UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

Form 10-Q

 

(Mark One)

For the quarterly period ended June 30, 2018

or

For the transition period from ______________ to ______________

Commission file number: 000-52421

 

ADVANCED BIOENERGY, LLC

(Exact name of Registrant as Specified in its Charter)

 

8000 Norman Center Drive, Suite 610

Bloomington, Minnesota 55437

(763) 226-2701

(Address, including zip code, and telephone number,

including area code, of Registrant’s Principal Executive Offices)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑       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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes ☑       No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth 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.

 

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 August 1, 2018, the number of outstanding units was 25,410,851.

 

 

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ADVANCED BIOENERGY, LLC

FORM 10-Q

Index

 

 

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ADVANCED BIOENERGY, LLC & SUBSIDIARIES

Consolidated Balance Sheets

(Dollars in thousands)

 

 

See notes to consolidated financial statements.

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ADVANCED BIOENERGY, LLC & SUBSIDIARIES

Consolidated Statements of Operations

(Dollars in thousands, except per unit data)

(Unaudited)

 

 

See notes to consolidated financial statements.

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ADVANCED BIOENERGY, LLC & SUBSIDIARIES

Consolidated Statement of Changes in Members’ Equity

For the Nine Months Ended June 30, 2018

(Dollars in thousands)

(Unaudited)

 

 

See notes to consolidated financial statements

 

 

 

 

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ADVANCED BIOENERGY, LLC & SUBSIDIARIES

Consolidated Statements of Cash Flows

(Dollars in thousands)

(Unaudited)

 

 

See notes to consolidated financial statements.

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ADVANCED BIOENERGY, LLC & SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Organization and Significant Accounting Policies

The consolidated financial statements include the accounts of Advanced BioEnergy, LLC (“ABE” or the “Company”) and its wholly owned subsidiaries, ABE Fairmont, LLC (“ABE Fairmont”) and ABE South Dakota, LLC (“ABE South Dakota”). Substantially all of the assets of ABE Fairmont were sold in December 2012 and the subsidiary is now inactive.  All intercompany balances and transactions have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles, or GAAP, for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  The interim financial statements should be read in conjunction with the audited financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended September 30, 2017. The financial information as of June 30, 2018 and the results of operations for the three and nine months ended June 30, 2018 are not necessarily indicative of the results for the fiscal year ending September 30, 2018. In the opinion of management, the interim financial statements reflect all normal recurring adjustments necessary for fair presentation.

Certain expenses recognized in previous quarters were reclassified for year-end presentation in the prior year to be consistent with the classifications that management had adopted. As such, certain amounts have been reclassified for the prior year quarter periods presented, with no effect on members’ equity or net income.

The Company currently owns two ethanol production facilities in Aberdeen and Huron, South Dakota with a combined production capacity of 80 million gallons per year.

Cash, Cash Equivalents, and Restricted Cash

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The Company’s cash balances are maintained in bank depositories and periodically exceed federally insured limits. The Company has not experienced losses in these accounts.  Restricted cash at June 30, 2018 and September 30, 2017 included a deposit for a rail car sublease.

The following table provides a reconciliation of cash and cash equivalents, and restricted cash reported within the consolidated balance sheet that sum to the total of the same such amounts in the consolidated statement of cash flows (in thousands):

 

Fair Value of Financial Instruments

Financial instruments include cash, cash equivalents and restricted cash, accounts receivable, accounts payable, accrued expenses, and long-term debt. The fair value of the long-term debt is estimated on level 3 inputs based on current anticipated interest rate that management believes would be available to the Company for similar debt, taking into account the current credit risk of the Company and other market factors.  Based on these factors, the fair value of the long-term debt is currently estimated at carrying value. Excluding cash and cash equivalents, the fair value of the other financial instruments are estimated to approximate carrying value due to the short-term nature of these instruments, and are considered to be Level 3 inputs.

 

Receivables

Credit sales are made to a relatively small number of customers with no collateral required. Trade receivables are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly

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basis. Management determines the allowance for doubtful accounts by regularly evaluating individual receivables and considering a customer’s financial condition, credit history and current economic conditions. Receivables are written off if deemed uncollectible. Recoveries of receivables previously written off are recorded when received.  There was no allowance for doubtful accounts recorded at June 30, 2018 or September 30, 2017.

Inventories

Ethanol inventory, raw materials, work-in-process and parts inventory are valued using methods that approximate the lower of cost (first-in, first-out) or net realizable value (“NRV”). Distillers grains and related products are stated at NRV. In the valuation of inventories and purchase and sale commitments, the Company determines NRV by estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.

Property and Equipment

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

 

 

 

Maintenance and repairs are charged to expense as incurred; major improvements and betterments are capitalized. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset group may not be recoverable. The Company is not aware of any events or circumstances that would indicate a decline in the fair value below the carrying value of the long-lived assets. An impairment loss would be recognized when estimated undiscounted future cash flows from operations are less than the carrying value of the asset group. An impairment loss would be measured by the amount by which the carrying value of the asset exceeds the estimated fair value on that date.

Commodity Sales and Purchase Contracts, Derivative Instruments

The Company enters into forward sales contracts for ethanol, distillers and corn oil, and purchase contracts for corn and natural gas. The Company classifies these sales and purchase contracts as normal sales and purchase contracts and accordingly these contracts are not marked to market. These contracts provide for the sale or purchase of an item other than a financial instrument or derivative instrument that will be delivered in quantities expected to be sold or used over a reasonable period in the normal course of business.

In addition, certain derivative financial instruments that meet the criteria for derivative accounting treatment also qualify for a scope exception to derivative accounting, as they are considered normal purchases and sales.  The availability of this exception is based on the assumption that the Company has the ability and it is probable that it will deliver or take delivery of the underlying item.  Derivatives that are considered to be normal purchases and sales are exempt from derivative accounting treatment, and are accounted for under accrual accounting.

Revenue Recognition

Ethanol revenue is recognized when product title and all risk of ownership is transferred to the customer as specified in the contractual agreements with the marketers. Under the terms of the marketing agreements, revenue is recognized when product is loaded into rail cars or trucks for shipment. Revenue from the sale of co-products is recorded when title and all risk of ownership transfers to customers. Co-products are normally shipped free on board (“FOB”) shipping point. In accordance with the Company’s agreements for the marketing and sale of ethanol and related products, commissions due to the marketers are deducted from the gross sale price at the time of payment.  Interest income is recognized as earned.

Income per Unit

Basic and diluted income (loss)-per-unit is computed using the weighted-average number of vested units outstanding during the period. Unit warrants are considered unit equivalents and are considered in the diluted income (loss)-per-unit compensation.

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Accounting Estimates

Management uses estimates and assumptions in preparing these financial statements in accordance with generally accepted accounting principles, or GAAP. 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. Actual results could differ from those estimates.

Income Taxes

          The Company has elected to be treated as a partnership for tax purposes and generally does not incur income taxes. Instead, the Company’s earnings and losses are included in the income tax returns of the members. Therefore, no provision or liability for federal or state income taxes has been included in these financial statements. The Company files income tax returns in the U.S. federal and various state jurisdictions.

Recent Accounting Pronouncements

Effective October 1, 2018, the Company will adopt the amended guidance in ASC 606, “Revenue from Contracts with Customers”, which requires revenue recognition to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The updated standard permits either the retrospective or cumulative effect transition method.  The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.

Effective January 1, 2018, and presented retrospectively,  the Company adopted the amended guidance in ASC 230, “Statement of Cash Flows”, which amends existing guidance to require that the Statement of Cash Flows now include restricted cash and restricted cash equivalents along with cash and cash equivalents when reconciling beginning and end-of-period amounts. Effective January 1, 2018, the Company no longer presents transfers between cash and cash equivalents and restricted cash and restricted cash equivalents in the Statement of Cash Flows.

          In February 2016, the ASC was amended and a new accounting standard, ASC Topic 842, “Leases,” was issued to increase the transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The new standard requires recognition of the assets and liabilities that arise from leases. Accordingly, a lessee will recognize a right-of-use (“ROU”) asset for its right to use the underlying asset and a lease liability for the corresponding lease obligation. The lease liability will initially be measured at the present value of the future minimum lease payments over the lease term. The ROU asset will initially be measured as the sum of the initial lease liability, initial costs directly attributable to negotiating and arranging the lease, and payments made by a lessee to the lessor at or before the lease commencement date less any lease incentives received. Lessees can make an accounting policy election by class of underlying asset not to recognize a ROU asset and corresponding lease liability for leases with a term of 12 months or less. Accounting by lessors will remain largely unchanged from current U.S. GAAP. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that companies may elect to apply. These practical expedients relate to the identification and classification of leases that commenced before the effective date, initial direct costs for leases that commenced before the effective date, and the ability to use hindsight in evaluating lessee options to extend or terminate a lease or to purchase the underlying asset. The transition guidance also provides specific guidance for sale-and-leaseback transactions, build-to-suit leases, leveraged leases, and amounts previously recognized in accordance with the business combinations guidance for leases. The new standard is effective for public companies for fiscal years beginning after December 15, 2018, and interim periods within those years, with early adoption permitted. We are currently evaluating the potential effect of this new accounting standard on our balance sheet.

 

2. Inventories

A summary of inventories is as follows (in thousands):

 

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3. Property and Equipment

A summary of property and equipment is as follows (in thousands):

 

 

4. Long-term Debt

A summary of long-term debt is as follows (in thousands, except percentages):

 

 

The estimated maturities of debt are as follows (in thousands):

 

 

2015 Senior Credit Agreement for the South Dakota Plants

On December 29, 2015, ABE South Dakota entered into a Master Credit Agreement (“2015 Credit Agreement”) with AgCountry Farm Credit Services, PCA as lender, (“AgCountry”) to refinance its existing 2010 Senior Credit Agreement. On December 29, 2015, the Company also entered into (i) a First Supplement to the 2015 Credit Agreement covering a $10.0 million Revolving Term Facility and (ii) a Second Supplement covering a $20.0 million Term Loan. The transaction funded on December 30, 2015.

The $20.0 million Term Loan has a variable interest rate (“Variable Rate”) equal to the one-month LIBOR rate plus a “Margin” of 350 basis points. The applicable LIBOR interest rate at June 30, 2018 was 1.93%. Beginning April 1, 2016, the Company began making quarterly principal payments of $1.0 million, plus accrued interest, on the Term Loan. The Term Loan will be fully amortized over five years with the final payment on January 1, 2021. The Company may elect one or more fixed or adjustable interest rates, rather than the Variable Rate, based on AgCountry’s cost of funds at the time of the election, plus the Margin. Any election must apply to $1.0 million or more owing on the Term Loan. At June 30, 2018, the balance of the Term Loan was $11.0 million.

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The $10.0 million Revolving Term Facility also has a Variable Rate equal to the one-month LIBOR rate plus an initial Margin of 350 basis points. Borrowings under the Revolving Term Facility may be advanced, repaid and re-borrowed during the term. The Company is required to make quarterly interest payments on the Revolving Term Facility, with the full principal amount outstanding due on January 1, 2021. Under the Revolving Term Facility, the Company is required to pay unused commitment fees of 50 basis points. At June 30, 2018, the balance of the Revolving Term Facility was $10.0 million.

The Margin will (i) decrease to 3.25% when the aggregate principal balance of all outstanding loans and the unfunded commitment level is $20.0 million or less, and (ii) decrease to 3.00% when this amount is $15.0 million or less.

ABE South Dakota, LLC also entered into a Security Agreement with AgCountry under which borrowings under the 2015 Credit Agreement are secured by substantially all of ABE South Dakota’s assets. AgCountry holds a first priority security interest and mortgage in all inventory, accounts receivable, intangibles, equipment, fixtures, buildings, and a first mortgage in land owned or leased by ABE South Dakota.

The 2015 Credit Agreement also includes customary financial and non-financial covenants that limit capital expenditures, distributions and debt and require minimum working capital, current ratio, debt to EBITDA, and fixed charge coverage ratios. See “Amendment and Waivers to 2015 Credit Agreement” below.

2016 Term Loan

On September 28, 2016, ABE South Dakota entered into the Third Supplement to the 2015 Credit Agreement (“2016 Term Loan”) with AgCountry to finance the corn oil extraction system at the Huron plant.  The original loan commitment for the 2016 Term Loan was $1.7 million, and the loan has a variable interest rate equal to the one-month LIBOR rate plus a “Margin” of 350 basis points. A total of $1.1 million of the $1.7 million commitment was drawn from this loan. On January 1, 2017, the Company began making quarterly payments of accrued interest on the 2016 Term Loan. On April 1, 2017, the Company began making quarterly principal payments of $212,500 on the 2016 Term Loan. As of June 30, 2018 the balance of the 2016 Term Loan was $0.04 million. Subsequent to the quarter ended June 30, 2018, the 2016 Term Loan was paid in full.

2018 Construction and Term Loan

On March 13, 2018, ABE South Dakota entered into the Fourth Supplement to the 2015 Credit Agreement (“2018 Term Loan”) with AgCountry to finance a grain storage and receiving facility at the Aberdeen plant. The agreement provides for a $5.0 million multiple advance credit facility. The loan has a variable interest rate equal to the one-month LIBOR rate plus a “Margin” of 350 basis points.  During the construction period, the Company will make quarterly interest payments in arrears on the first day of each quarter.  Upon completion of construction, the Company will begin making quarterly principal payments in the amount of $250,000 per quarter, plus accrued interest. The 2018 Term Loan will be fully amortized over five years, with the final payment on July 1, 2024.  At June 30, 2018, no funds had been drawn on the 2018 Term Loan, and $47,000 in loan fees and closing costs had been incurred, which have been classified as deferred financing costs and will be amortized as interest expense over the term of the loan.

Amendment and Waivers to 2015 Credit Agreement

On September 28, 2016, ABE South Dakota entered into a Limited Waiver and First Amendment to the 2015 Credit Agreement (“First Amendment”) to (i) eliminate the Owner’s Equity Ratio Covenant, (ii) temporarily increase the Capital Expenditures Covenant to $3.0 million for fiscal 2016 to finance the corn oil extraction system at the Huron plant, and (iii) waive other post-closing obligations. 

On November 19, 2016, ABE South Dakota received a waiver to the 2015 Credit Agreement from AgCountry that waived certain Events of Default related to the Working Capital requirement and the Total Outstanding Debt to EBITDA Ratio at September 30, 2016.

On October 16, 2017 ABE South Dakota received a waiver to the 2015 Credit Agreement from AgCountry that waived an Event of Default related to the Capital Expenditure Covenant for fiscal 2017. The Capital Expenditure Covenant for fiscal 2016 was increased to $3.0 million due to addition of the corn oil extraction system at Huron.  However, a portion of the capital expenditure cost was incurred in fiscal 2017, so an additional waiver was granted for this period.

On March 13, 2018, in conjunction with the 2018 Term Loan, ABE South Dakota entered into a Second Amendment to the 2015 Credit Agreement (“Second Amendment”) to temporarily increase the Capital Expenditures Covenant to $6.0 million per year for the years ending September 30, 2018 and 2019.  The covenant will revert back to $2.0 million per year for all years ending after September 30, 2019.  

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The Company was in compliance with the applicable covenants of the 2015 Credit Agreement as of June 30, 2018. However, based on financial results for the nine months ended June 30, 2018, the Company is unable to project with certainty compliance with covenants of the 2015 Credit Agreement as of September 30, 2018.   The Company has been in discussions with AgCountry regarding a potential waiver to the 2015 Credit Agreement as of September 30, 2018.  Although the Company believes it is probable it will obtain any necessary waivers at September 30, 2018, in the event such waivers are not obtained, AgCountry may accelerate the repayment of outstanding principal and exercise its rights as a secured party.

ABE Letter of Credit

The Company has a $1.0 million irrevocable and non-transferable standby letter of credit related to a rail car sublease.  This letter of credit is collateralized by $1.0 million of cash in a restricted account; the cash in this account has been classified as restricted cash.

5. Major Customers

ABE South Dakota has ethanol marketing agreements with NGL Energy Partners, LP (“NGL”), a diversified energy business.  These ethanol marketing agreements require that we sell to NGL all of the denatured fuel-grade ethanol produced at the South Dakota plants.  The term of these ethanol marketing agreements expires on June 30, 2019.

ABE South Dakota is party to a co-product marketing agreement with Dakotaland Feeds, LLC (“Dakotaland Feeds”), whereby Dakotaland Feeds markets wet distillers’ grains produced at the Huron plant and modified distillers’ at the Aberdeen plant to third parties for an agreed-upon commission.  ABE South Dakota has a marketing agreement with Gavilon Ingredients, LLC (“Gavilon”) to market the dried distillers’ grains at the Aberdeen and Huron plants through July 31, 2019. ABE South Dakota self-markets its wet and a small portion of modified distillers’ grains produced at the Aberdeen plant.

ABE South Dakota is party to an agreement with Gavilon to market all of the corn oil produced by the Huron and Aberdeen plants through September 30, 2018 and November 30, 2018, respectively.

Sales and receivables from the ABE South Dakota’s major customers were as follows (in thousands):

 

 

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6. Risk Management

The Company is exposed to a variety of market risks, including the effects of changes in commodity prices and interest rates. These financial exposures are monitored and managed by the Company as an integral part of its overall risk management program. The Company’s risk management program seeks to reduce the potentially adverse effects that the volatility of these markets may have on its current and future operating results. To reduce these effects, the Company generally attempts to fix corn purchase prices and related sale prices of ethanol, distillers’ grains and corn oil, with forward purchase and sale contracts to lock in future operating margins. The Company had entered into the following fixed price forward contracts at June 30, 2018:

 

 

Unrealized gains and losses on forward contracts, in which delivery has not occurred, are deemed “normal purchases and normal sales” and therefore are not marked to market in the financial statements.

7.  Parent Financial Statements

The following financial information represents the unconsolidated financial statements of Advanced BioEnergy, LLC (“ABE”) as of June 30, 2018 and September 30, 2017, and for the nine months ended June 30, 2018 and 2017.  ABE’s ability to receive distributions from ABE South Dakota is based on the terms and conditions in ABE South Dakota credit agreement. Under its current credit agreement, ABE South Dakota is allowed to make equity distributions of up to 40% of its net income and may distribute up to 100% of its net income if it achieves and maintains an owner’s equity ratio of at least 60% and working capital of at least $15 million. There were no distributions from ABE South Dakota during the last three fiscal years due to covenant limitations and/or future planned capital requirements.

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Advanced BioEnergy, LLC (Unconsolidated)

Balance Sheets

(Dollars in thousands)

 

 

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Advanced BioEnergy, LLC (Unconsolidated)

Statements of Operations

(Dollars in thousands)

(Unaudited)

 

 

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Advanced BioEnergy, LLC (Unconsolidated)

Statements of Cash Flows

(Dollars in thousands)

(Unaudited)

 

 

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

Information Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements regarding our business, financial condition, results of operations, performance and prospects. All statements that are not historical or current facts are forward-looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks, uncertainties and other factors, many of which may be beyond our control and may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Certain of these risks and uncertainties are described in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended September 30, 2017 and in this Form 10-Q. These risks and uncertainties include, but are not limited to, the following:

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

General

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

Overview

Advanced BioEnergy, LLC (“Company,” “we,” “our,” “Advanced BioEnergy” or “ABE”) was formed in 2005 as a Delaware limited liability company. Our business consists of producing ethanol and co-products, including wet, modified and dried distillers’ grains, and corn oil. Ethanol is a renewable, environmentally clean fuel source that is produced at numerous facilities in the United States, mostly in the Midwest. In the U.S., ethanol is produced primarily from corn and then blended with unleaded gasoline in varying percentages. The ethanol industry in the U.S. has grown significantly as the use of ethanol reduces harmful auto emissions, enhances octane ratings of the gasoline with which it is blended, offers consumers a cost-effective choice, and decreases the amount of crude oil the U.S. needs to import from foreign sources.

To execute our business plan, in November 2006 we acquired ABE South Dakota, LLC (f/k/a Heartland Grain Fuels, LP), which owned existing ethanol production facilities in Aberdeen and Huron, South Dakota. We commenced construction of our expansion facility in Aberdeen, South Dakota in April 2007, and commenced operations in January 2008. Our production operations are carried out primarily through our operating subsidiary ABE South Dakota, which owns and operates ethanol facilities in Aberdeen and Huron, South Dakota.

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, the Company’s plants are aggregated into one reporting segment.

DRY MILL PROCESS

Dry mill ethanol plants produce ethanol primarily by processing corn. Other possible feeds are grain sorghum, or other cellulosic materials. The corn is conveyed directly from Agtegra Cooperative to the plant where it is weighed and transferred to a scalper to remove rocks, cobs, and other debris.  The corn is then fed to a hammer mill where it is ground into flour and conveyed into a slurry tank. Water, heat and enzymes are added to the flour in the slurry tank to start the process of converting starch from the corn into sugar. The slurry is pumped to a liquefaction tank where additional enzymes are added. These enzymes continue the starch-to-sugar conversion. The grain slurry is pumped into fermenters, where yeast is added to begin the batch-fermentation process. Fermentation is the process of the yeast converting the sugar into alcohol and carbon dioxide. After the fermentation is complete, a vacuum distillation system removes the alcohol from the corn mash. The 95% (190-proof) alcohol from the distillation process is then transported to a molecular sieve system, where it is dehydrated to 100% alcohol (200 proof). The 200-proof alcohol is then pumped to storage tanks and blended with a denaturant, usually natural gasoline. The 200-proof alcohol and 2.0-2.5% denaturant constitute denatured fuel ethanol.

Corn mash left over from distillation is pumped into a centrifuge for dewatering. The liquid from the centrifuge, known as thin stillage, is then pumped from the centrifuges to an evaporator, where it is concentrated into a syrup. The solids that exit the centrifuge, known as the wet cake, are conveyed to the dryer system. Syrup is added to the wet cake as it enters the dryer, where moisture is removed. The process produces distillers’ grains with solubles, which is used as a high-protein/fat animal-feed supplement. Dry-mill ethanol processing creates three forms of distillers’ grains: wet distillers’ grains with solubles, known as wet distillers’ grains; modified wet distillers’ grains with solubles, known as modified distillers’ grains; and dry distillers’ grains with solubles, known as dry distillers’ grains. Wet and modified distillers’ grains have been dried to approximately 65% and 50% moisture levels, respectively, and are predominately sold to nearby markets. Dried distillers’ grains have been dried to 11% moisture, have an almost indefinite shelf life and may be sold and shipped to more distant markets.

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Corn oil is produced by processing evaporated thin stillage through a disk stack style centrifuge. Corn oil has a lower density than water or solids that make up the syrup. The centrifuges separate the relatively light oil from the heavier components of the syrup, eliminating the need for significant retention time. De-oiled syrup is returned to the process for blending into wet, modified, or dry distillers’ grains. The corn oil is then pumped into storage tanks before being loaded onto trucks for sale.

FACILITIES

The table below provides a summary of our ethanol plants in operation as of June 30, 2018:

 

 

In October 2015, we amended the existing lease agreement for our corporate headquarters. Under the amended lease, we agreed to lease approximately 4,400 square feet for our corporate and administrative staff in Bloomington, Minnesota, through September 2021. The base rent is $19.00 per square foot, or approximately $7,000 per month for the twelve month period beginning July 1, 2016, with annual increases of $.50 per square foot. We believe this space will be sufficient for our needs until the end of the lease period.

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

Under the ABE South Dakota security agreement with AgCountry (defined below), AgCountry holds a first priority security interest and mortgage in all inventory, accounts receivable, intangibles, equipment, fixtures, buildings, and a first mortgage in land owned or leased by ABE South Dakota.

Plan of Operations through June 30, 2019

Over the next year, we will continue our focus on operational improvements at our South Dakota operating facilities. These operational improvements include exploring methods to improve ethanol yield per bushel and increasing production output at each of our plants, continuing emphasis on safety and environmental regulation, reducing our operating costs, and optimizing our margin opportunities through prudent risk-management policies. We began construction of a grain receiving and storage facility at our Aberdeen plant beginning in July 2018, and are in the process of evaluating construction of a similar facility at our Huron plant.  We expect the Aberdeen facility to be completed around July 2019.   In anticipation of the completion of construction, we have terminated, effective November 8, 2019, the grain origination agreement with Agtegra with respect to the Aberdeen plant. Once operational, we believe this facility will help to reduce our operating costs, specifically our cost to procure corn.

 

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Results of Operations for the Quarter Ended June 30, 2018 Compared to Quarter Ended June 30, 2017

The following tables reflect quantities of our products sold at average net prices as well as bushels of corn ground and therms of natural gas burned at average costs for three months ended June 30, 2018 and 2017 for our South Dakota plants:

 

 

 

Net Sales

Net sales for the quarter ended June 30, 2018 were $36.2 million, compared to $33.8 million for the quarter ending June 30, 2017, an increase of $2.4 million or 7%. Higher net sales for the quarter ended June 30, 2018 reflect an increase in ethanol gallons sold of 5% compared to the prior quarter ended June 30, 2017, offset by a decrease in ethanol prices of 8% for the quarter ended June 30, 2018, compared to the prior quarter ended June 30, 2017. As a percentage of net sales, ethanol sales were 75% and 83%; distillers’ sales were 22% and 13%; and corn oil sales were 3% and 3% for the quarters ending June 30, 2018 and June 30, 2017, respectively.

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

Cost of Goods Sold

Cost of goods sold for the quarter ended June 30, 2018 was $36.0 million, compared to $32.6 million for the quarter ended June 30, 2017, an increase of $3.4 million. Our primary costs in the production of ethanol and related co-products are corn and natural gas.  A $3.9 million increase in corn costs, resulting from a combination of increased bushels and increased price per bushel, offset by a $0.1 million decrease in natural gas costs represented a majority of the increase in cost of goods sold in the quarter ended June 30, 2018. Corn costs represented 75% and 71% of cost of sales for the quarters ended June 30, 2018 and 2017, respectively. Corn prices per bushel increased 11% during the three-month period ending June 30, 2018 compared to the prior year quarter. We used 5% more corn in the three-month period ending June 30, 2018, compared to the three months ended June 30, 2017.

Natural gas costs represented 4% and 5% of total cost of sales for the quarters ending June 30, 2018 and 2017, respectively. The cost of natural gas per mmbtu decreased by 8% to $3.00 for the quarter ended June 30, 2018 compared to the previous year quarter. Our natural gas consumption increased by 3% due to higher production in the quarter ending June 30, 2018 versus the quarter ending June 30, 2017.

Selling, General, and Administrative Expenses

Selling, general and administrative expenses are comprised primarily of recurring administrative personnel compensation, legal, technology, consulting, insurance and accounting fees.

Overall selling, general and administrative costs for the quarter ended June 30, 2018 were $0.6 million compared to $0.7 million for the previous quarter.  As a percentage of net sales, selling, general and administrative expenses were 1.8% and 2.1% of net sales, for the quarters ending June 30, 2018 and 2017, respectively.

Interest Expense

Interest expense for the quarter ended June 30, 2018 was $187,000 compared to $217,000 for the quarter ending June 30, 2017. The lower interest expense was the result of less interest bearing debt outstanding compared to the prior year quarter.

 

 

 

 

 

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Results of Operations for the Nine Months Ended June 30, 2018 Compared to Nine Months Ended June 30, 2017

     The following tables reflect quantities of our products sold at average net prices as well as bushels of corn ground and therms of natural gas burned at average costs for the nine months ended June 30, 2018 and 2017 for our South Dakota plants only:    

 

 

 

Net Sales

Net sales for the nine months ended June 30, 2018 were $100.4 million, compared to $106.1 million for the nine months ending June 30, 2017 a decrease of $5.7 million or 5%. Ethanol gallons sold decreased by 1% for the nine months ended June 30, 2018, compared to the prior nine months ended June 30, 2017.  As a percentage of net sales, ethanol sales were 77% and 82%; distillers’ sales were 21% and 14%; and corn oil sales were 3% and 3% for both nine months ending June 30, 2018 and 2017.  

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

Cost of Goods Sold

Cost of goods sold for the nine months ended June 30, 2018 was $100.7 million, compared to $96.6 million for the nine months ended June 30, 2017, an increase of $4.1 million. Our primary costs in the production of ethanol and related co-products are corn and natural gas.  A $2.6 million increase in corn costs and a $1.2 million increase in natural gas costs represented a majority of the increase in cost of goods sold in the nine months ended June 30, 2018. Corn costs represented 71% of cost of sales for both nine months ended June 30, 2018 and 2017.  Corn prices per bushel increased 4% during the nine-month period ending June 30, 2018 compared to the prior year nine months.  We used 1% less corn in the nine month period ending June 30, 2018, compared to the nine months ended June 30, 2017 as a result of increased production efficiencies.

Natural gas costs represented 7% and 6% of total cost of goods sold for the nine months ended June 30, 2018 and 2017, respectively. The cost of natural gas per mmbtu increased by $0.77 per mmbtu, or 22% for the nine months ending June 30, 2018 compared to the prior year period. Prices were higher in the current year due to increased demand as a result of colder winter months. Natural gas stocks have dropped year over year due to increased demand from colder weather and exports, resulting in higher prices in the current quarter versus last year.  Natural gas consumption decreased 1% for the nine months ending June 30, 2018 compared to the prior year period.

Selling, General, and Administrative Expenses

Selling, general and administrative expenses are comprised primarily of recurring administrative personnel compensation, legal, technology, consulting, insurance and accounting fees.

Overall selling, general and administrative costs for the nine months ended June 30, 2018 were $2.1 million compared to $2.6 million for the prior year nine months.  As a percentage of net sales, selling, general and administrative expenses for the nine months ending June 30, 2018 decreased to 2.1%, compared to 2.5% for the nine months ended June 30, 2017.

Interest Expense

Interest expense for the nine months ending June 30, 2018 was $584,000, compared to $665,000 for the prior year period.  The lower interest expense for the current nine months was the result of a lower level of long-term debt.

  

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Changes in Financial Position for the Nine Months ended June 30, 2018

Current Assets

The $4.2 million decrease in current assets at June 30, 2018 compared to September 30, 2017 was primarily due to a decrease in cash due to negative operating margins in the nine months ended June 30, 2018 and partially offset by a $0.9 million increase in trade receivables and inventory, mostly due to timing differences.

Property, Plant and Equipment

The $1.3 million decrease in property, plant and equipment at June 30, 2018 compared to September 30, 2017, was primarily due to recognizing $2.9 million depreciation expense offset by $1.6 million of capital expenditures year to date fiscal 2018.

Current Liabilities

Accounts payable and accrued expenses decreased by $0.5 million at June 30, 2018 compared to September 30, 2017 primarily due to timing of payments to vendors.

Current Portion of Long-Term Debt and Long-term Debt

The current portion of long-term debt decreased by $636,000 June 30, 2018 compared to September 30, 2017.  The decrease was due to debt payments made on the 2016 Term Loan, which had a remaining balance of $40,000 at June 30, 2018 and was paid in full in July 2018.

Long-term debt decreased by $3.0 million at June 30, 2018 compared to September 30, 2017. This decrease was due to debt payments made in October 2017, January 2018 and April 2018.

TRENDS AND UNCERTAINTIES AFFECTING THE ETHANOL INDUSTRY AND OUR FUTURE OPERATIONS

Overview

Ethanol is currently blended with gasoline to meet regulatory standards as a clean air additive, an octane enhancer, a fuel extender and a gasoline alternative. According to the Renewable Fuels Association (“RFA”), as of June 2018, current annualized U.S. ethanol production capacity was approximately 16.2 billion gallons per year. The demand for ethanol is affected by what is commonly referred to as the “blending wall,” which is a regulatory cap on the amount of ethanol that can be blended into gasoline.  The blend wall affects the demand for ethanol, and as industry production capacity reaches the blend wall, the supply of ethanol in the market may surpass the demand. Assuming current gasoline usage in the U.S. at 143.85 billion gallons per year and a blend rate of 10% ethanol and 90% gasoline, the current blend wall is approximately 14.4 billion gallons of ethanol per year.

Ethanol is most commonly sold as E10, the 10 percent blend of ethanol that can be used in all American automobiles. Increasingly, ethanol is also available as E15, which is a higher octane fuel with a 15 percent blend of ethanol. In June 2012, the EPA approved E15 for use in vehicles with model years 2001 and later. According to the RFA, this group of approved vehicles makes up 80 percent of all vehicles on the road today.  Although regulatory issues remain in many states, E15 is now available in limited locations in 29 states.  Ethanol is also available as E85, a higher percentage ethanol blend for use in flexible fuel vehicles.

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

We focus on locking in margins based on a cash flows model that continually monitors market prices of corn, natural gas and other input costs against prices for ethanol and distillers grains at each of our production facilities. We create offsetting positions by using a combination of derivative instruments, fixed-price purchases and sales, or a combination of strategies to manage risk associated with commodity price fluctuations. Our primary focus is not to manage general price movements, for example minimize the cost of corn consumed, but rather to lock in favorable margins whenever possible. In the quarter ended June 30, 2018, the average Chicago OPIS Spot Ethanol Assessment was $1.45 per gallon and the average NYMEX RBOB spot gasoline price was $2.11 per gallon, or approximately $0.66 per gallon above ethanol prices.

Federal policy has a significant impact on ethanol market demand. Ethanol blenders previously benefited from incentives that encouraged usage and a tariff on imported ethanol that supported the domestic industry, both of which have now expired. Additionally, the Environmental Protection Agency’s Renewable Fuels Standard (“RFS”) mandates increased level of usage of both

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corn-based and cellulosic ethanol. Any adverse ruling on, or legislation affecting, RFS mandates in the future could have an adverse impact on short-term ethanol prices and our financial performance in the future.

The ethanol industry and our business depend upon continuation of the federal and state ethanol supports such as the RFS. We believe the ethanol industry expanded due to these federal mandates, policies, and incentives. These government mandates have supported a market for ethanol that might disappear without these programs. Alternatively, the government mandates may be continued at lower levels than those at which they currently exist. In addition, state regulatory activity may also negatively affect the consumption of corn-based ethanol in certain domestic markets such as California, due to low-carbon fuel standards that take into consideration the effects caused by indirect land use.

The Renewable Fuels Standard

The RFS is a national program that imposes requirements with respect to the amount of renewable fuel produced and used in the United States. The RFS was revised by the EPA in July 2010 (“RFS2”) and applies to refineries, blenders, distributors and importers. We believe the RFS2 program has and will continue to increase the market for renewable fuels, such as ethanol, as a substitute for petroleum-based fuels. The RFS2 required that 16.55 billion gallons be sold or dispensed in 2013, increasing to 36.0 billion gallons by 2022, representing 7% of the anticipated gasoline and diesel consumption in 2022. In 2013, RFS2 required refiners and importers to blend renewable fuels totaling at least 9.74% of total fuel volume, of which 8.12% of total fuel volume, or 13.8 billion gallons, could be derived from corn-based ethanol. The remainder of the requirement is to be met by non-corn related advanced renewable fuels such as cellulosic ethanol and biomass-based biodiesel. The RFS requirement for corn-based ethanol was capped at 15.0 billion gallons starting in 2015.

As of June 2018, current annualized ethanol production is approximately 16.2 billion gallons per the RFA. On November 30, 2017 the EPA announced the final rule for the 2018 RVOs, which is set at 15.0 billion gallons for corn-based ethanol. This rule is also set at 100% of the original conventional biofuel requirement of 15.0 billion gallons, but has a reduction in the amount of advanced biofuels required.  On June 26, 2018 the EPA announced proposed RVOs for 2019, which include 15.0 billion gallons for corn-based ethanol, consistent with both the 2018 RVOs and the original statutory volumes.  

The following chart illustrates the potential United States ethanol demand based on the schedule of minimum usage established by the RFS2 program through the year 2022 (in billions of gallons).

 

 

The RFS2 went into effect on July 1, 2010 and requires certain gas emission reductions for the entire lifecycle, including production of fuels. The greenhouse gas reduction requirement generally does not apply to facilities that commenced construction prior to December 2007. If this changes and our plants must meet the standard for emissions reduction, it may impact the way we procure feed stock and modify the way we market and transport our products.

Tax Cuts and Job Act

On December 22, 2017, H.R. 1, originally known as the Tax Cuts and Jobs Act (the “2017 Tax Reform Act”), was signed into law. The 2017 Tax Reform Act includes significant changes to the taxation of business entities, including a permanent reduction to the federal corporate income tax rate from 35% to 21% effective in 2018 and changes to deductibility of interest on debt obligation. The Company is currently evaluating the impact of the 2017 Tax Reform Act, as well as potential future regulations implementing the new

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tax law and interpretation of the new tax law with its professional advisors. The full impact of the 2017 Tax Reform Act on the Company in future periods cannot be predicted at this time.

Ethanol Competition

The ethanol we produce is similar to ethanol produced by other plants. The RFA reports that as of June 2018, current annualized U.S. ethanol production was approximately 16.2 billion gallons per year. On a national level, there are numerous other production facilities with which we are in direct competition, many of whom have greater resources than we do. As of June 2018, South Dakota had 15 ethanol plants producing an aggregate of 1.1 billion gallons of ethanol per year.

The largest ethanol producers include: Archer Daniels Midland Company; Cargill, Inc.; Flint Hills Resources, LP; Green Plains Renewable Energy, Inc.; POET, LLC and Valero Renewable Fuels. Producers of this size may have an advantage over us from economies of scale and stronger negotiating positions with purchasers. We market our ethanol primarily on a regional and national basis. We believe that we are able to reach the best available markets through the use of experienced ethanol marketers and by the rail delivery methods we use. Our plants compete with other ethanol producers on the basis of price, and, to a lesser extent, delivery service. We believe that we can compete favorably with other ethanol producers due to our proximity to ample grain, natural gas, electricity and water supplies at favorable prices.

Competition from Alternative Fuels

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

Ethanol Marketing

ABE South Dakota has ethanol marketing agreements with NGL Energy Partners, LP (“NGL”), a diversified energy business. These ethanol marketing agreements require that we sell to NGL all of the denatured fuel-grade ethanol produced at the South Dakota plants. These ethanol marketing agreements expire on June 30, 2019.

CO-PRODUCTS

Sales of distillers’ grains have represented 22% and 13% of our revenues for the quarters ended June 30, 2018 and 2017, respectively. When the plants are operating at capacity, they produce approximately 231,000 tons of dried distillers’ grains equivalents per year, approximately 15-16 pounds per bushel of corn used.  Distillers’ grains are a high-protein, high-energy animal feed supplement primarily marketed to the dairy and beef industry, but also to the poultry and swine markets. Dry mill ethanol processing creates three forms of distillers’ grains: wet distillers’ grains with solubles, known as wet distillers’ grains; modified wet distillers’ grains with solubles, known as modified distillers’ grains; and dry distillers’ grains with solubles. Wet and modified distillers’ grains have been dried to approximately 65% and 50% moisture levels, respectively, and are predominately sold to nearby markets. Dried distillers’ grains have been dried to 11% moisture, have an almost indefinite shelf life and may be sold and shipped to more distant markets. In this Form 10-Q, we sometimes refer to these products as “distillers’ grains” or “distillers.”

We installed corn oil extraction technology at our Aberdeen plant in 2012.  We installed corn oil extraction technology at our Huron plant that became fully operational in October 2016. Corn oil systems are designed to extract non-edible corn oil during the thin stillage evaporation process immediately prior to production of distillers’ grains. Corn oil is produced by processing evaporated thin stillage through a disk stack style centrifuge. Corn oil has a lower density than the water or solids that make up the syrup. The centrifuges separate the relatively light oil from the heavier components of the syrup, eliminating the need for significant retention time. De-oiled syrup is returned to the process for blending into wet, modified, or dry distillers’ grains.

Industrial uses for corn oil include feedstock for biodiesel, livestock feed additives, rubber substitutes, rust preventatives, inks, textiles, soaps and insecticides. Our corn oil is primarily sold by truck to biodiesel manufacturers.

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Competition

In the sales of distillers’ grains, we compete with other ethanol producers, as well as a number of large and smaller suppliers of competing animal feed. We believe the principal competitive factors are price, proximity to purchasers and product quality. Currently we derive 64% of our distillers’ grain revenues from the sale of dried distillers’ grains, which have an indefinite shelf life and can be transported by truck or rail, and 36% from the sale of modified or wet distillers’ grains, which have a shorter shelf life and are typically sold in local markets via truck.

We compete with other ethanol producers in the sale of corn oil. We ship all of the corn oil at our facilities via truck. Many ethanol producers have added corn oil technology to their facilities.

Co-Product Marketing

ABE South Dakota has a marketing agreement with Dakotaland Feeds, LLC (“Dakotaland Feeds”) for marketing the sale of wet distillers grains produced at the Huron plant and modified distillers grains produced at the Aberdeen plant. ABE South Dakota has a marketing agreement with Gavilon Ingredients, LLC, (“Gavilon”) for dried distillers’ grains produced at the Aberdeen and Huron plants that became effective July 1, 2013. The marketing agreement requires Gavilon to use commercially reasonable efforts to purchase substantially all of the dried distillers’ grains produced at the Aberdeen and Huron plants through July 31, 2019.

ABE South Dakota is party to an agreement with Gavilon to market all the corn oil produced by the Aberdeen and Huron plants through September 30, 2018 and November 30, 2018, respectively.

CAPITAL RESOURCES

During the quarter ended June 30, 2018, we conducted our business activities and plant operations through the parent company, Advanced BioEnergy, and its primary operating subsidiary, ABE South Dakota. ABE Fairmont has had minimal activity since the December 2012 sale of the Fairmont facility. The liquidity and capital resources for each entity are based on the entity’s existing financing arrangements and capital structure. Advanced BioEnergy is highly restricted in its ability to use the cash and other financial resources of ABE South Dakota for the benefit of Advanced BioEnergy, with the exception of allowable distributions as defined under the 2015 Credit Agreement with AgCountry.

Advanced BioEnergy, LLC (“ABE”)

ABE had cash and cash equivalents of $0.3 million on hand at June 30, 2018. ABE did not have any debt outstanding as of June 30, 2018.  

From time to time, ABE may also receive certain allowable distributions from ABE South Dakota, subject to compliance with the terms and conditions of the 2015 Credit Agreement. ABE will not receive any distribution from ABE South Dakota for its fiscal 2017 financial results.

In connection with the execution of a rail car sublease, the Company, as parent of ABE South Dakota, agreed to post a $2.5 million irrevocable and non-transferable standby letter of credit in May 2012 for the benefit of NGL Crude Logistics, LLC (“NGL” f/k/a Gavilon) as security for the payment obligations of ABE South Dakota under certain agreements with NGL. The Company deposited $2.5 million in a restricted account as collateral for this letter of credit and classified it as restricted cash. Effective May 15, 2014, the letter of credit and corresponding deposit of collateral was decreased by $1.0 million in conjunction with an amendment to the rail car sublease. Effective June 27, 2016, the letter of credit and corresponding deposit of collateral was decreased by $0.5 million in conjunction with an amendment to the rail car sublease.

We believe ABE has sufficient financial resources available to fund current operations and capital expenditure requirements for at least the next 12 months.

ABE Fairmont

ABE Fairmont had no cash or cash equivalents on hand at June 30, 2018.

During the quarter ended March 31, 2018, ABE Fairmont completed its obligations to Flint Hills Resources, LLC with respect to post-closing matters, including completing the transfer of certain railway lines. The Company anticipates that it will begin a dissolution of the ABE Fairmont entity in the next several months.

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ABE South Dakota

ABE South Dakota had cash and cash equivalents of $13.7 million on hand at June 30, 2018. As of June 30, 2018, ABE South Dakota had interest-bearing term debt outstanding of $21.0 million, which is summarized below.

2015 Senior Credit Agreement

On December 29, 2015, ABE South Dakota entered into a Master Credit Agreement (“2015 Credit Agreement”) with AgCountry Farm Credit Services, PCA as lender, (“AgCountry”) to refinance its existing 2010 Senior Credit Agreement. On December 29, 2015, the Company also entered into (i) a First Supplement to the 2015 Credit Agreement covering a $10.0 million Revolving Term Facility and (ii) a Second Supplemental covering a $20.0 million Term Loan. The transaction funded on December 30, 2015.

The $20.0 million Term Loan has a variable interest rate (“Variable Rate”) equal to the one-month LIBOR rate plus a “Margin” of 350 basis points. The applicable LIBOR interest rate at June 30, 2018 was 1.93%. Beginning April 1, 2016, the Company began making quarterly principal payments of $1.0 million, plus accrued interest, on the Term Loan. The Term Loan will be fully amortized over five years with the final payment on January 1, 2021. The Company may elect one or more fixed or adjustable interest rates, rather than the Variable Rate, based on AgCountry’s cost of funds at the time of the election, plus the Margin. Any election must apply to $1.0 million or more owing on the Term Loan. At June 30, 2018, the balance of the Term Loan was $11.0 million.

The $10.0 million Revolving Term Facility also has a Variable Rate equal to the one-month LIBOR rate plus an initial Margin of 350 basis points. Borrowings under the Revolving Term Facility may be advanced, repaid and re-borrowed during the term. The Company is required to make quarterly interest payments on the Revolving Term Facility, with the full principal amount outstanding due on January 1, 2021. Under the Revolving Term Facility, the Company is required to pay unused commitment fees of 50 basis points. At June 30, 2018, the balance of the Revolving Term Facility was $10.0 million.

The Margin will (i) decrease to 3.25% when the aggregate principal balance of all outstanding loans and the unfunded commitment level is $20.0 million or less, and (ii) decrease to 3.00% when this amount is $15.0 million or less.

ABE South Dakota, LLC also entered into a Security Agreement with AgCountry under which borrowings under the 2015 Credit Agreement are secured by substantially all of ABE South Dakota’s assets. AgCountry holds a first priority security interest and mortgage in all inventory, accounts receivable, intangibles, equipment, fixtures, buildings, and a first mortgage in land owned or leased by ABE South Dakota.

The 2015 Credit Agreement also includes customary financial and non-financial covenants that limit capital expenditures, distributions and debt and require minimum working capital, current ratio, debt to EBITDA, and fixed charge coverage ratios. See “Amendment and Waivers to 2015 Credit Agreement” below.

2016 Term Loan

On September 28, 2016, ABE South Dakota entered into the Third Supplement to the 2015 Credit Agreement (“2016 Term Loan”) with AgCountry to finance the corn oil extraction system at the Huron plant.  The original loan commitment for the 2016 Term Loan was $1.7 million, and the loan has a variable interest rate equal to the one-month LIBOR rate plus a “Margin” of 350 basis points. A total of $1.1 million of the $1.7 million commitment was drawn from this loan. On January 1, 2017, the Company began making quarterly payments of accrued interest on the 2016 Term Loan. On April 1, 2017, the Company began making quarterly principal payments of $212,500 on the 2016 Term Loan. As of June 30, 2018 the balance of the 2016 Term Loan was $0.04 million. Subsequent to the quarter ended June 30, 2018, the 2016 Term Loan was paid in full.

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2018 Construction and Term Loan

On March 13, 2018, ABE South Dakota entered into the Fourth Supplement to the 2015 Credit Agreement (“2018 Term Loan”) with AgCountry to finance a grain storage and receiving facility at the Aberdeen plant. The agreement provides for a $5.0 million multiple advance credit facility. The loan has a variable interest rate equal to the one-month LIBOR rate plus a “Margin” of 350 basis points.  During the construction period, the Company will make quarterly interest payments in arrears on the first day of each quarter.  Upon completion of construction, the Company will begin making quarterly principal payments in the amount of $250,000 per quarter, plus accrued interest. The 2018 Term Loan will be fully amortized over five years, with the final payment on July 1, 2024.  At June 30, 2018, no funds had been drawn on the 2018 Term Loan, and $47,000 in loan fees and closing costs had been incurred, which have been classified as deferred financing costs and will be amortized as interest expense over the term of the loan.

Amendment and Waivers to 2015 Credit Agreement

On September 28, 2016, ABE South Dakota entered into a Limited Waiver and First Amendment to the 2015 Credit Agreement (“First Amendment”) to (i) eliminate the Owner’s Equity Ratio Covenant, (ii) temporarily increase the Capital Expenditures Covenant to $3.0 million for fiscal 2016 to finance the corn oil extraction system at the Huron plant, and (iii) waive other post-closing obligations. 

On November 19, 2016, ABE South Dakota received a waiver to the 2015 Credit Agreement from AgCountry that waived certain Events of Default related to the Working Capital requirement and the Total Outstanding Debt to EBITDA Ratio at September 30, 2016.

On October 16, 2017 ABE South Dakota received a waiver to the 2015 Credit Agreement from AgCountry that waived an Event of Default related to the Capital Expenditure Covenant for fiscal 2017. The Capital Expenditure Covenant for fiscal 2016 was increased to $3.0 million due to addition of the corn oil extraction system at Huron.  However, a portion of the capital expenditure cost was incurred in fiscal 2017, so an additional waiver was granted for this period.

On March 13, 2018, in conjunction with the 2018 Term Loan, ABE South Dakota entered into a Second Amendment to the 2015 Credit Agreement (“Second Amendment”) to temporarily increase the Capital Expenditures Covenant to $6.0 million per year for the years ending September 30, 2018 and 2019.  The covenant will revert back to $2.0 million per year for all years ending after September 30, 2019.  

The Company was in compliance with the applicable covenants of the 2015 Credit Agreement as of June 30, 2018. However, based on financial results for the nine months ended June 30, 2018, the Company is unable to project with certainty compliance with covenants of the 2015 Credit Agreement as of September 30, 2018.   The Company has been in discussions with AgCountry regarding a potential waiver to the 2015 Credit Agreement as of September 30, 2018.  Although the Company believes it is probable it will obtain any necessary waivers at September 30, 2018, in the event such waivers are not obtained, AgCountry may accelerate the repayment of outstanding principal and exercise its rights as a secured party.

 

CASH FLOWS

The following table shows our cash flows for the nine months ended June 30, 2018 and 2017:

 

 

Cash Flow from Operations

Cash flows provided by operating activities for the nine months ending June 30, 2018 were approximately $0.2 million compared to $10.3 million used in the prior year period, a decrease of $10.1 million. Lower operating margins, driven by negative margins in the first and third quarters of fiscal 2018, accounted for the majority of the overall decrease in cash flows from operating activities.

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Cash Flow from Investing Activities

Cash flows used in investing activities for the nine months ending June 30, 2018 were approximately $1.3 million compared to $2.4 million provided by investing activities for the prior year period. The current year nine months included $1.6 million in additions to property and equipment offset by $0.3 million of patronage income. The prior year nine months included a $2.5 million in additions to property and equipment offset by $0.2 million of patronage income.

Cash Flow from Financing Activities

Cash flows used in financing activities for the nine months ending June 30, 2018 were $3.7 million compared to $5.9 million used in for the prior year period. The current year period included long-term debt payments of $3.0 million on the 2015 Credit Agreement and $0.6 million debt payments on the 2016 Term Loan. Cash used in financing activities in the prior year period included $1.1 million in debt proceeds in conjunction with the Huron corn oil project which was offset by long-term debt payments of $3.2 million and a distribution of $3.8 million to unit holders.

CREDIT ARRANGEMENTS

Long-term debt consists of the following (in thousands, except percentages):

 

 

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

 

 

SUMMARY OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

Revenue Recognition

Ethanol revenue is recognized when product title and all risk of ownership is transferred to the customer as specified in the contractual agreements with the marketers. Under the terms of the marketing agreements with NGL, revenue is recognized when product is loaded into rail cars or trucks for shipment.  Revenue from the sale of co-products is recorded when title and all risk of ownership transfers to customers. Co-products are normally shipped free on board (“FOB”) shipping point. Interest income is recognized as earned. In accordance with the Company’s agreements for the marketing and sale of ethanol and related products, commissions due to the marketers are deducted from the gross sale price at the time of payment.

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Inventories

Ethanol inventory, raw materials, work-in-process and parts inventory are valued using methods that approximate the lower of cost (first-in, first-out) or net realizable value (“NRV”). Distillers grains and related products are stated at NRV. In the valuation of inventories and purchase and sale commitments, the Company determines NRV by estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.

Commodity Sales and Purchase Contracts, Derivative Instruments

The Company enters into forward sales contracts for ethanol, distillers and corn oil, and purchase contracts for corn and natural gas. The Company classifies these sales and purchase contracts as normal sales and purchase contracts and accordingly these contracts are not marked to market. These contracts provide for the sale or purchase of an item other than a financial instrument or derivative instrument that will be delivered in quantities expected to be sold or used over a reasonable period in the normal course of business.

On occasion, the Company has entered into derivative contracts to hedge the Company’s exposure to price risk related to forecasted corn purchases and forecasted ethanol sales. Accounting for derivative contracts requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction.

 

Although the Company believes its derivative positions are economic hedges, it has not designated any of these positions as hedges for accounting purposes and has recorded its derivative positions on its balance sheet at their fair value, with changes in fair value recognized in current period earnings.

In addition, certain derivative financial instruments that meet the criteria for derivative accounting treatment also qualify for a scope exception to derivative accounting, as they are considered normal purchases and sales.  The availability of this exception is based on the assumption that the Company has the ability and it is probable that it will deliver or take delivery of the underlying item.  Derivatives that are considered to be normal purchases and sales are exempt from derivative accounting treatment, and are accounted for under accrual accounting.

Property and Equipment

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

 

 

During the fourth quarter of fiscal 2016, the Company decided to permanently cease operations at its smaller Aberdeen plant.  Accordingly, the Company recorded an impairment of $1.6 million during the fourth quarter of fiscal 2016. In connection with the impairment of the smaller Aberdeen plant, the Company also re-evaluated the estimated lives of process equipment.  Prior to June 30, 2016, the Company used an estimated useful life of 10 years for process equipment.  Based on the re-evaluation, the Company determined a change in estimate was necessary.  Accordingly, the Company adjusted the estimated useful life for process equipment to 15 years in the fourth quarter of fiscal 2016.  As a result of this change in estimate, depreciation expense was reduced by approximately $1.8 million in fiscal 2016 and annual depreciation in subsequent periods has been and will be reduced to reflect the longer estimate useful life.

 

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

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

COMMODITY PRICE RISK

We consider market risk to be the impact of adverse changes in market prices on our results of operations. We are subject to significant market risk with respect to the price of ethanol and corn. For the quarter ended June 30, 2018, sales of ethanol represented 77% of our total revenues and corn costs represented 71% of total cost of goods sold. In general, ethanol prices are affected by the supply and demand for ethanol, the cost of ethanol production, the availability of other fuel oxygenates, the regulatory climate and the cost of alternative fuels such as gasoline. The price of corn is affected by weather conditions and other factors affecting crop yields, farmer planting decisions and general economic, market and regulatory factors. At June 30, 2018, the price per gallon of ethanol and the price per bushel of corn on the CBOT were $1.42 and $3.50 respectively.

We are also subject to market risk on the selling prices of our distillers’ grains, which represented 21% of our total revenues for the quarter ended June 30, 2018. These prices fluctuate seasonally when the price of corn or other cattle feed alternatives fluctuate in price. The average dried distillers’ grains spot price for local customers was $119 per ton at June 30, 2018.

We are also subject to market risk with respect to our supply of natural gas that we consume in the ethanol production process. Natural gas costs represented 6.6% of total cost of sales for the quarter ended June 30, 2018. The price of natural gas is affected by overall supply, weather conditions and general economic, market and regulatory factors. At June 30, 2018, the price of natural gas on the NYMEX was $2.92 per mmbtu.

To reduce price risk caused by market fluctuations in the cost and selling prices of related commodities, we have entered into forward purchase/sale contracts. We entered into forward sales contracts that guaranteed prices on 67% of our ethanol gallons sold through July 2018. At June 30, 2018 we had entered into forward sale contracts representing 42% of our expected distillers’ grains production output through August 2018.

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

 

 

INTEREST RATE/FOREIGN EXCHANGE RISK

Our future earnings may be affected by changes in interest rates due to the impact those changes have on our interest expense on borrowings under our credit facility. As of June 30, 2018, we had $21.0 million of outstanding borrowings with variable interest rates. With each 1% increase in interest rates we will incur additional annual interest charges of $0.21 million.

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Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our chief executive officer, who is also our chief financial officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on this evaluation, our chief executive officer, who is also our chief financial officer, concluded that our disclosure controls and procedures are effective.

Changes in Internal Controls

There were no changes in our internal controls over financial reporting during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

 

None.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

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