amount of the Company’s outstanding corn derivative instruments was approximately; 2,995,000 bushels, comprised of long corn positions on 500,000 bushels, and short corn positions on 2,455,000 bushels, that were entered into to hedge forecasted corn purchases through December 2016. There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding.

 

As of January 31, 2016, the total notional amount of the Company’s outstanding ethanol derivative instruments was approximately 840,000 gallons that were entered into to hedge forecasted ethanol sales through March 2016.

 

The following tables provide details regarding the Company’s derivative instruments at January 31,  2016, none of which are designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Balance Sheet Location

    

Assets

    

Liabilities

 

Corn contracts

 

Commodity derivative instruments

 

$

111,363

 

$

 —

 

Ethanol contracts

 

Commodity derivative instruments

 

 

14,875

 

 

 —

 

Totals

 

 

 

$

126,238

 

$

 —

 

 

As of October 31, 2015, the total notional amount of the Company's outstanding corn derivative instruments was approximately 1,875,000 bushels, comprised of long corn positions on 360,000 bushels, and short corn positions on 1,515,000 bushels, that were hedge forecasted corn purchases through July 2016.  

 

The following tables provide details regarding the Company’s derivative instruments at October 31, 2015, none of which are designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Balance Sheet Location

    

Assets

    

Liabilities

 

Corn contracts

 

Commodity derivative instruments

 

$

677,149

 

$

 —

 

 

The following tables provide details regarding the gains and (losses) from Company’s derivative instruments in its consolidated statements of operations, none of which are designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Statement of

    

Three Months Ended January 31,

 

 

    

Operations location

    

2016

    

2015

 

Corn contracts

 

Cost of goods sold

 

$

187,387

 

$

14,038

 

Ethanol contracts

 

Revenues

 

 

44,747

 

 

 —

 

Natural gas contracts

 

Cost of goods sold

 

 

21,550

 

 

 —

 

Totals

 

 

 

$

253,684

 

$

14,038

 

 

6


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2016

 

As of January 31,  2016, the Company had approximately $363,000 of cash collateral (restricted cash) related to corn derivatives held by a broker.  At October 31, 2015, the Company had no cash collateral (restricted cash) related to derivatives held by a broker.

 

 

5.FAIR VALUE

 

The following table provides information on those derivative assets measured at fair value on a recurring basis at January 31,  2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement Using

 

 

 

Carrying Amount

 

Quoted Prices in

 

Significant Other

 

Unobservable

 

 

 

 in Balance Sheet

 

Active Markets

 

Observable Inputs

 

inputs

 

Financial Assets

    

January 31, 2016

    

(Level 1)

    

(Level 2)

    

(Level 3)

 

Commodity Derivative instruments

 

$

126,238

 

$

126,238

 

$

 —

 

$

 —

 

 

The following table provides information on those derivative assets measured at fair value on a recurring basis at October 31, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement Using

 

 

 

 

 

 

 

 

 

Significant

 

 

 

Carrying Amount

 

Quoted Prices in

 

Significant Other

 

Unobservable

 

 

 

 in Balance Sheet

 

Active Markets

 

Observable Inputs

 

inputs

 

Financial Assets

    

October 31, 2015

    

(Level 1)

    

(Level 2)

    

(Level 3)

 

Commodity Derivative instruments

 

$

677,149

 

$

677,149

 

$

 —

 

$

 —

 

 

The Company determines the fair value of commodity derivative instruments by obtaining fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes and live trading levels from the Chicago Board of Trade market and New York Mercantile Exchange.

 

6.DEBT FINANCING

 

Debt financing consists of the following:

 

 

 

 

 

 

 

 

 

 

 

January 31, 2016

 

October 31, 2015

 

 

 

(unaudited)

 

 

 

Revolving term loan to lending institution, see terms below

 

$

5,776,421

 

$

4,822,777

 

Assessments payable

 

 

1,954,059

 

 

1,963,405

 

Note payable to electrical company

 

 

125,000

 

 

143,750

 

Note payable to noncontrolling interest member of Agrinatural

 

 

266,000

 

 

300,000

 

Total

 

 

8,121,480

 

 

7,229,932

 

Less amounts due within one year

 

 

584,674

 

 

517,957

 

Net long-term debt

 

$

7,536,806

 

$

6,711,975

 

 

Revolving Term Loan

 

The Company has a revolving term loan with a lender initially totaling $28,000,000.  Amounts borrowed by the Company under the revolving term loan and repaid or prepaid may be re-borrowed at any time prior to the March 1, 2022 maturity date.  Under the terms of the credit facility, the revolving term loan commitment declines by $3,500,000 annually, starting March 1, 2015 and continues each anniversary thereafter until maturity. Therefore, the amount available on this facility at January 31, 2016 was $24,500,000 and was reduced again at March 1, 2016 to $21,000,000.  Interest on the revolving term loan accrues at a variable rate equal to 3.25% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate. The Company may elect to enter into a fixed interest rate on this loan at various times throughout the term of the loan as provided in the loan agreements. The Company also agreed to pay an unused commitment fee on

7


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2016

 

the unused portion of the revolving term loan commitment at the rate of 0.50% per annum. The revolving term loan is subject to a prepayment fee for any prepayment on the term loan prior to July 1, 2016 due to refinancing. The credit facility contains customary covenants.  The loan is secured by substantially all of the Company assets including a subsidiary guarantee.  The outstanding balance on the revolving term loan totaled approximately $5,776,000 and $4,823,000 at January 31,  2016, and October 31, 2015, respectively.  The interest rate on the revolving term loan was 3.69% and 3.45% at January 31,  2016, and October 31, 2015, respectively.

 

As part of the credit facility closing, the Company entered into an administrative agency agreement with CoBank, ACP (“CoBank”).  CoBank purchased a participation interest in the AgStar loans and was appointed the administrative agent for the purpose of servicing the loans.  As a result, CoBank will act as the agent for AgStar with respect to the credit facility.

 

In October 2003, the Company entered into an industrial water supply development and distribution agreement with the City of Heron Lake, Jackson County, and Minnesota Soybean Processors. In consideration of this agreement, the Company and Minnesota Soybean Processors are allocated equally the debt service on $735,000 in water revenue bonds that were issued by the City to support this project that mature in February 2019. The parties have agreed that prior to the scheduled expiration of the agreement, they will negotiate in good faith to replace the agreement with a further agreement regarding the wells and related facilities. In May 2006, the Company entered into an industrial water supply treatment agreement with the City of Heron Lake and Jackson County. Under this agreement, the Company pays monthly installments over 24 months starting January 1, 2007 equal to one years' debt service on approximately $3.6 million in water revenue bonds, which will be returned to the Company if any funds remain after final payment in full on the bonds and assuming we comply with all payment obligations under the agreement. As of January 31,  2016 and October 31, 2015, there was a total of approximately $1,954,000 and $1,963,000, respectively, in outstanding water revenue bonds. The Company classifies its obligations under these bonds as assessments payable. The interest rates on the bonds range from 0.50% to 8.73%.

 

Estimated annual maturities of debt at January 31,  2016 are as follows based on the most recent debt agreements:

 

 

 

 

 

 

2016

    

$

584,674

 

2017

 

 

462,086

 

2018

 

 

333,015

 

2019

 

 

307,709

 

2020

 

 

326,798

 

After 2020

 

 

6,107,198

 

Total debt

 

$

8,121,480

 

 

 

7.COMMITMENTS AND CONTINGENCIES

 

Forward Contracts

 

At January 31,  2016, the Company had cash and basis contracts for forward corn purchase commitments for approximately 4,597,000 bushels for deliveries through December 2016.

 

At January 31,  2016, the Company had forward contracts to sell approximately $2,100,000 of ethanol for various delivery periods from February 2016 through March 2016 which approximates 15% of its anticipated ethanol sales during that period.

 

At January 31,  2016, the Company had forward contracts to sell approximately $95,000 of distillers' grains for delivery through February 2016.

 

At January 31, 2016, the Company had forward contracts to sell approximately $391,000 of corn oil for delivery through May 2016.

 

Construction in Progress

 

8


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2016

 

On July 31, 2015, the Company placed a purchase order with an unrelated party for a new regenerative thermal oxidizer and made a down payment on the equipment of approximately $375,000 to secure the order.  The total commitment approximates $1,900,000 and is expected to be completed during the latter part of fiscal year 2016.

 

 

8.MEMBERS’ EQUITY

 

The Company is authorized to issue 80,000,000 capital units, of which 65,000,000 have been designated Class A units and 15,000,000 have been designated as Class B units. Members of the Company are holders of units who have been admitted as members and who hold at least 2,500 units. Any holder of units who is not a member will not have voting rights. Transferees of units must be approved by our Board of Governors to become members. Members are entitled to one vote for each unit held. Subject to the Member Control Agreement, all units share equally in the profits and losses and distributions of assets on a per unit basis.

 

The Company has a total of 62,932,107 Class A units and 15,000,000 Class B units issued and outstanding, for an aggregate total of 77,932,107 units issued and outstanding at both January 31, 2016 and October 31, 2015.

 

In December 2015, the Board of Governors declared a cash distribution of $0.05 per unit, or approximately $3,897,000. The distribution was paid in January 2016.

 

In December 2014, the Board of Governors declared a cash distribution of $0.12 per unit, or approximately $9,352,000. The distribution was paid in January 2015. 

 

9.LEASES

 

The Company leases equipment, primarily rail cars, under operating leases through 2017.  Rent expense for these leases was approximately $533,000 and $519,000 for the three months ended January 31,  2016 and 2015, respectively.

 

 

 

10.RELATED PARTY TRANSACTIONS

 

On March 27, 2015, Agrinatural executed a new management and operating agreement with Swan Engineering, Inc. ("SEI"). SEI, together with an unrelated third party owns Rural Energy Solutions, LLC ("RES"), the 27% minority owner of Agrinatural. Under the new management and operating agreement, SEI will continue to provide Agrinatural with day-to-day management and operation of Agrinatural's pipeline distribution business. In exchange for these services, Agrinatural will pay SEI an aggregate management fee equal to the fixed monthly base fee plus the variable customer management fee based on the number of customers served on the pipeline less the agreed monthly fee reduction of $4,500. The Company paid approximately $44,000 and $56,000 for the monthly base fee and variable customer management fee, for the three month periods ended January 31, 2016 and 2015, respectively. The new management and operating agreement with SEI expires July 1, 2019, unless earlier terminated for cause as defined in the agreement.

 

On March 27, 2015, Agrinatural also executed a new project management agreement with SEI. Pursuant to the new project management agreement, SEI will continue to supervise all of Agrinatural's pipeline construction projects. These projects are constructed by unrelated third-party pipeline construction companies. Under the new project management agreement, Agrinatural will pay SEI a total of 10% of the actual capital expenditures for construction projects approved by Agrinatural's Board of Directors, excluding capitalized marketing costs. The Company recorded approximately $1,000 and $37,000 for the project management fees for the three month periods ended January 31, 2016 and 2015, respectively. The new project management with SEI expires June 30, 2019, unless earlier terminated for cause as defined in the agreement.

 

 

9


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2016

 

11.BUSINESS SEGMENTS

 

Based on the growth of the Company’s natural gas pipeline subsidiary during the fourth quarter of fiscal 2014, the Company has determined they have two operating segments. The Company groups its operations into the following two business segments:

 

 

 

Ethanol Production

Ethanol and co-product production and sales

Natural gas pipeline

Ownership and operations of natural gas pipeline

 

Segment reporting is intended to give financial statement users a better view of how the Company manages and evaluates its businesses.   The accounting policies for each segment are the same as those described in the summary of significant accounting policies. Segment income or loss does not include any allocation of shared-service costs.  Segment assets are those that are directly used in or identified with segment operations. Inter-segment balances and transactions have been eliminated.

 

The following tables summarize financial information by segment and provide a reconciliation of segment revenue, contribution to operating income, and total assets:

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Three Months Ended

 

 

 

January 31, 2016

 

January 31, 2015

 

Revenue:

    

(Unaudited)

    

(Unaudited)

 

Ethanol production

 

$

26,248,829

 

$

26,813,093

 

Natural gas pipeline

 

 

788,959

 

 

816,562

 

Eliminations

 

 

(449,223)

 

 

(452,206)

 

Total Revenue

 

$

26,588,565

 

$

27,177,449

 

 

 

 

 

 

 

 

 

 

 

Operating Income (Loss):

 

 

 

 

 

 

 

Ethanol production

    

$

(332,118)

    

$

678,513

 

Natural gas pipeline

 

 

496,692

 

 

404,550

 

Eliminations

 

 

(115,627)

 

 

(116,395)

 

Operating Income

 

$

48,947

 

$

966,668

 

 

 

 

 

 

 

 

 

 

 

 

 

 

January 31, 2016

 

 

October 31, 2015

 

Total Assets:

    

 

(Unaudited)

    

 

 

 

Ethanol production

 

$

52,691,207

 

$

53,663,064

 

Natural gas pipeline

 

 

12,691,396

 

 

13,033,320

 

Total assets

 

$

65,382,603

 

$

66,696,384

 

 

 

 

 

10


 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

We prepared the following discussion and analysis to help readers better understand our financial condition, changes in our financial condition, and results of operations for the three months ended January 31, 2016, compared to the same periods of the prior fiscal year.  This section should be read in conjunction with the condensed consolidated unaudited financial statements and related notes in PART I - Item 1 of this report and the Company’s annual report on Form 10-K for the fiscal year ended October 31, 2015.

 

Disclosure Regarding Forward-Looking Statements

 

The SEC encourages companies to disclose forward-looking information so investors can better understand future prospects and make informed investment decisions. As such, we have historical information, as well as forward-looking statements regarding our business, financial condition, results of operations, performance and prospects in this report.  All statements that are not historical or current facts are forward-looking statements. In some cases,  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. 

 

Forward-looking statements are subject to a number of known and unknown risks, uncertainties and other factors, many of which may be beyond our control, and may cause actual results, performance or achievements to differ materially from those projected in, expressed or implied by forward-looking statements. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us are described more particularly in the “Risk Factors” section of our annual report on Form 10-K for the year ended October 31, 2015 and of this report on Form 10-Q. These risks and uncertainties include, but are not limited to, the following:

·

Reductions or eliminations in the corn-based ethanol use requirement in the federal Renewable Fuels Standard (“RFS”);

·

Lower distillers grains prices which result from the Chinese antidumping investigation;

·

Ethanol may trade at a premium to gasoline at times, causing a disincentive for discretionary blending of ethanol beyond the rates required to comply with the RFS.  Consequently, there may be a negative impact on ethanol pricing and demand;

·

Fluctuations in the price of crude oil and gasoline;

·

Changes in the availability and price of corn and natural gas;

·

Our operating margins have fluctuated in the past and could become negative due to spread between the selling price of our products and our raw material costs;

·

Our plant may experience technical difficulties and not produce the gallons of ethanol expected;

·

Negative impacts that our hedging activities may have on our operations;

·

Ethanol and distiller grains supply exceeding demand and corresponding price reductions;

·

Our ability to generate free cash flow to fund our operations, invest in our business and service our debt;

·

Changes in the environmental regulations or our ability to comply with with the environmental regulations that apply to our plant and our operations;

·

Changes in our business strategy, capital improvements or development plans;

·

Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;

·

Lack of transport, storage and blending infrastructure preventing our products from reaching high demand markets;

·

Changes in federal and/or state laws, including changes in legislation benefiting renewable fuels;

·

Competition from alternative fuels and alternative fuel additives;

·

Changes in interest rates or the lack of credit availability; and

·

Changes and advances in ethanol production technology.

 

11


 

We believe our expectations regarding future events are based on reasonable assumptions; however, these assumptions may not be accurate or account for all risks and uncertainties. Consequently, forward-looking statements are not guaranteed. Actual results may vary materially from those expressed or implied in our forward-looking statements. In addition, we are not obligated and do not intend to update our forward-looking statements as a result of new information unless it is required by applicable securities laws. We caution investors not to place undue reliance on forward-looking statements, which represent management’s views as of the date of this report. We qualify all of our forward-looking statements by these cautionary statements.

 

Industry and Market Data

 

Much of the information in this report regarding the ethanol industry, including government regulation relevant to the industry is from information published by the Renewable Fuels Association (RFA), a national trade association for the United States ethanol industry, and information about the market for our products and competition is derived from publicly available information from governmental agencies or publications and other published independent sources.   Although we believe our third-party sources are reliable, we have not independently verified the information.

 

Available Information

 

Our website address is www.heronlakebioenergy.com.  Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are available, free of charge, on our website under the link “SEC Filings”, as soon as reasonably practicable after we electronically file such materials with, or furnish such materials to, the Securities and Exchange Commission. The contents of our website are not incorporated by reference in this report on Form 10-Q.

 

Overview

 

Heron Lake BioEnergy, LLC is a Minnesota limited liability company that owns and operates a dry mill corn-based, natural gas fired ethanol plant near Heron Lake, Minnesota. References to “we”, “us”, “our”, “Heron Lake BioEnergy”, “HLBE”, and the “Company” refer to Heron Lake BioEnergy, LLC.  Our business consists of the production and sale of our ethanol throughout the continental United States and sale of its co-products (wet, modified wet and dried distillers’ grains, corn oil and corn syrup) locally, and throughout the continental United States.  Additionally, our business includes natural gas pipeline operations, natural gas pipeline distribution and services through the Company's majority owned subsidiary, Agrinatural Gas, LLC (“Agrinatural”).

 

Reportable Operating Segments

 

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.  Based on the nature of the products, services and operations and the expected financial results, we review our operations within the following two separate operating segments: (1) ethanol production; and (2) natural gas pipeline operations. We currently do not have or anticipate we will have any other lines of business or other significant sources of revenue other than the sale of ethanol, distillers' grains, corn oil and natural gas transportation.  Refer to Note 11, “Business Segments”, of the notes to the condensed consolidated unaudited financial statements for financial information about our financial reporting segments.

 

Ethanol Production

 

Our primary line of business is the Company’s operation of its ethanol plant, including the production and sale of ethanol and its co-products (wet, modified wet, and dried distillers' grains, non-edible corn oil and corn syrup).  These operations are aggregated into one financial reporting segment. 

 

Our ethanol plant has a nameplate capacity of 50 million gallons per year and our permitted production capacity is approximately 72.3 million gallons of undenatured fuel-grade ethanol on a twelve-month rolling sum basis.  We are currently operating above our stated nameplate capacity and intend to continue to do into the near future, taking advantage of the additional production allowed pursuant to our permit, as long as we believe it is profitable to do so.

 

12


 

We market and sell our products primarily using third party marketers. The markets in which our products are sold may be local, regional, national, and international and depend primarily upon the efforts of third party marketers. We have contracted with Eco-Energy, LLC to market all of our ethanol, Gavilon Ingredients, LLC to market our distillers' grains, and Renewable Products Marketing Group, LLC to market our corn oil.  We also occasionally independently market and sell excess corn syrup from the distillation process to local livestock feeders. 

 

Our cost of our goods sold consists primarily of costs relating to the corn and natural gas supplies necessary to produce ethanol and distillers' grains for sale at our ethanol plant. We generally do not have long-term, fixed price contracts for the purchase of corn. Typically, we purchase our corn directly from grain elevators, farmers, and local dealers within approximately 80 miles of Heron Lake, Minnesota.

 

We have a facilities agreement with Northern Border Pipeline Company, which allows us access to an existing interstate natural gas pipeline located approximately 17 miles north from our plant. We have entered into a firm natural gas transportation agreement with Agrinatural, our majority owned subsidiary. We also have an agreement with Constellation NewEnergy—Gas Division, LLC to supply the natural gas necessary to operate our plant.

 

Natural Gas Pipeline

 

We own a controlling 73% interest in Agrinatural, which is a natural gas distribution and sales company located in Heron Lake, Minnesota.  Agrinatural owns approximately 187 miles of natural gas pipeline and provides natural gas to the Company's ethanol plant and other commercial, agricultural and residential customers through a connection with the natural gas pipeline facilities of Northern Border Pipeline Company.  Agrinatural's revenues are generated through natural gas distribution fees and sales.  The operations of Agrinatural's natural gas pipeline are aggregated into a separate financial reporting segment.

 

The Company has entered into two intercompany credit facilities with Agrinatural. Under these credit facilities, the Company agreed to make a five-year term loan in the principal amount of $3.05 million and a four-year term loan in the principal amount of $3.5 million to Agrinatural. Details of the Agrinatural credit facilities are provided below in the section below entitled “PART I - Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources; Indebtedness”.

 

During the normal course of business, the Company enters into transactions between its two operating segments as a result of the Company's firm natural gas transportation agreement with Agrinatural. These intersegment activities are recorded by each segment at prices approximating market and treated as if they are third-party transactions. Consequently, these transactions impact segment performance. However, the revenues and corresponding costs are eliminated in consolidation and do not impact the Company’s unaudited condensed consolidated results.

 

Plan of Operations for the Next Twelve Months

 

Over the next twelve months, we will continue our focus on operational improvements at our ethanol plant. These operational improvements include exploring methods to improve ethanol yield per bushel and increasing production output at our plant to take full advantage of our permitted production capacity, reducing our operating costs, and optimizing our margin opportunities through prudent risk-management policies.

 

We expect to have sufficient cash generated by continuing operations and availability on our credit facility to fund our operations.  However, should we experience unfavorable operating conditions in the ethanol industry that prevent us from profitably operating our plant, we may need to seek additional funding.

 

Several upscaling projects will be required to increase to increase the plant's current production capacity. One such project includes replacing our existing regenerative thermal oxidizer (“RTO”).  We estimate that the total capital commitment for the new RTO will be approximately $1.9 million. Once installed, the new RTO will improve emissions control and allow us to continue to maintain applicable regulatory compliance.  We expect completion of this project during the latter part of fiscal year 2016.

 

13


 

In addition, we anticipate continuing to conduct routine maintenance and repair activities at the ethanol plant. We anticipate using cash we generate from our operations and our revolving term loan to finance these plant upgrade projects. Our RTO replacement project is being funded from current earnings from operations and we do not expect that we require additional capital to fund this project.

 

Trends and Uncertainties Impacting Our Operations

 

Our results of operation are affected and will continue to be affected by factors such as (a) volatile and uncertain commodity prices, especially prices for corn, ethanol, distillers' grains and natural gas; (b) availability of corn that is, in turn, affected by trends such as corn acreage, weather conditions, and yields on existing and new acreage diverted from other crops; and (c) the supply and demand for ethanol, which is affected by acceptance of ethanol as a substitute for fuel, public perception of the ethanol industry, government incentives and regulation, and competition from new and existing construction, among other things.  Management anticipates that ethanol prices will continue to change in relation to changes in corn and energy prices and that declining crude oil prices, as well as proposed decreases in the renewable fuel standard volume obligations, will have a significant impact on the market price of ethanol and our profitability over the next twelve months.

 

The Renewable Fuels Standard

 

The RFS has been, and we expect will continue to be, a significant factor impacting ethanol usage.  The RFS is a national program that does not require that any renewable fuels be used in any particular area or state, allowing refiners to use renewable fuel blends in those areas where it is most cost-effective. Under the RFS, the Environmental Protection Agency (“EPA”) is supposed to pass an annual rule that establishes the number of gallons of different types of renewable fuels that must be used in the United States which is called the renewable volume obligations (RVOs). On November 30, 2015, the EPA released the long-delayed final renewable volume obligations for corn-based ethanol for 2014 through 2016. The final RVO’s for corn-based ethanol blending for 2016 are 14.5 billion gallons,  well below the original statutory blending requirements of 15 billion gallons set by the RFS and the current annual U.S. corn-based ethanol production capacity 15.1 billion gallons. Many in the ethanol industry believe EPAs reduction of RVOs from the statutory requirements is not supported by the law and will have a significant negative impact on the ethanol industry. Management anticipates that there will be legal challenges to the EPA's final renewable volume obligation release.

 

Beyond the federal mandates, there are limited markets for ethanol. Further, opponents of ethanol such as large oil companies will likely continue their efforts to repeal or reduce the RFS through lawsuits or lobbying of Congress. If such efforts are successful in further reducing or repealing the blending requirements of the RFS, a significant decrease in ethanol demand may result and could have a material adverse effect on our results of operations, cash flows and financial condition, unless additional demand from exports or discretionary or E85 blending develops.

 

Environmental and Other Regulations

 

Our business subjects us to various federal, state, and local environmental laws and regulations.  These laws and regulations require us to obtain and comply with numerous permits to construct and operate our ethanol plant, including water, air and other environmental permits. Although we have been successful in obtaining all of the permits currently required, any retroactive change in environmental regulations, either at the federal or state level, could require us to obtain additional or new permits or spend considerable resources in complying with such regulations. Additionally, any changes that are made to the ethanol plant or its operations must be reviewed to determine if amended permits need to be obtained in order to implement these changes.

 

In particular, the Minnesota Pollution Control Agency (“MPCA”) has issued an air emission permit that established the applicable limits for each type of emission generated by our plant.  On July 10, 2015, MPCA approved a major amendment to our air emission permit which increased our permitted production capacity from 59.9 million gallons to approximately 72.3 million gallons of undenatured fuel-grade ethanol on a twelve-month rolling sum basis. In addition to increasing our permitted capacity, the amendment also authorized equipment flexibility for various facility processes and increased various emission limits to accommodate the increase in ethanol production capacity, amongth other changes.  However, in connection with RTO replacement project, we expect to file an application for an amendment of our air emissions permit with the MPCA in the near term to allow for the replacement under our current permit.  We may incur additional costs related to ensure compliance with our permit once amended. 

 

14


 

Other factors that may affect our future results of operation include those risks discussed below and in “PART II - Item 1A. Risk Factors” of this report and “PART I -  Item 1. Business” and “PART I - Item 1A. Risk Factors” of our annual report on Form 10-K for the fiscal year ended October 31, 2015.

 

Results of Operations for the Three Months Ended January 31, 2016 and 2015

 

The following table shows summary information from the results of our operations and the approximate percentage of revenues, costs of goods sold, operating expenses and other items to total revenues in our unaudited condensed consolidated statements of operations for the three months ended January 31, 2016 and 2015.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31, 2016

 

 

 

 

 

Three Months Ended January 31, 2015

 

 

 

Income Statement Data

    

 

(Unaudited)

    

%

 

 

(Unaudited)

    

%

Revenues

 

$

26,588,565

 

100.0

%  

 

$

27,177,449

 

100.0

%

Cost of Goods Sold

 

 

25,730,984

 

96.8

%  

 

 

25,330,399

 

93.2

%

Gross Profit

 

 

857,581

 

3.2

%  

 

 

1,847,050

 

6.8

%

Operating Expenses

 

 

808,634

 

3.0

%  

 

 

880,382

 

3.2

%

Operating Income

 

 

48,947

 

0.2

%  

 

 

966,668

 

3.6

%

Other Income (Expense), net

 

 

9,257

 

0.0

%  

 

 

(23,815)

 

(0.1)

%

Net Income

 

 

58,204

 

0.2

%  

 

 

942,853

 

3.5

%

Less: Net Income Attributable to Noncontrolling Interest

 

 

(83,759)

 

(0.3)

%  

 

 

(63,597)

 

(0.2)

%

Net Income (Loss) Attributable to Heron Lake BioEnergy, LLC

 

$

(25,555)

 

(0.1)

%  

 

$

879,256

 

3.3

%

 

Revenues

 

Revenues from our ethanol production segment represented approximately 77.9% of our total revenues for the three months ended January 31, 2016 and 2015.  Revenues from our ethanol production segment derive primarily from three sources: sales of fuel ethanol, sales of distillers' grains and sales of corn oil.  The remaining revenues from ethanol production are attributable to sales of corn syrup. 

 

Before intercompany eliminations, revenues from our natural gas pipeline segment represented approximately 3.0% of our total consolidated revenues for the three months ended January 31, 2016 and 2015.  After accounting for intercompany eliminations for distribution fees paid by the Company to Agrinatural for natural gas transportation services, Agrinatural's revenues represented 1.3% of our consolidated revenues for the three months ended January 31, 2016 and January 31, 2015.

 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our unaudited condensed consolidated statements of operations for the three months ended January 31, 2016:

 

 

 

 

 

 

 

 

 

    

Amount

    

% of Total Revenues

 

Ethanol sales

 

$

20,702,483

 

77.9

%

Distillers' grains sales

 

 

4,306,000

 

16.2

%

Corn oil sales

 

 

1,042,431

 

3.9

%

Corn syrup sales

 

 

197,915

 

0.7

%

Agrinatural revenues (net of intercompany eliminations)

 

 

339,736

 

1.3

%

Total Revenues

 

$

26,588,565

 

100.0

%

 

15


 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our unaudited condensed consolidated statements of operations for the three months ended January 31, 2015:

 

 

 

 

 

 

 

 

 

    

Amount

    

% of Total Revenues

 

Ethanol sales

 

$

21,750,167

 

80.0

%

Distillers' grains sales

 

 

4,283,575

 

15.8

%

Corn oil sales

 

 

645,036

 

2.4

%

Corn syrup sales

 

 

134,315

 

0.5

%

Agrinatural revenues (net of intercompany eliminations)

 

 

364,356

 

1.3

%

Total Revenues

 

$

27,177,449

 

100.00

%

 

Revenues decreased by 2.2% for the three months ended January 31, 2016 as compared to the three months ended January 31, 2015 due primarily to decreases in the average prices received for our ethanol and distillers' grains, despite increases in the total volumes of ethanol and tons of distillers' grains sold.

 

Ethanol

 

The average price per gallon we received for our ethanol was approximately 17.3% lower for the quarter ended January 31, 2016 as compared to the quarter ended January 31, 2015.  This decrease was partially offset by an increase of approximately 15.1% in the number of gallons sold during the three months ended January 31, 2016 as compared to the three months ended January 31, 2015 which was due to increased production in the current period.  We produced and sold more ethanol gallons during three months ended January 31, 2016 as compared to the same period of 2015 primarily due to system pressure fluctuations we experienced during the first half of the quarter ended January 31, 2015 which impacted our ability to maintain production rates during the 2015 period.

 

The decline in average market price for the three months ended January 31, 2016, as compared to the three months ended January 31, 2015, is due to several factors.  Industry-wide production outpaced domestic consumption and net exports during the quarter causing an increase in domestic ethanol stocks resulting in lower ethanol prices. In addition, ethanol prices were also depressed by lower unleaded gasoline and crude oil prices as well as lower corn prices. The reduction of the volume obligations set forth in the RFS by the EPA in November 2015 also had a negative effect on ethanol prices. 

 

Management anticipates that ethanol prices will continue to change in relation to changes in corn and energy prices. In addition, management anticipates that ethanol prices will remain lower during our 2016 fiscal year due to anticipated low crude oil and unleaded gasoline prices. Continued low prices or further declines in the crude oil and unleaded gasoline markets could have a significant negative impact on the market price of ethanol and our profitability particularly if domestic ethanol stocks remain high or further increase.

 

Ethanol exports have provided some support for ethanol prices, especially as ethanol prices have been reduced.  However, we could experience a decrease in U.S. ethanol exports due to the premium on the price of ethanol as compared to unleaded gasoline. As a result, ethanol exports may decrease which may contribute to growth in domestic ethanol stocks and a decrease in U.S. domestic ethanol prices unless additional demand from domestic discretionary blending or other foreign markets develop.  The EPA's reduction of the RVOs set forth in the RFS may limit demand for ethanol beyond obligated blending requirements negatively impacting ethanol prices throughout 2016 and potentially after that time. Operating conditions deteriorated towards the end of 2015 fiscal year and through our first fiscal quarter.  Management expects margins will remain tight through fiscal year 2016 and possibly negative at times during our second fiscal quarter which could have a material adverse effect on our results of operations, cash flows and financial condition.

 

Management anticipates that our ethanol production during our 2016 fiscal year will be higher than during our 2015 fiscal year due to increased permitted production capacity and capital improvement projects we have been undertaking designed to increase our production capacity. However, if the ethanol industry experiences unfavorable operating margins during our 2016 fiscal year, it is possible that we may be forced to reduce production based on these market conditions.

 

From time to time, we engage in hedging activities with respect to our ethanol sales. At January 31, 2016, we had approximately 840,000 gallons of ethanol derivative instruments. These ethanol derivative instruments resulted in a gain

16


 

of approximately $45,000 during the three months ended January 31, 2016, which increased our revenue.  We had no gain or loss on ethanol derivative instruments during the three months ended January 31, 2015.

 

Distillers’ Grains

 

Total sales of distillers’ grains during the three months ended January 31, 2016 were relatively unchanged, increasing by only approximately 0.5%, compared to distillers’ grains sales during the three months ended January 31, 2015.  This slight increase in distillers' grains revenues is primarily attributable to an approximately 5.1% increase in the tons of distillers’ grains sold during the three months ended January 31, 2016 as compared to the same period in 2015.  We produced and sold more total tons of distillers grains during the three months ended January 31, 2016 compared to the same period of 2015 due to increased total production during the first quarter of our 2016 fiscal year. This increase in tons sold from period to period was a result of our increased production capcity during the three months ended January 31, 2016 as well as the system pressure fluctuations we experienced during the three months ended January 31, 2015 discussed above. Since distillers grains are a co-product of the ethanol production process, when our ethanol production increases, our distillers grains production increases as well.

 

The effect of the increase in total tons sold was partially offset by an approximately 4.4% decrease in the average distillers’ grains price for the quarter ended January 31, 2016 as compared to the quarter ended January 31, 2015.  The price decline was due primarily to increased corn and soybeans supplies, which resulted lower market corn and soybean meal prices during the three months ended January 31, 2016. Since distillers grain are primarily used as an animal feed substitute for corn and soybean meal, the price of distillers grain is impacted by these competing products.    Management anticipates continued lower corn and soybean prices which may result in continued low or declining distillers grain prices.

 

In addition, management anticipates distillers’ grains prices will be lower during the remainder of our 2016 fiscal year as a result of the Chinese antidumping and countervailing duty investigation.  This investigation may lead to a decrease in distillers’ grains exports to China in the near term and may result in the imposition of tariffs by the Chinese in the future. This antidumping and countervailing duty investigation could significantly decrease demand and prices for distillers grains produced in the United States. This potential reduction in demand along with lower domestic corn prices could result in excess distillers’ grains supplies in the United States and could negatively impact our results of operations. 

 

Corn Oil

 

Total corn oil sales for the three months ended January 31, 2016 were up 98.5% compared to total corn oil sales for the same period in 2015.  Management attributes this increase to an 86.9% increase in the volume of corn oil sold for the three months ended January 31, 2016 compared to the same period in 2015, which was partially offset by 18.6% reduction in corn oil prices.  The increase in pounds sold from period to period was a result of our increased production capcity during the three months ended January 31, 2016, and increased corn oil extraction efficiencies. Management anticipates that our corn oil production will continue to be higher during our 2016 fiscal year compared to our 2015 fiscal year.

 

Corn oil prices have been impacted by oversupply and lower soybean oil prices, a product that typically competes with corn oil, particularly for biodiesel production. Biodiesel production is a major source of corn oil demand.  Management anticipates corn oil prices may rebound during our 2016 fiscal year since the biodiesel blenders tax credit was renewed for 2016 which may lead to increased biodiesel production and increased corn oil prices. However, management believes that corn oil production capacity still exceeds demand which may continue to negatively impact corn oil prices. Unless additional demand can be created, management anticipates continued lower corn oil prices during our 2016 fiscal year.

 

Cost of Goods Sold

 

Our costs of goods sold include, among other things, the cost of corn and natural gas (which are the two largest single components of costs of goods sold), as well as processing ingredients, electricity, and wages, salaries and benefits of production personnel.

 

17


 

The following table shows the costs of corn and natural gas and the approximate percentage of costs of those components to total costs of goods sold in our unaudited condensed consolidated statements of operations for the three months ended January 31, 2016:

 

 

 

 

 

 

 

 

 

    

 

Amount

    

% of Cost of Goods Sold

 

Corn costs

 

$

20,309,596

 

79.0

%

Natural gas costs

 

 

1,399,146

 

5.4

%

All other components of costs of goods sold

 

 

4,022,242

 

15.6

%

Total Cost of Goods Sold

 

$

25,730,984

 

100.0

%

 

The following table shows the costs of corn and natural gas and the approximate percentage of costs of those components to total costs of goods sold in our unaudited condensed consolidated statements of operations for the three months ended January 31, 2015:

 

 

 

 

 

 

 

 

 

    

 

Amount

    

% of Cost of Goods Sold

 

Corn costs

 

$

19,688,222

 

77.7

%

Natural gas costs

 

 

2,270,114

 

9.0

%

All other components of costs of goods sold

 

 

3,372,063

 

13.3

%

Total Cost of Goods Sold

 

$

25,330,399

 

100.0

%

 

Our cost of goods sold increased slightly by 1.6% for the three months ended January 31, 2016 as compared to the three months ended January 31, 2015.  Additionally, cost of goods sold as a percentage of revenues increased for the three month period ended January 31, 2016 compared the same period of 2015 due to the narrowing of the margin between the price of ethanol and the price of corn.

 

Corn

 

Our cost of goods sold related to corn was 3.2% more for the three months ended January 31, 2016 compared to the same period of 2015 because we consumed approximately 7.9% more bushels of corn during the three months ended January 31, 2016.  This increase in the total volume of corn we processed was offset by a slight decrease in the average price per bushel we paid the three months ended January 31, 2016 as compared to the three months ended January 31, 2015.  The decrease in corn prices was primarily driven by the strong corn harvest in the fall of 2015 resulting in a significant increase in the supply of corn available to the market. Management anticipates that corn prices will remain relatively stable during our 2016 fiscal year due to ample corn supplies and relatively stable corn demand. These lower corn prices could impact the amount of corn which is planted during 2016 which could result in higher corn prices later in our 2016 fiscal year.

 

From time to time we enter into forward purchase contracts for our commodity purchases and sales. At January 31, 2016, we had forward corn purchase contracts for various delivery periods through December 2016 for a total commitment of approximately $3.1 million. Our corn derivative positions resulted in gains of approximately $187,000 for the three months ended January 31, 2016, which decreased cost of goods sold, compared to gains of approximately $14,000 related to corn derivative instruments for the same period of 2015.  We recognize the gains or losses that result from the changes in the value of our derivative instruments from corn in cost of goods sold as the changes occur.  As corn prices fluctuate, the value of our derivative instruments are impacted, which affects our financial performance.  We anticipate continued volatility in our cost of goods sold due to the timing of the changes in value of the derivative instruments relative to the cost and use of the commodity being hedged. 

 

18


 

Natural Gas

 

Natural gas costs decreased 38.4% for the three months ended January 31, 2016 as compared to the three months ended January 31, 2015. The decrease in natural gas costs was due to plentiful supply, resulting in lower natural gas prices for the three months ended January 31, 2016 as compared to the three months ended January 31, 2015.  Additionally, winter was milder, resulting in lower natural gas demand during the three months ended January 31, 2016 as compared to the same period of 2015.  Management anticipates that natural gas prices will continue to hold steady, unless there are major supply disruptions due to production problems or catastrophic weather events, as natural gas production has replenished stock shortages from last year and is currently exceeding demand.

 

Our natural gas derivative positions resulted in a gain of approximately $22,000 during the three months ended January 31, 2016, which decreased our cost of goods sold. In comparision, we had no gain or loss on natural gas derivative instruments during the three months ended January 31, 2015.

 

Operating Expenses

 

Operating expenses include wages, salaries and benefits of administrative employees at the plant, insurance, professional fees and similar costs.  Operating expenses for the three months ended January 31, 2016 decreased 8.1% compared to the three months ended January 31, 2015.  However, due to the decrease in total revenues, operating expenses, as a percentage of total revenues, remained relatively unchanged from period to period, at 3.0% for the three months ended January 31, 2016, as compared to 3.2% for three months ended January 31, 2015.  Although we are focused on increasing operating efficiencies, these expenses generally do not vary with the level of production at the plant.  We expect that going forward our operating expenses will remain relatively steady.

 

Operating Income

 

Our income from operations for the three months ended January 31, 2016 was approximately $49,000 compared to approximately $967,000 for the same period 2015.  This decrease resulted largely from decreased prices for our ethanol and its co-products and the narrowing of our net operating margin.

 

Other Income (Expense), Net

 

We had other income, net of approximately $9,000 during the three months ended January 31, 2016 compared to other expense, net of approximately $24,000 the three months ended January 31, 2015We had more other income during the three months ended January 31, 2016 compared to the three months ended January 31, 2015 due to miscellaneous other revenue. Additionally, we had a minimal amount of interest income for the three months ended January 31, 2016 compared to no interest income for the three months ended January 31, 2015 due to having slightly more cash on hand during the 2016 period. We also had more interest expense during the three months ended January 31, 2016 compared to the three months ended January 31, 2015 because we had more borrowings on our credit facilities.

 

Changes in Financial Condition at January 31, 2016

 

The following table highlights our financial condition at January 31, 2016 and October 31, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

January 31, 2016

 

 

October 31, 2015

 

 

    

 

(Unaudited)

    

 

 

 

Current Assets

 

$

12,230,133

 

$

12,892,432

 

Total Assets

 

$

65,382,603

 

$

66,696,384

 

Current Liabilities

 

$

8,236,889

 

$

6,456,103

 

Long-Term Debt

 

$

7,536,806

 

$

6,711,975

 

Members' Equity attributable to Heron Lake BioEnergy, LLC

 

$

48,524,340

 

$

52,446,500

 

Non-Controlling Interest

 

$

1,084,568

 

$

1,081,806

 

 

19


 

Total assets decreased from approximately $66.7 million at October 31, 2015 to approximately $65.4 million at January 31, 2016.  This decrease is primarily due to a decrease in net property and equipment of approximately $642,000 at January 31, 2016 compared to October 31, 2015, and a decrease in total current assets of approximately $662,000 from period to period. The 5.1% decrease in current assets is due primarily to a decrease in accounts receivable of approximately $924,000 and a decrease in the value of our commodity derivative instruments of $550,000 at January 31, 2016 as compared to October 31, 2015. Our trade accounts receivable decreased due to primarily to timing of shipments. Offsetting, the decrease in accounts receivable was increases of approximately $363,000 in restricted cash related to cash we deposit in our margin account for our hedging transactions, $233,000 in inventory as a result of having more corn and ethanol on hand at January 31, 2016, and $176,000 in prepaid expenses at January 31, 2016 compared to October 31, 2015.

 

Current liabilities totaled approximately $8.2 million at January 31, 2016, an increase of approximately $1.7 million from October 31, 2015. This increase was primarily due to an increase of $3.5 million in checks drawn in excess of bank balance at January 31, 2016 compared to October 31, 2015. Our outstanding checks in excess of our bank balance represents any checks that we have issued that have not yet been cashed and exceed the cash we have in our bank account.  Checks that we issue are paid from our revolving term loan and any cash that we generate is used to pay down our revolving term loan with our primary lender. Partially offsetting the increase in checks drawn in excess of bank balance was an decrease of approximately $1.9 million in our accounts payable at January 31, 2016 compared to October 31, 2015.  This decrease is due primarily to lower corn prices during the quarter, which reduced the amount of our corn payable at January 31, 2016.

 

Our long-term debt increased approximately $825,000 at January 31, 2016 compared to October 31, 2015. The increase is due to increased borrowings on our AgStar debt facilities to finance a portion of distributions made to unit holders in January 2016.

 

Members’ equity attributable to Heron Lake BioEnergy, LLC decreased approximately $3.9 million at January 31, 2016 as compared to October 31, 2015. The decrease was related to the distribution to members of approximately $3.9 million. 

 

Noncontrolling interest totaled approximately $1.1 million at January 31, 2016 and October 31, 2015.  This is directly related to recognition of the 27.0% noncontrolling interest in Agrinatural at January 31, 2016 and October 31, 2015.

 

Liquidity and Capital Resources

 

Our principal sources of liquidity consist of cash provided by operations, cash and equivalents on hand, and available borrowings under our credit facility with AgStar.  Our principal uses of cash are to pay operating expenses of the plant, to make debt service payments on our long-term debt, and to make distribution payments to our members.  We expect to have sufficient cash generated by continuing operations and revolving term loan to fund our operations for the next twelve months.

 

We do not currently anticipate any significant purchases of property and equipment that would require us to secure additional capital in the next twelve months. However, management continues to evaluate conditions in the ethanol industry and explore opportunities to improve the efficiency and profitability of our operations which may require additional capital to supplement cash generated from operations and our revolving term loan.  Our RTO replacement project is being funded from current earnings from operations and we do not expect that we require additional capital to fund this project.

 

20


 

Cash Flows

 

The following table summarizes our sources and uses of cash from our unaudited condensed consolidated statements of cash flows for the periods presented:

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31,

 

 

 

2016

 

2015

 

 

    

(Unaudited)

    

(Unaudited)

 

Net cash provided by operating activities

    

$

339,289

    

$

6,576,325

 

Net cash used in investing activities

 

$

(718,062)

 

$

(3,897,444)

 

Net cash provided by (used in) financing activities

 

$

419,032

 

$

(2,716,610)

 

Net increase (decrease) in cash

 

$

40,259

 

$

(37,729)

 

 

Operating Cash Flows

 

During the three months ended January 31, 2016, cash flows from operating activities decreased by approximately $6.2 million compared to the three months ended January 31, 2015 due to decreases in our net income and accounts receivable, increases in accounts payable and restricted cash, and realized gains on derivative instruments.    

 

Investing Cash Flows

 

During the three months ended January 31, 2016, capital expenditures decreased 81.6% compared to the same period of 2015 due to fewer payments for construction in progress. During the three months ended January 31, 2016, we used cash for our RTO replacement project. During the three months ended January 31, 2015, we used cash primarily to purchase a condenser and sieve beads to remediate the system pressure fluctuations we experienced during the first quarter of fiscal year 2015.

 

Financing Cash Flows

 

During the three months ended January 31, 2016, we had proceeds of approximately $419,000 from financing activities compared to approximately $2.7 million in cash used in financing activities for the three months ended January 31, 2015. This change is primarily attributable to payments of approximately $3.9 million in distributions to our unit holders, payments of $3.7 million on our long term debt offset by approximately $4.6 million in proceeds from our long term debt, and approximately $3.5 million provided by checks in excess of bank balance.  In comparison, for the same period in 2015, we had proceeds of of approximately $3.4 million on our long term debt and made payments of approximately $9.4 million in distributions to our unit holders.

 

Indebtedness

 

Revolving Term Note

 

We have a comprehensive credit facility with AgStar Financial Services, FCLA (“AgStar”) which consists of a revolving term loan with a maturity date of March 1, 2022.  The credit facility is secured by all of our real property, equipment and other assets.  Our credit facility with AgStar is subject to numerous covenants requiring us to maintain various financial ratios. As of January 31, 2016, we were in compliance with these financial covenants and management expects we will continue to be in compliance throughout fiscal 2016.

 

Under the AgStar revolving term note, we could initially borrow, repay, and re-borrow up to $28.0 million.  However, the maximum principal amount of this loan decreases by $3.5 million annually starting on March 1, 2015 and continuing each anniversary thereafter until maturity.   The amount available under this facility at January 31, 2016 was $24.5 million.  The amount available was reduced again at March 1, 2016 to $21.0 million in accordance with reduction schedule imposed by credit facility.

 

21


 

Interest on this loan accrues at 3.25% above the One-Month London Interbank Offered Rate (LIBOR) Index rate.  HLBE may elect to enter into a fixed interest rate on this loan at various times throughout the term of the loan as provided in the loan agreements.  The revolving term loan is subject to an annual fee of 0.5% of the unused portion of this loan.  The revolving term loan is also subject to a prepayment fee for any prepayment on the loan prior to July 1, 2016 due to refinancing.

 

We had approximately $5.7 million outstanding on this loan at January 31, 2016, and $4.8 million at October 31, 2015.  The interest rate was 3.69% and 3.45% at January 31, 2016, and October 31, 2015, respectively.

 

Other Credit Arrangements

 

In addition to our primary credit arrangement with AgStar, we have other material credit arrangements and debt obligations.

 

In October 2003, we entered into an industrial water supply development and distribution agreement with the City of Heron Lake, Jackson County, and Minnesota Soybean Processors. In consideration of this agreement, the Company and Minnesota Soybean Processors are allocated equally the debt service on $735,000 in water revenue bonds that were issued by the City to support this project that mature in February 2019. The parties have agreed that prior to the scheduled expiration of the agreement, they will negotiate in good faith to replace the agreement with a further agreement regarding the wells and related facilities.

 

In May 2006, we entered into an industrial water supply treatment agreement with the City of Heron Lake and Jackson County. Under this agreement, we pay monthly installments over 24 months starting January 1, 2007 equal to one years' debt service on approximately $3.6 million in water revenue bonds, which will be returned to the Company if any funds remain after final payment in full on the bonds and assuming we comply with all payment obligations under the agreement.

 

There was a total of approximately $2.0 million in outstanding water revenue bonds at January 31, 2016 and October 31, 2015. We classify our obligations under these bonds as assessments payable. The interest rates on the bonds range from 0.50% to 8.73%.

 

To fund the purchase of the distribution system and substation for our ethanol plant, we entered into a loan agreement with Federated Rural Electric Association pursuant to which we borrowed $600,000 by a secured promissory note. Under the note the Company is required to make monthly payments to Federated Rural Electric Association of $6,250 consisting of principal and an annual fee of 1% beginning on October 10, 2009. In exchange for this loan, Federated Rural Electric Association was granted a security interest in the distribution system and substation for the plant. The balance of this loan was approximately $125,000 and $144,000 at January 31, 2016, and October 31, 2015, respectively.

 

We also have a note payable to the minority owner of Agrinatural in the amount of $266,000 and $300,000 at January 31, 2016 and October 31, 2015, respectively. Interest on the note is One-Month LIBOR rate plus 4.0%. Payment of the note is due on demand at the discretion of the board of managers of Agrinatural.

 

Loans to Agrinatural

 

Original Agrinatural Credit Facility

 

On July 29, 2015, the Company entered into an intercompany loan agreement and related loan documents with Agrinatural (the Original Agrinatural Credit Facility). Under the Original Agrinatural Credit Facility, the Company agreed to make a five-year term loan in the principal amount of $3.05 million to Agrinatural for use by Agrinatural to repay approximately $1.4 million of its outstanding debt and provide approximately $1.6 million of working capital to Agrinatural. The Original Agrinatural Credit Facility contains customary financial and non-financial affirmative covenants and negative covenants for loans of this type and size.

 

22


 

On March 30, 2015, we entered into an allonge (the “Allonge”) to the July 29, 2015 note with Agrinatural. Under the terms of the Allonge, the Company and Agrinatural agreed to increase the principal amount of the Original Agrinatural Credit Facility to approximately $3.06 million, defer commencement of repayment of principal until May 1, 2015, decrease the monthly principal payment to $36,000 per month and shorten maturity of the Original Agrinatural Credit Facility to May 1, 2019.

 

Interest on the Original Agrinatural Credit Facility was not amended and continues to accrue at a variable rate equal to the One-Month LIBOR rate plus 4.0%, with the interest rate capped and not to exceed 6.0% per annum.  Accrued interest is due and payable on a monthly basis. Except as otherwise provided in the Allonge, all of the terms and conditions contained in the Original Agrinatural Credit Facility remain in full force and effect.

 

In exchange for the Loan Agreement, the Agrinatural executed a security agreement granting the Company a first lien security interest in all of Agrinatural's equipment and assets and a collateral assignment assigning the Company all of Agrinatural's interests in its contracts, leases, easements and other agreements. In addition, Rural Energy Solutions, LLC, the minority owner of Agrinatural ("RES"), executed a guarantee under which RES guaranteed full payment and performance of 27% of Agrinatural's obligations to the Company.

 

The balance of this loan was approximately $2.7 million at January 31, 2016 and $2.8 million at October 31, 2015.

 

Additional Agrinatural Credit Facility

 

On March 30, 2015, the Company entered into a second intercompany loan agreement and related loan documents (the Additional Agrinatural Credit Facility) with Agrinatural.  Under the Additional Agrinatural Credit Facility, the Company agreed to make a four-year term loan in the principal amount of $3.5 million to Agrinatural for use by Agrinatural to repay its outstanding trade debt and provide working capital.  The Additional Agrinatural Credit Facility contains customary financial and non-financial affirmative covenants and negative covenants for loans of this type and size.

 

Interest on the additional term loan accrues at a variable rate equal to the One-Month LIBOR rate plus 4.0%, with the interest rate capped and not to exceed 6.0% per annum.  Prior to May 1, 2015, Agrinatural is required to pay only monthly interest on the term loan.  Commencing May 1, 2015, Agrinatural is required to make monthly installments of principal plus accrued interest. The entire principal balance and accrued and unpaid interest on the term loan is due and payable in full on May 1, 2019.

 

In exchange for the Additional Agrinatural Credit Facility, the Agrinatural executed a security agreement granting the Company a first lien security interest in all of Agrinatural's equipment and assets and a collateral assignment assigning the Company all of Agrinatural's interests in its contracts, leases, easements and other agreements. In addition, Rural Energy Solutions, LLC, the minority owner of Agrinatural (RES), executed a guarantee under which RES guaranteed full payment and performance of 27% of Agrinatural's obligations to the Company under the Additional Agrinatural Credit Facility.

 

The balance of this loan was approximately $3.1 million at January 31, 2016 and $3.2 million at October 31, 2015.

 

Critical Accounting Estimates

 

Management uses estimates and assumptions in preparing our financial statements in accordance with generally accepted accounting principles. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses.  We believe that of our significant accounting policies summarized in Note 1 to our condensed consolidated unaudited financial statements included with this quarterly report on Form 10-Q.

 

At January 31, 2016, our critical accounting estimates continue to include those described in our Annual Report on Form 10-K for the fiscal year ended October 31, 2015. Management has not changed the method of calculating and using estimates and assumptions in preparing our condensed consolidated unaudited financial statements in accordance with generally accepted accounting principles in the United States of America.

23


 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

We are exposed to the impact of market fluctuations associated with interest rates and commodity prices as discussed below. We have no exposure to foreign currency risk as all of our business is conducted in U.S. Dollars. We use derivative financial instruments as part of an overall strategy to manage market risk. We use cash, futures and option contracts to hedge changes to the commodity prices of corn, ethanol and natural gas. We do not enter into these derivative financial instruments for trading or speculative purposes, nor do we designate these contracts as hedges for accounting purposes pursuant to the requirements of Generally Accepted Accounting Principles (GAAP).

 

Interest Rate Risk

 

We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from our credit facility with AgStar,  as well as our note payable to the minority owner of Agrinatural. The specifics of these credit facilities are discussed in greater detail in “Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Indebtedness.”

 

Below is a sensitivity analysis we prepared regarding our income exposure to changes in interest rates. The sensitivity analysis below shows the anticipated effect on our income from a 10% adverse change in interest rates for a one-year period from January 31, 2016.

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

    

 

 

 

Outstanding Variable Rate Debt at

 

Interest Rate at

 

Interest Rate Following 10%

 

Approximate Adverse

 

January 31, 2016

    

January 31, 2016

    

 Adverse Change

    

Change to Income

 

$6,042,000

 

3.69%

 

4.1%

 

 

$22,000

 

Commodity Price Risk

 

We seek to minimize the risks from fluctuations in the prices of raw material inputs, such as corn and natural gas, and finished products, such as ethanol and distillers' grains, through the use of hedging instruments. In practice, as markets move, we actively manage our risk and adjust hedging strategies as appropriate. Although we believe our hedge positions accomplish an economic hedge against our future purchases and sales, management has chosen not to use hedge accounting, which would match the gain or loss on our hedge positions to the specific commodity purchase being hedged. We are using fair value accounting for our hedge positions, which means as the current market price of our hedge positions changes, the realized or unrealized gains and losses are immediately recognized in our cost of goods sold or as an offset to revenues. The immediate recognition of hedging gains and losses under fair value accounting can cause net income to be volatile from quarter to quarter due to the timing of the change in value of the derivative instruments relative to the cost and use of the commodity being hedged.

 

As of  January 31, 2016, we had price protection in place for approximately 15% of our anticipated corn needs and approximately 4% of our ethanol sales for the next 12 months. Through these contracts we hope to minimize risk from future market price fluctuations and basis fluctuations. As input prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to produce long-term positive growth for us.

 

24


 

A sensitivity analysis has been prepared to estimate our exposure to ethanol, corn and natural gas price risk. Market risk related to these factors is estimated as the potential change in income resulting from a hypothetical 10% adverse change in the fair value of our corn and natural gas prices and average ethanol price as of January 31, 2016, net of the forward and future contracts used to hedge our market risk for corn and natural gas usage requirements. The results of this analysis, which may differ from actual results, are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

    

 

    

 

 

 

 

 

Estimated Volume Requirements for the 

 

 

 

Hypothetical Adverse

 

 

 

 

 

next 12 months (net of forward and futures 

 

Unit of

 

Change in Price as of

 

Annual Adverse

 

    

contracts)

    

Measure

    

January 31, 2016

    

Change to Income

Ethanol