HIGHWATER ETHANOL LLC - FORM 10-Q - March 11, 2020

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EX-32.2 - EXHIBIT 32.2 CERTIFICATION 1-31-2020 - HIGHWATER ETHANOL LLCa322-certification1x31x2020.htm
EX-32.1 - EXHIBIT 32.1 CERTIFICATION 1-31-2020 - HIGHWATER ETHANOL LLCa321-certification1x31x2020.htm
EX-31.2 - EXHIBIT 31.2 CERTIFICATION 1-31-2020 - HIGHWATER ETHANOL LLCa312-certification1x31x2020.htm
EX-31.1 - EXHIBIT 31.1 CERTIFICATION 1-31-2020 - HIGHWATER ETHANOL LLCa311-certification1x31x2020.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
 
 
For the quarterly period ended January 31, 2020
 
 
 
OR
 
 
o
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
 
 
For the transition period from               to               .
 
 
 
COMMISSION FILE NUMBER 000-53588
 
HIGHWATER ETHANOL, LLC
(Exact name of registrant as specified in its charter)
 
Minnesota
 
20-4798531
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
24500 US Highway 14, Lamberton, MN 56152
(Address of principal executive offices)
 
(507) 752-6160
(Registrant's telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act: None
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
 
 
 

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.
x Yes     o No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).
x Yes     o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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:
Large Accelerated Filer o
Accelerated Filer  o
Non-Accelerated Filer x
Smaller Reporting Company o
 
Emerging Growth Company o
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. o

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:  As of March 11, 2020 there were 4,807 membership units outstanding.

1

INDEX



2



PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

HIGHWATER ETHANOL, LLC
Condensed Balance Sheets
 ASSETS
January 31, 2020
 
October 31, 2019

(Unaudited)
 

Current Assets

 

Cash and cash equivalents
$
1,509,175

 
$
1,639,114

Derivative instruments
408,913

 
469,740

Accounts receivable
3,087,055

 
2,961,977

Inventories
7,961,514

 
7,367,356

Prepaids and other
203,130

 
166,243

Total current assets
13,169,787

 
12,604,430



 

Property and Equipment

 

Land and land improvements
12,836,332

 
12,836,332

Buildings
38,818,532

 
38,818,532

Office equipment
1,151,330

 
1,151,330

Plant and process equipment
78,061,869

 
78,050,785

Vehicles
123,779

 
123,779

Construction in progress
530,430

 
278,333


131,522,272

 
131,259,091

Less accumulated depreciation
(75,039,232
)
 
(72,784,587
)
Net property and equipment
56,483,040

 
58,474,504



 

Other Assets

 

Investments
3,029,489

 
2,752,266

  Right of use asset - operating leases
659,301

 
—

  Right of use asset - finance leases
1,338,616

 
—

Deposits
409,283

 
191,457

Total other assets
5,436,689

 
2,943,723



 

Total Assets
$
75,089,516

 
$
74,022,657


3



LIABILITIES AND MEMBERS' EQUITY
January 31, 2020
 
October 31, 2019

(Unaudited)
 

Current Liabilities

 

Accounts payable
$
6,780,759

 
$
6,908,305

Accrued expenses
1,704,000

 
1,156,038

Current maturities of long-term debt
2,731,689

 
2,729,739

  Current portion of operating lease liability
135,603

 
—

  Current portion of finance lease liability
107,396

 
—

Total Current Liabilities
11,459,447

 
10,794,082

 
 
 
 
 
 
 
 
Long-Term Liabilities
 
 
 
  Term Debt
8,499,000

 
7,244,124

  Operating lease liability
523,698

 
—

  Finance lease liability
1,239,603

 
—

Total Long-Term Liabilities
10,262,301

 
7,244,124

 
 
 
 
Commitments and Contingencies

 

 
 
 
 
Members' Equity

 

Members' equity, 4,807 units outstanding
53,367,768

 
55,984,451

 
 
 
 
Total Liabilities and Members’ Equity
$
75,089,516

 
$
74,022,657


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

4

HIGHWATER ETHANOL, LLC
Condensed Unaudited Statements of Operations


Three Months Ended

January 31, 2020
 
January 31, 2019


 

Revenues
$
27,184,024

 
$
22,688,410



 

Cost of Goods Sold
28,659,348

 
24,487,297



 

Gross Loss
(1,475,324
)
 
(1,798,887
)


 

Operating Expenses
1,020,521

 
761,331



 

Operating Loss
(2,495,845
)
 
(2,560,218
)


 

Other Income (Expense)

 

Interest income
2,412

 
742

Other income
15,536

 
6,898

Interest expense
(161,243
)
 
(202,594
)
Income from equity method investments
22,457

 
35,460

Total other income (expense), net
(120,838
)
 
(159,494
)

 
 
 
Net Loss
$
(2,616,683
)
 
$
(2,719,712
)
 
 
 
 
Weighted Average Units Outstanding
4,807

 
4,812

Net Loss Per Unit, Basic and Diluted
$
(544.35
)
 
$
(565.19
)
Distributions Per Unit
$
—

 
$
—


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

5

HIGHWATER ETHANOL, LLC
Statements of Changes in Members' Equity (Unaudited)

 
Members' Equity
 
 
Balance - October 31, 2018
$
64,297,887

 
 
Net loss for the three-month period ended January 31, 2019
(2,719,712
)
 
 
Balance - January 31, 2019
61,578,175


 
Members' Equity
 
 
Balance - October 31, 2019
$
55,984,451

 
 
Net loss for the three-month period ended January 31, 2020
(2,616,683
)
 
 
Balance - January 31, 2020
$
53,367,768


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

6

HIGHWATER ETHANOL, LLC
Condensed Unaudited Statements of Cash Flows

Three Months Ended

January 31, 2020
 
January 31, 2019
Cash Flows from Operating Activities

 

Net Loss
$
(2,616,683
)
 
$
(2,719,712
)
Adjustments to reconcile net loss to net cash used in operating activities
 
 
 
Depreciation and amortization
2,295,794

 
2,217,751

Distributions in excess of earnings from equity method investments
121,589

 
270,018

Non-cash patronage income
(398,812
)
 
(212,167
)
Changes in assets and liabilities

 

Accounts receivable
(125,078
)
 
(1,666,262
)
Inventories
(594,158
)
 
(922,746
)
Derivative instruments
60,827

 
234,255

Prepaids and other
(254,713
)
 
(19,432
)
Accounts payable
(201,356
)
 
443,993

Accrued expenses
547,962

 
(126,321
)
Net cash used in operating activities
(1,164,628
)
 
(2,500,623
)


 

Cash Flows from Investing Activities

 

Capital expenditures
(189,369
)
 
(453,021
)
   Net cash used in investing activities
(189,369
)
 
(453,021
)


 

Cash Flows from Financing Activities

 

Payments on long-term debt
(3,750,000
)
 
(750,000
)
Proceeds from long-term debt
5,000,000

 
4,000,000

Payment on finance lease liability
(25,942
)
 
—

Net cash provided by financing activities
1,224,058

 
3,250,000



 

Net (Decrease) Increase in Cash and Cash Equivalents
(129,939
)
 
296,356



 

Cash and Cash equivalents – Beginning of Period
1,639,114

 
430,702



 

Cash and Cash equivalents – End of Period
$
1,509,175

 
$
727,058

 
 
 
 
Supplemental Cash Flow Information

 

Cash paid for interest
$
123,030

 
$
171,079



 

Supplemental Disclosure of Noncash Financing and Investing Activities

 

Capital expenditures included in accounts payable
$
87,026

 
$
20,723

   Establishment of lease liability and right of use asset
$
2,064,994

 
$
—


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

7
HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2020


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote 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.  The accompanying balance sheet and related notes as of October 31, 2019 are derived from the audited financial statements as of that date. These condensed financial statements and related notes should be read in conjunction with the financial statements and notes thereto included in the Company’s audited financial statements for the year ended October 31, 2019, contained in the Company’s Form 10-K.
 
In the opinion of management, the interim condensed financial statements reflect all adjustments, consisting of only normal recurring adjustments, considered necessary for fair presentation of the Company's financial position as of January 31, 2020 and the results of operations and cash flows for all periods presented.

Nature of Business

Highwater Ethanol, LLC, (a Minnesota Limited Liability Company) operates a 50 million gallon nameplate per year ethanol plant in Lamberton, Minnesota. The Company produces and sells, primarily through third-party professional marketers, fuel ethanol and co-products of the fuel ethanol production process in the continental United States.

Accounting Estimates

Management uses estimates and assumptions in preparing these 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, among others, the carrying value of property and equipment and related impairment testing, inventory valuation, and derivative instruments. Actual results could differ from those estimates and such differences may be material to the financial statements. The Company periodically reviews estimates and assumptions and the effects of revisions are reflected in the period in which the revision is made.

Revenue Recognition

ASC Topic 606, Revenue from Contracts with Customers, further details the Company’s requirement to recognize revenue of transferred goods or services to customers in an amount which is expected to be received in exchange for those goods or services. Five steps were required as part of the new guidance: 1. Identify the contract 2. Identify the performance obligations 3. Determine the transaction price 4. Allocate the transaction price to the performance obligation 5. Recognize revenue when each performance obligation is satisfied. The adoption of this new guidance did not result in any material changes to our revenue recognition.
The Company generally sells ethanol and related products pursuant to marketing agreements. The Company’s products are shipped FOB shipping point. The Company recognizes revenue when control of goods is transferred, which is consistent with the Company's previous policy where revenues were recognized when the customer has taken title and has assumed the risks and rewards of ownership, prices are fixed or determinable and collectability is reasonably assured. For ethanol sales, control transfers when loaded into the rail car and for distiller’s grains when the loaded rail cars leave the plant facility.
In accordance with the Company’s agreements for the marketing and sale of ethanol and related products, marketing fees and freight due to the marketers are deducted from the gross sales price at the time incurred. Revenue is recorded net of these marketing fees and freight as they do not provide an identifiable benefit that is sufficiently separable from the sale of ethanol and related products.

The following is a description of principal activities from which we generate revenue. Revenues from contracts with customers are recognized when control of the promised goods or services are transferred to our customers, in an amount that reflects the consideration that we expect to receive in exchange for those goods or services.
•
ethanol sales
•
modified distillers grains sales
•
dried distillers grains sales
•
corn oil sales

8
HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2020


Disaggregation of revenue:

All revenue recognized in the income statement is considered to be revenue from contracts with customers. The following table depicts the disaggregation of revenue according to product line for the three months ended January 31, 2020 and 2019:
 
Three Months Ended January 31, 2020
 
Three Months Ended January 31, 2019
Revenue Sources
Amount (Unaudited)
 
Amount (Unaudited)
 
 
 
 
Ethanol Sales
$
21,355,975

 
$
16,949,206

Modified Distillers Grains Sales
1,293,345

 
1,157,453

Dried Distillers Grains Sales
3,683,362

 
3,850,366

Corn Oil Sales
851,342

 
731,385

Total Revenues
$
27,184,024

 
$
22,688,410


Contract assets and contract liabilities:

The following table provides information about receivables and contract liabilities from contracts with customers:
 
January 31, 2020
 
October 31, 2019
 
 
 
 
Accounts receivable
$
2,885,865

 
$
2,643,352

Short term contract liabilities
106,829

 
36,615


The Company receives payments from customers based upon contractual billing schedules; accounts receivable are recorded when the right to consideration becomes unconditional. Contract liabilities include payments received in advance of performance under the contract, and are realized with the associated revenue recognized under the contract.

Shipping Costs

Shipping costs incurred by the Company in the sale of ethanol, dried distillers grains and corn oil are not specifically identifiable and as a result, revenue from the sale of those products is recorded based on the net selling price reported to the Company from the marketer.

Operating Segment

The Company uses the "management approach" for reporting information about segments in annual and interim financial statements. The management approach is based on the way the chief operating decision-maker organizes segments within a company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure and any other manner in which management disaggregates a company. Based on the "management approach" model, the Company has determined that its business is comprised of a single operating segment.

Derivative Instruments

Derivatives are recognized in the balance sheets and the measurement of these instruments are 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.

Contracts are evaluated to determine whether the contracts are derivatives. Certain contracts that 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

9
HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2020


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 as derivatives, therefore, are not marked to market in our financial statements.

The Company enters into corn commodity-based and natural gas derivatives in order to protect cash flows from fluctuations caused by volatility in prices. These derivatives are not designated as effective hedges for accounting purposes. For derivative instruments that are not accounted for as hedges, or for the ineffective portions of qualifying hedges, the change in fair value is recorded through earnings in the period of change. Corn and natural gas derivative changes in fair market value are included in costs of goods sold.

Fair Value of Financial Instruments

The carrying value of accounts receivable, accounts payable, and other working capital items approximate fair value at January 31, 2020 due to the short maturity nature of these instruments (Level 2).

Commodities contracts are carried at fair value, based on dealer quotes and live trading levels (Note 5).

The Company believes the carrying amount of the long-term debt approximates fair value due to a significant portion of total indebtedness containing variable interest rates and this rate is a market interest rate for these borrowings (Level 2).

Investments

The Company has a 5.55% investment interest in an unlisted company, Renewable Products Marketing Group, LLC (RPMG), who markets the Company’s ethanol. The Company also has a 7% ownership interest in Lawrenceville Tank, LLC (LT), which owns and operates a trans load/tank facility near Atlanta, Georgia. These investments are flow-through entities and are being accounted for by the equity method of accounting under which the Company’s share of net income is recognized as income in the Company’s statements of operations and added to the investment account. Distributions or dividends received from the investment are treated as a reduction of the investment account. The Company consistently follows the practice of recognizing the net income from equity method investments based on the most recent reliable data. Therefore, the net income which is reported in the Company's statement of operations for the period ended January 31, 2020 is based on the investee’s results of operations for the period ended December 31, 2019.

Recently Issued or Adopted Accounting Pronouncements

Accounting for Leases (Adopted):

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU requires lessees to recognize a lease liability and a right of use asset for all leases with a lease term greater than twelve months on its balance sheet. Leases are classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The Company has elected the practical expedient to not record a right of use asset or lease liability for leases with a term of 12 months or less. See Note 7 for further information.

2. UNCERTAINTIES

The Company derives substantially all of its revenues from the sale of ethanol, distillers grains and corn oil. These products are commodities and the market prices for these products display substantial volatility and are subject to a number of factors which are beyond the control of the Company. The Company’s most significant manufacturing inputs are corn and natural gas. The price of these commodities is also subject to substantial volatility and uncontrollable market factors. In addition, these input costs do not necessarily fluctuate with the market prices for ethanol and distillers grains. As a result, the Company is subject to significant risk that its operating margins can be reduced or eliminated due to the relative movements in the market prices of its products and major manufacturing inputs. As a result, market fluctuations in the price of or demand for these commodities can have a significant adverse effect on the Company’s operations, profitability, and availability of cash flows to make loan payments and maintain compliance with the loan agreement.


10
HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2020


3. INVENTORIES

Inventories consisted of the following at:
 
 
January 31, 2020
 
October 31, 2019
 
 
 
 
 
Raw materials
 
$
3,201,958

 
$
2,801,255

Spare parts and supplies
 
3,618,980

 
3,384,360

Work in process
 
739,539

 
743,850

Finished goods
 
401,037

 
437,891

 Total
 
$
7,961,514

 
$
7,367,356


The Company recorded a lower of cost or net realizable value write-down on corn inventory of approximately $465,000, ethanol inventory of approximately $20,000 and dried distillers grains inventory of approximately $16,000 at January 31, 2020.

4. DERIVATIVE INSTRUMENTS

As of January 31, 2020, the Company had entered into corn and ethanol derivative instruments, which are required to be recorded as either assets or liabilities at fair value in the balance sheet. The Company uses these instruments to manage risks from changes in market rates and prices. Derivatives qualify for treatment as hedges when there is a high correlation between the change in fair value of the derivative instrument and the related change in value of the underlying hedged item. The Company may designate the hedging instruments based upon the exposure being hedged as a fair value hedge or a cash flow hedge. The derivative instruments outstanding at January 31, 2020 are not designated as effective hedges for accounting purposes.

Commodity Contracts

Management expects all open futures positions outstanding as of January 31, 2020 to be realized within the next twelve months.

The following tables provide details regarding the Company's derivative instruments at January 31, 2020 and October 31, 2019:
          Instrument
Balance Sheet location
 
January 31, 2020
October 31, 2019
 
 
 
 
 
Corn, natural gas and ethanol contracts
 
 




In gain position
 
 
$
78,903

$
124,069

In loss position
 
 
(883,788
)
(775,887
)
Deposits with broker
 
 
1,213,798

1,121,558

 
Current assets
 
$
408,913

$
469,740


The following tables provide details regarding the gains (losses) from the Company's derivative instruments in the statements of operations, none of which are designated as hedging instruments:
 
 
Statement of
 
Three Months Ended January 31,
 
 
Operations location
 
2020
2019
Ethanol contracts
 
Revenues
 
61,271

$
(135,797
)
Corn contracts
 
Cost of goods sold
 
38,355

675,365

Natural gas contracts
 
Cost of goods sold
 
6,321

19,806

 
 
 
 
 
 

5. FAIR VALUE MEASUREMENTS

The following table provides information on those assets (liabilities) measured at fair value on a recurring basis.

11
HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2020


 
 
Fair Value as of
 
Fair Value Measurement Using
 
 
January 31, 2020
 
Level 1
 
Level 2
 
Level 3
Derivative instruments - commodities
 


 


 


 


     In gain position
 
$
78,903

 
$
76,025

 
$
2,878

 
$
—

     In loss position
 
(883,788
)
 
(99,130
)
 
(784,658
)
 
—


 
 
Fair Value as of
 
Fair Value Measurement Using
 
 
October 31, 2019
 
Level 1
 
Level 2
 
Level 3
Derivative instruments - commodities
 


 


 


 


     In gain position
 
$
124,069

 
$
4,538

 
$
119,531

 
$
—

     In loss position
 
(775,887
)
 
(4,375
)
 
(771,512
)
 
—


The Company determines the fair values of commodities by obtaining the fair value measurements from an independent pricing service based on dealer quotes and live trading levels from the Chicago Board of Trade.
 
6. DEBT FINANCING

Long-term debt consists of the following at:
 
January 31, 2020
 
October 31, 2019
Variable Rate Term Loan
$
2,750,000

 
$
3,500,000

 
 
 
 
Term Revolving Loan
8,499,000

 
6,499,000

 
 
 
 
Total
11,249,000

 
9,999,000

 
 
 
 
Less Debt Issuance Costs
(18,311
)
 
(25,137
)
 
 
 
 
Less amounts due within one year
(2,731,689
)
 
(2,729,739
)
 
 
 
 
Net long-term debt
$
8,499,000

 
$
7,244,124


Bank Financing

On January 22, 2016, the Company entered into a Second Amended and Restated Credit Agreement with Compeer Financial PCA f/k/a AgStar Financial Services, PCA, as administrative agent for several financial institutions ("Compeer") which amended the Amended and Restated Credit Agreement dated September 22, 2014. The Second Amended and Restated Credit Agreement decreased the Term Loan to $15,000,000, increased the Term Revolving Loan to $15,000,000 and eliminated the Revolving Line of Credit. Effective April 20, 2018, the Company executed a First Amendment to the Second Amended and Restated Credit Agreement with Compeer Financial which increased the availability under the Term Revolving Loan to $20,000,000. In connection therewith, as of the same date, the Company executed a Third Amended and Restated Term Revolving Note and a Third Amended and Restated Mortgage, Security Agreement, Assignment of Leases and Fixture Financing Statement. On December 17, 2019, Compeer waived the Company's violation at October 31, 2019 of the minimum debt service coverage ratio set forth in the Second Amended and Restated Credit Agreement.
Term Loan

The Term Loan had an original balance of $15,000,000 with a variable interest rate based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at January 31, 2020 was 4.97%. Monthly principal payments are due on the Term Loan of approximately $250,000 plus accrued interest. Payments of all amounts outstanding are due on January 22, 2021. The outstanding balance on this note was $2,750,000 at January 31, 2020. The Company may convert the Term

12
HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2020


Loan to a fixed rate loan, subject to certain conditions as described in the Second Amended and Restated Credit Agreement and with the consent of Compeer.

Term Revolving Loan

The Term Revolving Loan is for $20,000,000 with a variable interest rate based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at January 31, 2020 was 4.97%. The Term Revolving Loan may be advanced, repaid and re-borrowed during the term. Monthly interest payments are due on the Term Revolving Loan. Payment of all amounts outstanding are due on January 22, 2023. The outstanding balance on this note was $8,499,000 at January 31, 2020. The Company pays interest at a rate of 1.50% on amounts outstanding for letters of credit which also reduce the amount available under the Term Revolving Loan. The Company has no letters of credit outstanding at January 31, 2020. The Company is also required to pay unused commitment fees for the Term Revolving Loan as defined in the Second Amended and Restated Credit Agreement.

Covenants and other Miscellaneous Terms
    
The loan facility with Compeer is secured by substantially all business assets. The Company executed a mortgage creating a first lien on its real estate and plant and a security interest in all personal property located on the premises and assigned all rents and leases to property, marketing contracts, risk management services contract, and natural gas, electricity, water service and grain procurement agreements.

The Company is also subject to various financial and non-financial covenants that limit distributions and debt and require minimum debt service coverage, tangible net worth, and working capital requirements. The debt service coverage ratio is no less than 1.25:1.00 measured annually by comparing adjusted EBITDA to scheduled payments of principal and interest. The minimum working capital is $8,250,000, which is calculated as current assets plus the amount available for drawing under the Term Revolving Loan and undrawn amounts on outstanding letters of credit, less current liabilities, and is measured quarterly.
The Company is limited to annual capital expenditures of $5,000,000 without prior approval, incurring additional debt over certain amounts without prior approval, and making additional investments as described in the Second Amended and Restated Credit Agreement without prior approval of Compeer. The Company is allowed to make cash distributions to members as frequently as monthly in an amount equal to 75% of net income if working capital is greater than or equal to $8,250,000, or 100% of net income if working capital is greater than or equal to $11,000,000, or an unlimited amount if working capital is greater than or equal to $11,000,000 and the outstanding balance on the Term Loan is $0.
The estimated maturities of the long-term debt at January 31, 2020 are as follows:
 
Principal
 
Debt Issuance Costs
 
Total
January 2021
2,750,000

 
(18,311
)
 
2,731,689

January 2022
—

 
—

 
—

January 2023
8,499,000

 
—

 
8,499,000

     Long-term debt
$
11,249,000

 
$
(18,311
)
 
$
11,230,689


7.  LEASES

Adoption of ASC 842

As discussed in Note 1, on November 1, 2019, the Company adopted the provisions of ASC 842 using the modified retrospective approach and elected the option to apply the transition provisions at adoption date instead of the earliest period presented in the financial statements. Due to this election, the Company is not required to retrospectively apply the standard to previous periods presented. This adoption resulted in the Company recognizing initial right of use assets and lease liabilities of approximately $692,000 and $1,373,000, operating leases and finance leases, respectively. The adoption did not have a significant impact on the Company’s statement of operations.


13
HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
January 31, 2020


The Company leases rail cars for its facility to transport dried distillers grains to its end customers. We classified these identified assets as operating leases after assessing the terms under lease classification guidance.

The Company has a contract for use of a natural gas pipeline which transports natural gas from the Northern Natural Gas pipeline to the Company’s facility. This natural gas line has no alternate use and is specifically for the benefit of the Company. The contract has minimum volume requirements as well as a fixed monthly fee. This contract meets the definition of a lease and is classified as a finance lease. Right of use assets and lease liabilities are recognized at commencement date based on the present value of lease payments over the lease term.
 
The discount rate used in determining the lease liability for each individual lease is the Company's estimated incremental borrowing rate. An incremental borrowing rate of 5.50% was utilized for each of the Company's leases.
 
The Company determines if an arrangement is a lease or contains a lease at inception. The Company’s operating and finance leases have remaining lease terms of approximately 5 years and 10 years, respectively. These leases include options to extend the lease when it is reasonably certain the Company will exercise those options. The Company does not have lease arrangements with residual value guarantees, sale leaseback terms or material restrictive covenants.

The following table summarizes the remaining maturities of the Company’s operating and finance lease liabilities as of January 31, 2020:
Operating Lease For the Period Ending January 31,
 
Operating Leases
 
Finance Leases
2021
 
$
168,480

 
$
178,800

2022
 
168,480

 
178,800

2023
 
168,480

 
178,800

2024
 
168,480

 
178,800

2025
 
70,200

 
178,800

Thereafter
 
—

 
849,300

Totals
 
744,120

 
1,743,300

Amount representing interest
 
(84,819
)
 
(396,301
)
Operating lease liability
 
$
659,301

 
$
1,346,999


Lease Cost
 
Three Months ended
January 31, 2020
 
 
 
Operating lease cost
 
$
42,120

Finance lease cost
 
 
Amortization of leased assets
 
34,323

Interest on lease liabilities
 
18,759

 
 
 
Net lease cost
 
$
95,202


8. COMMITMENTS AND CONTINGENCIES

Marketing Agreements

The Company has an ethanol marketing agreement with a marketer (RPMG) to purchase, market, and distribute all the ethanol produced by the Company. The Company also entered into a member control agreement with the marketer whereby the Company made capital contributions and became a minority owner of the marketer. The member control agreement became effective on February 1, 2011 and provides the Company a membership interest with voting rights. The marketing agreement will terminate if the Company ceases to be a member. The Company will assume certain of the member’s rail car leases if the agreement is terminated. The Company can sell its ethanol either through an index arrangement or at an agreed upon fixed price. The marketing agreement is perpetual until terminated according to the agreement.  The Company may be obligated to continue to market its ethanol through the marketer for a period of time. The amended agreement requires minimum capital amounts invested as required under the agreement.

The Company has a distillers grains marketing agreement with a marketer to market all the dried distillers grains produced at the plant. Under the agreement the marketer charges a maximum of $2.00 per ton and a minimum of $1.50 per ton using 2% of the FOB plant price actually received by them for all dried distillers grains removed. The agreement will remain in effect unless otherwise terminated by either party with 120 days notice. Under the agreement, the marketer is responsible for all transportation arrangements for the distribution of the dried distillers grains. The Company markets and sells its modified and wet distillers grains.

The Company has a corn oil marketing agreement with a marketer (RPMG) which became effective November 15, 2018. The agreement provides for an exclusive marketing arrangement with RPMG for the purposes of marketing and distributing our corn oil in exchange for payment of a marketing fee to RPMG. We may immediately terminate the agreement upon written notice to RPMG if: (1) RPMG fails on three separate occasions within a 12-month period to purchase corn oil or market corn oil, as not otherwise excused under the Agreement; or (2) upon RPMG's insolvency. RPMG may immediately terminate the agreement upon written notice if: (A) during any consecutive three (3) months the actual production or inventory of any corn oil product at the plant varies by twenty (20%) or more from the monthly production and inventory estimates provided to RPMG (other than for reasons permitted under the RPMG Agreement); or (B) upon our insolvency.

Regulatory Agencies

The Company is subject to oversight from regulatory agencies regarding environmental concerns which arise in the ordinary course of its business.

Forward Contracts

In the ordinary course of business, we enter into forward contracts for our commodity purchases and sales. The Company recorded a lower of cost or net realizable value write-down on the forward fixed price contracts of approximately $626,000 at January 31, 2020. Forward contracts are as follows at January 31, 2020:


 
Quantity
Average Price
Delivery Date
 
 
 
 
Purchase of corn (in bushels):
 
 
 
    Basis Contracts
1,906,457

 
By 7/31/21
    Priced Contracts
1,469,085

$
3.87

By 1/31/21
        Total
3,375,542

 
 
 
 
 
 
Purchase of natural gas (in dekatherms):
 
 
 
    Index contracts
—

 
 
    Priced contracts
3,170,350

$
2.41

By 3/31/23
        Total
3,170,350

 
 
 
 
 
 
Purchase of denaturant (in gallons):
 
 
 
    Index contracts
—

 
 
    Priced contracts
1,242,000

$
1.26

By 12/31/20
        Total
1,242,000

 
 
 
 
 
 
Sales of dry distillers grains (in tons):
 
 
 
    Index contracts
—

 
 
    Priced contracts
3,100

$
140.48

By 2/29/20
        Total
3,100

 
 
 
 
 
 
Sales of modified distillers grains (in tons)
 
 
 
    Index contracts
—

 
 
    Priced contracts
18,700

$
72.27

By 8/31/20
        Total
18,700

 
 
 
 
 
 
Sales of corn oil (in pounds)
 
 
 
    Index contracts
—

 
 
    Priced contracts
1,398,000

$
0.24

By 9/30/20
        Total
1,398,000

 
 


14

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

We prepared the following discussion and analysis to help you better understand our financial condition, changes in our financial condition, and results of operations for the three month period ended January 31, 2020, compared to the same period of the prior fiscal year. This discussion should be read in conjunction with the condensed financial statements and notes and the information contained in the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 2019.

Forward-Looking Statements

This report contains forward-looking statements that involve future events, our future performance and our expected future operations and actions.  In some cases you can identify forward-looking statements by the use of words such as “will,” “may,” “should,” “anticipate,” “believe,” “expect,” “plan,” “future,” “intend,” “could,” “estimate,” “predict,” “hope,” “potential,” “continue,” or the negative of these terms or other similar expressions. These forward-looking statements are only our predictions and involve numerous assumptions, risks and uncertainties. Many factors could cause actual results to differ materially from those projected in 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 include, but are not limited to:
Ÿ
Changes in the availability and price of corn and natural gas;
Ÿ
Reduction or elimination of the Renewable Fuel Standard;
Ÿ
Volatile commodity and financial markets;
Ÿ
Changes in legislation benefiting renewable fuels;
Ÿ
Our ability to comply with the financial covenants contained in our credit agreements with our lenders;
Ÿ
Our ability to profitably operate the ethanol plant and maintain a positive spread between the selling price of our products and our raw material costs;
Ÿ
Results of our hedging activities and other risk management strategies;
Ÿ
Ethanol and distillers grains supply exceeding demand and corresponding price reductions;
Ÿ
Our ability to generate cash flow to invest in our business and service our debt;
Ÿ
Changes in the environmental regulations that apply to our plant operations and changes in our ability to comply with such regulations;
Ÿ
Changes in our business strategy, capital improvements or development plans;
Ÿ
Changes in plant production capacity or technical difficulties in operating the plant;
Ÿ
Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;
Ÿ
Lack of transportation, storage and blending infrastructure preventing ethanol from reaching high demand markets;
Ÿ
Changes in federal and/or state laws or policies impacting the ethanol industry;
Ÿ
Changes and advances in ethanol production technology and the development of alternative fuels and energy sources and advanced biofuels;
Ÿ
Competition from alternative fuel additives;
Ÿ
Changes in interest rates and lending conditions;
Ÿ
Decreases in the price we receive for our ethanol and distillers grains;
Ÿ
Our inability to secure credit or obtain additional equity financing we may require in the future;
Ÿ
Our ability to retain key employees and maintain labor relations;
Ÿ
Changes in the price of oil and gasoline;
Ÿ
Competition from clean power systems using fuel cells, plug-in hybrids and electric cars; and
Ÿ
International trade disputes and the imposition of tariffs by foreign governments on our products.
Ÿ
Use by the EPA of small refinery exemptions.

The cautionary statements referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We are not under any duty to update the forward-looking statements contained in this report. Furthermore, we cannot guarantee future results, levels of activity, performance or achievements. We caution you not to put undue reliance on any forward-looking statements, which speak only as of the date of this report. You should read this report and the documents that we reference in this report and have filed as exhibits

15

completely and with the understanding that our actual future results may be materially different from what we currently expect. We qualify all of our forward-looking statements by these cautionary statements.

Available Information

Our website address is www.highwaterethanol.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), are available, free of charge, on our website at www.highwaterethanol.com under the link “SEC Compliance,” 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 Quarterly Report on Form 10-Q.

Overview

Highwater Ethanol, LLC (“we,” “our,” “Highwater Ethanol” or the “Company”) was formed as a Minnesota limited liability company organized on May 2, 2006, for the purpose of constructing, owning, and operating a 50 million gallon nameplate per year ethanol plant near Lamberton, Minnesota. Since August 2009, we have been engaged in the production of ethanol and distillers grains at the plant. We were operating at an annual rate of approximately 59.5 million gallons for the fiscal year ended October 31, 2019. However, in October 2019, our air permit application to the Minnesota Pollution Control Agency to allow for 70.2 million gallons of denatured ethanol per 12-month rolling average was approved. As a result, we are currently operating at an annual rate of approximately 66 million gallons.
    
We expect to fund our operations during the next 12 months using cash flow from our continuing operations and our current credit facilities. However, should we experience unfavorable operating conditions in the ethanol industry that prevent us
from profitably operating the ethanol plant, we may need to seek additional funding.

Results of Operations for the Three Months Ended January 31, 2020 and 2019
 
The following table shows the results of our operations and the approximate percentage of revenues, cost of goods sold, operating expenses and other items to total revenues in our unaudited statements of operations for the three months ended January 31, 2020 and 2019:
 
2020
 
2019
Statements of Operations Data
Amount
(unaudited)
 
%
 
Amount
(unaudited)
 
%
 
 
 
 
 
 
 
 
Revenues
$
27,184,024

 
100.00
 %
 
$
22,688,410

 
100.00
 %
Cost of Goods Sold
28,659,348

 
105.43
 %
 
24,487,297

 
107.93
 %
Gross Loss
(1,475,324
)
 
(5.43
)%
 
(1,798,887
)
 
(7.93
)%
Operating Expenses
1,020,521

 
3.75
 %
 
761,331

 
3.36
 %
Operating Loss
(2,495,845
)
 
(9.18
)%
 
(2,560,218
)
 
(11.28
)%
Other Income (Expense), net
(120,838
)
 
(0.44
)%
 
(159,494
)
 
(0.70
)%
Net Loss
$
(2,616,683
)
 
(9.63
)%
 
$
(2,719,712
)
 
(11.99
)%

The following table shows the sources of our revenue for the three months ended January 31, 2020 and 2019:
 
2020
 
 
 
2019
 
 
Revenue Sources
Amount
(Unaudited)
 
%
 
Amount
(Unaudited)
 
%
 
 
 
 
 
 
 
 
Ethanol Sales
$
21,355,975

 
78.56
%
 
$
16,949,206

 
74.71
%
Modified Distillers Grains Sales
1,293,345

 
4.76
%
 
1,157,453

 
5.10
%
Dried Distillers Grains Sales
3,683,362

 
13.55
%
 
3,850,366

 
16.97
%
Corn Oil Sales
851,342

 
3.13
%
 
731,385

 
3.22
%
Total Revenues
$
27,184,024

 
100.00
%
 
$
22,688,410

 
100.00
%

16

Revenue
Ethanol
Our ethanol revenues were greater for the three months ended January 31, 2020, as compared to the three months ended January 31, 2019. Revenue from ethanol sales increased by approximately 26.0% during the three months ended January 31, 2020, as compared to the three months ended January 31, 2019, due primarily to an increase in the average price per gallon of ethanol and number of gallons of ethanol sold. The average price per gallon of ethanol sold for the three months ended January 31, 2020 was approximately 15.3% higher than the average price we received for the three months ended January 31, 2019. While the average price we received for the three months ended January 31, 2020 was higher when compare to the same period in 2019, this was primarily due to some plants in the industry curtailing production during the period due to unfavorable operating conditions. Unfavorable operating conditions in the industry resulted in part from lower ethanol prices due to the EPA's use of the small refinery exemption which contributed to lower domestic demand. In addition, a decline in ethanol exports due to trade disputes with foreign governments and the institution of a tariff by China on ethanol produced in the United States contributed to lower ethanol prices.
Trade agreements between the United States and China and other foreign governments could lead to an increase in ethanol export demand and higher ethanol prices. In addition, a reduction in the EPA's use of the the small refinery exemption or a reallocation of gallons exempted would have a positive impact on demand. Other factors likely to affect ethanol prices in the coming fiscal year include global demand for sugar and sugar prices, approval of the year-round sale of E15 and changes in domestic corn and energy prices.
The number of gallons of ethanol sold increased by approximately 9.3% during the three months ended January 31, 2020, as compared to the three months ended January 31, 2019 due to our receipt of our updated air permit which allows us to increase gallons produced to approximately 70.2 million gallons of denatured ethanol per 12-month rolling average. Management anticipates that the amount of ethanol produced for the three months ended January 31, 2020 will remain relatively consistent in the future unless we experience unfavorable operating conditions in the ethanol industry that require us to decrease production at the plant.
    
We had gains related to ethanol based derivative instruments of $61,271 for the three months ended January 31, 2020. We had losses related to ethanol based derivative instruments of $135,797 for the three months ended January 31, 2019.

Distillers Grains

Revenue from distillers grains sales decreased by approximately 0.6% during the three months ended January 31, 2020, as compared to the three months ended January 31, 2019. For the three months ended January 31, 2020, the average price per ton of dried distillers grains sold was approximately 5.8% lower than the average price we received during the three months ended January 31, 2019, due to price decreases in the protein market that correlate to the price of soybean meal and lower export demand due to the swine fever outbreak in China, Vietnam and other foreign countries and trade disputes with foreign governments. However, for the three months ended January 31, 2020, the average price per ton of modified distillers grains sold was approximately 7.7% higher than during the three months ended January 31, 2019, due to increased demand and reduced production in our local area.

Distillers grains prices typically change in proportion to corn prices and availability of corn. Domestic demand for distillers grains could decrease if corn prices decline and end-users switch to lower priced alternatives or if there is a swine fever outbreak in the U.S. Changes in foreign demand also impact distillers grains prices. If the swine fever outbreak continues in or spreads to other countries that could have a negative effect on distillers grains prices. The imposition by China of anti-dumping and anti-subsidy duties on distillers grains produced in the U.S. has also had a negative effect on export demand from China resulting in lower distillers grains prices. In addition, trade actions by the United States and foreign governments have created uncertainty as to future agricultural export demand from China and other countries. However, trade agreements between the United States and foreign governments could lead to an increase in distillers grains export demand.

The tons of dried distillers grains sold increased by approximately 1.6% during the three months ended January 31, 2020, as compared to the three months ended January 31, 2019. The tons of modified distillers grains sold during the three months ended January 31, 2020, increased by approximately 3.7% as compared to the three months ended January 31, 2019. The overall tons of distillers grains produced increased due to our receipt of our updated air permit which allows us to increase our gallons of ethanol produced and which also increases our distillers grains production. Management anticipates that the amount of distillers grains produced for the three months ended January 31, 2020, will remain relatively consistent in the future.


17

Corn Oil

Revenue from corn oil sales increased by approximately 16.4% during the three months ended January 31, 2020, as compared to the three months ended January 31, 2019. This is primarily the result of an increase in corn oil sold during the three months ended January 31, 2020. The pounds of corn oil sold during the three months ended January 31, 2020, increased by approximately 29.5% as compared to the the three months ended January 31, 2019. The amount of corn oil sold increased due to our receipt of our updated air permit which allows us to increase our gallons of ethanol produced and which also increases our corn oil production. Management anticipates that the amount of corn oil produced for the three months ended January 31, 2020, will remain relatively consistent in the future.

The average price per pound of corn oil sold decreased during the three months ended January 31, 2020, as compared to the three months ended January 31, 2019. For the three months ended January 31, 2020, the average price per pound of corn oil we received was approximately 12% lower than the three months ended January 31, 2019, due to decreased demand from the corn oil feed market. Corn oil prices were negatively affected by the expiration of the biodiesel blenders' tax credit. However, the tax credit was renewed in December 2019 which is expected to positively affect demand and contribute to higher corn oil prices. Corn oil prices in the future will also likely be affected by changes in corn and energy prices.

Cost of Goods Sold

Our two largest costs of production are corn (70.9% of cost of goods sold for the three months ended January 31, 2020) and natural gas (5.5% of cost of goods sold for the three months ended January 31, 2020). Our total cost of goods sold was approximately 17.1% more during the three months ended January 31, 2020, as compared to the three months ended January 31, 2019, due to increased corn costs and bushels ground.

Corn

Our average price per bushel of corn for the three months ended January 31, 2020 increased by approximately 19.2% per bushel, as compared to the three months ended January 31, 2019, due to a smaller corn crop in places near our local area which has led to a higher market value for corn as end users from those areas encroach on our local market.

Management expects there to be an adequate corn supply available in our area to operate the ethanol plant. However, corn prices have been volatile and are likely to remain so in the future depending on weather conditions, supply and demand, stocks and other factors and could significantly impact our costs of production.

We used approximately 12.3% more bushels of corn in the three months ended January 31, 2020, as compared to the three months ended January 31, 2019, due to an increase in ethanol production for the period.

At January 31, 2020, we have 1,906,457 bushels of forward fixed basis corn purchase contracts and 1,469,085 bushels of forward fixed price corn contracts valued at approximately $5,680,000 for various delivery periods through July 2021. We had gains related to corn derivative instruments of $38,355 and $675,365 for the three months ended January 31, 2020 and 2019, respectively.

Natural Gas

Our average price per MMBTU of natural gas was approximately 2.2% higher for the three months ended January 31, 2020, as compared to the three months ended January 31, 2019. Natural gas prices were higher due to new interim tariff rates levied by Northern Natural Gas effective January 1, 2020. Management anticipates that natural gas prices will continue at current levels unless the natural gas industry experiences production problems or if there are large increases in natural gas demand.

For the three months ended January 31, 2020, we purchased approximately 6.3% more natural gas as compared to the three months ended January 31, 2019. This increase in natural gas usage is primarily due to an increase in dried distillers grains production.

At January 31, 2020, we have 3,170,350 MMBTUs of forward natural gas sales contracts valued at approximately $7,630,000 for various delivery periods through March 2023. We had gains related to natural gas derivative instruments of $6,321 and $19,806 for the three months ended January 31, 2020 and 2019, respectively.



18

Operating Expense

We had operating expenses for the three months ended January 31, 2020 of $1,020,521, as compared to operating expenses of $761,331 for the three months ended January 31, 2019. Management attributes this increase in operating expenses primarily to an increase in consulting fees and insurance costs for the three months ended January 31, 2020, as compared to the three months ended January 31, 2019. Management continues to pursue strategies to optimize efficiencies and maximize production. These efforts may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses do not vary with the level of production at the plant, we expect our operating expenses to remain relatively steady.

Operating Loss

We had a loss from operations for the three months ended January 31, 2020 of $2,495,845, which is approximately (9.18%) of our revenues, compared to a loss of $2,560,218, which was approximately (11.28)% of our revenues, for the three months ended January 31, 2019. This decrease in operating loss is primarily due to an increase in the price received for our ethanol relative to the price we paid for corn.

Other Income (Expense)

We had total other expense for the three months ended January 31, 2020 of $120,838, as compared to total other expense of $159,494 for the three months ended January 31, 2019. Our other expense for the three months ended January 31, 2020, consisted primarily of interest expense offset by income from investments. This decrease in other expense is primarily due to a decrease in interest expense and income from investments.

Changes in Financial Condition for the Three Months Ended January 31, 2020

The following table highlights the changes in our financial condition as of January 31, 2020 from our previous fiscal year ended October 31, 2019:

 
January 31, 2020
 
October 31, 2019
Current Assets
$
13,169,787

 
$
12,604,430

Current Liabilities
11,459,447

 
10,794,082

Long-Term Liabilities
10,262,301

 
7,244,124

    
Current Assets

The increase in current assets is primarily the result of increases in accounts receivable, inventories which were offset partially by a decrease in cash and cash equivalents and derivative instruments at January 31, 2020, as compared to October 31, 2019.
    
Current Liabilities

The increase in current liabilities is due primarily to an increase in accrued expenses at January 31, 2020, as compared to October 31, 2019.

Long-Term Liabilities

Long-term liabilities increased at January 31, 2020, as compared to October 31, 2019, primarily due to increased borrowings on the Term Revolving Loan and adoption of ASC 842 which resulted in recording lease liabilities.

Liquidity and Capital Resources

Our primary sources of liquidity are our Term Revolving Loan and cash generated from operations. Based on financial forecasts prepared by our management, we anticipate that we will have sufficient cash on hand, cash from our current credit facilities, and cash from our operations to continue to operate the ethanol plant at capacity for the next 12 months. We do not currently anticipate seeking additional equity or debt financing in the near term. However, high corn prices significantly increase our cost of goods sold. If increases in cost of goods sold are not offset by corresponding increases in the prices we receive from the sale of our products, these increases in cost of goods sold can have a significant negative impact on our financial performance.

19

If we experience unfavorable operating conditions in the ethanol industry that prevent us from profitably operating the ethanol plant, we could have difficulty maintaining our liquidity and we may have to secure additional debt or equity financing for working capital or other purposes. We do not currently anticipate that we will need to secure additional capital resources for any other significant purchases of property and equipment in the next 12 months.

The following table shows cash flows for the three months ended January 31, 2020 and 2019:
 
2020
2019
 
(unaudited)
(unaudited)
Net cash used in operating activities
$
(1,164,628
)
$
(2,500,623
)
Net cash used in investing activities
(189,369
)
(453,021
)
Net cash provided by financing activities
1,224,058

3,250,000


Cash Flow From Operations

We used less cash in operating activities for the three months ended January 31, 2020, as compared to the same period in 2019. This decrease was primarily due to a decrease in net loss and changes in accounts receivables, inventories and accrued expenses for the three months ended January 31, 2020, as compared to the same period in 2019.

Cash Flow From Investing Activities

We used less cash in investing activities for the three month period ended January 31, 2020, as compared to the same period in 2019. This change was primarily due to a decrease in capital expenditures during the three months ended January 31, 2020.

Cash Flow From Financing Activities

We had less cash provided by financing activities during the three months ended January 31, 2020, as compared to the same period in 2019. This decrease in cash provided was primarily the result of decreased net borrowings on long-term debt during the three months ended January 31, 2020, as compared to the same period in 2019.

Short-Term and Long-Term Debt Sources
            
On January 22, 2016, we entered into a Second Amended and Restated Credit Agreement with Compeer Financial f/k/a AgStar Financial Services, PCA ("Compeer"). In connection therewith, as of the same date, we executed Second Amended and Restated Term Notes, Second Amended and Restated Term Revolving Notes, an Amended and Restated Security Agreement and a Second Amended and Restated Mortgage, Security Agreement, Assignment of Leases and Fixture Financing Statement. The Second Amended and Restated Credit Agreement decreased the Variable Rate Term Loan to $15,000,000, increased the Term Revolving Loan to $15,000,000 and eliminated the Revolving Line of Credit. Effective April 20, 2018, we executed a First Amendment to Second Amended and Restated Credit Agreement with Compeer which increased the availability under the Term Revolving Loan to $20,000,000. In connection therewith, as of the same date, we executed a Third Amended and Restated Term Revolving Note and a Third Amended and Restated Mortgage, Security Agreement, Assignment of Leases and Fixture Financing Statement. On December 17, 2019, Compeer waived our violation at October 31, 2019, of the minimum debt service coverage ratio set forth in the Second Amended and Restated Credit Agreement.

Term Loan
    
The Term Loan had an original balance of $15,000,000 with a variable interest rate based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at January 31, 2020 was 4.97%. Monthly principal payments are due on the Term Loan of approximately $250,000 plus accrued interest. Payments of all amounts outstanding are due on January 22, 2021. The outstanding balance on this note was $2,750,000 at January 31, 2020. We may convert the Term Loan to a fixed rate loan, subject to certain conditions as described in the Second Amended and Restated Credit Agreement and with the consent of Compeer.

Term Revolving Loan

The Term Revolving Loan is for up to $20,000,000 with a variable interest rate based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at January 31, 2020 was 4.97%. The Term Revolving

20

Loan may be advanced, repaid and re-borrowed during the term. Monthly interest payments are due on the Term Revolving Loan with payment of all amounts outstanding due on January 22, 2023. The outstanding balance on this note was $8,499,000 at January 31, 2020. We pay interest at a rate of 1.50% on amounts outstanding for letters of credit which also reduce the amount available under the Term Revolving Loan. We had no letters of credit outstanding at January 31, 2020. We are also required to pay unused commitment fees for the Term Revolving Loan as defined in the Second Amended and Restated Credit Agreement.

Covenants and Other Miscellaneous Financing Agreement Terms
    
The loan facility with Compeer is secured by substantially all business assets. We executed a mortgage in favor of Compeer creating a first lien on our real estate and plant and a security interest in all personal property located on the premises and assigned in favor of Compeer, all rents and leases to our property, our marketing contracts, our risk management services contract, and our natural gas, electricity, water service and grain procurement agreements.

We are also subject to various financial and non-financial covenants that limit distributions and new debt and require minimum debt service coverage and working capital requirements. Our debt service coverage ratio is to be no less than 1.25:1.00 measured annually by comparing our adjusted EBITDA to our scheduled payments of principal and interest. Our minimum working capital is $8,250,000, which is calculated as current assets plus the amount available for drawing under our Term Revolving Loan and undrawn amounts on outstanding letters of credit, less current liabilities, and is measured quarterly.

We are limited to annual capital expenditures of $5,000,000 without prior approval, incurring additional debt over certain amounts without prior approval, and making additional investments as described in the Amended and Restated Credit Agreement without prior approval of Compeer. We are allowed to make cash distributions to members as frequently as monthly in an amount equal to 75% of net income if working capital is greater than or equal to $8,250,000, or 100% of net income if working capital is greater than or equal to $11,000,000, or an unlimited amount if working capital is greater than or equal to $11,000,000 and there is no outstanding balance on the Term Loan.

Presently, we are meeting our liquidity needs and complying with our financial covenants and the other terms of our loan agreements with Compeer except as to our violation, at October 31, 2019, of the minimum debt service coverage ratio requirement of 1.25:1.00 which was waived by Compeer on December 17, 2019. We will continue to work with Compeer to try to ensure that the terms of our loan agreements are met going forward. However, we cannot provide any assurance that our actions will result in sustained profitable operations or that we will not be in violation of our loan covenants or in default on our principal payments in the future. Should unfavorable market conditions result in our violation of the terms or covenants of our loan and we fail to obtain a waiver of any such term or covenant, Compeer could deem us in default of our loans and require us to immediately repay a significant portion or possibly the entire outstanding balance of our loans. In the event of a default, Compeer could also elect to proceed with a foreclosure action on our plant.

Capital Expenditures    
We do not currently anticipate making significant capital expenditures during the remainder of our 2020 fiscal year.
Critical Accounting Estimates
    
Management uses various estimates and assumptions in preparing our financial statements in accordance with generally accepted accounting principles.  These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Accounting estimates that are the most important to the presentation of our results of operations and financial condition, and which require the greatest use of judgment by management, are designated as our critical accounting estimates. We have the following critical accounting estimates:

Long-Lived Assets
         
We review long-lived assets for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable.  Impairment testing for assets requires various estimates and assumptions, including an allocation of cash flows to those assets and, if required, an estimate of the fair value of those assets.  Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management's assumptions, which do not reflect unanticipated events and circumstances that may occur.  Given the significant assumptions required and the possibility that actual conditions will differ, we consider the assessment of carrying value of property and equipment to be a critical accounting estimate.


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Inventory Valuation

We value our inventory at lower of cost or net realizable value. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management's assumptions which do not reflect unanticipated events and circumstances that may occur. In our analysis, we consider corn costs and ethanol prices, break-even points for our plant and our risk management strategies in place through our derivative instruments. Given the significant assumptions required and the possibility that actual conditions will differ, we consider the valuation of the lower of cost or net realizable value on inventory to be a critical accounting estimate.

Derivatives

We are exposed to market risks from changes in interest rates, corn, natural gas, and ethanol prices. We may seek to minimize these commodity price fluctuation risks through the use of derivative instruments. In the event we utilize derivative instruments, we will attempt to link these instruments to financing plans, sales plans, market developments, and pricing activities. Such instruments in and of themselves can result in additional costs due to unexpected directional price movements.

We have entered into ethanol, corn and natural gas derivatives in order to protect cash flows from fluctuations caused by volatility in commodity prices. In practice, as markets move, we actively attempt to manage our risk and adjust hedging strategies as appropriate. We do not use hedge accounting which would match the gain or loss on our hedge positions to the specific commodity contracts being hedged. Instead, we use fair value accounting for our hedge positions, which means that as the current market price of our hedge position changes, the gains and losses are immediately recognized in our statement of operations. The immediate recognition of hedging gains and losses under fair value accounting can cause net income (loss) to be volatile from quarter to quarter due to the timing of the change in value of the derivative instruments relative to the cost and use of the commodity being hedged.

As of January 31, 2020, the fair values of our commodity-based derivative instruments are a net liability of approximately $805,000. As the prices of the hedged commodity moves in reaction to market trends and information, our statement of operations will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to protect the Company over the term of the contracts for the hedged amounts.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.     

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

Interest Rate Risk

We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from our Term Loan and our Term Revolving Loan, each bearing a variable interest rate.  As of January 31, 2020, we had $2,750,000 outstanding on the Term Loan and $8,499,000 outstanding on the Term Revolving Loan. Interest will accrue at the 30-day LIBOR rate plus 325 basis points. The applicable interest rate on these loans at January 31, 2020 was 4.97%. If we were to experience a 10% adverse change in the applicable interest rate, the annual effect such change would have on our income statement, based on the amount we had outstanding on our Term Loan and Term Revolving Loan at January 31, 2020, would be approximately $56,000.

The specifics of each note are discussed in greater detail in “Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”


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Commodity Price Risk

We expect to be exposed to market risk from changes in commodity prices.  Exposure to commodity price risk results from our dependence on corn and natural gas in the ethanol production process and the sale of ethanol and distillers grains. We may seek to minimize the risks from fluctuations in the prices of raw material inputs through the use of corn commodity-based and natural gas derivatives. These derivatives are not designated as effective hedges for accounting purposes. For derivative instruments that are not accounted for as hedges, or for the ineffective portions of qualifying hedges, the change in fair value is recorded through earnings in the period of change. Corn and natural gas derivative changes in fair market value are included in costs of goods sold.

In the ordinary course of business, we enter into forward contracts for our commodity purchases. At January 31, 2020, we have 1,906,457 bushels of forward fixed basis corn purchase contracts and 1,469,085 bushels of forward fixed price corn purchase contracts valued at approximately $5,680,000. These purchase contracts are for various delivery periods through July 2021. At January 31, 2020, we have 3,170,350 MMBTUs of forward natural gas fixed price purchase contracts valued at approximately $7,630,000 for delivery periods through March 2023. In addition, at January 31, 2020, we have 1,242,000 gallons of forward fixed price denaturant purchase contracts valued at approximately $1,559,000 for delivery periods through December 2020.

In the ordinary course of business, we enter into forward contracts for our commodity sales. At January 31, 2020, we have 3,100 tons of forward fixed price dried distillers grains sales contracts valued at approximately $435,000 for delivery periods through February 2020. At January 31, 2020, we have 18,700 tons of forward fixed price modified distillers grains sales contracts valued at approximately $1,352,000 for delivery periods through August 2020. In addition, at January 31, 2020, we have 1,398,000 pounds of forward fixed price corn oil sales contracts valued at approximately $335,000 for delivery periods through September 2020.
These derivatives have not been designated as effective hedges for accounting purposes and are forecasted to settle within the next twelve months. We had gains related to corn derivative instruments of $38,355 and $675,365 for the three months ended January 31, 2020 and 2019, respectively. We had gains related to ethanol based derivative instruments of $61,271 for the three months ended January 31, 2020. We had losses related to ethanol based derivative instruments of $135,797 for the three months ended January 31, 2019. We had gains related to natural gas derivative instruments of $6,321 and $19,806 for the three months ended January 31, 2020 and 2019, respectively.
    
As commodity prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to produce long-term positive growth for us.

A sensitivity analysis has been prepared to estimate our exposure to ethanol, distillers grains, corn and natural gas price risk. Market risk related to these factors is estimated as the potential change in income resulting from a hypothetical 10% adverse change in the average cost of our corn and natural gas prices and average ethanol and distillers grains prices as of January 31, 2020 net of the forward and future contracts used to hedge our market risk for corn and natural gas usage requirements. The volumes are based on our expected use and sale of these commodities for a one year period from January 31, 2020. The results of this analysis, which may differ from actual results, are approximately as follows:
 
Estimated Volume Requirements for the next 12 months (net of forward and futures contracts)
Unit of Measure
Hypothetical Adverse Change in Price as of
January 31, 2020
Approximate Adverse Change to Income
Natural Gas
1,541,000

MMBTU
10
%
 
$
693,450

Ethanol
67,000,000

Gallons
10
%
 
$
8,107,000

Corn
22,558,922

Bushels
10
%
 
$
8,527,272

DDGs
157,912

Tons
10
%
 
$
2,226,559




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Item 4.  Controls and Procedures
 
Disclosure Controls and Procedures

Our management is responsible for maintaining disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. In addition, the disclosure controls and procedures must ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required financial and other required disclosures.

Our management, including our Chief Executive Officer (the principal executive officer), Brian Kletscher, along with our Chief Financial Officer (the principal financial officer), Lucas Schneider, have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of January 31, 2020.  Based on this review and evaluation, these officers have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the forms and rules of the Securities and Exchange Commission; and to ensure that the information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the three months ended January 31, 2020, which were identified in connection with management’s evaluation required by paragraph (d) of rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.
    
Item 1A. Risk Factors
    
The following risk factor is provided due to material changes from the risk factors previously disclosed in our annual report on Form 10-K for the fiscal year ended October 31, 2019. The risk factor set forth below should be read in conjunction with the risk factors section and the Management's Discussion and Analysis section included in our annual report on Form 10-K for the fiscal year ended October 31, 2019.

We are subject to global and regional economic downturns and related risks.
 
The level of demand for our products is affected by global and regional demographic and macroeconomic conditions. A significant downturn in global economic growth, or recessionary conditions in major geographic regions for prolonged periods, may lead to reduced demand for our products, which could have a negative effect on the market price of our products in the United States.  For example, in December 2019, a novel strain of coronavirus surfaced in Wuhan, China (“COVID-19”). In just a few months, the spread of COVID-19 has resulted in businesses suspending or terminating global operations and travel, self-imposed or government-mandated quarantines, and an overall slowdown of economic activity in some areas.  Cases have been confirmed worldwide, including in Japan, Italy, Brazil, Canada and the United States.  To the extent that such economic conditions negatively impact consumer and business confidence, travel and consumption patterns or volumes for our products, our business and results of operations could be significantly and adversely affected.

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

None.
    


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Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Item 6. Exhibits.

(a)
The following exhibits are filed as part of this report.
Exhibit No.
 
Exhibit
31.1

 
31.2

 
32.1

 
32.2

 
101

 
The following financial information from Highwater Ethanol, LLC's Quarterly Report on Form 10-Q for the quarter ended January 31, 2020, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Balance Sheets as of January 31, 2020 and October 31, 2019, (ii) Condensed Statements of Operations for the three months ended January 31, 2020 and 2019, (iii) Statements of Cash Flows for the three months ended January 31, 2020 and 2019, (iv) the Notes to Condensed Financial Statements and (v) Condensed Statements of Changes in Members' Equity for the three months ended January 31, 2020 and 2019.**
(+) Confidential Treatment Requested.
* Filed herewith.
** Furnished herewith.

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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.
 
 
 
HIGHWATER ETHANOL, LLC
 
 
 
 
Date:
March 11, 2020
 
/s/ Brian Kletscher
 
 
 
Brian Kletscher
 
 
 
Chief Executive Officer
 
 
 
(Principal Executive Officer)
 
 
 
 
Date:
March 11, 2020
 
/s/ Lucas Schneider
 
 
 
Lucas Schneider
 
 
 
Chief Financial Officer
 
 
 
(Principal Financial and Accounting Officer)
 
 
 
 


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HIGHWATER ETHANOL LLC Reports