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Heron Lake BioEnergy, LLC SEC Filing Form 10-Q Quartely report 2/2017, submited: 2017-06-14

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Form 10-Q

The SEC form 10-Q is a comprehensive report of a company's performance that must be submitted quarterly by all public companies to the Securities and Exchange Commission. In the 10-Q, firms are required to disclose relevant information regarding their financial position. The form must be submitted on time, and the information should be available to all interested parties.

The 10-Q is due 35 days (it used to be 45 days) after each of the first three fiscal quarters. There is no filing after the fourth quarter because that is when the 10-K is filed.

10-Q 1 c964-20170430x10q.htm 10-Q hlb_Current_Folio_10Q

 

 

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 April 30, 2017 

 

OR

 

 

 

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

 

For the transition period from                    to                  .

 

COMMISSION FILE NUMBER 000-51825

 

HERON LAKE BIOENERGY, LLC

(Exact name of Registrant as specified in its charter)

 

 

 

 

Minnesota

 

41-2002393

(State or other jurisdiction of organization)

 

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

 

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

(Address of principal executive offices)

 

(507) 793-0077

(Issuer’s telephone number)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  ☒  Yes  ☐  No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

 

 

Large accelerated filer  ☐

 

Accelerated filer  ☐

 

 

Smaller reporting company ☐

Non-accelerated filer  ☒

 

Emerging growth company ☐

(Do not check if a smaller reporting company)

 

 

 

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

 

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

 

As of June 14, 2017, 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

 

 

 

 

 

 

 

 

 

 

    

April 30, 2017

    

October 31, 2016

 

 

 

(unaudited)

 

 

 

 

ASSETS

 

 

 

 

 

 

 

Current Assets

 

 

 

 

 

 

 

Cash

 

$

7,204,428

 

$

1,297,644

 

Restricted Cash

 

 

178,766

 

 

 —

 

Accounts receivable

 

 

359,729

 

 

4,607,202

 

Inventory

 

 

5,648,021

 

 

5,864,545

 

Commodity derivative instruments

 

 

210,593

 

 

662,338

 

Prepaid expenses and other current assets

 

 

355,726

 

 

181,853

 

Total current assets

 

 

13,957,263

 

 

12,613,582

 

 

 

 

 

 

 

 

 

Property and Equipment, net

 

 

48,597,726

 

 

50,376,210

 

 

 

 

 

 

 

 

 

Other Assets

 

 

 

 

 

 

 

Other intangible assets, net

 

 

64,926

 

 

84,000

 

Other assets

 

 

697,254

 

 

697,254

 

Total other assets

 

 

762,180

 

 

781,254

 

 

 

 

 

 

 

 

 

Total Assets

 

$

63,317,169

 

$

63,771,046

 

 

 

 

 

 

 

 

 

LIABILITIES AND MEMBERS' EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities

 

 

 

 

 

 

 

Current maturities of long-term debt

 

$

444,123

 

$

490,057

 

Checks drawn in excess of bank balance

 

 

 —

 

 

1,866,683

 

Accounts payable

 

 

2,291,939

 

 

4,878,210

 

Accrued expenses

 

 

562,715

 

 

397,407

 

Total current liabilities

 

 

3,298,777

 

 

7,632,357

 

 

 

 

 

 

 

 

 

Long-Term Debt, less current portion

 

 

1,281,710

 

 

1,393,669

 

 

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Members' Equity

 

 

 

 

 

 

 

Members' equity attributable to Heron Lake BioEnergy, LLC consists of 77,932,107 units issued and outstanding at both April 30, 2017 and October 31, 2016

 

 

57,351,130

 

 

53,499,596

 

Non-controlling interest

 

 

1,385,552

 

 

1,245,424

 

Total members' equity

 

 

58,736,682

 

 

54,745,020

 

 

 

 

 

 

 

 

 

Total Liabilities and Members' Equity

 

$

63,317,169

 

$

63,771,046

 

 

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  April 30,

 

Six Months Ended April 30,

 

 

2017

 

2016

 

2017

 

2016

 

    

(unaudited)

    

(unaudited)

    

(unaudited)

    

(unaudited)

Revenues

 

$

25,990,784

 

$

25,241,981

 

$

53,380,858

 

$

51,830,546

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of Goods Sold

 

 

24,140,518

 

 

24,321,911

 

 

48,116,361

 

 

50,052,895

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross Profit

 

 

1,850,266

 

 

920,070

 

 

5,264,497

 

 

1,777,651

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Expenses

 

 

(769,672)

 

 

(811,959)

 

 

(1,616,369)

 

 

(1,620,593)

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Income

 

 

1,080,594

 

 

108,111

 

 

3,648,128

 

 

157,058

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Income (Expense)

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

1,788

 

 

222

 

 

2,208

 

 

475

Interest expense

 

 

(25,803)

 

 

(90,268)

 

 

(57,190)

 

 

(148,942)

Other income, net

 

 

19,958

 

 

27,546

 

 

398,515

 

 

95,224

Total other income (expense), net

 

 

(4,057)

 

 

(62,500)

 

 

343,533

 

 

(53,243)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

 

1,076,537

 

 

45,611

 

 

3,991,661

 

 

103,815

 

 

 

 

 

 

 

 

 

 

 

 

 

Less: Net Income Attributable to Non-controlling Interest

 

 

(57,417)

 

 

(58,869)

 

 

(140,128)

 

 

(142,628)

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

1,019,120

 

$

(13,258)

 

$

3,851,533

 

$

(38,813)

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

0.01

 

$

0.00

 

$

0.05

 

$

0.00

 

 

 

 

 

 

 

 

 

 

 

 

 

Distributions Per Unit (Class A and B)

 

$

0.00

 

$

0.00

 

$

0.00

 

$

0.05

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

Six Months Ended

 

 

 

 

April 30, 2017

 

 

April 30, 2016

 

 

    

 

(unaudited)

    

 

(unaudited)

 

Cash Flow From Operating Activities

 

 

 

 

 

 

 

Net income

 

$

3,991,661

 

$

103,815

 

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

 

 

 

 

 

 

 

Depreciation and amortization

 

 

2,480,740

 

 

2,368,635

 

Gain on sale of asset

 

 

(45,000)

 

 

 —

 

Change in fair value of commodity derivative instruments

 

 

(142,694)

 

 

(142,105)

 

Change in operating assets and liabilities:

 

 

 

 

 

 

 

Restricted cash

 

 

(178,766)

 

 

(443,133)

 

Accounts receivable

 

 

4,247,473

 

 

4,476,925

 

Inventory

 

 

216,524

 

 

298,262

 

Commodity derivative instruments

 

 

594,440

 

 

822,892

 

Prepaid expenses and other current assets

 

 

(173,873)

 

 

(86,738)

 

Accounts payable

 

 

(2,773,771)

 

 

(1,706,048)

 

Accrued expenses

 

 

165,308

 

 

157,244

 

Net cash provided by operating activities

 

 

8,382,042

 

 

5,849,749

 

 

 

 

 

 

 

 

 

Cash Flows from Investing Activities

 

 

 

 

 

 

 

Capital expenditures

 

 

(495,682)

 

 

(1,033,545)

 

Proceeds from disposal of asset

 

 

45,000

 

 

 —

 

Net cash used in investing activities

 

 

(450,682)

 

 

(1,033,545)

 

 

 

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

 

 

Proceeds from long-term debt

 

 

 —

 

 

7,611,182

 

Payments on checks drawn in excess of bank balance

 

 

(1,866,683)

 

 

(838,449)

 

Payments on long-term debt

 

 

(157,893)

 

 

(7,786,568)

 

Distributions to Heron Lake BioEnergy, LLC members

 

 

 —

 

 

(3,896,605)

 

Distribution to non-controlling interest

 

 

 —

 

 

(81,000)

 

Net cash used in financing activities

 

 

(2,024,576)

 

 

(4,991,440)

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash

 

 

5,906,784

 

 

(175,236)

 

 

 

 

 

 

 

 

 

Cash—Beginning of period

 

 

1,297,644

 

 

1,126,283

 

 

 

 

 

 

 

 

 

Cash—End of period

 

$

7,204,428

 

$

951,047

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

 

Interest expense

 

$

57,190

 

$

148,942

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Non-Cash Investing and Financing Activities

 

 

 

 

 

 

 

Capital expenditures included in accounts payable

 

$

187,500

 

$

721,811

 

 

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

April 30, 2017

 

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 April  30, 2017 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% noncontrolling interest identified separately in the accompanying condensed consolidated balance sheets and statements of operations.  All significant intercompany balances and transactions are eliminated in consolidation.

 

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, 2016, 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 and valuation of commodity derivative instruments, inventory, and inventory purchase and sales commitments. The Company periodically reviews estimates and assumptions, and the effects of revisions are reflected in the period in which the revision is made. Actual results could differ from those estimates.

 

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

April 30, 2017

 

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.

 

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 75% to 85% of total revenues and corn costs average 70% to 90% of cost of goods sold.

 

5


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2017

 

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

 

The supply and demand for ethanol are impacted by federal and state legislation and regulation, most significantly the Renewable Fuels Standard (“RFS”), and any changes in legislation or regulation could cause the  demand for ethanol to decline or its supply to increase, which could have a material adverse effect on our business, results of operations and financial condition, and the ability to operate at a profit.

 

On November 23, 2016, the U.S. Environmental Protection Agency (the “EPA”) announced the final rule for 2017 Renewable Volume Obligation (“RVO”) requirements, which is set at 15.0 billion gallons for corn-based ethanol, which equates to the original requirements set by the RFS. However, in January 2017, the Trump administration imposed a government-wide freeze on new and pending regulations, which included the 2017 RVOs that were originally intended to go into effect on February 10, 2017. On March 20, 2017, following the termination of the Trump administration’s regulatory freeze, the EPA allowed the previously announced 2017 RVOs to go into effect. Additionally, opponents of ethanol such as large oil companies will likely continue their efforts to repeal or reduce the RFS through lawsuits or lobbying of and legislative efforts in Congress. Successful reduction or repeal of the blending requirements of the RFS and/or continued political uncertainty under the new administration regarding the RFS could result in a significant decrease in ethanol demand. If demand for ethanol decreases, it could materially adversely affect our business, results of operations and financial condition.

 

Ethanol has historically traded at a discount to gasoline. However, any declines in crude oil and unleaded gasoline prices could have a negative impact on the market price of ethanol which could cause ethanol to trade at a premium to gasoline.  When ethanol trades at a premium to gasoline,  a disincentive for discretionary blending of ethanol beyond the required RFS blend rate results. 

 

Management anticipates that ethanol prices will continue to change in relation to changes in corn and energy prices. If corn, crude oil and gasoline prices decrease, that could have a negative impact on ethanol pricing and demand, which could result in a material adverse effect on our business, results of operations and financial condition. Further, the ethanol industry is currently experiencing growth in production capacity, largely through plant optimization and expansions versus new construction. If ethanol supply increases at a greater pace compared to ethanol demand, it could result in oversupply and negatively affecting prices unless additional demand can be created.

 

 

3.INVENTORY

 

Inventory consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

April 30, 2017

 

October 31, 2016

 

 

    

(unaudited)

    

 

 

 

Raw materials

 

$

770,268

 

$

1,434,854

 

Work in process

 

 

732,070

 

 

696,013

 

Finished Goods

 

 

3,072,668

 

 

2,713,716

 

Supplies

 

 

1,073,015

 

 

1,019,962

 

Totals

 

$

5,648,021

 

$

5,864,545

 

 

6


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2017

 

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 $0 and $173,000 for the six months ended April 30, 2017 and 2016, respectively.

 

 

4.DERIVATIVE INSTRUMENTS

 

As of April 30, 2017, the total notional amount of the Company’s outstanding corn derivative instruments was approximately 3,315,000 bushels, comprised of long corn positions on 1,200,000 bushels that were entered into to hedge forecasted ethanol sales through July 2017, and short corn positions on 2,115,000 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 April 30, 2017,  the total notional amount of the Company’s outstanding ethanol derivative instruments was approximately 2,940,000 gallons that were entered into to hedge forecasted ethanol sales through September 2017.

 

As of April 30, 2017, the Company had $178,766 of cash collateral (restricted cash) and approximately $218,000 due to broker related to corn derivatives held by a broker. 

 

The following tables provide details regarding the Company’s derivative instruments at April 30, 2017, none of which are designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Balance Sheet Location

    

Assets

    

Liabilities

 

Corn contracts

 

Commodity derivative instruments

 

$

60,813

 

$

 —

 

Ethanol contracts

 

Commodity derivative instruments

 

 

149,780

 

 

 —

 

Totals

 

 

 

$

210,593

 

$

 —

 

 

As of October 31, 2016, the total notional amount of the Company's outstanding corn derivative instruments was approximately 4,285,000 bushels, comprised of long corn positions on 3,100,000 bushels that were entered into to hedge forecasted ethanol sales through March 2017, and short corn positions on 1,185,000 bushels that were entered into to hedge forecasted corn purchases through August 2017.     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, 2016, the Company had no cash collateral (restricted cash) related to corn derivatives held by a broker.

 

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

 

 

 

 

 

 

 

 

 

 

 

 

    

Consolidated Balance Sheet Location

    

Assets

    

Liabilities

 

Corn contracts

 

Commodity derivative instruments

 

$

388,525

 

$

 —

 

Ethanol contracts

 

Commodity derivative instruments

 

 

273,813

 

 

 —

 

Totals

 

 

 

$

662,338

 

$

 —

 

 

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:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Statement of

    

Three Months Ended  April 30,

 

Six Months Ended  April 30,

 

    

Operations location

    

2017

    

2016

 

2017

    

2016

Corn contracts

 

Cost of goods sold

 

$

470,114

 

$

(124,689)

 

$

413,486

 

$

62,698

Ethanol contracts

 

Revenues

 

 

(547,049)

 

 

13,110

 

 

(270,792)

 

 

57,857

Natural gas contracts

 

Cost of goods sold

 

 

 —

 

 

 —

 

 

 —

 

 

21,550

Total gain (loss)

 

 

 

$

(76,935)

 

$

(111,579)

 

$

142,694

 

$

142,105

 

 

7


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2017

 

5.FAIR VALUE

 

The following table provides information on those derivative assets and liabilities measured at fair value on a recurring basis at April 30, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement Using

 

 

 

Carrying Amount in

 

    

 

 

Quoted Prices in

 

Significant Other

 

Significant

 

 

 

Consolidated Balance Sheet

 

 

 

 

Active Markets

 

Observable Inputs

 

Unobservable inputs

 

Financial Assets

    

April 30, 2017

 

Fair Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

 

Commodity Derivative instruments - Corn

 

$

60,813

 

$

60,813

 

$

60,813

 

$

 —

 

$

 —

 

Commodity Derivative instruments - Ethanol

 

$

149,780

 

$

149,780

 

$

20,000

 

$

129,780

 

$

 —

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement Using

 

 

 

Carrying Amount in

 

    

 

 

Quoted Prices in

 

Significant Other

 

Significant

 

 

 

Consolidated Balance Sheet

 

 

 

 

Active Markets

 

Observable Inputs

 

Unobservable inputs

 

Financial Assets

    

October 31, 2016

 

Fair Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

 

Commodity Derivative instruments - Corn

 

$

388,525

 

$

388,525

 

$

388,525

 

$

 —

 

$

 —

 

Commodity Derivative instruments - Ethanol

 

$

273,813

 

$

273,813

 

$

273,813

 

$

 —

 

$

 —

 

 

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 Level 2 instruments by model-based techniques in which all significant inputs are observable in the markets noted above.

 

8


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2017

 

6.DEBT FINANCING

 

Long-term debt consists of the following:

 

 

 

 

 

 

 

 

 

 

 

April 30, 2017

 

October 31, 2016

 

 

 

(unaudited)

 

 

 

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

 

$

 —

 

$

 —

 

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

 

 

1,516,977

 

 

1,517,046

 

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.

 

 

77,606

 

 

97,930

 

Note payable to electrical company with monthly payments of $6,250 with interest at 0.00% and a 1.00% maintenance fee due each October. The note is due September 2017. The electrical company is a member of the Company.

 

 

31,250

 

 

68,750

 

Note payable to non-controlling interest member of Agrinatural. Interest is at One Month LIBOR plus 4.0%, which was approximately 5.00% and 4.53% at April 30, 2017 and October 31, 2016, respectively. The note is considered due on demand with payments due at Agrinatural Board of Managers discretion.

 

 

100,000

 

 

200,000

 

Totals

 

 

1,725,833

 

 

1,883,726

 

Less amounts due within one year

 

 

444,123

 

 

490,057

 

Net long-term debt

 

$

1,281,710

 

$

1,393,669

 

 

Revolving Term Note

 

The Company has a revolving term note payable with a lender, under which the Company could initially borrow, repay, and re-borrow in an amount up to $28,000,000 at any time prior to the March 2, 2022 maturity date.  However, the amount available for borrowing under the revolving term note reduces by $3,500,000 annually, starting March 1, 2015 and continuing each anniversary thereafter until maturity. Therefore, the aggregate principal amount available to the Company for borrowing at April  30, 2017, and October 31, 2016 was $17,500,000 and $21,000,000, respectively.  There was no outstanding balance on this facility at April 30, 2017, and October 31, 2016.

 

Interest on the revolving term loan accrues at a variable rate equal to 3.25% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate, which was 4.25% and 3.45% at April 30, 2017, and October 31, 2016, respectively. The Company may elect to enter into a fixed interest rate on this loan at various times throughout the term of the loan as provided in the loan agreements.

 

The Company also agreed to pay an unused commitment fee on the unused portion of the revolving term loan commitment at the rate of 0.50% per annum. The loan is secured by substantially all of the Company assets including a subsidiary guarantee. 

 

The credit facility contains customary covenants, including restrictions on the payment of dividends and loans and advances to Agrinatural,  and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility. Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges or penalties. As of  April 30, 2017 and October 31, 2016, the Company was in compliance with these financial covenants and expects to be in compliance throughout fiscal 2017.

 

As part of the credit facility closing, the Company entered into an administrative agency agreement with CoBank, ACP (“CoBank”). CoBank purchased a participation interest in the revolving term loan and was appointed the administrative agent for the purpose of servicing the loan.  As a result, CoBank will act as the agent for AgStar with respect to the credit facility. The Company agreed to pay CoBank an annual fee of $2,500 as the agent for AgStar.

 

9


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2017

 

Estimated annual maturities of long-term debt at April 30, 2017 are as follows based on the most recent debt agreements:

 

 

 

 

 

 

2018

    

$

444,123

 

2019

 

 

322,733

 

2020

 

 

306,706

 

2021

 

 

326,798

 

2022

 

 

325,473

 

Total debt

 

$

1,725,833

 

 

 

7.COMMITMENTS AND CONTINGENCIES

 

Corn Forward Contracts

 

At April 30, 2017, the Company had cash and basis contracts for forward corn purchase commitments totaling approximately 6,653,000 bushels of corn for various delivery periods through March 2018.

 

Ethanol Forward Contracts

 

At April 30, 2017,  the Company had fixed and basis contracts to sell approximately $13,810,000 of ethanol for various delivery periods through June 2017.   

 

Distillers’ Grains Forward Contracts

 

At April 30, 2017, the Company had forward contracts to sell approximately $137,000 of distillers’ grains for delivery through May 2017.

 

Corn Oil Forward Contracts

 

At April 30, 2017, the Company had forward contracts to sell approximately $379,000 of corn oil for delivery through June 2017.

 

 

8.MEMBERS’ EQUITY

 

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

 

The Company has a total of 62,932,107 Class A units and 15,000,000 Class B units issued and outstanding, for an aggregate total of 77,932,107 units issued and outstanding at April 30, 2017 and October 31, 2016. 

 

9.LEASES

 

The Company leases equipment, primarily rail cars, under operating leases through 2027.  Rent expense for these leases was approximately $438,000 and $710,000 for the three months ended April 30, 2017 and 2016, respectively. Rent expense for these leases was approximately $978,000 and $1,245,000 for the six months ended April 30, 2017 and 2016, respectively.  

 

 

10


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2017

 

10.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 $91,000 and $80,000 for the three months ended April 30, 2017 and 2016, respectively, and approximately $199,000 and $193,000 for the six months ended April 30, 2017 and 2016, respectively.

 

Corn Purchases - Members

 

The Company purchased corn from board members of approximately $2,569,000 and $2,990,000 for the three months ended April 30, 2017 and 2016, respectively, and approximately $5,594,000 and $8,636,000 for the six months ended April 30, 2017 and 2016, respectively.

 

Agrinatural

 

During 2013, the Company borrowed $300,000 from the non-controlling interest member of Agrinatural.  Total interest paid in relation to this note payable amounted to approximately $1,000 and $2,000 for the three months ended April 30, 2017 and 2016, respectively.  Interest paid in relation to this note payable amounted to approximately $3,000 and $5,000 for the six months ended April 30, 2017 and 2016, respectively.

 

Swan Engineering

 

On March 27, 2015, Agrinatural executed a new management and operating agreement with Swan Engineering, Inc. (“SEI”). SEI, together with an unrelated third party owns Rural Energy Solutions, LLC (“RES”), the 27% minority owner of Agrinatural. Under the new management and operating agreement, SEI will continue to provide Agrinatural with day-to-day management and operation of Agrinatural's pipeline distribution business. In exchange for these services, Agrinatural will pay SEI an aggregate management fee equal to the fixed monthly base fee plus the variable customer management fee based on the number of customers served on the pipeline less the agreed monthly fee reduction of $4,500. The Company paid monthly base fee and variable customer management fee of approximately $48,000 and $44,000 for the three months ended April 30, 2017 and 2016, respectively, and approximately $97,000 and $88,000 for the six months ended April 30, 2017 and 2016, respectively. The new management and operating agreement with SEI expires July 1, 2019, unless earlier terminated for cause as defined in the agreement.

 

On March 27, 2015, Agrinatural also executed a new project management agreement with SEI. Pursuant to the new project management agreement, SEI will continue to supervise all of Agrinatural's pipeline construction projects. These projects are constructed by unrelated third-party pipeline construction companies. Under the new project management agreement, Agrinatural will pay SEI a total of 10% of the actual capital expenditures for construction projects approved by Agrinatural's Board of Directors, excluding capitalized marketing costs. The Company recorded project management fees of approximately $2,000 and $1,000 for the three months ended April 30, 2017 and 2016, respectively, and approximately $12,000 and $39,000 for the six months ended April 30, 2017 and 2016, respectively. The new project management with SEI expires June 30, 2019, unless earlier terminated for cause as defined in the agreement.

 

 

11


 

Table of Contents

Heron Lake BioEnergy, LLC and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

April 30, 2017

 

11.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

 

Six Months Ended

 

 

 

April 30, 2017

 

April 30, 2016

 

April 30, 2017

 

April 30, 2016

 

Revenue:

    

(unaudited)

    

(unaudited)

 

(unaudited)

 

(unaudited)

 

Ethanol production

 

$

25,698,621

 

$

25,001,160

 

$

52,663,512

 

$

51,249,989

 

Natural gas pipeline

 

 

716,978

 

 

665,980

 

 

1,585,613

 

 

1,454,939

 

Eliminations

 

 

(424,815)

 

 

(425,159)

 

 

(868,267)

 

 

(874,382)

 

Total Revenue

 

$

25,990,784

 

$

25,241,981

 

$

53,380,858

 

$

51,830,546

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

April 30, 2017

 

April 30, 2016

 

April 30, 2017

 

April 30, 2016

 

Operating Income:

 

(unaudited)

    

(unaudited)

 

(unaudited)

 

(unaudited)

 

Ethanol production

    

$

804,315

    

$

223,603

 

$

2,998,513

    

$

(108,515)

 

Natural gas pipeline

 

 

441,408

 

 

168,863

 

 

1,005,338

 

 

665,555

 

Eliminations

 

 

(165,129)

 

 

(284,355)

 

 

(355,723)

 

 

(399,982)

 

Operating Income

 

$

1,080,594

 

$

108,111

 

$

3,648,128

 

$

157,058

 

 

 

 

 

 

 

 

 

 

 

 

April 30, 2017

 

October 31, 2016

 

Total Assets:

    

(unaudited)

 

 

 

Ethanol production

 

$

50,745,300

 

$

51,080,443

 

Natural gas pipeline

 

 

12,571,869

 

 

12,690,603

 

Total Assets

 

$

63,317,169

 

$

63,771,046

 

 

 

 

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 six months ended April 30, 2017 and 2016. 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, 2016.

 

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, 2016  as supplemented by the risk factors disclosed in Item 1A of our Form 10-Q for the three months ended January 31, 2017, 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 as a result of a number of factors, including: the price and availability of competing fuels; the overall supply and demand for ethanol and corn; the price of gasoline, crude oil and corn; and government policies;

·

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, resulting from factors such as domestic stocks, demand from corn-consuming industries, such as the ethanol industry, prices for alternative crops, increasing input costs, changes in government policies, shifts in global markets or damaging growing conditions, such as plant disease or adverse weather, including drought;

·

Fluctuations in the availability and price of natural gas, which is may be affected by 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 trading at a premium to gasoline at times, resulting in a disincentive for discretionary blending of ethanol beyond the requirements of the Renewable Fuels Standard (“RFS”) and consequently negatively impacting ethanol prices and demand;

·

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

·

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

·

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

·

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

·

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

·

Competition from alternative fuels and alternative fuel additives;

·

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

·

Our reliance on key management personnel.

13


 

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

 

Industry and Market Data

 

Much of the information in this report regarding the ethanol industry, including government regulation relevant to the industry is from information published by the Renewable Fuels Association (“RFA”), a national trade association for the United States (“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 (“Heron Lake BioEnergy” or  “HLBE”) 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 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 “we”, “us”, “our”, the “Company” or similar words in this Annual Report on Form 10‑Q, unless the context otherwise requires, we are referring to Heron Lake BioEnergy and its wholly owned and majority owned subsidiaries. 

 

Reportable Operating Segments

 

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

 

Ethanol Production

 

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

14


 

Our ethanol plant has a nameplate capacity of 50 million gallons per year.  We have received EPA pathway approval and have obtained permits from the Minnesota Pollution Control Authority to increase our production capacity to approximately 72.3 million gallons of undenatured fuel-grade ethanol on a twelve-month rolling sum basis. We are currently operating above our stated nameplate capacity and intend to continue to do into the near future, dependent on industry conditions and plant profitability.

 

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

 

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

 

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

 

We have a facilities agreement with Northern Border Pipeline Company, which allows us access to an existing interstate natural gas pipeline located approximately 16 miles north from our plant. We have entered into a firm natural gas transportation agreement with Agrinatural, our majority owned subsidiary. We also have an agreement with Constellation NewEnergy—Gas Division, LLC to supply the natural gas necessary to operate our plant.

 

Natural Gas Pipeline

 

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

 

The Company has entered into two intercompany credit facilities with Agrinatural: the July 2014 credit facility, as amended (the “Orginal Credit Facility”) and the March 2015 credit facility, as amended (the “Additional Credit Facility”). Under the Orignal Credit Facility, the Company made a five-year term loan in the principal amount of $3.05 million and pursuant to the Additional Credit Facility, made a four-year term loan in the principal amount of $3.5 million to Agrinatural. Details of these credit facilities to Agrinatural are provided below in the section below entitled “PART I - Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources; Indebtedness”.

 

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

 

15


 

Plan of Operations for the Next Twelve Months

 

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

 

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

 

Additionly, we expect to continue to conduct routine maintenance and repair activities at the ethanol plant. We anticipate using cash we generate from our operations and our revolving term loan to finance these plant upgrade projects.

 

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 well as governmental programs designed to create incentives for the use of corn-based 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 I - Item 1. Business” and “PART I - Item 1A. Risk Factors” of our annual report on Form 10-K for the fiscal year ended October 31, 2016, and “PART II - Item 1A. Risk Factors” of our quarterly report on Form 10-Q for the three months ended January 31, 2017.

 

Our operations are highly dependent on commodity prices, especially 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. 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 in order to minimize our variable costs and optimize cash flow.

 

Management currently believes that our margins will remain steady during the remainder of fiscal year 2017. However, low crude oil and unleaded gasoline prices or further decreases in the price of such commodities could have a negative impact on the market price of ethanol which could adversely impact our profitability. Further, the ethanol industry is currently experiencing growth in production capacity,  largely through plant optimization and expansions versus new construction. If ethanol supply increases at a greater pace compared to ethanol demand, it could result in oversupply and negatively affecting prices unless additional demand can be created.

 

16


 

Domestic ethanol inventories continued to increase during the three and six months ended April 30, 2017. The increased supply of ethanol was partially absorbed by higher blending rates resulting from higher gasoline demand. During the three months ended April 30, 2017, ethanol futures continued trading at a discount to gasoline, after trading at a premium for much of fiscal year 2016, which improved the economics of ethanol blending and encouraging discretionary blending as an oxygenate and octane enhancer for gasoline. Additionally, as the U.S. moves into its traditional summer driving season, gasoline demand and ethanol consumption is expected to increase over the next several months.   Management anticipates that increased gasoline demand in the summer months will positively impact ethanol prices.

 

Although ethanol exports have provided support for ethanol prices,  export demand for ethanol is less consistent compared to domestic demand which can lead to ethanol price volatility.  If ethanol exports are lower during fiscal year 2017 compared to 2016, it could result in lower ethanol prices and could negatively impact our profitability. According to the U.S. Energy Information Administration (“EIA”), net U.S. ethanol exports are forecasted to exceed one billion gallons in 2017.  However, China, which was the second largest importer of U.S. ethanol in 2016, increased its ethanol import tariff from 5% to 30% as of January 1, 2017 on imports of U.S. ethanol. While ethanol exports to China continue, if ethanol prices increase, these exports to China may cease. Further, ethanol exports could potentially be higher without the higher Chinese tariff. However, it is possible that declines in domestic ethanol prices could result if export demand for U.S. ethanol by China decreases due to the higher tariff.

 

Despite the fall off of Chinese exports, ethanol export activity to other destinations has remained strong. Year-to-date domestic ethanol exports through March 31, 2017, were up approximately 56.4% compared to the same period in 2016, as reported by the EIA.  Increases in export sales of ethanol to a variety of foreign markets resulted from high blending demand from a variety of customers. For exports through March 31, 2017, the EIA reports that Brazil accounted for approximately 37.5% of the domestic ethanol export volumes, while Canada, India, the Philippines, and United Arab Emirates and accounted for approximately 18.9%, 18.3%, 8.0, and 5.36%, respectively.

 

Due the price of corn relative to sugar, corn-based ethanol from the United States continues to be more competitive relative to sugarcane-based Brazilian ethanol. As a result, U.S. ethanol was more attractive in the Brazilian market. However, both the Brazilian sugarcane industry and Brazilian ethanol producers are pushing the Brazilian government to institute a tariff on imported ethanol. To date, no tariff has been implemented. If Brazil's trade counsel imposes a tariff on ethanol imports from the U.S., demand from Brazil could decrease even if sugar prices remain high. Additionally, it is possible that declines in domestic ethanol prices could result if Brazilian export demand for U.S. ethanol declines, unless additional demand from domestic discretionary blending or other foreign markets develop.

 

Our margins have also been, and could continue to be, negatively impacted due to the lower prices received for our distillers’ grains due to lower export demand and oversupply in the domestic market,  along with increased corn and soybean availability.  Export demand from China and Vietnam, historically two of the largest importers of U.S. produced distillers grains, has significantly declined. Last year, China began an anti-dumping and countervailing duty investigation related to distillers grains imported from the U.S. which contributed to a decline in distillers grains shipped to China. In January 2017, the Chinese issued final tariffs on U.S. distillers grains. The Chinese distillers grains anti-dumping tariffs range from 42.2% to 53.7% and the anti-subsidy tariffs range from 11.2% to 12%. As a result of the imposition of these duties, exports of U.S. distillers’ grains to China have signicantly declined.  

 

Additionally, exports of U.S. distillers’ grains to Vietnam have halted completely due to Vietnam’s imposition of stricter regulations on fumigation. In December 2016, Vietnam's Plant Protection Department issued a ruling that only methyl bromide would be acceptable as fumigation for bulk and container shipments of distillers’ grains, banning phosphine, the chemical generally used in the U.S. industry. The ruling cited concerns about containers arriving infested with the larger cabinet beetle although some in the industry believe that the infestation may be taking place as fumigated U.S. containers move overseas and are exposed to other containers on the ship that may carry insects.  Management anticipates distillers’ grains prices will remain lower during the remaining quarters of our 2017 fiscal year, unless additional domestic demand or other foreign markets develop.

 

Corn oil prices have also been adversely impacted by oversupply of corn oil due to the substantial increase in corn oil production during the last few years.  Additionally, corn oil prices have been impacted by the oversupply of soybeans and the resulting lower price of soybean oil which competes with corn oil for biodiesel production. However, despite the expiration of the biodiesel blenders' tax credit, demand from the biodiesel industry for corn oil remains relatively strong, offsetting some of the impact of lower soybean oil prices and oversupply of corn oil.  However,

17


 

biodiesel production may not continue at its current level, especially if the biodiesel blenders' credit is not renewed. Renewal of biodiesel blenders' tax credit could lead to increased biodiesel production, which, in turn, could result in increased demand for corn oil.

 

Management anticipates continued lower corn prices due to the balance between corn supply and demand. Lower corn prices are primarily the result of the strong corn harvest in the fall of 2016, which increased the supply of corn available to the market.  However, as we progress into the U.S. growing season, we may still experience some short term corn price volatility in response to summer weather impacts on the current crop. Additionally, the South American corn crop is expected to be large. If the South American harvest is as large as anticipated,  it could put downward pressure on corn prices in the U.S. due to increase in global supply.

 

Management anticipates relatively stable natural gas prices during the rest of our 2017 fiscal year. Management does not expect significant shifts in market natural gas prices unless there are disruptions in natural gas production which impact natural gas supplies. If a shortage of natural gas were to occur in the future, it could result in significantly higher natural gas prices which could negatively impact our profitability.

 

Government Supports and Regulation

 

On November 23, 2016, the Environmental Protection Agency (“EPA”) announced the final rule for 2017 renewable volume obligations (“RVOs”), which is set at 15.0 billion gallons for corn-based ethanol.  This rule is set at 100% of the original statutory requirement for conventional ethanol, and is considered a favorable outcome by the industry. However, in January 2017, the Trump administration imposed a broad-based regulatory freeze on new and pending regulations, which included the 2017 RVOs that were originally intended to go into effect on February 10, 2017. On March 20, 2017, following the termination of the Trump administration’s regulatory freeze, the EPA allowed the previously announced 2017 RVOs to go into effect.

 

On March 2, 2017, the Consumer and Fuel Retailer Choice Act was introduced in the U.S. Senate and the House of Representatives, proposing to lift restrictions on the sale of E15 between June 1 and September 15 by extending the Reid Vapor Pressure waiver, also known as the One-Pound Waiver, to gasoline blended with 15% ethanol. Also on March 2, 2017, the RFS Elimination Act and RFS Reform Act were introduced in the House of Representatives, proposing to repeal the RFS program and cap the amount of ethanol allowed to be blended with conventional gasoline at 10% beginning in 2017.  

 

Current ethanol production capacity exceeds the EPA’s 2017 RVO mandates which can be satisfied by corn based ethanol.  Future demand will be influenced by economic incentives to blend based on the relative value of gasoline versus ethanol, taking into consideration the octane value of ethanol, environmental requirements and the RFS RVO requirements. A significant increase in supply beyond the RFS RVO mandates could have an adverse impact on ethanol prices. Moreover, beyond the federal mandates, there are limited markets for ethanol. Further, if opponents of ethanol are successful in their efforts to repeal or reduce the RFS through lawsuits or lobbying of Congress. If such efforts are successful in further reducing or repealing the blending requirements of the RFS, a significant decrease in ethanol demand may result and could have a material adverse effect on our results of operations, cash flows and financial condition, unless additional demand from exports or discretionary blending develops.

 

18


 

Results of Operations for the Three Months Ended April 30, 2017 and 2016

 

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 April 30, 2017 and 2016 (amounts in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Three Months Ended  April 30, 2017

 

Three Months Ended  April 30, 2016

Income Statement Data

    

(unaudited)

    

%

 

(unaudited)

    

%

Revenues

 

$

25,991

 

100.0

%  

 

$

25,242

 

100.0

%

Cost of Goods Sold

 

 

24,141

 

92.9

%  

 

 

24,322

 

96.4

%

Gross Profit

 

 

1,850

 

7.1

%  

 

 

920

 

3.6

%

Operating Expenses

 

 

(770)

 

(3.0)

%  

 

 

(812)

 

(3.2)

%

Operating Income

 

 

1,080

 

4.1

%  

 

 

108

 

0.4

%

Other Income (Expense), net

 

 

(4)

 

(0.0)

%  

 

 

(62)

 

(0.2)

%

Net Income

 

 

1,076

 

4.1

%  

 

 

46

 

0.2

%

Less: Net Income Attributable to Noncontrolling Interest

 

 

(57)

 

(0.2)

%  

 

 

(59)

 

(0.2)

%

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

 

$

1,019

 

3.9

%  

 

$

(13)

 

 —

%

 

Revenues

 

Our consolidated revenue is derived principally from revenues from our ethanol production segment, which consists primarily of sales of our three principal products: ethanol, distillers’ grains and corn oil, as well as incidental sales of corn syrup. Revenues from our ethanol production segment represented approximately 98.9%  and 99.0%  of our total revenues for the three months ended April 30, 2017 and 2016, respectively. Our remaining consolidated revenues are attributable to Agrinatural revenues, net of eliminations for distribution fees paid by HLBE to Agrinatural for natural gas transportation services. The revenues attributable to our natural gas pipeline segment represented approximately 1.1% and 1.0%  of our consolidated revenues for the three months ended April 30, 2017 and 2016, respectively.

 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our unaudited condensed consolidated statements of operations the three months ended April 30, 2017:

 

 

 

 

 

 

 

 

 

 

Three Months Ended  April 30, 2017

 

 

Sales Revenue

    

% of Total Revenues

 

 

(in thousands)

 

 

 

Ethanol sales

 

$

21,062

 

81.1

%

Distillers' grains sales

 

 

3,622

 

13.9

%

Corn oil sales

 

 

877

 

3.4

%

Corn syrup sales

 

 

138

 

0.5

%

Agrinatural revenues (net of intercompany eliminations)

 

 

292

 

1.1

%

Total Revenues

 

$

25,991

 

100.0

%

 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our unaudited condensed consolidated statements of operations for the three months ended April 30, 2016:

 

 

 

 

 

 

 

 

 

 

Three Months Ended  April 30, 2016

 

 

Sales Revenue

    

% of Total Revenues

 

 

(in thousands)

 

 

 

Ethanol sales

 

$

19,941

 

79.0

%

Distillers' grains sales

 

 

3,863

 

15.3

%

Corn oil sales

 

 

1,069

 

4.2

%

Corn syrup sales

 

 

128

 

0.5

%

Agrinatural revenues (net of intercompany eliminations)

 

 

241

 

1.0

%

Total Revenues

 

$

25,242

 

100.0

%

19


 

Our total consolidated revenues increased by approximately 3.0% for the three months ended April 30, 2017, as compared to the three months ended April 30, 2016, due to increases the average price received for our ethanol and corn oil.  The following table reflects quantities of our three primary products sold and the average net prices received for the three months ended April 30, 2017 and 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended  April 30, 2017

 

Three Months Ended  April 30, 2016

 

 

Quantity Sold

 

Avg. Net Price

 

Quantity Sold

 

Avg. Net Price

Product

 

(in thousands)

 

 

 

 

(in thousands)

 

 

 

Ethanol (gallons)

 

15,609

 

$

1.35

 

15,522

 

$

1.28

Distillers' grains (tons)

 

39

 

$

92.85

 

35

 

$

111.39

Corn oil (pounds)

 

3,289

 

$

0.27

 

4,119

 

$

0.26

 

Ethanol

 

Total revenues from sales of ethanol increased by approximately 5.6%  for the three months ended April 30, 2017, compared to the same period of 2016 due to an approximately 5.0%  increase in the average price per gallon we received for our ethanol,  coupled with a slight increase of 0.6% in the volume of ethanol sold. 

 

The increase in average market price for the three months ended April 30, 2017 compared to the same period of 2016 is due to several factors. Strong domestic demand due to increased domestic driving and strong export demand, as well as higher market prices for crude oil and gasoline, put upward pressure on ethanol prices counter-balancing downward price pressure from the increase in domestic stocks due to increased domestic production.  In comparison, for the three months ended April 30, 2016, lower crude oil and gasoline prices, oversupply of ethanol and the reduction of the volume obligations set forth in the RFS by the EPA in November 2015 had a negative effect on ethanol prices.     

 

We sold slightly more ethanol gallons during three months ended April 30, 2017 as compared to the same period of 2016 primarily due to the timing of ethanol shipments. We are currently operating above our nameplate capacity. Management anticipates relatively stable ethanol production and sales during our 2017 fiscal year. 

 

From time to time, we engage in hedging activities with respect to our ethanol sales. At April 30, 2017, we had approximately 2.9 million gallons of fixed and basis contracts for forward ethanol sales for delivery periods through June 2017 valued at approximately $13.8 million.  Separately, ethanol derivative instruments resulted in a loss of approximately $547,000 for the three months ended April 30, 2017 and a gain of $13,000 for the three months ended April 30, 2016.