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EX-32.2 - EX-32.2 - Heron Lake BioEnergy, LLCc964-20180131ex32217d340.htm
EX-32.1 - EX-32.1 - Heron Lake BioEnergy, LLCc964-20180131ex321073351.htm
EX-31.2 - EX-31.2 - Heron Lake BioEnergy, LLCc964-20180131ex31260a085.htm
EX-31.1 - EX-31.1 - Heron Lake BioEnergy, LLCc964-20180131ex3116e1bbf.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, 2018 

 

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”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

 

 

Large accelerated filer  ☐

 

Accelerated filer  ☐

 

 

Smaller reporting company ☐

Non-accelerated filer  ☒

 

Emerging growth company ☐

(Do not check if a smaller reporting company)

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐ 

 

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 19, 2018, 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, 2018

    

October 31, 2017

 

 

 

(unaudited)

 

 

 

 

ASSETS

 

 

 

 

 

 

 

Current Assets

 

 

 

 

 

 

 

Cash

 

$

1,010,836

 

$

10,065,367

 

Restricted cash

 

 

160,708

 

 

 -

 

Accounts receivable

 

 

4,025,241

 

 

4,031,977

 

Inventory

 

 

7,701,647

 

 

7,064,344

 

Commodity derivative instruments

 

 

36,525

 

 

141,644

 

Prepaid expenses and other current assets

 

 

430,166

 

 

259,106

 

Total current assets

 

 

13,365,123

 

 

21,562,438

 

 

 

 

 

 

 

 

 

Property and Equipment, net

 

 

45,587,835

 

 

46,567,087

 

 

 

 

 

 

 

 

 

Other Assets

 

 

 

 

 

 

 

Other intangible assets, net

 

 

36,315

 

 

45,852

 

Other assets

 

 

697,254

 

 

697,254

 

Total other assets

 

 

733,569

 

 

743,106

 

 

 

 

 

 

 

 

 

Total Assets

 

$

59,686,527

 

$

68,872,631

 

 

 

 

 

 

 

 

 

LIABILITIES AND MEMBERS' EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities

 

 

 

 

 

 

 

Current maturities of long-term debt

 

$

333,015

 

$

432,183

 

Checks drawn in excess of bank balance

 

 

963,247

 

 

 —

 

Accounts payable

 

 

2,371,176

 

 

4,771,197

 

Commodity derivative instruments

 

 

6,264

 

 

27,630

 

Accrued expenses

 

 

469,596

 

 

415,106

 

Total current liabilities

 

 

4,143,298

 

 

5,646,116

 

 

 

 

 

 

 

 

 

Long-Term Debt, less current portion

 

 

953,826

 

 

965,502

 

 

 

 

 

 

 

 

 

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, 2018 and October 31, 2017

 

 

53,061,627

 

 

60,767,951

 

Non-controlling interest

 

 

1,527,776

 

 

1,493,062

 

Total members' equity

 

 

54,589,403

 

 

62,261,013

 

 

 

 

 

 

 

 

 

Total Liabilities and Members' Equity

 

$

59,686,527

 

$

68,872,631

 

 

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  January 31,

 

 

 

2018

 

2017

 

 

    

(unaudited)

    

(unaudited)

    

Revenues

 

$

27,972,451

 

$

27,390,074

 

 

 

 

 

 

 

 

 

Cost of Goods Sold

 

 

26,391,269

 

 

23,975,843

 

 

 

 

 

 

 

 

 

Gross Profit

 

 

1,581,182

 

 

3,414,231

 

 

 

 

 

 

 

 

 

Operating Expenses

 

 

(865,043)

 

 

(846,697)

 

 

 

 

 

 

 

 

 

Operating Income

 

 

716,139

 

 

2,567,534

 

 

 

 

 

 

 

 

 

Other Income (Expense):

 

 

 

 

 

 

 

Interest income

 

 

21,973

 

 

420

 

Interest expense

 

 

(18,613)

 

 

(31,387)

 

Other income, net

 

 

258,212

 

 

378,557

 

Total other income, net

 

 

261,572

 

 

347,590

 

 

 

 

 

 

 

 

 

Net Income

 

 

977,711

 

 

2,915,124

 

 

 

 

 

 

 

 

 

Less: Net Income Attributable to Non-controlling Interest

 

 

(115,714)

 

 

(82,711)

 

 

 

 

 

 

 

 

 

Net Income Attributable to Heron Lake BioEnergy, LLC

 

$

861,997

 

$

2,832,413

 

 

 

 

 

 

 

 

 

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

 

 

77,932,107

 

 

77,932,107

 

 

 

 

 

 

 

 

 

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

 

$

0.01

 

$

0.04

 

 

 

 

 

 

 

 

 

Distributions Per Unit (Class A and B)

 

$

0.11

 

$

0.00

 

 

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

 

 

 

 

January 31, 2018

 

 

January 31, 2017

 

 

    

 

(unaudited)

    

 

(unaudited)

 

Cash Flow From Operating Activities:

 

 

 

 

 

 

 

Net income

 

$

977,711

 

$

2,915,124

 

Adjustments to reconcile net income to net cash provided by operations:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

1,222,508

 

 

1,238,782

 

Gain on sale of asset

 

 

(24,815)

 

 

(45,000)

 

Change in fair value of commodity derivative instruments

 

 

55,067

 

 

(219,629)

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Restricted cash

 

 

(160,708)

 

 

 —

 

Accounts receivable

 

 

6,736

 

 

634,307

 

Inventory

 

 

(637,303)

 

 

(899,582)

 

Commodity derivative instruments

 

 

28,686

 

 

441,043

 

Prepaid expenses and other current assets

 

 

(171,060)

 

 

(26,121)

 

Accounts payable

 

 

(2,400,021)

 

 

(2,578,869)

 

Accrued expenses

 

 

54,490

 

 

52,302

 

Net cash provided by (used in) operating activities

 

 

(1,048,709)

 

 

1,512,357

 

 

 

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

 

 

Capital expenditures

 

 

(233,719)

 

 

(385,558)

 

Proceeds from disposal of asset

 

 

24,815

 

 

45,000

 

Net cash used in investing activities

 

 

(208,904)

 

 

(340,558)

 

 

 

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

 

 

Proceeds from (payments on) checks drawn in excess of bank balance

 

 

963,247

 

 

(1,230,005)

 

Payments on long-term debt

 

 

(110,844)

 

 

(128,887)

 

Distributions to Heron Lake BioEnergy, LLC members

 

 

(8,568,321)

 

 

 —

 

Distribution to non-controlling interest

 

 

(81,000)

 

 

 —

 

Net cash used in financing activities

 

 

(7,796,918)

 

 

(1,358,892)

 

 

 

 

 

 

 

 

 

Net decrease in cash

 

 

(9,054,531)

 

 

(187,093)

 

 

 

 

 

 

 

 

 

Cash—Beginning of period

 

 

10,065,367

 

 

1,297,644

 

 

 

 

 

 

 

 

 

Cash—End of period

 

$

1,010,836

 

$

1,110,551

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

 

Interest expense

 

$

18,613

 

$

31,387

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Non-Cash Investing and Financing Activities

 

 

 

 

 

 

 

Capital expenditures included in accounts payable

 

$

 —

 

$

63,773

 

 

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, 2018

 

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Business

 

Heron Lake BioEnergy, LLC owns and operates an ethanol plant near 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, Heron Lake BioEnergy, LLC produces and sells distillers’ grains with solubles and corn oil as co-products of ethanol production. 

 

Heron Lake BioEnergy, LLC’s wholly owned subsidiary, HLBE Pipeline Company, LLC (“HLBE Pipeline Company”), owns 73% of Agrinatural Gas, LLC (“Agrinatural”).  Agrinatural operates a natural gas pipeline that provides natural gas to Heron Lake BioEnergy, LLC 's ethanol production facility and other customers.

 

Basis of Presentation and Principles of Consolidation

 

The condensed consolidated unaudited financial statements as of January 31, 2018 include the accounts of Heron Lake BioEnergy, LLC and its wholly owned subsidiary, HLBE Pipeline Company (collectively the “Company”).  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% non-controlling interest identified separately in the accompanying condensed consolidated balance sheets and statements of operations.  All significant intercompany balances and transactions are eliminated in consolidation.

 

The condensed consolidated unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  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, 2017, 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 fiscal period or for the fiscal year.

 

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, valuation of commodity derivative instruments, inventory, inventory purchase and sales commitments, and evaluation of railcar damages contingency. 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.

 

Non-controlling Interest

 

Amounts recorded as non-controlling 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.  Pursuant to the firm natural gas transportation agreement,  Agrinatural will provide natural gas to the plant with a specified price per MMBTU for a term ending on October 31, 2021, with one automatic renewal option to extend the term for an additional  five years. 

 

4


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

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.

 

Agrinatural recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the fee for the arrangement is fixed or determinable and collectability is reasonably assured.

 

Inventory

 

Inventory is stated at the lower of cost or net realizable value.  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.

 

Derivative Instruments

 

From time to time the Company enters into derivative transactions to hedge its exposures to commodity price fluctuations.  The Company is required to record these derivatives on the balance sheets at fair value.

 

In order for a derivative to qualify as a hedge, specific criteria must be met and appropriate documentation maintained.  Gains and losses from derivatives that do not qualify as hedges, or are undesignated, must be recognized immediately in earnings.  If the derivative does qualify as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will be either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings.  Changes in the fair value of undesignated derivatives are recorded in earnings.

 

Additionally, the Company is required to evaluate its contracts to determine whether the contracts are derivatives.  Certain contracts that literally meet the definition of a derivative may be exempted as “normal purchases or normal sales”.  Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business.  Contracts that meet the requirements of normal purchases or sales are documented as normal and exempted from accounting and reporting requirements, and therefore, are not marked to market in our condensed consolidated unaudited financial statements.

 

In order to reduce the risks caused by market fluctuations, the Company occasionally hedges its anticipated corn, natural gas, and denaturant purchases and ethanol sales by entering into options and futures contracts.  These contracts are used with the intention to fix the purchase price of anticipated requirements for corn in the Company's ethanol production activities and the related sales price of ethanol.  The fair value of these contracts is based on quoted prices in active exchange-traded or over-the-counter market conditions.  Although the Company believes its commodity derivative positions are economic hedges, none have been formally designated as a hedge for accounting purposes and derivative positions are recorded on the balance sheet at their fair market value, with changes in fair value recognized in current period earnings or losses.  The Company does not enter into financial instruments for trading or speculative purposes.

 

5


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

The Company has adopted authoritative guidance related to “Derivatives and Hedging”, and has included the required enhanced quantitative and qualitative disclosure about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses from derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements.  See further discussion in Note 4.

 

Reportable Operating Segments

 

Accounting Standards Codification (“ASC”) 280, “Segment Reporting”, establishes the standards for reporting information about segments in financial statements. 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 related business nature and expected financial results criteria set forth in ASC 280, the Company has two reportable operating segments for financial reporting purposes.

 

·

Ethanol Production.   Based on the nature of the products and production process and the expected financial results, the Company’s operations at its ethanol plant, including the production and sale of ethanol and its co-products, are aggregated into one financial reporting segment.

 

·

Natural Gas Pipeline.  The Company has majority ownership in Agrinatural, through its wholly owned subsidiary, HLBE Pipeline, LLC, and operations of Agrinatural’s natural gas pipeline are aggregated into another financial reporting segment.

 

 

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 70% to 90% of total revenues and corn costs average 70% to 90% of cost of goods sold.

 

The Company’s operating and financial performance is largely driven by the prices at which it sells ethanol, distillers’ grains, and corn oil and the related costs 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 Company's 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 commodities 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. The Company's risk management program is used to protect against the price volatility of these commodities.

 

 

3.INVENTORY

 

Inventory consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

January 31, 2018

 

October 31, 2017

 

 

    

(unaudited)

    

 

 

 

Raw materials

 

$

1,695,592

 

$

1,442,844

 

Work in process

 

 

687,607

 

 

652,296

 

Finished goods

 

 

4,135,911

 

 

3,747,779

 

Supplies

 

 

1,182,537

 

 

1,221,425

 

Totals

 

$

7,701,647

 

$

7,064,344

 

 

6


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

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, as a component of cost of goods sold, of approximately $126,000 and $191,000 for the three months ended January 31, 2018 and 2017, respectively.

 

 

4.DERIVATIVE INSTRUMENTS

 

As of January 31, 2018, the total notional amount of the Company’s outstanding corn derivative instruments was approximately 5,635,000 bushels, comprised of long corn positions on 1,995,000 bushels that were entered into to hedge forecasted ethanol sales through March 2018, and short corn positions on 3,640,000 bushels that were entered into to hedge forecasted corn purchases through December 2019.  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, 2018,  the Company had outstanding natural gas derivative instruments totaling approximately                            40,000 MMBTU that were entered into to hedge forecasted natural gas purchases through February 2018.

 

As of January 31, 2018, the Company had approximately $161,000 of cash collateral (restricted cash) related to derivatives held by a broker. 

 

The following tables provide details regarding the Company’s derivative instruments at January 31, 2018, none of which are designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Balance Sheet Location

    

Assets

    

Liabilities

 

Corn contracts

 

Commodity derivative instruments

 

$

5,025

 

$

 —

 

Ethanol contracts

 

Commodity derivative instruments

 

 

31,500

 

 

 —

 

Natural gas contracts

 

Commodity derivative instruments

 

 

 —

 

 

6,264

 

Totals

 

 

 

$

36,525

 

$

6,264

 

 

As of October 31, 2017, the total notional amount of the Company's outstanding corn derivative instruments was approximately 1,120,000 bushels, comprised of long corn positions on 215,000 bushels that were entered into to hedge forecasted ethanol sales through December 2017, and short corn positions on 905,000 bushels that were entered into to hedge forecasted corn purchases through July 2018.     There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding. 

 

As of October 31, 2017, the Company had outstanding natural gas derivative instruments totaling 120,000 MMBTU entered into to hedge forecasted natural gas purchases through February 2018.

 

As of October 31, 2017, the total notional amount of the Company’s outstanding ethanol derivative instruments was approximately 420,000 gallons that were entered into to hedge forecasted ethanol sales through November 2017.

 

As of October 31, 2017, the Company had no cash collateral (restricted cash) and approximately $12,000 due to broker related to derivatives held by a broker, recorded as a component of accounts payable.

 

The following tables provide details regarding the Company’s derivative instruments at October 31, 2017, none of which were designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Balance Sheet Location

    

Assets

    

Liabilities

 

Corn contracts

 

Commodity derivative instruments

 

$

141,644

 

$

 —

 

Ethanol contracts

 

Commodity derivative instruments

 

 

 —

 

 

12,249

 

Natural gas contracts

 

Commodity derivative instruments

 

 

 —

 

 

15,381

 

Totals

 

 

 

$

141,644

 

$

27,630

 

 

7


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

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

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Statement of

    

Three Months Ended  January 31,

 

 

    

Operations location

    

2018

    

2017

 

Corn contracts

 

Cost of goods sold

 

$

(152,654)

 

$

(56,628)

 

Ethanol contracts

 

Revenues

 

 

85,249

 

 

276,257

 

Natural gas contracts

 

Cost of goods sold

 

 

12,338

 

 

 —

 

Total gain (loss)

 

 

 

$

(55,067)

 

$

219,629

 

 

 

 

5.FAIR VALUE

 

The following table sets forth, by level, the Company assets that were accounted for at fair value on a recurring basis at January 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement Using

 

 

 

Carrying Amount in

 

 

 

 

Quoted Prices

 

Significant Other

 

Significant

 

 

 

Consolidated

 

 

 

 

in Active Markets

    

Observable Inputs

    

Unobservable Inputs

 

Financial Assets:

 

Balance Sheet

 

Fair Value

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Commodity Derivative instruments - Corn

 

$

5,025

 

$

5,025

 

$

5,025

 

$

 —

 

$

 —

 

Commodity Derivative instruments - Ethanol

 

$

31,500

 

$

31,500

 

$

31,500

 

$

 —

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity Derivative instruments - Natural Gas

 

$

6,264

 

$

6,264

 

$

 —

 

$

6,264

 

$

 —

 

 

The following table sets forth, by level, the Company assets that were accounted for at fair value on a recurring basis at October 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement Using

 

 

 

Carrying Amount in

 

 

 

 

Quoted Prices in

 

Significant Other

 

Significant

 

 

 

Consolidated

 

 

 

 

Active Markets

 

Observable Inputs

 

Unobservable Inputs

 

Financial Assets:

    

Balance Sheet

 

Fair Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

 

Commodity Derivative instruments - Corn

 

$

141,644

 

$

141,644

 

$

141,644

 

$

 —

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity Derivative instruments - Ethanol

 

$

12,249

 

$

12,249

 

$

18,000

 

$

(5,751)

 

$

 —

 

Commodity Derivative instruments - Natural Gas

 

$

15,381

 

$

15,381

 

$

 —

 

$

15,381

 

$

 —

 

 

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.  We determine the fair value of ethanol and natural gas Level 2 instruments by model-based techniques in which all significant inputs are observable in the markets noted above.

 

8


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

6.DEBT FINANCING

 

Long-term debt consists of the following:

 

 

 

 

 

 

 

 

 

 

 

January 31, 2018

 

October 31, 2017

 

 

 

(unaudited)

 

 

 

Revolving term note payable to lending institution, see terms below.

 

$

 —

 

$

 —

 

Assessment payable as part of water treatment agreement, due in semi-annual installments of $189,393 with interest at 6.55%, enforceable by statutory lien, with the final payment due in 2021. The Company made deposits for one years' worth of debt service payments of approximately $364,000, which is included with other assets that are held on deposit to be applied with the final payments of the assessment.

 

 

1,241,171

 

 

1,241,171

 

Assessment payable as part of water supply agreement, due in monthly installments of $3,942 with interest at 8.73%, enforceable by statutory lien, with the final payment due in 2019.

 

 

45,670

 

 

56,514

 

Note payable to non-controlling interest member of Agrinatural. Interest is at One Month LIBOR plus 4.0%, which was approximately 5.58% and 5.24% at January 31, 2018 and October 31, 2017, respectively. The note was paid in full in January 2018.

 

 

 —

 

 

100,000

 

Totals

 

 

1,286,841

 

 

1,397,685

 

Less amounts due within one year

 

 

333,015

 

 

432,183

 

Net long-term debt

 

$

953,826

 

$

965,502

 

 

Revolving Term Note

 

The Company has a revolving term note payable with a lender  under which the Company can borrow, repay and re-borrow in an amount up to the original aggregate principal commitment at any time prior to maturity at March 1, 2022.  The original aggregate principal commitment was $28,000,000, which reduced by $3,500,000 annually, starting March 1, 2015 and continuing each anniversary thereafter until maturity.  In December 2017, the Company and its lender orally agreed to reduce the aggregate principal commitment of the revolving term loan to $8,000,000.  The Company had no outstanding balance on the revolving term loan at January 1, 2018 and October 31, 2017.  Therefore, the aggregate principal amount available to the Company for borrowing at January 31, 2018 and October 31, 2017 was $8,000,000 and $17,500,000, respectively.

 

In connection to the reduction in the aggregate principal commitment, the interest rate on the revolving term loan was reduced to 2.85% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate, which was 4.42% and 4.49% at January 31, 2018 and October 31, 2017, respectively.  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 the unused portion of the revolving term loan commitment at the rate of 0.50% per annum.  The loan is secured by substantially all of the Company assets including a subsidiary guarantee. 

 

The credit facility contains customary covenants, including restrictions on the payment of dividends and loans and advances to Agrinatural, and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility.  Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges, or penalties.

 

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 revolving term loan and was appointed the administrative agent for the purpose of servicing the loan.  As a result, CoBank will act as the agent for the lender with respect to the credit facility.  The Company agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.

9


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

Estimated annual maturities of long-term debt at January 31, 2018 are as follows based on the most recent debt agreements:

 

 

 

 

 

 

2019

    

$

333,015

 

2020

 

 

307,207

 

2021

 

 

326,798

 

2022

 

 

319,821

 

Total debt

 

$

1,286,841

 

 

 

 

7.COMMITMENTS AND CONTINGENCIES

 

Corn Forward Contracts

 

At January 31, 2018, the Company had cash and basis contracts for forward corn purchase commitments totaling approximately 3,392,000 bushels for various delivery periods through January 2019.

 

Ethanol Forward Contracts

 

At January 31, 2018,  the Company had fixed and basis contracts to sell approximately $14,003,000 of ethanol for various delivery periods through March 2018.   

 

Distillers’ Grains Forward Contracts

 

At January 31, 2018, the Company had forward contracts to sell approximately $1,640,000 of distillers’ grains for delivery through March 2018.

 

Corn Oil Forward Contracts

 

At January 31, 2018, the Company had forward contracts to sell approximately $466,000 of corn oil for delivery through February 2018.

 

Railcar Damages 

 

In accordance with certain railcar lease agreements, at expiration, the Company is required to return the railcars in good condition, less normal wear, and tear.  Primarily due to the ongoing maintenance and repair activities performed on its railcars, the Company has determined that no accrual for leased railcar damages is necessary and an estimate of the possible range of loss cannot be made.

 

 

8.MEMBERS’ EQUITY

 

Heron Lake BioEnergy, LLC is authorized to issue up to 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 Heron Lake BioEnergy, LLC 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 Heron Lake BioEnergy, LLC’s Board of Governors to become members.  Members are entitled to one vote for each unit held.  Subject to Heron Lake BioEnergy, LLC’s Member Control Agreement, all units share equally in the profits and losses and distributions of assets on a per unit basis.

 

Heron Lake BioEnergy, LLC 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 January 31, 2018 and October 31, 2017. 

 

On December 21, 2017,  Heron Lake BioEnergy, LLC’s Board of Governors declared a cash distribution of $0.11 per unit, or approximately $8,573,000, for unit holders of record as of December 21, 2017.  The distribution was paid in January 2018.  

10


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

 

9.RELATED PARTY TRANSACTIONS

 

Granite Falls Energy, LLC

 

The Company has a management services agreement with GFE. Under the terms of the management services agreement, GFE supplies its own personnel to act as part-time officers and managers of the Company for the positions of Chief Executive Officer, Chief Financial Officer, and Commodity Risk Manager and the Company pays GFE 50% of the total salary, bonuses, and other expenses and costs incurred by GFE for the three management positions.  The management services agreement automatically renews for successive one-year terms unless and until the Company or GFE gives the other party 90-days written notice of termination prior to expiration of then current term.  The management services agreement may also be terminated by either party for cause under certain circumstances. Total expenses under this agreement were approximately $138,000 and $108,000 for the three months ended January 31, 2018 and 2017,  respectively.

 

Corn Purchases - Members

 

The Company purchased corn from board members of approximately $4,455,000 and $3,025,000 for the three months ended January 31, 2018 and 2017, respectively.

 

Agrinatural

 

During 2013, the Company borrowed $300,000 from the non-controlling interest member of Agrinatural.  Total interest paid in relation to this note payable amounted to approximately $1,000 and $2,000 for the three months ended January 31, 2018 and 2017, respectively.

 

Swan Engineering

 

Agrinatural has a management and operating agreement with Swan Engineering, Inc. (“SEI”).  SEI is an affiliate of Rural Energy Solutions, LLC (“RES”), the 27% minority owner of Agrinatural.  A controlling interest of RES is owned by the principal of SEI.

 

Under the management and operating agreement, SEI provides Agrinatural with day-to-day management and operation of Agrinatural's pipeline distribution business.  In exchange for these services, Agrinatural pays 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 monthly base fee and variable customer management fee of approximately $49,000 and $48,000 for the three months ended January 31, 2018 and 2017, respectively.  The management and operating agreement with SEI expires July 1, 2019, unless earlier terminated for cause as defined in the agreement.

 

Agrinatural also has a project management agreement with SEI.  Pursuant to the project management agreement, SEI supervises all Agrinatural's pipeline construction projects.  These projects are constructed by unrelated third-party pipeline construction companies.  Under the project management agreement, Agrinatural pays SEI a total of 10% of the actual capital expenditures for construction projects approved by Agrinatural's board of managers, excluding capitalized marketing costs.  The Company recorded project management fees of approximately $5,000 and $10,000 for the three months ended January 31, 2018 and 2017, respectively.  The project management with SEI expires June 30, 2019, unless earlier terminated for cause as defined in the agreement.

 

 

10.BUSINESS 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

 

11


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

January 31, 2018

 

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

 

 

January 31, 2018

 

January 31, 2017

 

Revenue:

 

(unaudited)

 

(unaudited)

 

Ethanol production

 

$

27,278,093

 

$

26,964,891

 

Natural gas pipeline

 

 

1,156,274

 

 

868,635

 

Eliminations

 

 

(461,916)

 

 

(443,452)

 

Total Revenue

 

$

27,972,451

 

$

27,390,074

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

January 31, 2018

 

January 31, 2017

 

Operating Income:

 

(unaudited)

 

(unaudited)

 

Ethanol production

 

$

224,439

    

$

2,194,198

 

Natural gas pipeline

 

 

688,128

 

 

563,930

 

Eliminations

 

 

(196,428)

 

 

(190,594)

 

Operating Income

 

$

716,139

 

$

2,567,534

 

 

 

 

 

 

 

 

 

 

 

 

January 31, 2018

 

October 31, 2017

 

Assets:

    

(unaudited)

 

 

 

Ethanol production

 

$

47,472,738

 

$

56,373,335

 

Natural gas pipeline

 

 

12,213,789

 

 

12,499,296

 

Total Assets

 

$

59,686,527

 

$

68,872,631

 

 

 

 

 

12


 

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, 2018 and 2017.  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 information contained in the Company’s annual report on Form 10-K for the fiscal year ended October 31, 2017.

 

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, 2017  as supplemented by the risk factors disclosed in Item 1A of this report on Form 10-Q.  These risks and uncertainties include, but are not limited to, the following:

·

Fluctuations in the price of ethanol, which is affected by various factors including: the overall supply and demand for ethanol and corn; the price of gasoline, crude oil and corn, government policies, the price and availability of competing fuels;

·

Fluctuations in the price of crude oil and gasoline and the impact of lower oil and gasoline prices on ethanol prices and demand;

·

Fluctuations in the availability and price of corn,  which is affected by various factors including: domestic stocks, demand from corn-consuming industries, such as the ethanol industry, prices for alternative crops, increasing input costs, changes in government policies, shifts in global markets or damaging growing conditions, such as plant disease or adverse weather, including drought;

·

Fluctuations in the availability and price of natural gas, which is may be affected by factors such as weather, drilling economics, overall economic conditions, and government regulations;

·

Negative operating margins which may result from lower ethanol and/or high corn prices;

·

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

·

Overcapacity and oversupply in the ethanol industry;

·

Ethanol may trade at a premium to gasoline at times, resulting in a disincentive for discretionary blending of ethanol beyond the requirements of the Renewable Fuels Standard (“RFS”) and consequently negatively impacting ethanol prices and demand;

·

Changes in federal and/or state laws and environmental regulations including elimination, waiver, or reduction of the corn-based ethanol use requirement in the RFS and legislative acts taken by state governments such as California related to low-carbon fuels, may have an adverse effect on our business; 

·

Any impairment of the transportation, storage and blending infrastructure that prevents ethanol from reaching markets;

·

Any effect on prices and demand for our products resulting from actions in international markets, particularly imposition of tariffs on ethanol imported to Brazil and/or increased tariffs on ethanol exported to China and anti-dumping and countervailing duties on U.S. distillers’ grains exported to China;

·

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

·

Effect of our risk mitigation strategies and hedging activities on our financial performance and cash flows;

·

Competition from alternative fuels and alternative fuel additives;

·

Changes or advances in plant production capacity or technical difficulties in operating the plant; and

·

Our reliance on key management personnel.

13


 

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 because 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 (“U.S.”) 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, periodic 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.  Our business consists of the production and sale of our ethanol throughout the continental U.S. and sale of its co-products (wet, modified wet and dried distillers’ grains, corn oil, and corn syrup) locally, and throughout the continental U.S. Additionally, through a wholly owned subsidiary, HLBE Pipeline Company, LLC (“HLBE Pipeline Company”), we own a  73% controlling interest of Agrinatural Gas, LLC (“Agrinatural”).  Agrinatural operates a natural gas pipeline that provides natural gas to Heron Lake BioEnergy, LLC 's ethanol production facility and other customers. 

 

When we use the terms “Heron Lake BioEnergy”, “Heron Lake”, or “HLBE” or similar words, unless the context otherwise requires, we are referring to Heron Lake BioEnergy, LLC and our operations at our ethanol production facility located near Heron Lake, Minnesota.  When we use the terms the “Company”, “we”, “us”, “our” or similar words, unless the context otherwise requires, we are referring to Heron Lake BioEnergy and its wholly owned subsidiary, HLBE Pipeline Company, LLC, and its majority-owned subsidiary 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 10, “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 (distillers’ grains, non-edible corn oil and corn syrup).  These operations are aggregated into one financial reporting segment. 

 

14


 

Our ethanol plant has a nameplate capacity of 50 million gallons per year.  We have received EPA pathway approval and have obtained permits from the Minnesota Pollution Control Authority to increase our production capacity to 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, dependent on industry conditions and plant profitability.

 

We have entered into a management services agreement with Granite Falls Energy, LLC, a Minnesota limited liability company that operates an ethanol plant located in Granite Falls, Minnesota (“GFE”).  GFE owns approximately 50.7% of our outstanding membership units.    Pursuant to the management services agreement, GFE provides its chief executive officer, chief financial officer, and commodity risk manager to act in those positions as our part-time officers.  The management services automatically renews for successive one-year terms until either party gives the other party written notice of termination prior to expiration of the then current term.  The management services agreement may also be terminated by either party for cause under certain circumstances.

 

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 16 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 New Energy—Gas Division, LLC to supply the natural gas necessary to operate our plant.

 

Natural Gas Pipeline

 

We own a controlling 73% interest in Agrinatural, a natural gas distribution and sales company located in Heron Lake, Minnesota.  Agrinatural owns approximately 190 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: the July 2014 credit facility, as amended (the “Original Credit Facility”) and the March 2015 credit facility, as amended (the “Additional Credit Facility”).  Under the Original Credit Facility, the Company made a five-year term loan in the principal amount of $3.05 million and pursuant to the Additional Credit Facility, made a four-year term loan in the principal amount of $3.5 million to Agrinatural.  Details of these credit facilities to Agrinatural 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 HLBE’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.

 

15


 

Plan of Operations for the Next Twelve Months

 

Over the next twelve months we will continue our focus on operational improvements at our plant.  These operational improvements include exploring methods to improve ethanol yield per bushel and increasing production output at our plant, continued emphasis on safety and environmental regulation, 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.

 

In addition, we expect to continue to conduct routine maintenance and repair activities at the ethanol plant to maintain current plant infrastructure, as well as small capital projects to improve operating efficiency.  We anticipate using cash we generate from our operations and our revolving term loan to finance these plant upgrade projects. 

 

Trends and Uncertainties Impacting Our Operations

 

The principal factors affecting our results of operations and financial conditions are the market prices for corn, ethanol, distillers’ grains, and natural gas.  As a result, our operating results can fluctuate substantially due to volatility in these commodity markets.  Governmental programs designed to create incentives for the use of corn-based ethanol also have a significant impact on market prices for ethanol.  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 1A. Risk Factors” of our annual report on Form 10-K for the fiscal year ended October 31, 2017.

 

The price and availability of corn is subject to significant fluctuations depending upon a number of factors that affect commodity prices in general, including crop conditions, yields, domestic and global stocks, weather, federal policy, and foreign trade.  Natural gas prices are influenced by severe weather in the summer and winter and hurricanes in the spring, summer, and fall.  Other factors include North American exploration and production, and the amount of natural gas in underground storage during injection and withdrawal seasons.  Ethanol prices are sensitive to world crude oil supply and demand, domestic gasoline supply and demand, the price of crude oil, gasoline and corn, the price of substitute fuels and octane enhancers, refining capacity and utilization, government regulation and incentives and consumer demand for alternative fuels.  Distillers’ grains prices are impacted by livestock numbers on feed, prices for feed alternatives and supply, which is associated with ethanol plant production. 

 

Because the market price of ethanol is not always directly related to corn, at times ethanol prices may lag price movements in corn prices and corn-ethanol price spread may be tightly compressed or negative.  If the corn-ethanol spread is compressed or negative for sustained period, it is possible that our operating margins will decline or become negative and our ethanol plant may not generate adequate cash flow for operations.  In such cases, we may reduce or cease production at our ethanol plant to minimize our variable costs and optimize cash flow.

 

Management currently believes that our margins will remain modest during the remainder of the fiscal year 2018.  However, continued large corn supplies and ethanol production capacity increases could have a negative impact on the market price of ethanol which could adversely impact our profitability.  This negative impact could worsen if domestic ethanol inventories remain high or grow, or if U.S. exports of ethanol decline.  The ethanol industry is currently experiencing growth in production capacity principally through plant optimization and some new construction.  The EIA has reported that during 2017, increasing ethanol production rates have outpaced domestic E10 gasoline demand and export growth, leading to elevated ethanol inventory levels.  

 

In recent years, the ethanol industry in the U.S. has increased exports of ethanol and distillers’ grains.  However, export demand for ethanol is less consistent compared to domestic demand which can lead to ethanol price volatility.  During 2017, China and Brazil instituted tariffs on ethanol produced in the U.S., which are expected to continue to negatively impact U.S. exports.  In September 2017, China’s National Development and Reform Commission, the National Energy Board and 15 other state departments issued a joint plan to expand the use and production of biofuels containing up to 10% ethanol by 2020.  China, the number three importer of U.S. ethanol in 2016, imported negligible volumes during calendar year 2017 due to a 30% tariff imposed on imports of U.S. and Brazil fuel ethanol, which took effect in January 2017.  There is no assurance that the recently issued joint plan will lead to increased imports of U.S. ethanol by China but any increase in exports to China could have a positive impact on the ethanol market.

16


 

While Chinese export demand has fallen off since imposition of its tariffs, Brazilian demand from the U.S. has remained relatively steady.  Additionally, given the ethanol supply struggles Brazil is currently facing, the government of Brazil has indicated that it is contemplating reversing the tariff.  As a result, management anticipates exports to Brazil will remain steady in the near term despite the tariff as a result of market conditions in Brazil.  Any decrease in U.S. ethanol exports could adversely impact the market price of ethanol unless domestic demand increases or foreign markets are developed.

 

Our margins have also been, and could continue to be, negatively impacted due to lower market prices for distillers’ grains due to lower export demand, largely due to Chinese tariffs, and oversupply in the domestic market, along with increased corn and soybean availability.  However, during the three months ended January 31, 2018, distillers’ grains prices were somewhat buoyed by improved domestic demand in response to the continued rise in soybean meal prices and increased export demand by southeast Asia, particularly Vietnam.  Exports of U.S. distillers’ grains to Vietnam had halted completely due to Vietnam’s imposition of stricter regulations on fumigation in December 2016. However, in a statement issued September 1, 2017, the U.S. Grains Council announced that Vietnam is lifting its suspension of U.S. distillers’ grains imports and easing fumigation requirements.  Since the lifting of Vietnam’s suspension, exports to Vietnam have resumed, although there is no guarantee that they will reach pre-suspension levels. 

 

Demand and prices for distillers’ grains have experienced significant decline due to decreased exports to China as a result of the substantial tariffs and duties imposed on imports into China of distillers’ grains produced in the U.S. imposed in January 2017.  China had historically been one of the largest importers of domestically produced distillers’ grains.  However, in November 2017, the Chinese foreign ministry announced that it would be removing the 11% value-added tax on U.S. produced dried distillers’ grains but no timeline for removal has been established.  While the anti-subsidy tariffs may be removed, the more substantial anti-dumping duties remain.  As a result, we cannot forecast how much demand from China will come back into the marketplace and distillers’ grains prices could remain low unless additional demand can be created from other foreign markets or domestically. 

 

Corn oil prices have been adversely impacted by oversupply of corn oil due to the substantial increase in ethanol production during the last few years.  Additionally, corn oil prices have been impacted by oversupply of soybeans and the resulting lower price of soybean oil which competes with corn oil for biodiesel production. The impact of lower soybean oil prices and the current oversupply of corn oil due to the substantial increase in corn oil production during the last few years will likely continue to impact corn oil prices.

 

In February 2018, legislation was signed retroactively extending the $1.00-per-gallon biodiesel blender tax credit retroactively to January 1, 2017.  Any extension of the biodiesel blenders tax credit beyond December 31, 2017 could increase demand for corn oil and soybean oil and positively impact the price of corn oil.  However, due to the recent uncertainty in Congress, management cannot predict whether additional legislation further extending the biodiesel tax credit will be passed by Congress. 

 

Given the inherent volatility in ethanol, distillers’ grains, non-food grade corn oil, grain and natural gas prices, we cannot predict the likelihood that the spread between ethanol, distillers’ grains, non-food grade corn oil, and grain prices in future periods will be consistent compared to historical periods.

 

Government Supports and Regulation

 

The Renewable Fuels Standard

 

The ethanol industry is dependent on several economic incentives to produce ethanol, the most significant of which is the federal Renewable Fuels Standard (the “RFS”).  The RFS has been, and we expect will continue to be, a significant factor impacting ethanol usage.  Any adverse ruling on, or legislation affecting, the RFS could have an adverse impact on short-term ethanol prices and our financial performance in the future.

 

Under the provisions of the RFS, the Environmental Protection Agency (“EPA”) must publish an annual rule that establishes the number of gallons of different types of renewable fuels, including corn-based ethanol, that must be blended with gasoline in the U.S. by refineries, blenders, distributors, and importers, which affects the domestic market for ethanol.  In November 2017, the EPA announced it would maintain the 15 billion gallon mandate for conventional ethanol in 2018. 

 

17


 

According to the RFS, if mandatory renewable fuel volumes are reduced by at least 20% for two consecutive years, the EPA is required to modify, or reset, statutory volumes through 2022.  Although the EPA maintained the RVO for conventional ethanol at 15 billion gallons, 2018 is the first year the total proposed RVOs are more than 20% below statutory volumes levels.  Thus, the EPA Administrator Pruitt directed his staff to initiate the required technical analysis to perform any future reset consistent with the reset rules. The reset will be triggered if the 2019 RVOs continue to be more than 20% below the statutory levels.  If the reset is triggered, the EPA will be required to modify statutory volumes through 2022 within one year of the trigger event, based on the same factors used to set the RVOs post-2022.  Any adverse ruling on, or legislation affecting, the RFS could have an adverse impact on short-term ethanol prices and our financial performance in the future.

 

The EPA assigns individual refiners, blenders, and importers the renewable volume obligations (“RVOs”) they are obligated to use based on their percentage of total fuel sales.  However, the EPA has the authority to waive the mandates in whole or in part if there is inadequate domestic renewable fuel supply or the requirement severely harms the economy or environment.  Obligated parties use RINs to show compliance with RFS-mandated volumes.  RINs are attached to renewable fuels by producers and detached when the renewable fuel is blended with transportation fuel or traded in the open market.  The market price of detached RINs affects the price of ethanol in certain markets and influences the purchasing decisions by obligated parties.  In November 2017, the EPA denied a petition to change the point of obligation under RFS to the parties that own the gasoline before it is sold.

 

On October 19, 2017, the EPA Administrator Pruitt reiterated his commitment to the text and spirit of the RFS.  In a letter to seven senators from the Midwestern states, he stated the EPA is actively exploring its authority to issue an RVP waiver and will not pursue action on RINs involving ethanol exports.  Moreover, on November 22, 2017, the EPA issued a Notice of Denial of Petitions for rulemaking to change the RFS point of obligation, confirming the point of obligation will not change.  The point of obligation does not directly impact ethanol producers; however, moving the point of obligation could indirectly affect ethanol producers.

 

Valero Energy and refining trade group American Fuel and Petrochemical Manufacturers (AFPM) have challenged the EPA’s handling of the U.S. biofuel mandate in separate actions on January 26, 2018.  AFPM is asking the D.C. U.S. Court of Appeals to review the EPA’s November 2017 decision to reject proposed changes to the structure of the RFS, including moving the point of obligation from refiners and importers of fuel to fuel blenders.  Valero filed two petitions with the same court, one seeking review of the annual Renewable Volume Obligation (RVO) rule set by EPA’s for 2018 and 2019, which dictates the volumes of renewable fuels to be blended in the coming years, and a second arguing against the EPA’s December 2017 assertion that the agency has fulfilled its duty to periodically review the RFS as directed by statute.

 

Although the maintenance of the 15 billion gallon RVO for corn-based ethanol, the October 2017 letter issued by EPA Administrator Pruitt, and the resulting actions taken by the EPA consistent with EPA Administrator Pruitt’s letter signals support from the EPA and the Trump administration for domestic ethanol production, the Trump administration could still elect to materially modify, repeal, or otherwise invalidate the RFS.  At the end of February 2018 and continuing into March, several discussions regarding the RFS were held between the Trump administration and congressional and petroleum and ethanol industry leaders.  A variety of proposals to modify obligations under the RFS have surfaced in recent months, including application of the various waiver authorities under the RFS, expanding the number of small refinery exemptions, and a $0.10 per gallon cap on the price of the RIN credits used to comply with the RFS.  There has also been discussion of granting an RVP waiver for E15 gasoline blends to remove barriers to the year-rounds use of E15 and other mid-level ethanol blendsHowever, it is unclear what regulatory changes, if any, will emerge from these discussions.    Any changes to the RFS which could significantly affect the market price of RINs or reduce RVOs could adversely affect the demand and price for ethanol and the Company's profitability.

 

Tax Cuts and Job Act

 

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Reform Act”) was signed into law.  The Tax Reform Act includes significant changes to the taxation of partnership entities.  Included in those changes were changes U.S. federal tax rates,  significant limitations on the deductibility of interest, and allowances for the expensing of capital expendituresThe Company is currently evaluating the impact of the Tax Reform Act, as well as potential future regulations implementing the new tax law and interpretations of the new tax law with its professional advisors.  The full impact of the Tax Reform Act on the Company in future periods cannot be predicted at this time.

 

18


 

The Tax Reform Act also included an unintended consequence under section 199A benefitting producers of agricultural products that sell their products through cooperatives.  Currently, sales to non-cooperative grain buyers, like the Company, do not qualify for the same benefit.  This may provide cooperatives with a potential marketplace advantage over us as we compete to purchase corn for our plant due to how sales from farmers to such entities are treated for income tax purposes.  Any increase in the price we must pay for the corn to effectively compete with cooperatives would result in lower profit margins and adversely affect our financial performance.  According recent industry new reports, draft legislation has been proposed to address the marketplace imbalance created by section 199A retroactive to January 1, 2018 for inclusion in the pending 2018 omnibus spending bill.  While we believe that Congress intends to correct these provisions favoring cooperatives, there is no assurance that Congress will act to resolve this issue or that if such changes are approved that they will be retroactively applied. 

 

Results of Operations for the Three Months Ended January 31, 2018 and 2017

 

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, 2018 and 2017 (amounts in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Three Months Ended  January 31, 2018

 

Three Months Ended  January 31, 2017

Income Statement Data

    

(unaudited)

    

%

 

(unaudited)

    

%

Revenues

 

$

27,972

 

100.0

%  

 

$

27,390

 

100.0

%

Cost of Goods Sold

 

 

26,391

 

94.3

%  

 

 

23,976

 

87.5

%

Gross Profit

 

 

1,581

 

5.7

%  

 

 

3,414

 

12.5

%

Operating Expenses

 

 

(865)

 

(3.1)

%  

 

 

(847)

 

(3.1)

%

Operating Income

 

 

716

 

2.6

%  

 

 

2,567

 

9.4

%

Other Income, net

 

 

262

 

0.9

%  

 

 

348

 

1.3

%

Net Income

 

 

978

 

3.5

%  

 

 

2,915

 

10.7

%

Less: Net Income Attributable to Non-controlling Interest

 

 

(116)

 

(0.4)

%  

 

 

(83)

 

(0.3)

%

Net Income Attributable to Heron Lake BioEnergy, LLC

 

$

862

 

3.1

%  

 

$

2,832

 

10.4

%

 

Revenues

 

Our consolidated revenue is derived principally from revenues from our ethanol production segment, which consists primarily of sales of our three principal products: ethanol, distillers’ grains, and corn oil, as well as incidental sales of corn syrup.  Revenues from our ethanol production segment represented approximately 97.5% and 98.4% of our total revenues for the three months ended January 31, 2018 and 2017, respectively.  Our remaining consolidated revenues are attributable to Agrinatural revenues, net of eliminations for distribution fees paid by HLBE to Agrinatural for natural gas transportation services.  The revenues attributable to our natural gas pipeline segment represented approximately 2.5% and 1.6% of our consolidated revenues for the three months ended January 31, 2018 and 2017, respectively.

 

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 the three months ended January 31, 2018:

 

 

 

 

 

 

 

 

 

 

Three Months Ended  January 31, 2018

 

 

Sales Revenue

    

% of Total Revenues

 

 

(in thousands)

 

 

 

Ethanol sales

 

$

20,697

 

74.0

%

Distillers' grains sales

 

 

5,135

 

18.3

%

Corn oil sales

 

 

1,284

 

4.6

%

Corn syrup sales

 

 

162

 

0.6

%

Agrinatural revenues (net of intercompany eliminations)

 

 

694

 

2.5

%

Total Revenues

 

$

27,972

 

100.0

%

 

19


 

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, 2017:

 

 

 

 

 

 

 

 

 

 

Three Months Ended  January 31, 2017

 

 

Sales Revenue

    

% of Total Revenues

 

 

(in thousands)

 

 

 

Ethanol sales

 

$

21,890

 

79.9

%

Distillers' grains sales

 

 

3,729

 

13.6

%

Corn oil sales

 

 

1,184

 

4.3

%

Corn syrup sales

 

 

162

 

0.6

%

Agrinatural revenues (net of intercompany eliminations)

 

 

425

 

1.6

%

Total Revenues

 

$

27,390

 

100.0

%

 

Our total consolidated revenues increased by approximately 2.1% for the three months ended January 31, 2018, as compared to the three months ended January 31, 2017, due to an increase the average price received for our distillers’ grains, which was partially offset by decreases the average price received for our ethanol and corn oil.  The following table reflects quantities of our three primary products sold and the average net prices received for the three months ended January 31, 2018 and 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  January 31, 2018

 

Three Months Ended  January 31, 2017

 

 

Quantity Sold

 

Avg. Net Price

 

Quantity Sold

 

Avg. Net Price

Product

 

(in thousands)

 

 

 

 

(in thousands)

 

 

 

Ethanol (gallons)

 

17,306

 

$

1.20