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EX-32.2 - EX-32.2 - Heron Lake BioEnergy, LLCc964-20180731ex32283dec4.htm
EX-32.1 - EX-32.1 - Heron Lake BioEnergy, LLCc964-20180731ex321e4d908.htm
EX-31.2 - EX-31.2 - Heron Lake BioEnergy, LLCc964-20180731ex3127ee534.htm
EX-31.1 - EX-31.1 - Heron Lake BioEnergy, LLCc964-20180731ex311bfd641.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 July 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 ☐

 

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 September 14, 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

 

 

 

 

 

 

 

 

 

 

  

July 31, 2018

  

October 31, 2017

 

 

 

(unaudited)

 

 

 

 

ASSETS

 

 

 

 

 

 

 

Current Assets

 

 

 

 

 

 

 

Cash

 

$

5,605,354

 

$

10,065,367

 

Restricted cash

 

 

23,620

 

 

 -

 

Accounts receivable

 

 

1,716,192

 

 

4,031,977

 

Inventory

 

 

6,516,264

 

 

7,064,344

 

Commodity derivative instruments

 

 

286,601

 

 

141,644

 

Prepaid expenses and other current assets

 

 

445,668

 

 

259,106

 

Total current assets

 

 

14,593,699

 

 

21,562,438

 

 

 

 

 

 

 

 

 

Property and Equipment, net

 

 

45,081,316

 

 

46,567,087

 

 

 

 

 

 

 

 

 

Other Assets

 

 

 

 

 

 

 

Other intangible assets, net

 

 

17,241

 

 

45,852

 

Other assets

 

 

697,254

 

 

697,254

 

Total other assets

 

 

714,495

 

 

743,106

 

 

 

 

 

 

 

 

 

Total Assets

 

$

60,389,510

 

$

68,872,631

 

 

 

 

 

 

 

 

 

LIABILITIES AND MEMBERS' EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities

 

 

 

 

 

 

 

Current maturities of long-term debt

 

$

322,048

 

$

432,183

 

Accounts payable

 

 

2,663,097

 

 

4,771,197

 

Commodity derivative instruments

 

 

35,196

 

 

27,630

 

Accrued expenses

 

 

290,146

 

 

415,106

 

Total current liabilities

 

 

3,310,487

 

 

5,646,116

 

 

 

 

 

 

 

 

 

Long-Term Debt, less current portion

 

 

795,555

 

 

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 July 31, 2018 and October 31, 2017

 

 

54,635,331

 

 

60,767,951

 

Non-controlling interest

 

 

1,648,137

 

 

1,493,062

 

Total members' equity

 

 

56,283,468

 

 

62,261,013

 

 

 

 

 

 

 

 

 

Total Liabilities and Members' Equity

 

$

60,389,510

 

$

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  July 31,

 

Nine Months Ended July 31,

 

 

2018

 

2017

 

2018

 

2017

 

  

(unaudited)

  

(unaudited)

  

(unaudited)

  

(unaudited)

Revenues

 

$

26,252,916

 

$

28,541,889

 

$

84,106,223

 

$

81,922,747

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of Goods Sold

 

 

25,160,502

 

 

26,290,595

 

 

79,304,820

 

 

74,406,956

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross Profit

 

 

1,092,414

 

 

2,251,294

 

 

4,801,403

 

 

7,515,791

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Expenses

 

 

(719,371)

 

 

(732,406)

 

 

(2,426,398)

 

 

(2,348,775)

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

 

373,043

 

 

1,518,888

 

 

2,375,005

 

 

5,167,016

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Income (Expense):

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

17,721

 

 

7,692

 

 

48,743

 

 

9,900

Interest expense

 

 

(53,190)

 

 

(79,022)

 

 

(81,556)

 

 

(136,212)

Other income, net

 

 

360

 

 

391

 

 

329,584

 

 

398,906

Total other income (expense), net

 

 

(35,109)

 

 

(70,939)

 

 

296,771

 

 

272,594

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

 

337,934

 

 

1,447,949

 

 

2,671,776

 

 

5,439,610

 

 

 

 

 

 

 

 

 

 

 

 

 

Less: Net Income Attributable to Non-controlling Interest

 

 

(35,248)

 

 

(33,197)

 

 

(236,075)

 

 

(173,325)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income Attributable to Heron Lake BioEnergy, LLC

 

$

302,686

 

$

1,414,752

 

$

2,435,701

 

$

5,266,285

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

77,932,107

 

 

77,932,107

 

 

77,932,107

 

 

77,932,107

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

0.00

 

$

0.02

 

$

0.03

 

$

0.07

 

 

 

 

 

 

 

 

 

 

 

 

 

Distributions Per Unit (Class A and B)

 

$

0.00

 

$

0.00

 

$

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

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended July 31,

 

 

 

 

2018

 

 

2017

 

 

  

 

(unaudited)

  

 

(unaudited)

 

Cash Flow From Operating Activities:

 

 

 

 

 

 

 

Net income

 

$

2,671,776

 

$

5,439,610

 

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

 

 

 

 

 

 

 

Depreciation and amortization

 

 

3,731,782

 

 

3,741,698

 

Gain on sale of asset

 

 

(24,815)

 

 

(45,000)

 

Change in fair value of commodity derivative instruments

 

 

(477,288)

 

 

(407,603)

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Restricted cash

 

 

(23,620)

 

 

(144,345)

 

Accounts receivable

 

 

2,315,785

 

 

2,857,378

 

Inventory

 

 

548,080

 

 

(583,522)

 

Commodity derivative instruments

 

 

339,897

 

 

914,550

 

Prepaid expenses and other current assets

 

 

(186,562)

 

 

(217,755)

 

Accounts payable

 

 

(3,042,596)

 

 

(1,916,193)

 

Accrued expenses

 

 

(124,960)

 

 

(104,048)

 

Net cash provided by operating activities

 

 

5,727,479

 

 

9,534,770

 

 

 

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

 

 

Capital expenditures

 

 

(1,282,904)

 

 

(967,937)

 

Proceeds from disposal of asset

 

 

24,815

 

 

45,000

 

Net cash used in investing activities

 

 

(1,258,089)

 

 

(922,937)

 

 

 

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

 

 

Payments on checks drawn in excess of bank balance

 

 

 —

 

 

(1,866,683)

 

Payments on long-term debt

 

 

(280,082)

 

 

(324,994)

 

Distributions to Heron Lake BioEnergy, LLC members

 

 

(8,568,321)

 

 

 —

 

Distribution to non-controlling interest

 

 

(81,000)

 

 

 —

 

Net cash used in financing activities

 

 

(8,929,403)

 

 

(2,191,677)

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash

 

 

(4,460,013)

 

 

6,420,156

 

 

 

 

 

 

 

 

 

Cash—Beginning of period

 

 

10,065,367

 

 

1,297,644

 

 

 

 

 

 

 

 

 

Cash—End of period

 

$

5,605,354

 

$

7,717,800

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

 

Interest expense

 

$

81,556

 

$

136,212

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Non-Cash Investing and Financing Activities

 

 

 

 

 

 

 

Capital expenditures included in accounts payable

 

$

934,496

 

$

45,328

 

 

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

July 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 July 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

July 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

July 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:

 

 

 

 

 

 

 

 

 

 

 

July 31, 2018

 

October 31, 2017

 

 

  

(unaudited)

  

 

 

 

Raw materials

 

$

1,197,309

 

$

1,442,844

 

Work in process

 

 

682,900

 

 

652,296

 

Finished goods

 

 

3,439,800

 

 

3,747,779

 

Supplies

 

 

1,196,255

 

 

1,221,425

 

Totals

 

$

6,516,264

 

$

7,064,344

 

 

 

6


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

July 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 $169,000 and $65,000 for the nine months ended July 31, 2018 and 2017, respectively.

 

 

4.DERIVATIVE INSTRUMENTS

 

As of July 31, 2018, the total notional amount of the Company’s outstanding corn derivative instruments was approximately 4,125,000 bushels, comprised of short corn positions 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 July 31, 2018, the Company had approximately $24,000 of cash collateral (restricted cash) and $0 due to a 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 July 31, 2018, none of which are designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Balance Sheet Location

    

Assets

    

Liabilities

 

Corn contracts

 

Commodity derivative instruments

 

$

286,601

 

$

35,196

 

Totals

 

 

 

$

286,601

 

$

35,196

 

 

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

 

 

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Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

July 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  July 31,

 

Nine Months Ended  July 31,

 

  

Operations Location

  

2018

  

2017

 

2018

  

2017

Corn contracts

 

Cost of goods sold

 

$

916,800

 

$

233,003

 

$

425,139

 

$

646,489

Ethanol contracts

 

Revenues

 

 

(142,625)

 

 

31,906

 

 

53,747

 

 

(238,886)

Natural gas contracts

 

Cost of goods sold

 

 

 —

 

 

 —

 

 

(1,598)

 

 

 —

Total gain

 

 

 

$

774,175

 

$

264,909

 

$

477,288

 

$

407,603

 

 

 

5.FAIR VALUE

 

The following table sets forth, by level, the Company assets and liabilities that were accounted for at fair value on a recurring basis at July 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

 

$

286,601

 

$

286,601

 

$

286,601

 

$

 —

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity Derivative instruments - Corn

 

$

35,196

 

$

35,196

 

$

 —

 

$

35,196

 

$

 —

 

 

The following table sets forth, by level, the Company assets and liabilities 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, corn, and natural gas Level 2 instruments by model-based techniques in which all significant inputs are observable in the markets noted above.

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Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

July 31, 2018

 

6.DEBT FINANCING

 

Long-term debt consists of the following:

 

 

 

 

 

 

 

 

 

 

 

July 31, 2018

 

October 31, 2017

 

 

 

(unaudited)

 

 

 

Amended revolving term note payable to lending institution, see terms below.

 

$

 —

 

$

 —

 

Seasonal line of credit 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.

 

 

1,094,236

 

 

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.

 

 

23,367

 

 

56,514

 

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

 

 

 —

 

 

100,000

 

Totals

 

 

1,117,603

 

 

1,397,685

 

Less amounts due within one year

 

 

322,048

 

 

432,183

 

Net long-term debt

 

$

795,555

 

$

965,502

 

 

Revolving Term Note

 

The Company had a revolving term note payable under which the Company could 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.  On April 6, 2018, the Company finalized loan agreements with an effective date of March 29, 2018 for an amended credit facility with its lender. 

 

Amended Credit Facility

 

The amended credit facility includes an amended and restated revolving term loan with a $4,000,000 principal commitment and a revolving seasonal line of credit with a $4,000,000 principal commitment.  The loans are secured by substantially all of the Company’s assets, including a subsidiary guarantee.  The amended 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 amended credit facility closing, the Company entered into an amended administrative agency agreement with CoBank, ACP (“CoBank”).  As a result, CoBank will continue act as the agent for the lender with respect to the amended credit facility.  The Company agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.

 

Amended Revolving Term Note

 

Under the terms of the amended revolving term loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4,000,000.  Final payment of amounts borrowed under amended revolving term loan is due December 1, 2021.  Interest on the amended revolving term loan accrues at a variable weekly rate equal to 3.10% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate, which was 5.18% at July 31, 2018    

 

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Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

July 31, 2018

 

The Company also agreed to pay an unused commitment fee on the unused available portion of the amended revolving term loan commitment at the rate of 0.500% per annum, payable monthly in arrears.

 

The aggregate principal amount available to the Company for borrowing under the revolving term loan at October 31, 2017 was $17,500,000, and under the amended revolving term loan at July 31, 2018 was $4,000,000.

 

Seasonal Revolving Loan

 

Under the terms of the seasonal revolving loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4,000,000 until its maturing on February 1, 2019.  Amounts borrowed under the seasonal revolving loan bear interest at a variable weekly rate equal to 2.850% above the rate quoted by LIBOR Index rate, which was 4.93% at July 31, 2018. 

 

The Company also agreed to pay an unused commitment fee on the unused portion of the seasonal revolving loan commitment at the rate of 0.250% per annum.

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

 

 

 

 

 

 

2019

  

$

322,048

 

2020

 

 

318,253

 

2021

 

 

339,097

 

2022

 

 

138,205

 

Total debt

 

$

1,117,603

 

 

 

 

7.COMMITMENTS AND CONTINGENCIES

 

Corn Forward Contracts

 

At July 31, 2018, the Company had cash and basis contracts for forward corn purchase commitments totaling approximately 4,189,000 bushels for various delivery periods through June 2019.

 

Ethanol Forward Contracts

 

At July 31, 2018, the Company had fixed and basis contracts to sell approximately $11,716,000 of ethanol for various delivery periods through September 2018.  

 

Distillers’ Grains Forward Contracts

 

At July 31, 2018, the Company had forward contracts to sell approximately $2,517,000 of distillers’ grains for various delivery periods through August 2018.

 

Corn Oil Forward Contracts

 

At July 31, 2018, the Company had forward contracts to sell approximately $775,000 of corn oil for various delivery periods through December 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 damages to leased railcar is necessary and an estimate of the possible range of loss cannot be made.

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Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

July 31, 2018

 

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 July 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.

 

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 $115,000 and $121,000 for the three months ended July 31, 2018 and 2017, respectively, and approximately $353,000 and $320,000 for the nine months ended July 31, 2018 and 2017, respectively.

 

Corn Purchases - Members

 

The Company purchased corn from board members of approximately $3,382,000 and $143,000 for the three months ended July 31, 2018 and 2017, respectively, and approximately $10,479,000 and $5,737,000 for the nine months ended July 31, 2018 and 2017, respectively. Of this total, approximately $0 and $607,000 was included in accounts payable at July 31, 2018 and October 31, 2017, respectively.

 

Agrinatural

 

During 2013, the Company borrowed $300,000 from the non-controlling interest member of Agrinatural.  This note was paid in full in January 2018.  Total interest paid in relation to this note payable amounted to approximately $0 and $1,000 for the three months ended July 31, 2018 and 2017, respectively, and approximately $1,000 and $5,000 for the nine months ended July 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.

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Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

July 31, 2018

 

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 $50,000 and $48,000 for the three months ended July 31, 2018 and 2017, respectively, and approximately $147,000 and $145,000 for the nine months ended July 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 and capital work of approximately $34,000 and $15,000 for the three months ended July 31, 2018 and 2017, respectively, and approximately $49,000 and $27,000 for the nine months ended July 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

 

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

 

Nine Months Ended

 

 

July 31, 2018

 

July 31, 2017

 

July 31, 2018

 

July 31, 2017

 

Revenue:

    

(unaudited)

    

(unaudited)

 

(unaudited)

 

(unaudited)

 

Ethanol production

 

$

26,161,809

 

$

28,451,695

 

$

82,906,086

 

$

81,115,207

 

Natural gas pipeline

 

 

522,551

 

 

527,432

 

 

2,537,485

 

 

2,113,045

 

Eliminations

 

 

(431,444)

 

 

(437,238)

 

 

(1,337,348)

 

 

(1,305,505)

 

Total Revenue

 

$

26,252,916

 

$

28,541,889

 

$

84,106,223

 

$

81,922,747

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

July 31, 2018

 

July 31, 2017

 

July 31, 2018

 

July 31, 2017

 

Operating Income:

 

(unaudited)

    

(unaudited)

 

(unaudited)

 

(unaudited)

 

Ethanol production

    

$

182,265

    

$

1,330,073

 

$

1,317,240

    

$

4,328,586

 

Natural gas pipeline

 

 

358,466

 

 

351,100

 

 

1,615,246

 

 

1,356,438

 

Eliminations

 

 

(167,688)

 

 

(162,285)

 

 

(557,481)

 

 

(518,008)

 

Operating Income

 

$

373,043

 

$

1,518,888

 

$

2,375,005

 

$

5,167,016

 

 

 

 

 

 

 

 

 

 

 

 

July 31, 2018

 

October 31, 2017

 

Assets:

    

(unaudited)

 

 

 

Ethanol production

 

$

48,243,110

 

$

56,373,335

 

Natural gas pipeline

 

 

12,146,400

 

 

12,499,296

 

Total Assets

 

$

60,389,510

 

$

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 and nine months ended July 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 our Form 10-Q for the three months ended January 31, 2018 and April 30, 2018, and 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 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 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;

·

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 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 two intercompany credit facilities with Agrinatural: a July 2014 credit facility, as amended (the “Original Credit Facility”) and a 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.

 

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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, “PART II - Item 1A. Risk Factors” of our quarterly reports on Form 10-Q for the three months ended January 31, 2018,the three months ended April 30, 2018, 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.

 

The latest estimates of supply and demand provided by the U.S. Department of Agriculture (the “USDA”) held steady with 2018 ending corn stocks of 2.1 billion bushels. Projections for 2019 ending corn stocks indicate a reduction of 25%, reflecting lower beginning stocks and a reduced crop size. However, given excellent early season weather and market concern for a potential reduction in U.S. agricultural exports resulting from various tariffs and sanctions resulting from these trade disputes, corn prices were generally very weak and fell during the three months ended July 31, 2018.

 

Ethanol continues trading at a significant discount to gasoline which has improved export demand somewhat. However, management currently believes that our margins will remain tight during the remainder of fiscal year 2018, due to uncertainty regarding the Trump Administration’s support for the Renewable Fuels Standard (“RFS”) and increased waivers of small refiner renewable volume obligations (“RVOs”) by the US Environmental Protection Agency (“EPA”).    Typically such an ethanol trading discount would also bolster demand in the domestic market by penetration of E15 blends. However, the impact of large increases in small refiner waivers granted by the EPA and the expected reductions in both Chinese and Brazilian imports continues to have a negative impact on prices for RINs for corn-based ethanol.  As a result, RINS prices remain lower, removing a blending incentive from the ethanol marketplace.

 

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Increases in the price for crude oil and unleaded gasoline could have a negative impact on the demand for gasoline and impact the market price of ethanol, which could adversely impact our profitability.  According to the US Energy Information Administration’s (“EIA”) June 2018 Short Term Energy Outlook, that U.S. gasoline demand was 9.3 million barrels per day in 2017 and is expected to stay at that same level in 2018. The EIA forecasts regular gasoline prices to average $2.87 per gallon compared to last summers' average $2.41 per gallon. The EIA also estimates the summer peak price will gradually decrease to $2.84 per gallon in September.  Any increase in the average gallon cost to the public could have a negative impact on the EIA’s forecast.

 

Continued ethanol production capacity increases also could have a negative impact on the market price of ethanol, which could be further exacerbated 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 reports that domestic ethanol production averaged 1.04 million barrels per day during the second calendar quarter of 2018, maintaining the same rate of production as the previous quarter but 3.8% higher than the same quarter of last year. Year-to-date, production volumes are up 1.8% in 2018 compared with the same period in 2017. Refiner and blender input volume decreased slightly to 930 thousand barrels per day for the second quarter of 2018 compared with 934 thousand barrels per day for the same quarter last year despite a 2.0% increase in consumer gasoline demand due to seasonal demand and growing numbers of retail stations offering higher blends.

 

In recent years, ethanol demand growth has resulted largely from increased exports.  However, export demand for ethanol is less consistent compared to domestic demand which can lead to ethanol price volatility. Global demand for US ethanol, as reported by the EIA, continues to increase with increased exports to various foreign markets, including China, Canada, and Mexico, in response to higher blending mandates and octane demand within the foreign countries and lower domestic ethanol prices.  Despite its imposition tariffs, China resumed imports of US ethanol during late 2017 and had been one of the top importers of US ethanol during the first three months of 2018. However, in April 2018, in response to the tariffs imposed by the Trump administration, China announced an additional retaliatory tariff on ethanol imports of 15%, bringing the total tariff up to 45%.  Brazilian demand from the US ethanol has remained relatively steady, despite a tariff imposed in 2017, due to the price of corn relative to sugar cane as a feedstock and high gasoline prices within 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 been positively impacted during the three months ended July 31, 2018 by the higher prices received for our distillers’ grains. During our third fiscal quarter of 2018, distillers’ grains prices improved as a result of relatively firm world soybean meal prices which management believes are attributable to the Argentinian drought. Argentina is the third largest soybean producer in the world and a leading exporter of soybean meal. In addition to being an animal feed substitute for corn, distillers’ grains are increasingly considered a protein feed substitute for soybean meal. In 2018, strong protein meal prices have enabled distillers’ grains prices to rally versus corn.  Management currently believes that the impact of the current Chinese imposition of antidumping and countervailing duties on distillers’ grains produced in the U.S. has been absorbed into the market. However, recent trade disputes with China, Mexico and Canada could result in the imposition of additional tariffs on distillers’ grains produced in the US, which could lead to an oversupply of distillers’ grains domestically and negatively impact distillers’ grains prices. Additionally, domestic feeding margins in cattle and hogs in particular could have a negative impact on total domestic distillers’ grains demand.

 

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.  However, management cannot predict whether additional legislation further extending the biodiesel tax credit will be passed by Congress.  Corn oil prices may decrease if biodiesel producers reduce production and/or demand for corn oil to reduce without extension of the biodiesel blenders tax credit.

 

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.

 

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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 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 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 15.0 billion gallon mandate for conventional ethanol in 2018, excluding any waivers granted by the EPA to small refiners for “hardship”.

 

On June 26, 2018, the EPA released a preliminary rule proposal for 2019 setting the blending requirements at 19.88 billion gallons, a slight increase from 2018 mandates. Conventional corn-based ethanol levels were left at 15.0 billion gallons, excluding any “hardship” waivers granted by the EPA to small refiners.

 

Under 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.  Since 2018 is the first year the total proposed volume requirements are more than 20% below statutory levels, the EPA Administrator directed his staff to initiate the required technical analysis to perform any future reset consistent with the reset rules. If the final 2019 volume requirements are also more than 20% below statutory levels, the reset will be triggered under the RFS and 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 volume requirements post-2022. The proposed 2019 Rule is more than 20% below the original 2019 statutory level of 28.0 billion gallons, and if finalized as proposed will fulfill the two consecutive year requirements and require a reset of the RFS.

 

The EPA assigns individual refiners, blenders, and importers the RVOs they are obligated to use based on their percentage of total fuel sales.  Obligated parties use renewable identification numbers (“RINs”) to show compliance with RVOs.  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. 

 

 The EPA has recently granted a number of small refiner exemptions, whereby such refiners were alleviated of their responsibility to supply RINS for their obligated volumes based upon the grounds of economic hardship.  In early July 2018, the EPA reported that hardship waivers for almost 2.25 billion gallons had been granted to small refiners for 2016 and 2017 RVOs.

 

Legal challenges are underway to the RFS, including the EPA's recent reductions in the RFS volume requirements, the Final 2018 Rule, and the denial of petitions to change the RFS point of obligation. If the EPA's decision to reduce the volume requirements under the RFS is allowed to stand, if the volume requirements are further reduced, or if the RFS point of obligation were changed, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.

 

On May 1, 2018, the Advanced Biofuel Association submitted a petition with the U.S. Court of Appeals for the D.C. Circuit challenging EPA’s process for granting exemptions from compliance under the RFS to small refineries. The Advanced Biofuel Association petition asks the court to review the EPA’s decision to modify criteria to lower the threshold by which the agency determines whether to grant small refineries an exemption for the RFS for reasons of disproportionate economic hardship. 

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Additionally, on May 29, 2018, the National Corn Growers Association, National Farmers Union, and the Renewable Fuels Association (“RFA”) filed a petition with the U.S. Court of Appeals for the 10th Circuit challenging the EPA’s grant of waivers to three specific refineries.  The petitioners are asking the U.S. Court of Appeals for the 10th Circuit to reject the waivers granted to three refineries located in Wynnewood, Oklahoma, Cheyenne, Wyoming, and Woods Cross, Utah as an abuse of EPA authority.  These waived gallons are not redistributed to obligated parties, and in effect, reduce the aggregate RVOs under the RFS. If the specific waivers granted by the EPA and/or its lower criteria for granting small refinery waivers under the RFS are allowed to stand, or if the volume requirements are further reduced, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.

 

Related to the recent lawsuits, the Renewable Fuels Association, American Coalition for Ethanol, Growth Energy, National Biodiesel Board, National Corn Growers Association, Biotechnology Industry Organization, and National Farmers Union petitioned the EPA on June 4, 2018 to change its regulations to account for lost volumes of renewable fuel resulting from the retroactive small refinery exemptions. This petition to EPA seeks a broader, forward-looking remedy to account for the collective lost volumes caused by the recent increase in retroactive small refinery RVO exemptions. It is unclear what regulatory changes, if any, will emerge from the petition to the EPA. 

 

Further, on August 30, 2018, the RFA and Growth Energy filed a lawsuit in federal district court, alleging that the EPA and U.S. Department of Energy have improperly denied agency records requested by RFA, Growth Energy, and others under the Freedom of Information Act. The requested documents relate to exemptions from Renewable Fuel Standard compliance obligations granted by EPA.

 

Although the maintenance of the 15.0 billion gallon threshold for volume requirements that may be met with corn-based ethanol in the final 2018 Rule and the proposed 2019 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.  Any such reform 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.  The Company continues to evaluate the impact of the Tax Reform Act with its professional advisors.  The full impact of the Tax Reform Act on the Company in future periods cannot be predicted at this time. On March 23, 2018, Congress rescinded an unintended consequence of the Tax Reform Act under section 199A, which provided certain tax benefits to producers selling grain to cooperative associations and enabled a potential marketplace advantage over other agribusiness companies.

 

Results of Operations for the Three Months Ended July 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 July 31, 2018 and 2017 (amounts in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

Three Months Ended  July 31,

 

 

2018

 

2017

Income Statement Data

  

(unaudited)

  

%

 

(unaudited)

  

%

Revenues

 

$

26,253

 

100.0

% 

 

$

28,542

 

100.0

%

Cost of Goods Sold

 

 

25,161

 

95.8

% 

 

 

26,291

 

92.1

%

Gross Profit

 

 

1,092

 

4.2

% 

 

 

2,251

 

7.9

%

Operating Expenses

 

 

(719)

 

(2.7)

% 

 

 

(732)

 

(2.6)

%

Operating Income

 

 

373

 

1.5

% 

 

 

1,519

 

5.3

%

Other Expense, net

 

 

(35)