10-K 1 herlakp_20141031-10k.htm 10-K HERLAKP_2014.10.31-10K
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ý
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended October 31, 2014.
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 000-51825
Heron Lake BioEnergy, LLC
(Exact name of registrant as specified in its charter)
Minnesota
(State or other jurisdiction of
incorporation or organization)
 
41-2002393
(IRS Employer
Identification No.)
91246 390th Avenue, Heron Lake, MN 56137-1375
(Address of principal executive offices)
Registrant's telephone number, including area code: (507) 793-0077
Securities registered pursuant to Section 12(b) of
the Act:
 
Securities registered pursuant to Section 12(g) of
the Act:
None
 
Class A Units
Name of Exchange on Which Registered: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: Yes o    No ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act: Yes o    No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o
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 ý    No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
Large Accelerated Filer o
 
Accelerated Filer o
 
Non-Accelerated Filer ý
 
Smaller Reporting Company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 126-2 of the Act) Yes o    No ý
As of April 30, 2014, the aggregate market value of the 25,720,720 Class A units held by non-affiliates (computed by reference to the most recent offering price of Class A membership units) was $7,227,416. The units are not listed on an exchange or otherwise publicly traded. Additionally, the membership units are subject to significant restrictions on transfer under the registrant's operating and member control agreement. In determining this value, the registrant has assumed that all of its directors, chief executive officer, chief financial officer, Granite Falls Energy, LLC and beneficial owners of 5% or more of its outstanding membership units are affiliates, but this assumption shall not apply to or be conclusive for any other purpose.


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As of April 30, 2014, all of the 15,000,000 Class B units were held by an affiliate of the Company.
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
As of January 28, 2015, there were 62,932,107 Class A units and 15,000,000 Class B units outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
The registrant has incorporated by reference into Part III of this Annual Report on Form 10-K portions of its definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year covered by this Annual Report (October 31, 2014). This proxy statement is referred to in this report as the 2015 Proxy Statement.



INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This annual report contains historical information, as well as forward-looking statements regarding our business, financial condition, results of operations, performance and prospects. All statements that are not historical or current facts are forward-looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and relate to future events, our future financial performance, or our expected future operations and actions. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expect," "plan," "anticipate," "believe," "estimate," "future," "intend," "could," "hope," "predict," "target," "potential," or "continue" or the negative of these terms or other similar expressions. These forward-looking statements are only our predictions based on current information and involve numerous assumptions, risks and uncertainties, including, but not limited to the following:
Fluctuations in the prices of grain, utilities and ethanol, which are affected by various factors including weather, production levels, supply, demand, and availability of production inputs;
Changes in the availability and price of corn and natural gas;
Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;
Fluctuations in the price of crude oil and gasoline;
Changes in federal and/or state laws and environmental regulations including elimination, waiver or reduction of the Renewable Fuels Standard, may have an adverse effect on our business;
Any delays in shipping our products by rail due to an increase in rail traffic congestion or delays in returning rail cars to our plant and any reductions of plant production due to ethanol storage capacity constraint;
Any shipping delays and corresponding decreases in our sales as a result of these shipping delays;
The supply of ethanol rail cars in the market has fluctuated in recent years and may affect our ability to obtain new tanker cars or negotiate new leases at a reasonable fee when our current leases expire;
Any impairment of the transportation, storage and blending infrastructure that prevents ethanol from reaching markets;
Any effect on prices of distillers' grains resulting from actions in international markets, particularly China, limiting imports due to the present of genetically modified material;
Changes in our business strategy, capital improvements or development plans;
The effect of our risk mitigation strategies and hedging activities on our financial performance and cash flows;
Competition from alternative fuel additives;
Changes or advances in plant production capacity or technical difficulties in operating the plant;
Our ability to profitably operate the ethanol plant and maintain positive margins and generate free cash flow, which may impact our ability to meet current obligations, invest in our business, service our debt and satisfy the financial covenants contained in our credit agreement with our lender;
Changes in interest rates or the lack of credit availability;
Our ability to make distributions in light of financial covenants in our credit facility;
Our ability to retain key employees and maintain labor relations;
Our units are subject to a number of transfer restrictions, no public market exists for our units, and we do not expect one to develop.
Our actual results or actions may differ materially from these forward-looking statements for many reasons, including the reasons described in Part I, Item 1A. "Risk Factors" of this Form 10-K. We undertake no duty to update these forward-looking statements, even though our situation may change in the future. 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, 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 with these cautionary statements. Unless otherwise stated, references in this report to particular years or quarters refer to our fiscal years ended October 31 and the associated quarters of those fiscal years.

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INDUSTRY AND MARKET DATA
Much of the information in this report regarding the ethanol industry, including government regulation relevant to the industry, the market for our products and competition is from information published by the Renewable Fuels Association ("RFA"), a national trade association for the United States ethanol industry, as well as other publicly available information from governmental agencies or publications. Although we believe these sources are reliable, we have not independently verified the information.
AVAILABLE INFORMATION
 
Our principal executive offices are located at 91246 390th Avenue, Heron Lake, Minnesota 56137, and our telephone number is 507-793-0077. We make available free of charge on or through our Internet website, www.heronlakebioenergy.com, all of our reports and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (SEC). The Securities and Exchange Commission also maintains an Internet site (http://www.sec.gov) through which the public can access our reports. We will provide electronic or paper copies of these documents free of charge upon request.
PART I
When we use the terms "Heron Lake BioEnergy," "we," "us," "our," the "Company", "HLBE" or similar words in this Annual Report on Form 10-K, unless the context otherwise requires, we are referring to Heron Lake BioEnergy, LLC and its subsidiaries, Lakefield Farmers Elevator, LLC (which sold substantially all of its assets during the second quarter of 2013) and HLBE Pipeline Company, LLC. Additionally, when we refer to "units" in this Annual Report on Form 10-K, unless the context otherwise requires, we are referring to the Class A units of Heron Lake BioEnergy, LLC.
ITEM 1.    BUSINESS
Overview
We were organized as a Minnesota limited liability company on April 12, 2001 under the name "Generation II, LLC." In June 2004, we changed our name to Heron Lake BioEnergy, LLC.
In July 2013, Granite Falls Energy, LLC ("Granite Falls" or "GFE") acquired a controlling interest in the Company from Project Viking, L.L.C. GFE, now a related party, owns an ethanol plant located in Granite Falls, Minnesota. As of January 28, 2015, GFE owns approximately 50.6% of our outstanding membership units. As a result of its majority ownership, GFE has the right to appoint five (5) of the nine (9) governors to our board of governors under our member control agreement.
We operate a dry mill fuel-grade ethanol plant in Heron Lake, Minnesota with a name plate production capacity of 50 million gallons of ethanol per year. Our plant was originally constructed as a coal fired plant but was converted to natural gas in November 2011.  Since beginning operation of our ethanol plant on September 21, 2007, our primary business has been the production and sale of ethanol and co-products, including dried distillers' grains and since February 2012, non-edible corn oil.
At nameplate, our ethanol plant has the capacity to process approximately 18.0 million bushels of corn each year, producing approximately 60.0 million gallons per year of fuel-grade ethanol and approximately 160,000 tons of distillers' grains and 11.0 million pounds of corn oil. Our permitted production capacity is approximately 60.0 million gallons of ethanol per year. In fiscal years 2014, 2013, and 2012, we sold approximately 59.3 million, 55.4 million and 58.2 million gallons of ethanol, respectively.
Our subsidiary, Lakefield Farmers Elevator, LLC, had grain facilities at Lakefield and Wilder, Minnesota that were sold on February 1, 2013.
Our wholly owned subsidiary, HLBE Pipeline Company, LLC, owns 73% of Agrinatural Gas, LLC ("Agrinatural"). Agrinatural is a natural gas pipeline company that was formed to construct, own, and operate the natural gas pipeline that provides natural gas to the Company's ethanol production facility and other customers through a connection with the natural gas pipeline facilities of Northern Border Pipeline Company in Cottonwood County, Minnesota. Rural Energy Solutions, LLC owns the remaining 27% minority interest in Agrinatural.

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Subsequent to the end of our 2014 fiscal year, on December 18, 2014, our board of governors declared a distribution of $0.12 per membership unit for a total of approximately $9.4 million to be paid to members of record as of December 18, 2014. The distribution was paid on January 19, 2015. Based on the covenants contained in our AgStar credit facilities, the foregoing distribution was approved by our lender prior to distribution.
Reportable Operating Segments
Accounting Standards Codification (ASC) 280, “Segment Reporting,” establishes the standards for reporting information about segments in financial statements. In applying the criteria set forth in ASC 280, the Company determined during the fourth fiscal quarter ended October 31, 2014 that it 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.
Before intercompany eliminations, revenues from our natural gas pipeline segment represented 1.8%, 1.5% and 0.0% of our total consolidated revenues in the years ended October 31, 2014, 2013, and 2012, respectively. After accounting for intercompany eliminations for fees paid by the Company for natural gas transportation services pursuant to our natural gas transportation agreement with Agrinatural, Agrinatural's revenues represented 0.6%, 0.6% and 0.0% of our consolidated revenues for the fiscal years ended October 31, 2014, 2013, and 2012, respectively, and have little to no impact on the overall performance of the Company.
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 13, “Business Segments,” of the notes to consolidated financial statements for financial information about our financial reporting segments.
Financial Information
Please refer to "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" for information about our revenue, profit and loss measurements and total assets and liabilities and "Item 8 - Financial Statements and Supplementary Data" for our consolidated financial statements and supplementary data.
Ethanol Production Segment
Revenues from our ethanol production segment have represented 99.4%, 99.4% and 98.9% of our revenues in the years ended October 31, 2014, 2013, and 2012 respectively.
Principal Products
The principal products from our ethanol production are fuel-grade ethanol, distillers' grains, non-edible corn oil and miscellaneous sales of distillers' syrup, a by-product of the ethanol production process. We did not introduce any new products or services as part of our ethanol production segment during our fiscal year ended October 31, 2014. The table below shows the approximate percentage of our total revenue which is attributable to each of our principal products for each of the last three fiscal years.
 
 
Fiscal Year 2014
 
Fiscal Year 2013
 
Fiscal Year 2012
Ethanol
 
79.7%
 
76.7%
 
76.0%
Distillers Grains
 
17.1%
 
19.9%
 
19.3%
Corn Oil
 
2.1%
 
2.5%
 
1.6%
Misc. Syrup Sales
 
0.5%
 
0.5%
 
2.0%

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Ethanol
Ethanol is a type of alcohol produced in the United States principally from corn. Ethanol is ethyl alcohol, a fuel component made primarily from corn in the United States but can also be produced from various other grains. Ethanol is primarily used as:
an octane enhancer in fuels;
an oxygenated fuel additive that can reduce ozone and carbon monoxide vehicle emissions;
a non-petroleum-based gasoline substitute; and
as a renewable fuel to displace consumption of imported oil.
Ethanol produced in the United States is primarily used for blending with unleaded gasoline and other fuel products as an octane enhancer or fuel additive. Ethanol is most commonly sold as E10 (10% ethanol and 90% gasoline), which is the blend of ethanol approved by the United States Environmental Protection Agency ("EPA") for use in all American automobiles. Increasingly, ethanol is also available as E85, a higher percentage ethanol blend (85% ethanol and 15% gasoline) approved by the EPA for use in flexible fuel vehicles.
The principal markets for our ethanol are petroleum terminals in the continental United States. The principal purchasers of ethanol are generally wholesale gasoline distributors or blenders.
Distillers' Grains
The principal co-product of the ethanol production process is distillers' grains, a high protein and high-energy animal feed ingredient primarily marketed to the dairy, swine, poultry and beef industries. Distillers grains contain by-pass protein that is superior to other protein supplements such as cottonseed meal and soybean meal. By-pass proteins are more digestible to the animal, thus generating greater lactation in milk cows and greater weight gain in beef cattle and swine. Distillers grains can also be included in the rations of breeder hens and laying hens which can potentially contain up to 20% and 15% percent distillers' grains, respectively.
Dry mill ethanol processing creates three primary forms of distillers' grains: wet distillers' grains, modified wet distillers' grains, and dried distillers' grains with solubles. Most of the distillers' grains that we sell are in the form of dried distillers' grains. Dried distillers' grains with solubles are corn mash that has been dried to approximately 10% moisture. It has an almost indefinite shelf life and may be sold and shipped to any market and fed to almost all types of livestock.
Corn Oil
Since our installation of a corn oil extraction system in February 2012, we are able to extract non-edible crude corn oil during the thin stillage evaporation process immediately prior to production of distillers’ grains. Corn oil is produced by processing evaporated thin stillage through a disk stack style centrifuge. Corn oil has a lower density than the water or solids that make up the corn syrup. The centrifuges separate the relatively light oil from the heavier components of the corn syrup, eliminating the need for significant retention time. Corn oil is used primarily as a biodiesel feedstock and as a supplement for animal feed.
Generally, we return the de-oiled corn syrup into the production process adding it to the modified, or dry distillers’ grains during the drying process. However, we also occasionally sell excess corn syrup in liquid syrup form to livestock feeders. Excess syrup results from a plant upset, or when the amount of syrup produced during evaporation process exceeds our distillers' grains' dryer capacity. Corn syrup is primarily used as a feed additive to moisten dry feed stuffs such as hay.
Principal Product Markets
As described below in “Distribution of Principal Products", we market and distribute all of our ethanol and all of our distillers' grains shipped by rail through professional third party marketers. Our ethanol and distillers' grains marketers make all decisions with regard to where our products are marketed. Our ethanol and distillers' grains are primarily sold in the domestic market. As distillers' grains become more accepted as an animal feed substitute throughout the world, distillers' grains exporting may increase.
We expect our ethanol and distillers' grains marketers to explore all markets for our products, including export markets. However, due to high transportation costs, and the fact that we are not located near a major international shipping port, we expect our products to continue to be marketed primarily domestically.

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Ethanol Markets
There are local, regional, national, and international markets for ethanol. Typically, a regional market is one that is outside of the local market, yet within the neighboring states. Some regional markets include large cities that are subject to anti-smog measures in either carbon monoxide or ozone non-attainment areas, or that have implemented oxygenated gasoline programs, such as Chicago, St. Louis, Denver, and Minneapolis. We consider our primary regional market to be large cities within a 450-mile radius of our ethanol plant. In the national ethanol market, the highest demand by volume is primarily in the southern United States and the east and west coast regions.
The markets in which our ethanol is sold will depend primarily upon the efforts of Eco-Energy, which buys and markets our ethanol. However, we believe that local markets will be limited and must typically be evaluated on a case-by-case basis. Although local markets will be the easiest to service, they may be oversold because of the number of ethanol producers near our plant, which may depress the price of ethanol in those markets.
We transport our ethanol primarily by rail. In addition to rail, we service certain regional markets by truck from time to time. We believe that regional pricing tends to follow national pricing less the freight difference.
Over the past several years, there has been an increase in rail traffic congestion throughout the United States primarily due to the increase in cargo trains carrying shale oil from the North Dakota Bakkan oil fields. This congestion has affected many ethanol plants' ability to ship ethanol on a timely basis and caused those plants to slow or suspend production. As of the date of this report, our plant has not experienced any material delays from the rail congestion problems. Delays in returning rail cars to our plants may affect our ability to operate our plants at full capacity due to ethanol storage capacity constraints.
Distillers' Grains Markets
We sell distillers' grains as animal feed for beef and dairy cattle, poultry, and hogs. Most of the distillers' grains that we sell are in the form of dried distillers' grains. Currently, the United States ethanol industry exports a significant amount of dried distiller grains. During our 2014 fiscal year, one of the largest importers of United States distiller grains was China. In June 2014, China announced that it would stop issuing import permits for United States distillers' grains due to the presence of a genetically modified trait, MIR 162, which is found in Syngenta AG's Agrisure Viptera corn and was not approved by China for import. As a result, China has not approved United States distillers' grains imports since June 2014 and caused a drop in distillers' grains prices. However, on December 17, 2014, the United States Secretary of Agriculture announced that Chinese officials had advised him that China would be lifting the ban on MIR162. Subsequently, Syngenta publicly confirmed that it received the safety certificate for its Agrisure Viptera trait from China's regulatory authorities, formally granting import approval for distillers' grains made from AgrisureViptera corn. As of the date of this report, it is unclear when Chinese imports will resume or at what volume level. Any future bans by China or other importing countries could have the effect of decreasing demand for distillers’ grains and declines in the price of distillers' grains in the United States, which could impact our ability to profitably operate.
We also sell modified wet distillers' grains, which typically have a shelf life of a maximum of fourteen days. This provides for a much smaller, more local market and makes the timing of its sale critical. Further, because of its moisture content, the modified wet distillers' grains are heavier and more difficult to handle. The customer must be close enough to justify the additional handling and shipping costs. As a result, modified wet distillers' grains are principally sold only to local feedlots and livestock operations.
Various factors affect the price of distillers' grain, including, among others, the price of corn, soybean meal and other alternative feed products, the performance or value of distillers' grains in a particular feed market, and the supply and demand within the market. Like other commodities, the price of distillers' grains can fluctuate significantly.
Corn Oil Markets
Our corn oil is primarily sold to biodiesel manufacturers and, to a lesser extent, feed lot and poultry markets. We generally transport our corn oil by truck to users located primarily in the upper Midwest.
Distribution of Principal Products
Our ethanol plant is located in Heron Lake, Minnesota in Jackson County. We selected the plant site because of its accessibility to road and rail transportation and its proximity to grain supplies. The ethanol plant has the facilities necessary to load ethanol and distillers' grains onto trucks and rail cars. It is served by the Union Pacific Railroad. Our site is in close proximity to major highways that connect to major population centers such as Minneapolis, Minnesota; Chicago, Illinois; and Detroit, Michigan.

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Ethanol Marketing
Eco-Energy, LLC is our ethanol marketer. Pursuant to the agreement we have with Eco-Energy, it has agreed to market the entire ethanol output of our ethanol plant. We pay Eco-Energy a certain percentage of the FOB plant price for each gallon of ethanol shipped from our plant in consideration of Eco-Energy's services.
Distillers' Grains Marketing
Gavilon Ingredients, LLC serves as the distillers' grains marketer for our plant pursuant to a distillers' grains off-take agreement. Pursuant to our agreement with Gavilon, Gavilon purchases all of the distillers' grains produced at our ethanol plant. We pay Gavilon a service fee for its services under this agreement.
Corn Oil Marketing
RPMG, Inc. markets the corn oil produced at our ethanol plant pursuant to a corn oil marketing agreement. We pay RPMG a commission based on each pound of corn oil sold by RPMG under the agreement.
New Products and Services
We did not introduce any new products or services during our fiscal year ended October 31, 2014.
Dependence on One or a Few Major Customers
As discussed above, we have exclusive ethanol marketing agreements with Eco-Energy. Additionally, we have agreements with Gavilon and RPMG to market all of the distillers' grains and corn oil, respectively, produced at the plant. We rely on Eco-Energy, RPMG and Gavilon for the sale and distribution of all of our products, therefore, we are highly dependent on Eco-Energy, RPMG and Gavilon for the successful marketing of our products. Any loss of these companies as our marketing agents for our ethanol, distillers' grains, or corn oil could have a negative impact on our revenues.
Seasonality of Ethanol Sales
Since ethanol is predominantly blended with conventional gasoline for use in automobiles, ethanol demand tends to shift in relation to gasoline demand. As a result, we experience some seasonality of demand for ethanol in the summer months related to increased driving. In addition, we experience some increased ethanol demand during holiday seasons related to increased gasoline demand.
Pricing of Corn and Ethanol
We expect that ethanol sales will represent our primary revenue source and corn will represent our primary component of cost of goods sold. Therefore, changes in the price at which we can sell the ethanol we produce and the price at which we buy corn for our ethanol plant present significant operational risks inherent in our business.
Generally, the price at which ethanol can be sold does not track with the price at which corn can be bought. Historically, ethanol prices have tended to correlate with wholesale gasoline prices, with demand for and the price of ethanol increasing as supplies of petroleum decreased or appeared to be threatened, crude oil prices increased and wholesale gasoline prices increased. However, the prices of both ethanol and corn do not always follow historical trends. Trends in ethanol prices and corn prices are subject to a number of factors and are difficult to predict.
Hedging
We may hedge anticipated corn purchases and ethanol and distillers' grain sales through a variety of mechanisms.
We procure corn through spot cash, fixed-price forward, basis only, futures only, and delayed pricing contracts. Additionally, we may use hedging positions in the corn futures and options market to manage the risk of excessive corn price fluctuations for a portion of our corn requirements.
For our spot purchases, we post daily corn bids so that corn producers can sell to us on a spot basis. Our fixed-price forward contracts specify the amount of corn, the price and the time period over which the corn is to be delivered. These forward contracts are at fixed prices indexed to Chicago Board of Trade, or CBOT, prices. Our corn requirements can be contracted in advance under fixed-price forward contracts or options. The parameters of these contracts are based on the local supply and demand situation and the seasonality of the price. For delayed pricing contracts, producers will deliver corn to us, but the pricing for that corn and the related payment will occur at a later date.

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To hedge a portion of our exposure to corn price risk, we may buy and sell futures and options positions on the CBOT. In addition, our facilities have significant corn storage capacity. At the ethanol plant, we have the ability to store approximately 10 days of corn supply.
Eco-Energy is the exclusive marketer for all of the ethanol produced at our facility. To mitigate ethanol price risk and to obtain the best margins on ethanol that is marketed and sold by our marketer, we may utilize ethanol swaps, over-the-counter ("OTC") ethanol swaps, or OTC ethanol options that are typically settled in cash, rather than gallons of the ethanol we produce.
Our marketing and risk management committee assists the board and our risk management personnel to, among other things, establish appropriate policies and strategies for hedging and enterprise risk.
Sources and Availability of Raw Materials
The primary raw materials used in the production of ethanol at our plant are corn and natural gas. Our ethanol plant also requires significant and uninterrupted amounts of electricity and water. We have entered into agreements for our supply of electricity, natural gas, and water.
Corn Procurement
The cost of corn represented approximately 70.0%, 82.0% and 82.4% of our cost of sales for the years ended October 31, 2014, 2013, and 2012, respectively. We need to procure approximately 18 million bushels of corn per year for our dry mill ethanol process. Typically, we purchase our corn directly from grain elevators, farmers, and local dealers within approximately 80 miles of Heron Lake, Minnesota.
Generally, higher corn prices will produce lower profit margins and, therefore, negatively affect our financial performance. If a period of high corn prices were to be sustained for some time, such pricing may reduce our ability to operate profitably because of the higher cost of operating our plants. We may not be able to offset any increase in the price of corn by increasing the price of our products. If we cannot offset increases in the price of corn, our financial performance may be negatively affected.
We generally purchase corn through cash fixed-price and basis contracts and may utilize hedging positions in the corn futures market for a portion of our corn requirements to manage the risk of excessive corn price fluctuations. Our fixed-price forward contracts specify the amount of corn, the price and the time period over which the corn is to be delivered. These forward contracts are at fixed prices or prices based on the Chicago Board of Trade (CBOT) prices. Our corn requirements can be forward contracted on either a fixed-price basis or futures only contracts. The parameters of these contracts are based on the local supply and demand situation and the seasonality of the price. We also purchase a portion of our corn on a spot basis.
The price and availability of corn is subject to significant fluctuation depending upon a number of factors that affect commodity prices generally. These include, among others, crop conditions, crop production, weather, government programs, and export demands. We can attempt to mitigate fluctuations in the corn and ethanol markets by locking in a favorable margin through the use of hedging activities, including forward contracts. However, we are not always presented with an opportunity to lock in a favorable margin and our plant's profitability may be negatively impacted during periods of high grain prices.
Natural Gas Procurement
The primary source of energy in our manufacturing process is natural gas. The cost of natural gas represented approximately 10.0%, 4.3% and 3.6% of our cost of sales for the years ended October 31, 2014, 2013, and 2012, respectively. 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 our majority owned subsidiary, Agrinatural Gas, LLC. Under the terms of the firm natural gas transportation agreement, Agrinatural will provide natural gas to the plant with a specified price per MMBTU for an initial term of 10 years, with two automatic renewal options for five years periods. On July 1, 2014, we entered into an amendment of this agreement pursuant to which we agreed on an early exercise of one of the two automatic five-year term renewals thereby extending the term of the firm natural gas transportation agreement to October 31, 2021.
We also have a base agreement for the sale and purchase of natural gas with Constellation NewEnergy—Gas Division, LLC. We buy all of our natural gas from Constellation and this agreement runs until October 31, 2015.

9


The prices for and availability of natural gas are subject to volatile market conditions.  These market conditions often are affected by factors beyond our control such as higher prices as a result of colder than average weather conditions or natural disasters, overall economic conditions and foreign and domestic governmental regulations and relations.  Significant disruptions in the supply of natural gas could impair our ability to manufacture ethanol and more significantly, dried distillers grains for our customers.  Furthermore, increases in natural gas prices or changes in our natural gas costs relative to natural gas costs paid by competitors may adversely affect our results of operations and financial condition.
Electricity
Our plant requires a continuous supply of electricity. We have agreements in place to supply electricity to our plant.
Water
Our plant also requires a continuous supply of water, which we obtain pursuant to an industrial water supply agreement with the City of Heron Lake and Jackson County, Minnesota.
Process Improvement
We are continually working to develop new methods of operating the ethanol plant more efficiently. We continue to conduct process improvement activities in order to realize these efficiency improvements.
Patents, Trademarks, Licenses, Franchises and Concessions
We do not currently hold any patents, trademarks, franchises or concessions. We were granted a license by ICM to use certain ethanol production technology necessary to operate our ethanol plant. The cost of the license granted by ICM was included in the amount we paid to Fagen, Inc. to design and build our ethanol plant.
Competition
Producers of Ethanol
We sell our ethanol in a highly competitive market. Ethanol is a commodity product where competition in the industry is predominantly based on price.
We are in direct competition with numerous other ethanol producers, both regionally and nationally, many of which have more experience and greater resources than we have. Some of these producers are, among other things, capable of producing a significantly greater amount of ethanol or have multiple ethanol plants that may help them achieve certain benefits that we could not achieve with one ethanol plant. Further, new products or methods of ethanol production developed by larger and better-financed competitors could provide them competitive advantages over us and harm our business.
Following the significant growth in the ethanol industry during 2005 and 2006, the ethanol industry has grown at a much slower pace. According to the RFA, as of December 11, 2014, there are approximately 213 biorefineries with a total nameplate capacity of 15 billion gallons of ethanol per year. However, the RFA estimates that approximately 3% of the ethanol production capacity in the United States was not operating as of December 11, 2014.
The largest ethanol producers include: Abengoa Bioenergy Corp.; Archer Daniels Midland Company; Cargill, Inc.; Flint Hills Resources, LP; Green Plains, Inc.; POET, LLC and Valero Renewable Fuels, each of which are capable of producing significantly more ethanol than we produce. Ethanol is a commodity product where competition in the industry is predominantly based on price. Larger ethanol producers may have an advantage over us from economies of scale and stronger negotiating positions with purchasers. This could put us at a competitive disadvantage to other ethanol producers.

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The following table identifies the largest ethanol producers in the United States along with their production capacities.

UNITED STATES FUEL ETHANOL PRODUCTION CAPACITY BY TOP PRODUCERS
Producers of Approximately 1,000 million gallons per year (mmgy) or more
Company
 
Nameplate Capacity (mmgy)
Archer Daniels Midland
 
1,762

POET Biorefining
 
1,626

Valero Renewable Fuels
 
1,240

Green Plains, Inc.
 
1,004

Flint Hills Resources LP
 
760

Abengoa Bioenergy Corp.
 
403

Cargill, Inc.
 
345

Updated: December 11, 2014, Renewable Fuels Association
A majority of the United States ethanol plants, and therefore, the greatest number of gallons of ethanol production capacity, are concentrated in the corn-producing states of Iowa, Nebraska, Illinois, Indiana, Minnesota, South Dakota, Ohio, Wisconsin, Kansas, and North Dakota. Below is the United States ethanol production by state in millions of gallons for the ten states with the most total ethanol production as of December 2014:
State
Nameplate

Operating

Under
Construction/
Expansion

Total
Iowa
3,963


3,958


52


4,105

Nebraska
1,992


1,897




1,992

Illinois
1,421


1,384




1,421

Indiana
1,148


936




1,148

Minnesota
1,147


1,129




1,147

South Dakota
1,019


1,019




1,019

Ohio
528


528





528

Wisconsin
506


506


5


511

Kansas
504


479


45


549

North Dakota
360


360


65


425

Total
12,588


12,196


167


12,845

Source: Renewable Fuels Association, 2014 Ethanol Industry Outlook
Because Minnesota is one of the top producers of ethanol in the United States, we face increased competition because of the location of our ethanol plant. There are seven ethanol plants within an approximate 50 mile radius of our plant with a combined ethanol capacity of 562 million gallons. Therefore, we compete with other ethanol producers both for markets in Minnesota and markets in other states. We believe that we are able to reach the best available markets through the use of our experienced marketer and by the rail delivery methods we use. We believe that we can compete favorably with other ethanol producers due to our proximity to ample grain, natural gas, electricity and water supplies at favorable prices.
In addition to intense competition with local, regional, and national producers of ethanol, we have faced increased competition from imported ethanol and foreign producers of ethanol due to the expiration of the 2.5 percent ad valorem tax and an additional 54 cents a gallon surcharge in December 2011. Large international companies have developed, or are developing, increased foreign ethanol production capacities. Brazil is the world’s second largest ethanol producer. Brazil’s ethanol production is sugarcane based, as opposed to corn based.
We anticipate increased competition from renewable fuels that do not use corn as the feedstock. Many of the current ethanol production incentives are designed to encourage the production of renewable fuels using raw materials other than corn. One type of ethanol production feedstock that is being explored is cellulose. Cellulose is found in wood chips, corn stalks and rice straw, amongst other common plants. Several companies and


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researchers have commenced pilot projects to study the feasibility of commercially producing cellulosic ethanol and some companies have started constructing commercial scale plants. If this technology can be profitably employed on a commercial scale, it could potentially lead to ethanol that is less expensive to produce than corn based ethanol, especially when corn prices are high. Cellulosic ethanol may also capture more government subsidies and assistance than corn based ethanol. This could decrease demand for our product or result in competitive disadvantages for our ethanol production process.
Producers of Other Fuel Additives and Alternative Fuels
In addition to competing with ethanol producers, we also compete with producers of other gasoline oxygenates. Many gasoline oxygenates are produced by other companies, including oil companies, that have far greater resources than we have. Historically, as a gasoline oxygenate, ethanol primarily competed with two gasoline oxygenates, both of which are ether-based: MTBE (methyl tertiary butyl ether) and ETBE (ethyl tertiary butyl ether). Many states have enacted legislation prohibiting the sale of gasoline containing certain levels of MTBE or are phasing out the use of MTBE because of health and environmental concerns. As a result, national use of MTBE has decreased significantly in recent years. Use of ethanol now exceeds that of MTBE and ETBE as a gasoline oxygenate.
While ethanol has displaced these two gasoline oxygenates, the development of ethers intended for use as oxygenates is continuing and we will compete with producers of any future ethers used as oxygenates.
A number of automotive, industrial and power generation manufacturers are developing alternative fuels and clean power systems, both for vehicles and other applications, using fuel cells, plug-in hybrids, electric cars or clean burning gaseous fuels. Like ethanol, the emerging fuel cell industry offers a technological option to address worldwide energy costs, the long-term availability of petroleum reserves and environmental concerns. Fuel cells have emerged as a potential alternative power system to certain existing power sources because of their higher efficiency, reduced noise and lower emissions. Fuel cell industry participants are currently targeting the transportation, stationary power, and portable power markets in order to decrease fuel costs, lessen dependence on crude oil, and reduce harmful emissions. If the fuel cell industry continues to expand and gain broad acceptance, and becomes readily available to consumers for motor vehicle use, we may not be able to compete effectively. This additional competition could reduce the demand for ethanol, which would negatively impact our profitability.
Additionally, there are more than a dozen alternative and advanced fuels currently in development, production or use, including the following alternative fuels that, like ethanol, have been or are currently commercially available for vehicles:
biodiesel
electricity
hydrogen
methanol
natural gas
propane
Several emerging fuels are currently under development. Many of these fuels are also considered alternative fuels and may have other benefits such as reduced emissions or decreasing dependence upon oil. Examples of emerging fuels include:
Biobutanol: Like ethanol, biobutanol is an alcohol that can be produced through the processing of domestically grown crops, such as corn and sugar beets, and other biomass, such as fast-growing grasses and agricultural waste products.
Biogas: Biogas is produced from the anaerobic digestion of organic matter such as animal manure, sewage, and municipal solid waste. After it is processed to required standards of purity, biogas becomes a renewable substitute for natural gas and can be used to fuel natural gas vehicles.
Fischer-Tropsch Diesel: Diesel made by converting gaseous hydrocarbons, such as natural gas and gasified coal or biomass, into liquid fuel, including transportation fuel.
Hydrogenation-Derived Renewable Diesel (HDRD): The product of fats or vegetable oils—alone or blended with petroleum—that has been refined in an oil refinery.
P-Series: A blend of natural gas liquids (pentanes plus), ethanol, and the biomass-derived co-solvent methyltetrahydrofuran (MeTHF) formulated to be used in flexible fuel vehicles.
Ultra-Low Sulfur Diesel: This is diesel fuel with 15 parts per million or lower sulfur content. This ultra-low sulfur content enables the use of advanced emission control technologies on vehicles using ULSD fuels produced from non-petroleum and renewable sources that are considered alternative fuels.
Additionally, there are developed and developing technologies for converting natural gas, coal, and biomass to liquid fuel, including transportation fuels such as gasoline, diesel, and methanol. We expect that competition will increase between ethanol producers, such as HLBE, and producers of these or other newly developed alternative fuels or power systems, especially to the extent they are used in similar applications such as vehicles.

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Producers of Distillers' Grains
The amount of distillers' grains produced annually in North America has increased significantly as the number of ethanol plants increased. We compete with other producers of distillers' grains products both locally and nationally, with more intense competition for sales of distillers' grains among ethanol producers in close proximity to our ethanol plant. There are eight ethanol plants within an approximate 50 mile radius of our plant with a combined capacity capable of producing approximately 1.5 million tons of distillers' grains. These competitors may be more likely to sell to the same markets that we target for our distillers' grains.
Additionally, distillers' grains compete with other feed formulations, including corn gluten feed, dry brewers' grain, and mill feeds. The primary value of these products as animal feed is their protein content. Dry brewers' grain and distillers' grains have about the same protein content, and corn gluten feed and mill feeds have slightly lower protein contents. Distillers' grains contain nutrients, fat content, and fiber that we believe will differentiate our distillers' grains products from other feed formulations. However, producers of other forms of animal feed may also have greater experience and resources than we do, and their products may have greater acceptance among producers of beef and dairy cattle, poultry, and hogs.
Competition for Corn
We will compete with ethanol producers in close proximity of our plant for the supplies of corn required to operate our plant. The existence of other ethanol plants, particularly those in close proximity to our plant, increase the demand for corn and may result in higher costs for supplies of corn. There are seven ethanol plants within an approximate 50 mile radius of our plant will use approximately 201 million bushels of corn and that we will compete with these other ethanol plants for corn for our ethanol plant.
We compete with other users of corn, including ethanol producers regionally and nationally, producers of food and food ingredients for human consumption (such as high fructose corn syrup, starches, and sweeteners), producers of animal feed and industrial users.
Competition for Personnel
We will also compete with ethanol producers in close proximity of our facilility for the personnel required to operate our plant. The existence and development of other ethanol plants will increase competition for qualified managers, engineers, operators and other personnel. We also compete for personnel with businesses other than ethanol producers and with businesses located outside the community of Heron Lake, Minnesota.
Demand for Ethanol
In recent years, the demand for ethanol has increased, particularly in the upper Midwest, in part because of two major programs established by the Clean Air Act Amendments of 1990: the Oxygenated Gasoline Program and the Reformulated Gasoline Program. Under these programs, an additive (oxygenate) is required to be blended with gasoline used in areas with excessive carbon monoxide or ozone pollution to help mitigate these conditions. Because of the potential health and environmental issues associated with MTBE and the actions of the EPA, ethanol is now used as the primary oxygenate in those areas requiring an oxygenate additive pursuant to state or federal law. A clean air additive is a substance that, when added to gasoline, reduces tailpipe emissions, resulting in improved air quality characteristics. Ethanol contains 35% oxygen, approximately twice that of MTBE, a historically used oxygenate. The additional oxygen found in ethanol results in more complete combustion of the fuel in the engine cylinder, which reduces tailpipe emissions by as much as 30%, including a 12% reduction in volatile organic compound emissions when blended at a 10% level. Pure ethanol, which is non-toxic, water soluble and biodegradable, replaces some of the harmful gasoline components, including benzene. The United States consumes approximately 135-140 billion gallons of gasoline a year. More than 95% of those gallons were blended with ethanol, predominantly at the E10 level.
Many in the ethanol industry believe that it will be difficult to meet the federal Renewable Fuels Standard renewable volume obligations in future years without an increase in the percentage of ethanol that can be blended with gasoline for use in standard (non-flex fuel) vehicles. This is commonly referred to as the “blend wall,” which represents a theoretical limit where more ethanol cannot be blended into the national gasoline pool. This is a theoretical limit because it is believed that it would not be possible to blend ethanol into every gallon of gasoline that is being used in the United States and it discounts the possibility of additional ethanol used in higher percentage blends such as E85 used in flex fuel vehicles.

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We believe that the "blend wall" is one of the most critical governmental policies currently facing the ethanol industry. The "blend wall" arises because of several conflicting requirements. First, the renewable fuels standards dictate a continuing increase in the amount of ethanol blended into the national gasoline supply requiring 36 billion gallons of renewable fuels be used annually by 2022. Second, the EPA mandates a limit of 10% ethanol inclusion in non-flex fuel vehicles. E10 is the most common ethanol blend sold and the only blend the EPA has approved for use in all American automobiles. There is growing availability of E85 (85% ethanol and 15% gasoline) for use in flexible fuel vehicles, however it is limited due to lacking infrastructure. In addition, the industry has been working to introduce E15 to the retail market since the EPA issued final approval in 2012 for the sale and use of E15 ethanol blends in light duty passenger vehicles model year 2001 and newer. Since that time, our application with the EPA to register ethanol for use in making E15 has also been approved, as well as 81 other fuel manufacturers according to EPA data. However, wide spread adoption of E15 is hampered by regulatory and infrastructure hurdles in many states, as well as consumer acceptance. To date only thirteen states have approved the commercial sale of E15. As such, we do not anticipate that E15 will impact ethanol demand or pricing in the near term. Additionally, sales of E15 may be limited because: (i) it is not approved for use in all vehicles; (ii) the EPA requires a label that management believes may discourage consumers from using E15; and (iii) retailers may choose not to sell E15 due to concerns regarding liability. In addition, different gasoline blendstocks may be required at certain times of the year in order to use E15 due to federal regulations related to fuel evaporative emissions. This may prevent E15 from being used during certain times of the year in various states. As a result, management believes that E15 may not have an immediate impact on ethanol demand in the United States. Rather, management believes consumer acceptance of E15 and flex fuel vehicles, along with continued growth of E85, is necessary before ethanol can achieve any market growth beyond the blend wall. As industry production capacity reaches the blend wall, the supply of ethanol in the market may surpass the demand which in turn may negatively impact prices.
Government Ethanol Supports
In addition to demand for ethanol as an oxygenate, ethanol demand has increased because of the adoption of federal and, to some extent, state ethanol support. The primary federal ethanol support is the federal Renewable Fuels Standard (the “RFS”). The RFS is a national program that does not require that any renewable fuels be used in any particular area or state, allowing refiners to use renewable fuel blends in those areas where it is most cost-effective. The RFS requires that in each year, a certain amount of renewable fuels must be used in the United States. The RFS is a national program that does not require that any renewable fuels be used in any particular area or state, allowing refiners to use renewable fuel blends in those areas where it is most cost-effective.
The first RFS program ("RFS1") was introduced through the Energy Policy Act of 2005. RFS1 required 7.5 billion gallons of renewable fuel to be blended into gasoline by 2012. With the passage of the Energy Independence and Security Act of 2007, Congress made several important revisions to the RFS and required the EPA to promulgate new regulations to implement these changes ("RFS2"). Starting in 2009, the RFS2 required that a portion of the RFS must be met by certain “advanced” renewable fuels. These advanced renewable fuels include ethanol that is not made from corn, such as cellulosic ethanol and biomass based biodiesel. The use of these advanced renewable fuels increases each year as a percentage of the total renewable fuels required to be used in the United States. The RFS2 requirement for corn-based ethanol, such as the ethanol we produce, is capped at 15 billion gallons starting in 2015. In February 2010, the EPA established the revised annual renewable fuel standard and made the necessary program modifications as set forth in the Energy Independence and Security Act of 2007. Further, for the first time, the EPA set volume standards for specific categories of renewable fuels including cellulosic, biomass-based diesel, and total advanced renewable fuels. In order to qualify for these new volume categories, fuels must demonstrate that they meet certain minimum greenhouse gas reduction standards, based on a lifecycle assessment, in comparison to the petroleum fuels they displace. Our ethanol does not qualify for the new volume categories of renewable fuels and therefore, the total renewable fuel requirement for each year will be most relevant to the demand for, and required use of, ethanol such as ours.
The RFS2 requirement increases incrementally each year until the United States is required to use 36 billion gallons of renewable fuels by 2022. The RFS2 statutory volume requirement for 2014 is approximately 18.15 billion gallons, of which corn based ethanol can be used to satisfy approximately 14.4 billion gallons. The RFS statutory volume requirement for 2015 is approximately 20.5 billion gallons, of which corn based ethanol can be used to satisfy approximately 15 billion gallons. However, the EPA has the authority to waive the RFS2 statutory volume requirement, in whole or in part, provided one of the following two conditions have been met: (1) there is inadequate domestic renewable fuel supply; or (2) implementation of the requirement would severely harm the economy or environment of a state, region or the United States. Annually, the EPA passes a rule that establishes the number of gallons of different types of renewable fuels that must be used in the United States which is called the renewable volume obligations ("RVO").
    

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For 2013, the RVO for corn-based ethanol was approximately 13.8 billion gallons, and the RVO for 2014 for corn-based ethanol was expected to be 14.4 billion gallons. In November 2013, the EPA issued a proposed rule that would reduce the 2014 RVO to 13.0 billion gallons of corn-based renewable fuel. As proposed, the 2014 RVO would be 1.4 billion gallon below the statutory RVO for 2014 and 800 million gallons less than the 2013 RVO, marking the first time the corn-based renewable fuel and total renewable fuel RVOs have been set below the legislated target. The proposal was subject to a 60-day comment period which ended in January 2014 during which the EPA received over 340,000 public comments and drew strong opposition from biofuels groups. On August 22, 2014, the final 2014 RVO rule was sent by the EPA to the Office of Management and Budget (OMB) for review. The proposal was originally subject to a 60-day comment period and the EPA planned to release the final version of the 2014 RVOs in June 2014, then extended the planned release date. On November 21, 2014, the EPA announced that it would not finalize the 2014 RVOs until sometime in 2015 to allow them to take the appropriate time to correct their methodology and establish the necessary volumes to move forward with the original intent of the RFS and set RVOs for 2014 through 2016. If the EPA elects to reduce the renewable fuels use requirements in the RFS in any material manner, the market price and demand for ethanol will likely decrease which will negatively impact our financial performance. Current ethanol production capacity exceeds the EPA's proposed 2014 standard which can be satisfied by corn based ethanol.
Compliance with Environmental Laws and Other Regulatory Matters
Our business subjects us to various federal, state, and local environmental laws and regulations, including: those relating to discharges into the air, water, and ground; the generation, storage, handling, use, transportation, and disposal of hazardous materials; and the health and safety of our employees.
These laws and regulations require us to obtain and comply with numerous permits to construct and operate our ethanol plant, including water, air, and other environmental permits. The costs associated with obtaining these permits and meeting the conditions of these permits have increased our costs of construction and production.
For the fiscal year ended October 31, 2014, we incurred costs and expenses of approximately $124,000 complying with environmental laws, including the cost of pursuing permit amendments. Although we have been successful in obtaining all of the permits currently required, any retroactive change in environmental regulations, either at the federal or state level, could require us to obtain additional or new permits or spend considerable resources in complying with such regulations.
Compliance with environmental laws and permit conditions in the future could require expensive pollution control equipment or operational changes to limit actual or potential impacts to the environment, as well as significant management time and expense. A violation of these laws, regulations or permit conditions can result in substantial fines, natural resource damage, criminal sanctions, permit revocations, and/or plant shutdown, any of which could have a material adverse effect on our operations. Although violations and environmental non-compliance still remain a possibility following our conversion from coal to natural gas combustion, the exposure to the company has been greatly reduced.
The California Air Resources Board, or CARB, has adopted a Low Carbon Fuel Standard, or LCFS, requiring a 10% reduction in average carbon intensity of gasoline and diesel transportation fuels from 2010 to 2020.  After a series of rulings that temporarily prevented CARB from enforcing these regulations, the LCFS regulations took effect in January 2013. The practical effect of California's low carbon fuel standard is that it precludes grain-based ethanol from outside California. Federal and state challenges to the LCFS remain ongoing but if ultimately unsuccessful, the LCFS could have a negative impact on demand for corn-based ethanol and result in decreased ethanol prices.
In February 2013, an anti-dumping duty was imposed as a regulation by the Council of the European Union. The Company does not export any ethanol to Europe at this time. Continuation of this duty or imposition of tariffs by other countries or regions could reduce United States exports to Europe, and possibly other export markets. A reduction of exports to Europe could have an adverse effect on domestic ethanol prices, as the available supply of ethanol for the domestic market would increase.
Employees
As of the date of this report, we have 37 full time employees, of which 5 employees are involved primarily in management and administration and the remaining employees are involved primarily in plant operations. We do not currently anticipate any significant change in the number of employees at our plant.
On July 31, 2013, we entered into a Management Services Agreement with Granite Falls Energy.  Pursuant to the Management Services Agreement, GFE agreed to provide 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.  Each person providing management services to the Company under the Management Services Agreement is subject to oversight by our board of governors.  However, the Chief Executive Officer is solely responsible for hiring and firing persons providing management services under the Management Services Agreement.

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The initial term of the Management Services Agreement ends on July 30, 2016.  Following the initial term, the Management Services Agreement automatically renews for additional one year terms unless either party gives notice of termination at least ninety days before the end of the initial or any renewal term.  The Management Services Agreement may also be terminated for cause under certain circumstances. 
GFE is responsible for and agreed to directly pay salary, wages, and/or benefits to the persons providing management services under the Management Services Agreement.  The Company agreed to pay GFE $35,000 per month for the first year of the Management Services Agreement.  During years two and three of the Management Services Agreement, the Company agreed to pay GFE 50% of the total salary, bonuses and other expenses and costs (including all benefits and tax contributions) incurred by GFE for the three management positions, paid on an estimated monthly basis with a “true-up” following the close of GFE’s fiscal year.
Natural Gas Pipeline Segment
Through our wholly owned subsidiary, HLBE Pipeline Company, LLC, we indirectly own 73% of Agrinatural Gas, LLC, a Delaware limited liability company. Rural Energy Solutions, LLC ("RES") owns the remaining 27% minority interest in Agrinatural. RES is owned by Swan Engineering, Inc. ("SEI") and an unrelated third party. SEI provides project management and management and operating services to Agrinatural as described below.
Agrinatural is governed by a seven (7) member board of managers. Under Agrinatural's operating agreement, we have the right to appoint four (4) of the seven (7) managers and RES has the right to appoint three (3) directors.
Agrinatural is a natural gas distribution and sales company located in Heron Lake, Minnesota. Agrinatural's natural gas pipeline originates from an interconnection with the natural gas transmission pipeline of Northern Border Pipeline Company approximately seven miles southwest of Jeffers, Minnesota in Cottonwood County. Agrinatural currently owns and operates approximately 185 miles of distribution mains and services. The Agrinatural pipeline was initially installed in 2011 to serve the Company. Since the initial installation of the pipeline, Agrinatural has added several other commercial, agricultural and residential customers in the communities and surrounding areas of Heron Lake, Jeffers, Delft, Dundee, Storder, and Okabena, Minnesota. As of October 31, 2014, Agrinatural has 732 customers.
Agrinatural has a management and operating agreement with SEI, which together with a third party owns RES. Under this management and operating, SEI provides Agrinatural with day-to-day management and operation of Agrinatural's pipeline distribution business and Agrinatural pays SEI monthly fee of $6,000. The management and operating agreement with SEI expires July 1, 2019.
Agrinatural also has a project management agreement with SEI. Pursuant to the project management agreement, SEI supervises all of Agrinatural's pipeline construction projects, which are constructed by unrelated third-party pipeline construction companies.
Assets from our natural gas pipeline segment have represented 18.6%, 10.2% and 4.9% of our consolidated total assets in the years ended October 31, 2014, 2013, and 2012, respectively. Agrinatural's assets consist of distribution main pipelines and service pipelines, together with the associated easement and land rights, a town border station, meters and regulators, office and other equipment and construction in process.
Agrinatural's revenues are generated through natural gas distribution fees and sales, including distribution fees paid by the Company pursuant to our firm natural gas transportation agreement with Agrinatural. Before intercompany eliminations, revenues from our natural gas pipeline segment represented 1.8%, 1.5% and 0.0% of our total consolidated revenues in the years ended October 31, 2014, 2013, and 2012, respectively. After accounting for intercompany eliminations for fees from the Company for natural gas transportation services, Agrinatural's revenues represented 0.6%, 0.6% and 0.0% of our consolidated revenues for the fiscal years ended October 31, 2014, 2013, and 2012, respectively, and have little to no impact on the overall performance of the Company.

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Financial Information about Geographic Areas
All of our operations are domiciled in the United States, including those of Agrinatural, our majority owned subsidiary. All of the products sold to our customers for fiscal years 2014, 2013, and 2012 were produced in the United States and all of our long-lived assets are domiciled in the United States.
For the principal products of our ethanol production segment, we have engaged third-party professional marketers who decide where our products are marketed and we have no control over the marketing decisions made by our third-party professional marketers. These third-party marketers may decide to sell our products in countries other than the United States. However, we anticipate that our products will primarily be sold in the United States.
ITEM 1A.    RISK FACTORS
You should carefully read and consider the risks and uncertainties below and the other information contained in this report.  The risks and uncertainties described below are not the only ones we may face.  The following risks, together with additional risks and uncertainties not currently known to us or that we currently deem immaterial could impair our financial condition and results of operation. If any of the following risks actually occur, our results of operations, cash flows and the value of our units could be negatively impacted.
Risks Relating to Our Ethanol Production Operations
Because we are primarily dependent upon one product of our ethanol production segment, our business is not diversified, and we may not be able to adapt to changing market conditions or endure any decline in the ethanol industry.
Our success depends on our ability to efficiently produce and sell ethanol, and, to a lesser extent, distillers' grains and corn oil. Although we operate a natural gas pipeline through our majority owned subsidiary, it does not produce significant revenue to rely upon if we are unable to produce and sell ethanol, distillers' grains and corn oil, or if the market for those products decline. Our lack of diversification means that we may not be able to adapt to changing market conditions, changes in regulation, increased competition or any significant decline in the ethanol industry.
Our profitability depends upon purchasing corn at lower prices and selling ethanol at higher prices and because the difference between ethanol and corn prices can vary significantly, our financial results may also fluctuate significantly.
The results of our ethanol production business are highly impacted by commodity prices. The substantial majority of our revenues are derived from the sale of ethanol. Our gross profit relating to the sale of ethanol is principally dependent on the difference between the price we receive for the ethanol we produce and the cost of corn and natural gas that we must purchase. Prices and supplies of corn and natural gas are subject to and determined by market forces over which we have no control, such as weather, domestic and global demand, shortages, export prices, and various governmental policies in the United States and around the world. As a result of price volatility for these commodities, our operating results may fluctuate substantially. Increases in corn or natural gas prices or decreases in ethanol, distillers' grains and corn oil prices may make it unprofitable to operate our plant. No assurance can be given that we will be able to purchase corn and natural gas at, or near, current prices and that we will be able to sell ethanol, distillers' grains and corn oil at, or near, current prices. Consequently, our results of operations and financial position may be adversely affected by increases in the price of corn or natural gas or decreases in the price of ethanol, distillers' grains and corn oil. 
We seek to minimize the risks from fluctuations in the prices of corn and natural gas through the use of hedging instruments.  However, these hedging transactions also involve risks to our business.  If we were to experience relatively higher corn and natural gas costs compared to the selling prices of our products for an extended period of time, the value of our units may be reduced.
Declining oil prices and resultant lower gas prices may materially affect ethanol pricing and demand.
Ethanol has historically traded at a discount to gasoline, however with the recent decline in oil prices ethanol is currently trading at a premium to gasoline causing a disincentive for blending of ethanol beyond the required 10% blend rate. Consequently, there may be 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.

17


If the supply of ethanol exceeds the demand for ethanol, the price we receive for our ethanol and distillers' grains may decrease.
Domestic ethanol production capacity has increased substantially over the past decade. However, demand for ethanol may not increase as quickly as expected or to a level that exceeds supply, or at all.
Excess ethanol production capacity may result from decreases in the demand for ethanol or increased domestic production or imported supply. There are many factors affecting demand for ethanol, including regulatory developments and reduced gasoline consumption as a result of increased prices for gasoline or crude oil. Higher gasoline prices could cause businesses and consumers to reduce driving or acquire vehicles with more favorable gasoline mileage, or higher prices could spur technological advances, such as the commercialization of engines utilizing hydrogen fuel-cells, which could supplant gasoline-powered engines. There are a number of governmental initiatives designed to reduce gasoline consumption, including tax credits for hybrid vehicles and consumer education programs.
If ethanol prices decline for any reason, including excess production capacity in the ethanol industry or decreased demand for ethanol, our business, results of operations and financial condition may be materially and adversely affected.
In addition, because ethanol production produces distillers' grains as a co-product, increased ethanol production will also lead to increased production of distillers' grains. An increase in the supply of distillers' grains, without corresponding increases in demand, could lead to lower prices or an inability to sell our distillers' grains production. A decline in the price of distillers' grains or the distillers' grains market generally could have a material adverse effect on our business, results of operations and financial condition.
The price of distillers' grains is affected by the price of other commodity products, such as soybeans, and decreases in the price of these commodities could decrease the price of distillers' grains.
Distillers' grains compete with other protein-based animal feed products. The price of distillers' grains may decrease when the price of competing feed products decrease. The prices of competing animal feed products are based in part on the prices of the commodities from which they are derived. Downward pressure on commodity prices, such as soybeans, will generally cause the price of competing animal feed products to decline, resulting in downward pressure on the price of distillers' grains. The price of distillers' grains is not tied to production costs. However, decreases in the price of distillers' grains would result in less revenue from the sale of distillers' grains and could result in lower profit margins.
The prices of ethanol and distillers' grains may decline as a result of trade barriers imposed by foreign countries with respect to ethanol and distillers' grains originating in the United States and negatively affect our profitability.
An increasing amount of our industry's products are being exported. If producers and exporters of ethanol and distillers' grains are subjected to trade barriers when selling products to foreign customers there may be a reduction in the price of these products in the United States. Declines in the price we receive for our products will lead to decreased revenues and may result in our inability to operate the ethanol plant profitably.
China, the largest buyer of distillers' grains in the world, announced in June 2014, China announced that it would stop issuing import permits for United States distillers' grains due to the presence of a genetically modified trait, MIR 162, which is found in Syngenta AG's Agrisure Viptera corn and was not approved by China for import. As a result, China has not approved United States distillers' grains imports since June 2014 and caused a drop in distillers' grains prices. However, on December 17, 2014, the United States Secretary of Agriculture announced that Chinese officials had advised him that China would be lifting the ban on MIR 162. Subsequently, Syngenta has publicly confirmed that it received the safety certificate for its Agrisure Viptera trait from China's regulatory authorities, formally granting import approval for distillers' grains made from AgrisureViptera corn. As of the date of this report, it is unclear when Chinese imports will resume or if they will resume at volumes prior to the ban.

Separately, Turkey, the sixth largest buyer of United States distillers' grains according to the United States Grains Council, has also rejected several shipments of distillers' grains due to the presence of genetically modified corn traits. Turkey previously rejected distillers' grains shipments resulting in a near halt of United States distillers' grains imports by Turkey in 2011 when Turkey tightened quality standards and imposed labeling and packaging requirements. If United States producers can not satisfy import requirements imposed due to the presence of genetically modified corn traits, export demand of distillers' grains could be significantly reduced as a result. If export demand of distillers' grains is significantly reduced as a result, the price of distillers' grains in the United States would likely continue to decline which would have a negative effect on our revenue and could impact our ability to profitably operate which could in turn reduce the value of our units.

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We face intense competition that may result in reductions in the price we receive for our ethanol, increases in the prices we pay for our corn, or lower gross profits.
Competition in the ethanol industry is intense. We face formidable competition in every aspect of our business from both larger and smaller producers of ethanol and distillers' grains. Some larger producers of ethanol, such as Archer Daniels Midland Company, Cargill, Inc., Valero Energy Corporation, have substantially greater financial, operational, procurement, marketing, distribution and technical resources than we have. Additionally, smaller competitors, such as farmer-owned cooperatives and independent companies owned by farmers and investors, have business advantages, such as the ability to more favorably procure corn by operating smaller plants that may not affect the local price of corn as much as a larger-scale plant like ours or requiring their farmer-owners to sell them corn as a requirement of ownership.
Because Minnesota is one of the top producers of ethanol in the United States, we face increased competition due to the location of our ethanol plant. Therefore, we compete with other local ethanol producers for markets in Minnesota and other states.
We also face increasing competition from international ethanol suppliers. Most international ethanol producers have cost structures that can be substantially lower than ours and therefore can sell their ethanol for substantially less than we can. While ethanol imported to the United States was subject to an ad valorem tax and a per gallon surcharge that helped mitigate the effects of international competition for United States ethanol producers, the tax and per gallon surcharge expired on December 31, 2011. Because the tax and surcharge on imported ethanol was not extended beyond December 31, 2011, we are facing increased competition from imported ethanol and foreign producers of ethanol. In addition, ethanol imports from certain countries are exempted from these tariffs under the Caribbean Basin Initiative to spur economic development in Central America and the Caribbean.
Competing ethanol producers may introduce competitive pricing pressures that may adversely affect our sales levels and margins or our ability to procure corn at favorable prices. As a result, we cannot assure you that we will be able to compete successfully with existing or new competitors.
We engage in hedging transactions which involve risks that can harm our business.
In an attempt to offset some of the effects of pricing and margin volatility, we may hedge anticipated corn purchases and ethanol and distillers' grain sales through a variety of mechanisms. Because of our hedging strategies, we are exposed to a variety of market risks, including the effects of changes in commodities prices of ethanol and corn.
Hedging arrangements also expose us to the risk of financial loss in situations where the other party to the hedging contract defaults on its contract or, in the case of exchange-traded contracts, where there is a change in the expected differential between the underlying price in the hedging agreement and the actual prices paid or received by us. Hedging activities can themselves result in losses when a position is purchased in a declining market or a position is sold in a rising market. Our losses or gains from hedging activities may vary widely.
There can be no assurance that our hedging strategies will be effective and we may experience hedging losses in the future. We also vary the amount of hedging or other price mitigation strategies we undertake, and we may choose not to engage in hedging transactions at all. As a result, whether or not we engage in hedging transactions, our business, results of operations and financial condition may be materially adversely affected by increases in the price of corn or decreases in the price of ethanol.
Operational difficulties at our plant could negatively impact our sales volumes and could cause us to incur substantial losses.
We have experienced operational difficulties at our plant in the past that have resulted in scheduled and unscheduled downtime or reductions in the number of gallons of ethanol we produce. Some of the difficulties we have experienced relate to production problems, repairs required to our plant equipment and equipment maintenance, the installation of new equipment and related testing, and our efforts to improve and test our air emissions. Our revenues are driven in large part by the number of gallons of ethanol and the number of tons of distillers' grains we produce. If our ethanol plant does not efficiently produce our products in high volumes, our business, results of operations, and financial condition may be materially adversely affected.

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Our operations are also subject to operational hazards inherent in our industry and to manufacturing in general, such as equipment failures, fires, explosions, abnormal pressures, blowouts, pipeline ruptures, transportation accidents and natural disasters. Some of these operational hazards may cause personal injury or loss of life, severe damage to or destruction of property and equipment or environmental damage, and may result in suspension of operations and the imposition of civil or criminal penalties. The occurrence of any of these operational hazards may materially adversely affect our business, results of operations and financial condition. Further, our insurance may not be adequate to fully cover the potential operational hazards described above or we may not be able to renew this insurance on commercially reasonable terms or at all.
Our operations and financial performance could be adversely affected by infrastructure disruptions and lack of adequate transportation and storage infrastructure in certain areas.
We ship our ethanol to our customers primarily by the railroad adjacent to our site. We also have the potential to receive inbound corn via the railroad. Our customers require appropriate transportation and storage capacity to take delivery of the products we produce. We also receive our natural gas through a pipeline that is approximately 16 miles in length. Without the appropriate flow of natural gas through the pipeline our plant may not be able to run at desired production levels or at all. Therefore, our business is dependent on the continuing availability of rail, highway and related infrastructure. Any disruptions in this infrastructure network, whether caused by labor difficulties, earthquakes, storms, other natural disasters, human error or malfeasance or other reasons, could have a material adverse effect on our business. We rely upon third-parties to maintain the rail lines from our plant to the national rail network, and any failure on their part to maintain the lines could impede our delivery of products, impose additional costs on us and could have a material adverse effect on our business, results of operations and financial condition.
In addition, lack of this infrastructure prevents the use of ethanol in certain areas where there might otherwise be demand and results in excess ethanol supply in areas with more established ethanol infrastructure, depressing ethanol prices in those areas. In order for the ethanol industry to grow and expand into additional markets and for our ethanol to be sold in these new markets, there must be substantial development of infrastructure including:
additional rail capacity;
additional storage facilities for ethanol;
increases in truck fleets capable of transporting ethanol within localized markets;
expansion of refining and blending facilities to handle ethanol; and
growth in service stations equipped to handle ethanol fuels.
The substantial investments that will be required for these infrastructure changes and expansions may not be made on a timely basis, if at all, and decisions regarding these infrastructure improvements are outside of our control. Significant delay or failure to improve the infrastructure that facilitates the distribution could curtail more widespread ethanol demand or reduce prices for our products in certain areas, which would have a material adverse effect on our business, results of operations or financial condition.
Rail logistical problems persist, we may face delays in shipments of our products which could negatively impact our financial performance. 
There has been an increase in rail traffic congestion throughout the United States primarily due to the increase in cargo trains carrying shale oil. High demand and an unusually harsh winter resulted in rail delays and rail logistical problems during fiscal year 2014. Rail delays have caused some ethanol plants to slow or suspend production. Due to our location, we have not been materially affected by these logistical problems. However, if inadequate rail logistics persist, we may face delays in returning rail cars to our plant which may affect our ability to operate our plant at full capacity due to ethanol storage capacity constraints, which in turn could have a negative affect on our financial performance.
Competition for qualified personnel in the ethanol industry is intense and we may not be able to hire and retain qualified personnel to operate our ethanol plant.
Our success depends in part on our ability to attract and retain competent personnel. For our ethanol plant, we must hire qualified managers, operations personnel, accounting staff and others, which can be challenging in a rural community. Further, our current employees may decide to end their employment with us.  Competition for employees in the ethanol industry is intense, and we may not be able to attract and retain qualified personnel. Part of our management team is provided by Granite Falls Energy pursuant to the

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Management Services Agreement.  The Management Services Agreement provides that it can be terminated on thirty days notice in certain circumstances. If the Management Services Agreement is terminated or one or more of our employees terminate their employment, either with us or Granite Falls Energy, we may not be able to replace these individuals.  Any loss of these managers or key employees may prevent us from operating the ethanol plant efficiently and comply with our other obligations.
Technology in our industry evolves rapidly, potentially causing our plant to become obsolete, and we must continue to enhance the technology of our plant or our business may suffer.
We expect that technological advances in the processes and procedures for processing ethanol will continue to occur. It is possible that those advances could make the processes and procedures that we utilize at our ethanol plant less efficient or obsolete. These advances could also allow our competitors to produce ethanol at a lower cost than we are able. If we are unable to adopt or incorporate technological advances, our ethanol production methods and processes could be less efficient than those of our competitors, which could cause our ethanol plant to become uncompetitive.
Ethanol production methods are continually advancing. The current trend in ethanol production research is to develop an efficient method of producing ethanol from cellulose-based biomass such as agricultural waste, forest residue and municipal solid waste. This trend is driven by the fact that cellulose-based biomass is generally cheaper than corn and producing ethanol from cellulose-based biomass would create opportunities to produce ethanol in areas that are unable to grow corn. Another trend in ethanol production research is to produce ethanol through a chemical or thermal process, rather than a fermentation process, thereby significantly increasing the ethanol yield per pound of feedstock. Although current technology does not allow these production methods to be financially competitive, new technologies may develop that would allow these methods to become viable means of ethanol production in the future. If we are unable to adopt or incorporate these advances into our operations, our cost of producing ethanol could be significantly higher than those of our competitors, which could make our ethanol plant obsolete. Modifying our plant to use the new inputs and technologies would likely require material investment.
If ethanol fails to compete successfully with other existing or newly-developed oxygenates or renewable fuels, our business will suffer.
Alternative fuels, additives and oxygenates are continually under development. Alternative fuels and fuel additives that can replace ethanol are currently under development, which may decrease the demand for ethanol. Technological advances in engine and exhaust system design and performance could reduce the use of oxygenates, which would lower the demand for ethanol, and our business, results of operations and financial condition may be materially adversely affected.
Our sales will decline, and our business will be materially harmed if our third party marketers do not effectively market or sell the ethanol, distillers' grains and corn oil we produce or if there is a significant reduction or delay in orders from our marketers.
We have entered into agreements with a third parties to market our supply of ethanol, distillers' grains and corn oil. Our marketers are independent businesses that we do not control. We cannot be certain that our marketers will market or sell our ethanol, distillers' grains and corn oil effectively. Our agreements with our marketers do not contain requirements that a certain percentage of sales are of our products, nor do the agreements restrict the marketer's ability to choose alternative sources for ethanol, distillers' grains or corn oil.
Our success in achieving revenue from the sale of ethanol, distillers' grains and corn oil will depend upon the continued viability and financial stability of our marketers. Our marketers may choose to devote their efforts to other producers or reduce or fail to devote the necessary resources to provide effective sales and marketing support of our products. We believe that our financial success will continue to depend in large part upon the success of our marketers in operating their businesses. If our marketers do not effectively market and sell our ethanol, distillers' grains and corn oil, our revenues may decrease and our business will be harmed.
We operate in an intensely competitive industry and compete with larger, better financed entities which could impact our ability to operate profitably.
There is significant competition among ethanol producers. There are numerous producer-owned and privately-owned ethanol plants planned and operating throughout the Midwest and elsewhere in the United States.  We also face competition from outside of the United States. The largest ethanol producers include Archer Daniels Midland, POET, Valero Renewable Fuels, and Green Plains Renewable Energy, each of which are each capable of producing significantly more ethanol than we produce. Further, many believe that there will be further consolidation in the ethanol industry in the future, which will likely lead to a few companies who control a significant portion of the ethanol production market. We may not be able to compete with these larger entities. These larger ethanol producers may be able to affect the ethanol market in ways that are not beneficial to us which could negatively impact our financial performance.

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Competition from the advancement of alternative fuels may lessen the demand for ethanol.
Alternative fuels, gasoline oxygenates and ethanol production methods are continually under development. A number of automotive, industrial and power generation manufacturers are developing alternative clean power systems using fuel cells, plug-in hybrids or clean burning gaseous fuels. Like ethanol, these emerging technologies offer an option to address worldwide energy costs, the long-term availability of petroleum reserves and environmental concerns. If these alternative technologies continue to expand and gain broad acceptance and become readily available to consumers for motor vehicle use, we may not be able to compete effectively. This additional competition could reduce the demand for ethanol, resulting in lower ethanol prices that might adversely affect our results of operations and financial condition.
Consumer resistance to the use of ethanol based on the belief that ethanol is expensive, adds to air pollution, harms engines and/or takes more energy to produce than it contributes may affect the demand for ethanol.
Certain individuals believe that the use of ethanol will have a negative impact on gasoline prices at the pump. Some also believe that ethanol adds to air pollution and harms car and truck engines. Still other consumers believe that the process of producing ethanol actually uses more fossil energy, such as oil and natural gas, than the amount of energy that is produced. These consumer beliefs could potentially be wide-spread and may be increasing as a result of recent efforts to increase the allowable percentage of ethanol that may be blended for use in conventional automobiles. If consumers choose not to buy ethanol based on these beliefs, it would affect the demand for the ethanol we produce which could negatively affect our profitability and financial condition.
Sustained negative operating margins may require some ethanol producers to temporarily limit or cease production.
Our ability and the ability of other ethanol producers to operate profitably is largely determined by the spread between the price paid for corn and the price received for ethanol. If this spread is narrow or is negative for a sustained period, some ethanol producers may elect to temporarily limit or cease production until their possibility for profitability returns. Although we currently have no plans to limit or cease ethanol production, we may be required to do so if we experience a period of sustained negative operating margins. In such an event, we would still incur certain fixed costs, which would impact our financial performance.
Risks Related to Government Programs and Regulation
Our failure to comply with existing or future regulatory requirements could have a material adverse effect on our business, financial condition and results of operations.
We are subject to various federal, state and local environmental laws and regulations, including those relating to the discharge of materials into the air, water and ground. Certain aspects of our operations require environmental permits and controls to prevent and reduce air and water pollution, and these permits are subject to modification, renewal and revocation by issuing authorities including the Minnesota Pollution Control Agency. We could incur substantial costs, including cleanup costs, fines and civil or criminal sanctions and third-party claims for property damage and personal injury as a result of violations of or liabilities under environmental laws or non-compliance with environmental permits. We could also incur substantial costs and experience increased operating expenses as a result of operational changes to comply with environmental laws, regulations and permits. We have previously incurred substantial costs relating to our air emissions permit and expect additional costs relating to this permit in the future.
Further, environmental laws and regulations are subject to substantial change. We cannot predict what material impact, if any, these changes in laws or regulations might have on our business. Future changes in regulations or enforcement policies could impose more stringent requirements on us, compliance with which could require additional capital expenditures, increase our operating costs or otherwise adversely affect our business. These changes may also relax requirements that could prove beneficial to our competitors and thus adversely affect our business. In addition, regulations of the Environmental Protection Agency and the Minnesota Pollution Control Agency depend heavily on administrative interpretations. We cannot assure you that future interpretations made by regulatory authorities, with possible retroactive effect, will not adversely affect our business, financial condition and results of operations. Failure to comply with existing or future regulatory requirements could have a material adverse effect on our business, financial condition and results of operations.

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Because federal and state regulation heavily influence the supply of and demand for ethanol, changes in government regulation that adversely affect demand or supply will have a material adverse effect on our business.
Various federal and state laws, regulations and programs impact the supply of and demand for ethanol. Some government regulation, for example those that provide economic incentives to ethanol producers, stimulate supply of ethanol by encouraging production and the increased capacity of ethanol plants. Others, such as a federal excise tax incentive program that provides gasoline distributors who blended ethanol with gasoline to receive a federal excise tax rate reduction for each blended gallon they sell, stimulate demand for ethanol by making it price competitive with other oxygenates. Further, tariffs generally apply to the import of ethanol from certain other countries, where the cost of production can be significantly less than in the United States. These tariffs are designed to increase the cost of imported ethanol to a level more comparable to the cost of domestic ethanol by offsetting the benefit of the federal excise tax program. Tariffs have the effect of maintaining demand for domestic ethanol.
Additionally, the Environmental Protection Agency has established a revised annual renewable fuel standard (RFS2) that sets minimum national volume standards for use of renewable fuels. The RFS2 also sets volume standards for specific categories of renewable fuels: cellulosic, biomass-based diesel and total advanced renewable fuels. While our ethanol does not qualify as one of the new volume categories of renewable fuels, we believe that the overall renewable fuels requirement of RFS2 creates an incentive for the use of ethanol. Other federal and state programs that require or provide incentives for the use of ethanol create demand for ethanol. Government regulation and government programs that create demand for ethanol may also indirectly create supply for ethanol as additional producers expand or new companies enter the ethanol industry to capitalize on demand. In the case of the RFS2, while it creates a demand for ethanol, the existence of specific categories of renewable fuels also creates a demand for these types of renewable fuels and will likely provide an incentive for companies to further develop these products to capitalize on that demand. In these circumstances, the RFS2 may also reduce demand for ethanol in favor of the renewable fuels for which specific categories exist.
There have been proposals in Congress to reduce or eliminate RFS2. Additionally, in November 2013 the Environmental Protection Agency issued a proposed rule that would reduce the RFS2 levels for 2014 from the statutory volume requirement of 18.15 billion gallons to 15.21 billion gallons, and reduce the renewable volume obligations that can be satisfied by corn-based ethanol from 14.4 billion gallons to 13 billion gallons, which is less than the 2013 volume requirement of 13.8 billion gallons. In November 2014, the EPA announced that it would delay finalizing the rule on the 2014 RFS standards until after the end of 2014. In addition, the EPA indicated that it intends to take action on the 2014 standards in 2015 prior to or in conjunction with action on the 2015 standards. If the EPA's proposal becomes a final rule significantly reducing the volume requirements under the RFS or if the RFS were to be otherwise reduced or eliminated by the exercise of the EPA waiver authority or by Congress, the market price and demand for ethanol could decrease which will negatively impact our financial performance.
Federal and state laws, regulations and programs are constantly changing. We cannot predict what material impact, if any, these changes might have on our business. Future changes in regulations and programs could impose more stringent operational requirements or could reduce or eliminate the benefits we receive, directly and indirectly, under current regulations and programs. Future changes in regulations and programs may increase or add benefits to ethanol producers other than us or eliminate or reduce tariffs or other barriers to entry into the United States ethanol market, any of which could prove beneficial to our competitors, both domestic and international. Future changes in regulation may also hurt our business by providing economic incentives to producers of other renewable fuels or oxygenates or encouraging use of fuels or oxygenates that compete with ethanol. In addition, both national and state regulation is influenced by public opinion and changes in public opinion. For example, certain states oppose the use of ethanol because, as net importers of ethanol from other states, the use of ethanol could increase gasoline prices in that state and because that state does not receive significant economic benefits from the ethanol industry, which are primarily experienced by corn and ethanol producing states. Further, some argue that the use of ethanol will have a negative impact on gasoline prices to consumers, result in rising food prices, add to air pollution, harm car and truck engines, and actually use more fossil energy, such as oil and natural gas, than the amount of ethanol that is produced. We cannot predict the impact that opinions of consumers, legislators, industry participants, or competitors may have on the regulations and programs currently benefiting ethanol producers.
The EPA imposed E10 "blend wall" if not overcome will have an adverse effect on demand for ethanol.
We believe that the E10 "blend wall" is one of the most critical governmental policies currently facing the ethanol industry. The "blend wall" issue arises because of several conflicting requirements. First, the renewable fuels standards dictate a continuing increase in the amount of ethanol blended into the national gasoline supply. Second, the EPA mandates a limit of 10% ethanol inclusion in non-flex fuel vehicles, and the E85 vehicle marketplace is struggling to grow due to lacking infrastructure. The EPA policy of 10% and the RFS increasing blend rate are at odds, which is sometimes referred to as the "blend wall." While the issue is being considered by the EPA, there have been no regulatory changes that would reconcile the conflicting requirements. In 2011,

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the EPA allowed the use of E15, gasoline which is blended at a rate of 15% ethanol and 85% gasoline, in vehicles manufactured in the model year 2001 and later. Management believes that many gasoline retailers will refuse to provide E15 due to the fact that not all standard vehicles will be allowed to use E15 and due to the labeling requirements the EPA may impose. As a result, the approval of E15 may not significantly increase demand for ethanol.
The California Low Carbon Fuel Standard may decrease demand for corn based ethanol which could negatively impact our profitability.
California passed a Low Carbon Fuels Standard ("LCFS") which requires that renewable fuels used in California must accomplish certain reductions in greenhouse gases which reductions are measured using a lifecycle analysis. Management believes that these regulations could preclude corn based ethanol produced in the Midwest from being used in California. California represents a significant ethanol demand market. If the ethanol industry is unable to supply corn based ethanol to California, it could significantly reduce demand for the ethanol we produce. This could result in a reduction of our revenues and negatively impact our ability to profitably operate the ethanol plant.
Risks Related to Agrinatural and Natural Gas Pipeline Operations
The expansion of Agrinatural's existing assets and construction of new assets is subject to regulatory, environmental, political, legal and economic risks, which could adversely affect our results of operations and financial condition, and require additional capital contributions or loans from us.
One of the ways Agrinatural intends to grow its business is through the expansion of its existing assets and construction of new energy infrastructure assets. The construction of additions or modifications to Agrinatural's existing pipelines, and the construction of other new energy infrastructure assets, involve numerous regulatory, environmental, political and legal uncertainties beyond Agrinatural's control and may require the expenditure of significant capital. Therefore, as the majority-owner of Agrinatural, we may be required to make additional capital contributions, loans and/or guaranty loans to Agrinatural in order to fund such expansion projects. If Agrinatural undertakes these projects they may not be completed on schedule, at the budgeted cost or at all. Moreover, Agrinatural's revenues may not increase immediately upon the expenditure of funds on a particular project. For instance, if it expands or adds a new pipeline, the construction may occur over an extended period of time, and we will not receive any material increases in revenues until the project is completed. Agrinatural may also construct facilities to capture anticipated future growth in production or demand, which may not materialize or where contracts are later canceled. As a result, new pipelines may not be able to attract enough throughput volume to achieve our expected investment return, which could adversely affect our results of operations and financial condition. The construction of new pipelines may also require Agrinatural to obtain new rights-of-way, and it may become more expensive for Agrinatural to obtain these new rights-of-way or to renew existing rights-of-way. If the cost of renewing or obtaining new rights-of-way increases, Agrinatural's cash flows could be adversely affected.
Transporting natural gas involves inherent risks that could cause Agrinatural, and therefore the Company as its majority owner, to incur significant financial losses.
There are inherent hazards and operation risks in gas distribution activities, such as leaks, accidental explosions and mechanical problems that could cause the loss of human life, significant damage to property, environmental pollution, impairment of operations and substantial losses to Agrinatural. The location of pipelines near populated areas, including residential areas, commercial business centers and industrial sites, could increase the level of damages resulting from these risks. These activities may subject us to litigation and administrative proceedings that could result in substantial monetary judgments, fines or penalties against us. To the extent that the occurrence of any of these events is not fully covered by insurance, they could adversely affect Agrinatural's earnings and cash flow.
Volatility in the price of natural gas could result in customers switching to alternative energy sources which could reduce Agrinatural's revenues, earnings and cash flow.
The market price of alternative energy sources such as coal, electricity, propane, oil and steam is a competitive factor affecting the demand for Agrinatural's gas distribution services. Its customers may have or may acquire the capacity to use one or more of the alternative energy sources if the price of natural gas and Agrinatural's distribution services increase significantly. Natural gas has typically been less expensive than these alternative energy sources. However, if natural gas prices increase significantly, some of these alternative energy sources may become more economical or more attractive than natural gas, which could reduce our earnings and cash flow.

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Agrinatural's natural gas pipeline operations are subject to significant governmental and private sector regulations.
Agrinatural's natural gas pipeline operations are subject to government regulation, including the Federal Energy Regulatory Commission and Minnesota Office of Pipeline Safety, compliance with which can impose significant costs on Agrinatural's natural gas distribution business. Failure to comply with such regulations can result in additional costs, fines or criminal action.
Risks Related to the Units
Granite Falls Energy owns a large percentage of our units, which may allow it to control or heavily influence matters requiring member approval, and has additional board rights under our member control agreement.
As of January 28, 2015, Granite Falls Energy, LLC, through its wholly owned subsidiary, Project Viking, L.L.C., owned 50.6% of our outstanding units. As a result, Granite Falls Energy can significantly influence our management and affairs and all matters requiring member approval, including the approval of significant corporate transactions.
Our member control agreement gives members who hold significant amounts of equity in us the right to designate governors to serve on our board of governors. Therefore, as of January 28, 2015, Granite Falls Energy has the right to appoint five persons to our nine-person board pursuant to this provision. With the right to designate a majority of our board, Granite Falls Energy can significantly influence the outcome of any actions taken by our board of governors and our business.
In addition, given the large ownership of Granite Falls Energy, they can significantly influence other actions, such as amendments to our operating agreement, mergers, going private transactions, and other extraordinary transactions, and any decisions concerning the terms of any of these transactions. The ownership and voting positions of Granite Falls Energy may have the effect of delaying, deterring, or preventing a change in control or a change in the composition of our board of directors.
Further, the interests of Granite Falls Energy may not coincide with our interests or the interests of our other members. For example, Granite Falls Energy owns and operates an ethanol production facility that could be considered our competitor. Granite Falls Energy may also use its rights under the member control agreement and their large ownership position to address their own interests, which may be different from those of our other members.
There is no public market for our units and no public market is expected to develop.
There is no established public trading market for our units, and we do not expect one to develop in the foreseeable future. As of January 1, 2014, we have established through FNC Ag Stock, LLC, a Unit Trading Bulletin Board, a private online matching service, in order to facilitate trading among our members. The Unit Trading Bulletin Board has been designed to comply with federal tax laws and IRS regulations establishing a “qualified matching service,” as well as state and federal securities laws. The Unit Trading Bulletin Board does not automatically affect matches between potential sellers and buyers and it is the sole responsibility of sellers and buyers to contact each other to make a determination as to whether an agreement to transfer units may be reached. There are detailed timelines that must be followed under the Unit Trading Bulletin Board Rules and Procedures with respect to offers and sales of membership units. All transactions must comply with the Unit Trading Bulletin Board Rules, our member control agreement, and are subject to approval by our board of governors. As a result, units held by our members may not be easily resold and members may be required to hold their units indefinitely. Even if members are able to resell our units, the price may be less than the members' investment in the units or may otherwise be unattractive to the member.
There are significant restrictions on the transfer of our units.
To protect our status as a partnership for tax purposes and to assure that no public trading market in our units develops, our units are subject to significant restrictions on transfer and transfers are subject to approval by our board of governors. All transfers of units must comply with the transfer provisions of our member control agreement and the unit transfer policy adopted by our board of governors. Our board of governors will not approve transfers which could cause us to lose our tax status or violate federal or state securities laws. As a result of the provisions of our member control agreement, members may not be able to transfer their units and may be required to assume the risks of the investment for an indefinite period of time.

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There is no assurance that we will be able to make distributions to our unit holders, which means that holders could receive little or no return on their investment.
Distributions of our net cash flow may be made at the sole discretion of our board of governors, subject to the provisions of the Minnesota Limited Liability Company Act, our member control agreement and restrictions imposed by AgStar under our credit facility. Our credit facility with AgStar currently limits our ability to make distributions to our members. If our financial performance and loan covenants permit, we expect to make cash distributions at times and in amounts that will permit our members to make income tax payments, along with distributions in excess of these amounts. However, our board may elect to retain cash for operating purposes, debt retirement, plant improvements or expansion. Although we have declared a distribution that was paid to members in January 2015, there is no guarantee that we will be in a financial position to pay distributions in the future, that the terms of our credit facility will allow us to make distributions to our members, or that distributions, if any, will be at times or in amounts to permit our members to make income tax payments. Consequently, members may receive little or no return on their investment in the units.
We may authorize and issue units of new classes which could be superior to or adversely affect holders of our outstanding units.
Our board of governors, upon the approval of a majority in interest of our members, has the power to authorize and issue units of classes which have voting powers, designations, preferences, limitations and special rights, including preferred distribution rights, conversion rights, redemption rights and liquidation rights, different from or superior to those of our present units. New units may be issued at a price and on terms determined by our board of governors. The terms of the units and the terms of issuance of the units could have an adverse impact on your voting rights and could dilute your financial interest in us.
Our use of a staggered board of governors and allocation of governor appointment rights may reduce the ability of members to affect the composition of the board.
We are managed by a board of governors, currently consisting of four (4) elected governors and five (5) appointed governors. The seats on the board that are not subject to a right of appointment will be elected by the members without appointment rights. An appointed governor serves indefinitely at the pleasure of the member appointing him or her (so long as such member and its affiliates continue to hold a sufficient number of units to maintain the applicable appointment right) until a successor is appointed, or until the earlier death, resignation or removal of the appointed governor.
Under our member control agreement, non-appointed governors are divided into three classes, with the term of one class expiring each year. As the term of each class expires, the successors to the governors in that class will be elected for a term of three years. As a result, members elect only approximately one-third of the non-appointed governors each year.
The effect of these provisions may make it more difficult for a third party to acquire, or may discourage a third party from acquiring, control of us and may discourage attempts to change our management, even if an acquisition or these changes would be beneficial to our members.
Our units represent both financial and governance rights, and loss of status as a member would result in the loss of the holder's voting and other rights and would allow us to redeem such holder's units.
Holders of units are entitled to certain financial rights, such as the right to any distributions, and to governance rights, such as the right to vote as a member. If a unit holder does not continue to qualify as a member or such holder's member status is terminated, the holder would lose certain rights, such as voting rights, and we could redeem such holder's units. The minimum number of units presently required for membership is 2,500 units. In addition, holders of units may be terminated as a member if the holder dies or ceases to exist, violates our member control agreement or takes actions contrary to our interests, and for other reasons. Although our member control agreement does not define what actions might be contrary to our interests, and our board of governors has not adopted a policy on the subject, such actions might include providing confidential information about us to a competitor, taking a board or management position with a competitor or taking action which results in significant financial harm to us in the marketplace. If a holder of units is terminated as a member, our board of governors will have no obligation to redeem such holder's units.
Voting rights of members are not necessarily equal and are subject to certain limitations.
Members of our company are holders of units who have been admitted as members upon their investment in our units and who are admitted as members by our board of governors. The minimum number of units required to retain membership is 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 who are holders of our present units are entitled to one vote for each unit held. The provisions of our member control agreement relating to voting rights applicable to any class of units will apply equally to all units of that class.

26


However, our member control agreement gives members who hold significant amounts of equity in us the right to designate governors to serve on our board of governors. For every 9% of our units held, the member has the right to appoint one person to our board. Granite Falls has the right to appoint five persons to our board pursuant to this provision and has currently appointed five persons. If units of any other class are issued in the future, holders of units of that other class will have the voting rights that are established for that class by our board of governors with the approval of our members. Consequently, the voting rights of members may not be necessarily proportional to the number of units held.
Further, cumulative voting for governors is not allowed, which makes it substantially less likely that a minority of members could elect a member to the board of governors. Members do not have dissenter's rights. This means that they will not have the right to dissent and seek payment for their units in the event we merge, consolidate, exchange or otherwise dispose of all or substantially all of our property. Holders of units who are not members have no voting rights. These provisions may limit the ability of members to change the governance and policies of our company.
All members will be bound by actions taken by members holding a majority of our units, and because of the restrictions on transfer and lack of dissenters' rights, members could be forced to hold a substantially changed investment.
We cannot engage in certain transactions, such as a merger, consolidation, dissolution or sale of all or substantially all of our assets, without the approval of our members. However, if holders of a majority of our units approve a transaction, then all members will also be bound to that transaction regardless of whether that member agrees with or voted in favor of the transaction. Under our member control agreement, members will not have any dissenters' rights to seek appraisal or payment of the fair value of their units. Consequently, because there is no public market for the units, members may be forced to hold a substantially changed investment.
Risks Related to Tax Issues in a Limited Liability Company
        EACH UNIT HOLDER SHOULD CONSULT THE INVESTOR'S OWN TAX ADVISOR WITH RESPECT TO THE FEDERAL AND STATE TAX CONSEQUENCES OF AN INVESTMENT IN HERON LAKE BIOENERGY, LLC AND ITS IMPACT ON THE INVESTOR'S TAX REPORTING OBLIGATIONS AND LIABILITY.
If we are not taxed as a partnership, we will pay taxes on all of our net income and you will be taxed on any earnings we distribute, and this will reduce the amount of cash available for distributions to holders of our units.
We consider Heron Lake BioEnergy, LLC to be a partnership for federal income tax purposes. This means that we will not pay any federal income tax, and our members will pay tax on their share of our net income. If we are unable to maintain our partnership tax treatment or qualify for partnership taxation for whatever reason, then we may be taxed as a corporation. We cannot assure you that we will be able to maintain our partnership tax classification. For example, there might be changes in the law or our company that would cause us to be reclassified as a corporation. As a corporation, we would be taxed on our taxable income at rates of up to 35% for federal income tax purposes. Further, distributions would be treated as ordinary dividend income to our unit holders to the extent of our earnings and profits. These distributions would not be deductible by us, thus resulting in double taxation of our earnings and profits. This would also reduce the amount of cash we may have available for distributions.
Your tax liability from your allocated share of our taxable income may exceed any cash distributions you receive, which means that you may have to satisfy this tax liability with your personal funds.
As a partnership for federal income tax purposes, all of our profits and losses "pass-through" to our unit holders. You must pay tax on your allocated share of our taxable income every year. You may incur tax liabilities from allocations of taxable income for a particular year or in the aggregate that exceed any cash distributions you receive in that year or in the aggregate. This may occur because of various factors, including but not limited to, accounting methodology, the specific tax rates you face, and payment obligations and other debt covenants that restrict our ability to pay cash distributions. If this occurs, you may have to pay income tax on your allocated share of our taxable income with your own personal funds.
You may not be able to fully deduct your share of our losses or your interest expense.
It is likely that your interest in us will be treated as a "passive activity" for federal income tax purposes. In the case of unit holders who are individuals or personal services corporations, this means that a unit holder's share of any loss incurred by us will be deductible only against the holder's income or gains from other passive activities, e.g., S corporations and partnerships that conduct a business in which the holder is not a material participant. Some closely held C corporations have more favorable passive loss limitations. Passive activity losses that are disallowed in any taxable year are suspended and may be carried forward and used as an offset against passive activity income in future years. Upon disposition of a taxpayer's entire interest in a passive activity to an unrelated person in a taxable transaction, suspended losses with respect to that activity may then be deducted.

27


Interest paid on any borrowings incurred to purchase units may not be deductible in whole or in part because the interest must be aggregated with other items of income and loss that the unit holder has independently experienced from passive activities and subjected to limitations on passive activity losses.
Deductibility of capital losses that we incur and pass through to you or that you incur upon disposition of units may be limited. Capital losses are deductible only to the extent of capital gains plus, in the case of non-corporate taxpayers, the excess may be used to offset up to $3,000 of ordinary income. If a non-corporate taxpayer cannot fully utilize a capital loss because of this limitation, the unused loss may be carried forward and used in future years subject to the same limitations in the future years.
You may be subject to federal alternative minimum tax
Individual taxpayers are subject to an "alternative minimum tax" if that tax exceeds the individual's regular income tax. For alternative minimum tax purposes, an individual's adjusted gross income is increased by items of tax preference. We may generate such preference items. Accordingly, preference items from our operations together with other preference items you may have may cause or increase an alternative minimum tax to a unit holder. You are encouraged and expected to consult with your individual tax advisor to analyze and determine the effect on your individual tax situation of the alternative minimum taxable income you may be allocated, particularly in the early years of our operations.
Preparation of your tax returns may be complicated and expensive.
The tax treatment of limited liability companies and the rules regarding partnership allocations are complex. We will file a partnership income tax return and will furnish each unit holder with a Schedule K-1 that sets forth our determination of that unit holder's allocable share of income, gains, losses and deductions. In addition to United States federal income taxes, unit holders will likely be subject to other taxes, such as state and local taxes, that are imposed by various jurisdictions. It is the responsibility of each unit holder to file all applicable federal, state and local tax returns and pay all applicable taxes. You may wish to engage a tax professional to assist you in preparing your tax returns and this could be costly to you.
Any audit of our tax returns resulting in adjustments could result in additional tax liability to you.
The IRS may audit our tax returns and may disagree with the positions that we take on our returns or any Schedule K-1. If any of the information on our partnership tax return or a Schedule K-1 is successfully challenged by the IRS, the character and amount of items of income, gains, losses, deductions or credits in a manner allocable to some or all our unit holders may change in a manner that adversely affects those unit holders. This could result in adjustments on unit holders' tax returns and in additional tax liabilities, penalties and interest to you. An audit of our tax returns could lead to separate audits of your personal tax returns, especially if adjustments are required.
ITEM 1B.    UNRESOLVED STAFF COMMENTS
None.
ITEM 2.    PROPERTIES
We own approximately 216 acres of land located near Heron Lake, Minnesota on which we have constructed our ethanol plant, which also includes corn, ethanol, distillers' grains and corn oil storage and handling facilities. Located on these 216 acres is an approximately 7,320 square foot building that serves as our headquarters. Our address is 91246 390th Avenue, Heron Lake, Minnesota 56137-3175.
All of our real property is subject to mortgages in favor of AgStar as security for loan obligations.
Our majority owned subsidiary, Agrinatural, property consists of 185 miles of distribution main pipelines and service pipelines, together with the associated easement and land rights, a town border station, meters and regulators, office and other equipment and construction in process. Agrinatural's assets have represented 18.6%, 10.2% and 4.9% of our consolidated total assets for the years ended October 31, 2014, 2013 and 2012, respectively. All of Agrinatural's real property and assets are subject to mortgages in favor of HLBE as security for loan obligations.
ITEM 3.    LEGAL PROCEEDINGS
From time to time in the ordinary course of business, Heron Lake BioEnergy, LLC may be named as a defendant in legal proceedings related to various issues, including workers’ compensation claims, tort claims, or contractual disputes. We are not currently involved in any material legal proceedings.

28


ITEM 4.    MINE SAFETY DISCLOSURES
None.
PART II
ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
There is no public trading market for our Class A or Class B units.
However, effective as of January 1, 2014, we established, an online unit trading bulletin board ("QMS") through FNC Ag Stock, LLC, in order to facilitate trading in our units. The QMS has been designed to comply with federal tax laws and IRS regulations establishing a “qualified matching service,” as well as state and federal securities laws. Our QMS consists of an electronic bulletin board that provides a list of interested buyers with a list of interested sellers, along with their non-firm price quotes. The QMS does not automatically affect matches between potential sellers and buyers and it is the sole responsibility of sellers and buyers to contact each other to make a determination as to whether an agreement to transfer units may be reached. We do not become involved in any purchase or sale negotiations arising from our QMS and have no role in effecting the transactions beyond approval, as required under our member control agreement, and the issuance of new certificates. We do not give advice regarding the merits or shortcomings of any particular transaction. We do not receive, transfer or hold funds or securities as an incident of operating the QMS. We do not receive any compensation for creating or maintaining the QMS. In advertising our QMS, we do not characterize Heron Lake BioEnergy, LLC as being a broker or dealer or an exchange. We do not use the QMS to offer to buy or sell securities other than in compliance with securities laws, including any applicable registration requirements.
There are detailed timelines that must be followed under the QMS rules and procedures with respect to offers and sales of membership units. All transactions must comply with the QMS rules and procedures, our member control agreement, and are subject to approval by our board of governors.
So long as we remain a publicly reporting company, information about the Company will be publicly available through the SEC's filing system. However, if at any time we cease to be a publicly reporting company, we anticipate continuing to make information about the Company publicly available on our website in order to continue operating the QMS.
The following table contains historical information by fiscal quarter for the past fiscal year regarding the actual unit transactions that were completed by our unit-holders during the periods specified. There were no secondary market unit sales transactions completed by our members during the fiscal year ended October 31, 2013 other than related-party transfers without consideration.
We believe the following table most accurately represents the current trading value of the Company's units. The information was compiled by reviewing the completed unit transfers that occurred on our qualified matching service bulletin board during the quarters indicated.
Quarter
Low Per Unit Price
High Per Unit Price
Total Units Traded
2014 1st
None
2014 2nd
0.37
0.43
44,500
2014 3rd
0.45
0.75
214,750
2014 4th
0.90
0.90
88,000
As a limited liability company, we are required to restrict the transfers of our membership units in order to preserve our partnership tax status.  Our membership units may not be traded on any established securities market or readily traded on a secondary market (or the substantial equivalent thereof).  All transfers are subject to a determination that the transfer will not cause Heron Lake BioEnergy to be deemed a publicly traded partnership.
Issuer Repurchases of Equity Securities
We did not make any repurchases of our Class A or Class B units during fiscal 2014.

29


Holders of Record
As of January 28, 2015, there were 62,932,107 Class A units outstanding held of record by 1,180 unit holders, and 15,000,000 Class B units outstanding held of record by one unit holder. There are no other classes of units outstanding. The determination of the number of members is based upon the number of record holders of the units as reflected in the Company's internal unit records.
As of January 28, 2015, Granite Falls Energy, LLC owns a 50.6% controlling interest in the Company through its wholly owned subsidiary, Project Viking, L.L.C. GFE, a related party by virtue of its ownership interest in us, owns an ethanol plant located in Granite Falls, Minnesota. As a result of its majority ownership, GFE has the right to appoint five (5) of the nine (9) governors to our board of governors under our member control agreement.
As of October 31, 2014 and January 28, 2015, there were no outstanding options or warrants to purchase, or securities convertible for or into, our units.
Distributions
Distributions by the Company to our unit holders are in proportion to the number of units held by each unit holder. A unit holder's distribution is determined by multiplying the number of units by distribution per unit declared. Our board of governors has complete discretion over the timing and amount of distributions to our unit holders. Distributions are restricted by certain loan covenants in our comprehensive credit facility with AgStar. We may only make distributions to our members in an amount that does not exceed 65% of our net profit (determined according to GAAP) for such fiscal year; provided that the we are and will remain in compliance with all of the covenants, terms and conditions of the comprehensive credit facility. If our financial performance and loan covenants permit, we expect to make future cash distributions at times and in amounts that will permit our members to make income tax payments, along with distributions in excess of these amounts. Cash distributions are not assured, however, and we may never be in a position to make distributions. Under Minnesota law, we cannot make a distribution to a member if, after the distribution, we would not be able to pay our debts as they become due or our liabilities, excluding liabilities to our members on account of their capital contributions, would exceed our assets.
We did not make any distributions to our members during fiscal years 2013 or 2014.
Subsequent to the end of our 2014 fiscal year, on December 18, 2014, our board of governors declared a distribution of $0.12 per membership unit for a total of approximately $9,352,000 to be paid to members of record as of December 18, 2014. The distribution was paid on January 19, 2015. Based on the covenants contained in our AgStar credit facilities, the foregoing distribution was approved by our lender prior to distribution.
Our expectations with respect to our ability to make future distributions are discussed in greater detail in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations". We do not currently have any plans to declare a future distribution.
Unregistered Sales of Equity Securities
The Company had no unregistered sales of securities in the fourth quarter of fiscal 2014.
On May 2, 2014, we issued a notice to U.S. Bank that we intend to redeem all of the 7.25% Secured Subordinated Notes due 2018, outstanding principal balance of $4.1 million (the “Notes”), on July 1, 2014. A notice of the redemption was mailed to Note holders by the trustee on May 23, 2014. The Company's obligation to pay the redemption price on the redemption date was subject to the right of the holders of the notes to elect to convert the principal amount of their notes into capital units of the Company at a conversion rate of $0.30 per unit.
As of the close of business on June 20, 2014, the last day to elect conversion, note holders holding an aggregate principal amount of approximately $3.9 million of Notes elected to convert their Notes into units of the Company. On July 1, 2014, the Company issued 13,120,000 Class A units of the Company to the holders of the Notes electing conversion per the terms of the Notes and the indenture.

30


Following the issuance of the Class A units described above, 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.  The Class A Units issued in this transaction have not been registered under the Securities Act of 1933, as amended and may not be offered or sold in the United States in the absence of an effective registration statement or exemption from the registration requirements under the Act. The Class A units were issued solely to former holders of the Notes upon conversion pursuant to the exemption from registration provided under Section 3(a)(9) of the Act. This exemption is available to the Company because the units were exchanged by the Company with its existing security holders in accordance with the terms of the indenture governing the Notes with no commission or other remunerations being paid or given for soliciting such an exchange. Based on representations from each note holder, including a representation that each such recipient is an accredited investor, the Company believes that the issuance of the Class A units is also exempt from registration under Section 4(2) of the Act, as a transaction by an issuer not involving a public offering.
Securities Authorized for Issuance Under Equity Compensation Plans
As of the date of this annual report, we had no "equity compensation plans" (including individual equity compensation arrangements) under which any of our equity securities are authorized for issuance.
Performance Graph
The following graph shows a comparison of cumulative total member return since October 31, 2009, calculated on a dividend reinvested basis, for the Company, the NASDAQ Composite Index (the “NASDAQ”) and an index of other companies that have the same SIC code as the Company (the “Industry Index”). The graph assumes $100 was invested in each of the Company's units, the NASDAQ, and the Industry Index on October 31, 2009. Data points on the graph are semi-annual. Note that historic stock price performance is not necessarily indicative of future unit price performance.
Pursuant to the rules and regulations of the Securities and Exchange Commission, the performance graph and the information set forth therein shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934, and shall not be deemed to be incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such a filing.

31



ITEM 6.    SELECTED FINANCIAL DATA
The following table presents selected consolidated financial and operating data as of the dates and for the periods indicated. The selected financial data for the balance sheets as of October 31, 2014 and 2013 and the consolidated statements of operations data for the years ended October 31, 2014, 2013, and 2012 have been derived from the audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected financial data for the consolidated balance sheets as of October 31, 2012, 2011 and 2010 and the statements of operations data for the years ended October 31, 2011 and 2010 were derived from audited consolidated financial statements filed previously.
This selected consolidated financial data should be read in conjunction with "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and the accompanying notes included elsewhere in this Annual Report on Form 10-K. Among other things, those financial statements include more detailed information regarding the basis of presentation for the following consolidated financial data.
Statement of Operations Data for the fiscal years ended October 31,
2014
 
2013
 
2012
 
2011
 
2010
Revenues
$
149,418,044

 
$
163,764,144

 
$
168,659,935

 
$
164,120,375

 
$
110,624,758

Total Cost of Goods Sold
120,569,409

 
155,536,974

 
166,529,283

 
157,163,624

 
103,690,208

Gross Profit
28,848,635

 
8,227,170

 
2,130,652

 
6,956,751

 
6,934,550

Operating Expenses
(2,950,047
)
 
(3,214,036
)
 
(3,171,331
)
 
(3,613,465
)
 
(3,857,492
)
Impairment Charge

 

 
(27,844,579
)
 

 

Settlement Income (Expense)

 

 
(900,000
)
 

 
2,600,000

Operating Income (Loss)
25,898,588

 
5,013,134

 
(29,785,258
)
 
3,343,286

 
5,677,058

Other expense, net
(1,571,070
)
 
(2,745,274
)
 
(2,567,385
)
 
(2,800,269
)
 
(3,993,537
)
Net Income (Loss)
24,327,518

 
2,267,860

 
(32,352,643
)
 
543,017

 
1,683,521

Net Income (Loss) Attributable to Noncontrolling Interest
358,673

 
327,018

 
353,019

 
(27,838
)
 

Net Income (Loss) Attributable to Heron Lake BioEnergy, LLC
$
23,968,845

 
$
1,940,842

 
$
(32,705,662
)
 
$
570,855

 
$
1,683,521

 
 
 
 
 
 
 
 
 
 
Weighted Average Units Outstanding—Basic (Class A and B)
69,233,367

 
44,868,463

 
38,510,066

 
33,391,636

 
28,141,942

Net Income (Loss) Per Unit Attributed to Heron Lake BioEnergy, LLC—Basic (Class A and B)
$
0.35

 
$
0.04

 
$
(0.85
)
 
$
0.02

 
$
0.06

 
 
 
 
 
 
 
 
 
 
Weighted Average Units Outstanding - Diluted (Class A and B)
78,389,586

 
48,086,445

 
38,510,066

 
33,391,636

 
28,141,942

Net Income (Loss) Per Unit Attributed to Heron Lake BioEnergy, LLC—Diluted (Class A and B)
$
0.31

 
$
0.04

 
$
(0.85
)
 
$
0.02

 
$
0.06

 

32


Balance Sheet Data at October 31,
2014
 
2013
 
2012
 
2011
 
2010
Current assets
$
10,896,702

 
$
7,849,244

 
$
7,538,782

 
$
14,237,942

 
$
18,254,313

Property and equipment, net
54,367,998

 
51,670,272

 
58,099,286

 
88,592,945

 
89,803,647

Other assets
857,550

 
1,274,401

 
942,951

 
1,303,037

 
1,482,617

Total assets
$
66,122,250

 
$
60,793,917

 
$
66,581,019

 
$
104,133,924

 
$
109,540,577

 
 
 
 
 
 
 
 
 
 
Current liabilities
$
8,109,395

 
$
5,061,910

 
$
45,000,237

 
$
7,807,727

 
$
60,034,589

Long-term debt
2,112,412

 
28,181,155

 
4,031,335

 
46,844,912

 
4,068,716

Total members' equity
55,900,443

 
27,550,852

 
17,549,447

 
49,481,285

 
45,437,272

Total liabilities and members' equity
$
66,122,250

 
$
60,793,917

 
$
66,581,019

 
$
104,133,924

 
$
109,540,577

ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
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 fiscal year ended October 31, 2014. This discussion should be read in conjunction with the consolidated financial statements included herewith and notes to the consolidated financial statements thereto and the risk factors contained herein.
Overview
Heron Lake BioEnergy, LLC is a Minnesota limited liability company that owns and operates a dry mill corn-based, natural gas fired ethanol plant near Heron Lake, Minnesota.
Our revenues are derived from the sale and distribution of our ethanol throughout the continental United States and in the sale and distribution of our distillers' grains (DGS) locally, and throughout the continental United States.
Our operations fall within the following two segments: (1) production of ethanol and related distillers' grains, corn oil and syrup collectively referred to as ethanol production; and (2) natural gas pipeline distribution and services from the Company's majority owned subsidiary, Agrinatural. Revenues from Agrinatural's natural gas pipeline have represented 0.6%, 0.6% and 1.1% of our revenues in the years ended October 31, 2014, 2013, and 2012 respectively.

In applying the criteria set forth in ASC 280, the Company determined during the fourth fiscal quarter ended October 31, 2014 that it has two reportable operating segments for financial reporting purposes. Before intercompany eliminations, revenues from our natural gas pipeline segment represented 1.8%, 1.5% and 0.0% of our total consolidated revenues in the years ended October 31, 2014, 2013, and 2012, respectively. After accounting for intercompany eliminations for fees paid by the Company for natural gas transportation services pursuant to our natural gas transportation agreement with Agrinatural, Agrinatural's revenues represented 0.6%, 0.6% and 0.0% of our consolidated revenues for the fiscal years ended October 31, 2014, 2013, and 2012, respectively, and have little to no impact on the overall performance of the Company.
Trends and Uncertainties Impacting Our Operations
Our current results of operation are affected and will continue to be affected by factors such as (a) volatile and uncertain pricing of ethanol and corn; (b) availability of corn that is, in turn, affected by trends such as corn acreage, weather conditions, and yields on existing and new acreage diverted from other crops; and (c) the supply and demand for ethanol, which is affected by acceptance of ethanol as a substitute for fuel, public perception of the ethanol industry, government incentives and regulation, and competition from new and existing construction, among other things. Other factors that may affect our future results of operation include those factors discussed in "Item 1. Business" and "Item 1A. Risk Factors."

33



Critical Accounting Estimates
Management uses estimates and assumptions in preparing our consolidated 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. Of the significant accounting policies described in the notes to our consolidated financial statements, we believe that the following are the most critical:
Property, Plant and Equipment
Management’s estimate of the depreciable lives of property, plant, and equipment is based on the estimated useful lives. 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. In our analysis, we consider future corn costs and ethanol prices, break-even points for our plant and our risk management strategies in place through our derivative instruments and forward contracts. Given the significant assumptions required and the possibility that actual conditions will differ, we consider the assessment of impairment of our long-lived assets to be a critical accounting estimate. As a result of our review of long-lived assets for impairment at October 31, 2012, we recorded an impairment charge of approximately $27.8 million. No impairment was recorded during fiscal year 2014 and 2013.
Derivative Instruments
We enter forward contracts for corn purchases to supply the plant. These contracts represent firm purchase commitments which along with inventory on hand must be evaluated for potential market value losses.
Inventory
We value our inventory at the lower of cost or market. 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 future corn costs and ethanol prices, break-even points for our plant and our risk management strategies in place through our use of 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 market on inventory to be a critical accounting estimate.
Recently Issued Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. This ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This pronouncement is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period and is to be applied using one of two retrospective application methods, with early application not permitted. We have not yet determined the potential effects of the new standard on the consolidated financial statements, if any.


34


Results of Operations for the Fiscal Years Ended October 31, 2014 and 2013
The following table shows the results of our operations and the percentage of revenues, cost of goods sold, operating expenses and other items to total revenues in our statements of operations for the fiscal year ended October 31, 2014 and 2013:
 
2014
 
2013
Income Statement Data
Amount
 
%
 
Amount
 
%
Revenues
$
149,418,044

 
100.0
 %
 
$
163,764,144

 
100.0
 %
Cost of Goods Sold
120,569,409

 
80.7
 %
 
155,536,974

 
95.0
 %
Gross Profit
28,848,635

 
19.3
 %
 
8,227,170

 
5.0
 %
Operating Expenses
(2,950,047
)
 
(2.0
)%
 
(3,214,036
)
 
(2.0
)%
Operating Income
25,898,588

 
17.3
 %
 
5,013,134

 
3.0
 %
Other Expense
(1,571,070
)
 
(1.1
)%
 
(2,745,274
)
 
(1.7
)%
Net Income before noncontrolling interest
24,327,518

 
16.2
 %
 
2,267,860

 
1.3
 %
Noncontrolling Income
358,673

 
0.2
 %
 
327,018

 
0.2
 %
Net Income attributable to Heron Lake BioEnergy, LLC
$
23,968,845

 
16.0
 %
 
$
1,940,842

 
1.1
 %
Our revenues from operations come from three primary sources: sales of fuel ethanol, distillers' grains and corn oil. Additionally, we also realize relatively immaterial revenue from incidental sales of distillers' syrup and revenues generated from natural gas pipeline operations at Agrinatural Gas, LLC. These incidental syrup sales and revenues from our natural gas pipeline operations are aggregated together for revenue reporting purposes as "Other/Miscellaneous".
 The following table shows the sources of our revenue for the fiscal year ended October 31, 2014:
Revenue Sources
Amount
 
Percentage of
Total Revenues
Ethanol sales
$
119,112,756

 
79.7
%
Distillers' grains sales
25,604,229

 
17.1
%
Corn oil sales
3,200,509

 
2.1
%
Other/Miscellaneous
1,500,550

 
1.0
%
    Total Revenues
$
149,418,044

 
100.0
%
The following table shows the sources of our revenue for the fiscal year ended October 31, 2013:
Revenue Sources
Amount
 
Percentage of
Total Revenues
Ethanol sales
$
125,541,065

 
76.6
%
Distillers' grains sales
32,575,616

 
19.9
%
Corn oil sales
4,033,942

 
2.5
%
Other/Miscellaneous
1,613,521

 
1.0
%
    Total Revenues
$
163,764,144

 
100.0
%
Our total revenue decreased 8.8% for our 2014 fiscal year compared to our 2013 fiscal year. Management attributes this decrease in revenues primarily to a lower average price for our ethanol and distillers' grains. Offsetting this decrease, however was an 7.1% and 38.0% increase in our production of ethanol and distillers' grains, respectively during our 2014 fiscal year compared to the same period of 2013.
Ethanol
The average price we received for our ethanol decreased by approximately 11.5% during our 2014 fiscal year compared to our 2013 fiscal year. Our average price per gallon of ethanol sold was $2.01 in 2014 and $2.27 in 2013. Management attributes the drop in ethanol prices to continuing lower corn and gasoline prices, which impacts the market price of ethanol. However, ethanol prices have been somewhat buoyed by tighter domestic ethanol inventories due to continuing rail delays causing production slow downs and reductions and stronger export markets as a result of lower United States ethanol prices making our ethanol more cost competitive in the world market. Management anticipates that ethanol prices will continue to change in relation to changes in corn and energy prices. In addition,

35


management believes the uncertainty related to EPA proposed changes in the RFS volume obligation during 2014 also impacted ethanol demand, negatively impacting ethanol prices. Management anticipates that ethanol prices will remain lower during our 2015 fiscal year as a result of lower corn prices, lower gasoline prices and continued uncertainty regarding the RFS.
Distillers' Grains
Sales of distillers' grains represent a slightly smaller portion of our revenues during our 2014 fiscal year compared to our 2013 fiscal year as a result of significantly lower prices which were offset by greater quantities of distillers' grains sold. The price we received for our distillers' grains in our 2014 fiscal year was approximately 11.5% lower than the price we received during our 2013 fiscal year; however, this decrease was offset by a increase of 38.0% in quantity sold in our 2014 fiscal year compared to our 2013 fiscal year. Management believes these lower distillers' grains prices are a result of low corn and soybean prices coupled with increased supplies of corn and soybeans during much of our 2014 fiscal year. We anticipate that the market price of our distillers' grains will continue to be volatile as a result of changes in the price of corn and competing animal feed substitutes such as soybean meal.
Additionally, changes in export demand for distillers' grains by China during summer 2014 have negatively impacted distillers' grains prices. In June 2014, China stopped issuing permits for the import of distillers' dried grains from the United States due to the presence of a unapproved genetically modified organism ("GMO") corn trait in some distillers' grains shipments. The GMO trait has been approved in the United States and a number of other countries but was not in China. However, on December 17, 2014, the United States Secretary of Agriculture announced that Chinese officials had advised him that China would be lifting the ban on MIR162. Recently Syngenta publicly confirmed that it received the safety certificate for its Agrisure Viptera trait from China's regulatory authorities, formally granting import approval for distillers' grains made from AgrisureViptera corn. Since the Chinese announcement, Chinese buyers have resumed purchases of United States distillers' grains and domestic distillers' grains prices have have risen. However, management cannot predict if Chinese import volumes will return to pre-ban levels. As a result, management cannot estimate the effect China's actions will have on the overall distillers' grains market long term.
Corn Oil
Separating the corn oil from our distillers' grains decreases the total tons of distillers' grains that we sell; however, our corn oil has a higher per ton value than our distillers' grains. The average price we received per pound of corn oil sold during our 2014 fiscal year was approximately 88.6% less than the average price received during our 2013 fiscal year. Management attributes the decrease in corn oil prices to additional corn oil entering the market without any corresponding increase in demand. Management anticipates continued lower corn oil prices due to ongoing imbalance between corn oil supplies and demand.
Offsetting this price decrease, our volume of corn oil sold increased significantly from approximately 1 million pounds during our 2013 fiscal year to approximately 10 million pounds during our 2014 fiscal year relative to due to increased extraction efficiencies. The net effect of the price decrease and increase in volume sold resulted in only slight decrease in corn oil revenue from approximately $4,034,000 in 2013 to approximately $3,201,000 in 2014.
Hedging and Volatility of Sales
We occasionally engage in hedging activities with respect to our ethanol sales. We recognize the gains or losses that result from the changes in the value of these derivative instruments in revenues as the changes occur. As ethanol prices fluctuate, the value of our derivative instruments are impacted, which affects our financial performance. However, we did not have any ethanol related derivative instruments other than forward sales contracts as discussed below under "Commodity Price Risk Protection."
Our results of operations for our 2015 fiscal year will continue to be affected by volatility in the commodity markets and uncertainty regarding the 2014 and future RFS RVO levels. The EPA has announced that it will be make a decision on whether to change the RFS requirements for using ethanol during 2015 but no definitive timeline for action has been given. As a result of this delay, the ethanol industry will continue to deal with the uncertainty related to the RFS. However, any change in the RFS that occurs during 2015 may be magnified if the change impacts prior year ethanol use requirements or otherwise significantly reduces ethanol demand.
Cost of Sales
We experienced an decrease in our cost of goods sold for our 2014 fiscal year compared to our 2013 fiscal year. Our cost of goods sold decreased to $120,569,409 for our fiscal year ended October 31, 2014 from $155,536,974 in our fiscal year ended October 31, 2013.
Our cost of goods sold as a percentage of revenues was 80.7% for our fiscal year ended October 31, 2014 compared to 95.0% for the same period of 2013. Our two largest costs of production are corn (70.0% of cost of goods sold for our fiscal year ended October 31, 2014) and natural gas (10.0% of cost of goods sold for our fiscal year ended October 31, 2014).

36


Corn Costs
We experienced an decrease of approximately 33.8% in the total amount we paid for corn for our 2014 fiscal year compared to our 2013 fiscal year. This was the net result of a 6.6% increase in the quantity of bushels we purchased, offset by a 38.0% decrease in our per bushel cost. A tight corn supply following the 2012 harvest put upward pressure on corn prices throughout much of our 2013 fiscal year. However, a record 2013 corn harvest eased prices substantially in our fourth fiscal quarter of 2013 and continued into fiscal year 2014. In addition, due to another record harvest in 2014, we expect corn prices to remain stable to lower during our 2015 fiscal year.
Natural Gas Costs
For our 2014 fiscal year, we experienced an increase of approximately 78.0% in our overall natural gas costs compared to our 2013 fiscal year due to significantly higher natural gas costs during our first and second quarters of 2014. We expect the market price for natural gas to increase again during the winter months of our 2015 fiscal year. However, we do not expect the increases in natural gas prices will match those that occurred in 2014 unless we experience another exceptionally cold and long winter.
Hedging and Volatility of Purchases
Realized and unrealized gains and losses related to our corn derivative instruments resulted in a decrease of approximately $788,000 in our cost of goods sold for our 2014 fiscal year compared to a decrease of $0 in our cost of goods sold for our 2013 fiscal year.  We recognize the gains or losses that result from the changes in the value of our derivative instruments related to corn in cost of goods sold as the changes occur.  As corn prices fluctuate, the value of our derivative instruments are impacted, which affects our financial performance.  We anticipate continued volatility in our cost of goods sold due to the timing of the changes in value of the derivative instruments relative to the cost and use of the commodity being hedged. 
Operating Expense
Operating expenses include wages, salaries and benefits of administrative employees at the plant, insurance, professional fees and similar costs. Operating expenses as a percentage of revenues held steady at 2.0% of revenues for our fiscal year ended October 31, 2013 compared to 2.0% of revenues for our fiscal year ended October 31, 2014. We continue to focus on increasing our operating efficiency as we strive to lower our operating expenses. We expect that going forward our operating expenses will remain relatively steady.
Operating Income
Our income from operations for our fiscal year ended October 31, 2014 was 17.3% of our revenues compared to income of 3.0% of our revenues for our fiscal year ended October 31, 2013. For our fiscal year ended October 31, 2014, we reported operating income of $25,898,588 and for our fiscal year ended October 31, 2013, we had operating income of $5,013,134. This increase from period to period resulted from increased production and the improvement of our net margin between the price we received for ethanol and the cost of corn and natural gas used in manufacturing.
Other Income (Expense), Net
We had total other expense, net for our fiscal year ended October 31, 2014 of $1,571,070 compared to total other expense, net of $2,745,274 for our fiscal year ended October 31, 2013. This decrease is primarily due to a decrease in interest expense during our fiscal year ended October 31, 2014 compared to the same period of 2013 due to decreased borrowings on our credit facilities. Additionally, our other income, net increased to $93,279 of income for our fiscal year ended October 31, 2014 to $17,335 of expense for our fiscal year ended October 31, 2013.

37


Changes in Financial Condition for the Fiscal Year Ended October 31, 2014 and 2013

The following table highlights the changes in our financial condition for the fiscal year ended ended October 31, 2014 from our previous fiscal year ended October 31, 2013:

 
October 31, 2014
 
October 31, 2013
Current Assets
$
10,896,702

 
$
7,849,244

Total Assets
$
66,122,250

 
$
60,793,917

Current Liabilities
$
8,109,395

 
$
5,061,910

Long-Term Debt
$
2,112,412

 
$
28,181,155

Members' Equity attributable to Heron Lake BioEnergy, LLC
$
55,047,120

 
$
27,142,275

Noncontrolling Interest
$
853,323

 
$
408,577


Total assets were approximately $66.1 million at October 31, 2014 compared to approximately $60.8 million at October 31, 2013.
Current assets totaled $10.9 million at October 31, 2014, which is more than our current assets as of October 31, 2013 which totaled approximately $7.8 million. The increase is primarily due to a significant increase accounts receivable, as well in increases in restricted cash and derivative instruments. These increases were offset slightly by a decrease in inventory. Trade accounts receivable increased because we were awaiting payment for a larger quantity of our products at October 31, 2014 compared to October 31, 2013 due to our change of ethanol marketers from Gavilon, LLC to Eco-Energy, LLC in November 2013. 
Also contributing to our increase in total assets was an increase in our property, plant and equipment. Property, plant and equipment, less accumulated depreciation, totaled $54.4 million at October 31, 2014, which is more than our property, plant and equipment, less accumulated depreciation, as of October 31, 2013, which totaled approximately $51.7 million. The increase is due to an increase of approximately $5.2 million of construction in progress at October 31, 2014 as compared to October 31, 2013 which is primarily attributable to an increase in Agrinatural's pipeline construction in progress at October 31, 2014.
Total current liabilities increased approximately $3.1 million and totaled approximately $8.1 million at October 31, 2014 as compared to total current liabilities of approximately $5.1 million at October 31, 2013. This increase was primarily due to an increase in our accounts payable to approximately $7.0 million at October 31, 2014 as compared to approximately $1.3 million at October 31, 2013, which was partially offset by a decrease in the current portion of our long-term debt from approximately $3.4 million at October 31, 2013 to approximately $0.8 million at October 31, 2014. The increase in our accounts payable is due to the termination of our corn supply agreement with Gavilon, our former procurement contractor and an increase in Agrinatural's accounts payables for pipeline construction in progress. Since terminating the corn supply agreement, we buy our own corn and are no longer netting corn purchases with sales of ethanol and distillers' grain. The decrease in the current liability of our long-term debt was a result of the redemption of our subordinated convertible debt effective July 1, 2014.
Long-term debt totaled approximately $2.1 million at October 31, 2014 which is significantly less than our long-term debt as of October 31, 2013 which totaled approximately $28.2 million. The decrease is due to payments on our AgStar debt facilities and the conversion and redemption of the subordinated convertible debt as discussed above.
Members’ equity attributable to Heron Lake BioEnergy, LLC totaled approximately $55.0 million at October 31, 2014 which is more than our Members’ equity attributable to Heron Lake BioEnergy, LLC as of October 31, 2013 which totaled $27.1 million. The increase was directly related to the net income attributable to Heron Lake BioEnergy, LLC of $24.0 million for the year ended October 31, 2014, along with the issuance of 13,120,000 Class A units in July 2014 as part of the subordinated debt conversion as discussed above. This issuance resulted in a $3.9 million increase in equity attributable to Heron Lake BioEnergy, LLC.
Noncontrolling interest totaled $853,323 at October 31, 2014 compared to $408,577 at October 31, 2013.  This is directly related to recognition of the 27.0% noncontrolling interest in Agrinatural, LLC.

38



Results of Operations for the Fiscal Years Ended October 31, 2013 and 2012
The following table shows the results of our operations and the percentage of revenues, cost of goods sold, operating expenses and other items to total revenues in our statements of operations for the fiscal year ended October 31, 2013 and 2012:
 
2013
 
2012
Income Statement Data
Amount
 
%
 
Amount
 
%
Revenues
$
163,764,144

 
100.0
 %
 
$
168,659,935

 
100.0
 %
Cost of Goods Sold
155,536,974

 
95.0
 %
 
166,529,283

 
98.7
 %
Gross Profit
8,227,170

 
5.0
 %
 
2,130,652

 
1.3
 %
Operating Expenses
(3,214,036
)
 
(2.0
)%
 
(3,171,331
)
 
(1.9
)%
Impairment Charge

 
 %
 
(27,844,579
)
 
(16.5
)%
Settlement Expense

 
 %
 
(900,000
)
 
(0.5
)%
Operating Income (Loss)
5,013,134

 
3.0
 %
 
(29,785,258
)
 
(17.6
)%
Other Expense
(2,745,274
)
 
(1.7
)%
 
(2,567,385
)
 
(1.5
)%
Net Income (Loss) before noncontrolling interest
2,267,860

 
1.3
 %
 
(32,352,643
)
 
(19.1
)%
Noncontrolling Income (Loss)
327,018

 
0.2
 %
 
353,019

 
0.2
 %
Net Income (Loss) attributable to Heron Lake BioEnergy, LLC
$
1,940,842

 
1.1
 %
 
$
(32,705,662
)
 
(19.3
)%
Revenues
Our revenues from operations come from three primary sources: sales of fuel ethanol, distillers' grains and corn oil. Additionally, we also realize relatively immaterial revenue from incidental sales of distillers' syrup and revenues generated from natural gas pipeline operations at Agrinatural Gas, LLC. These incidental syrup sales and revenues from our natural gas pipeline operations are aggregated together for revenue reporting purposes as "Other/Miscellaneous".
 The following table shows the sources of our revenue for the fiscal year ended October 31, 2013:
Revenue Sources
Amount
 
Percentage of
Total Revenues
Ethanol sales
$
125,541,065

 
76.6
%
Distillers' grains sales
32,575,616

 
19.9
%
Corn oil sales
4,033,942

 
2.5
%
Other/Miscellaneous
1,613,521

 
1.0
%
    Total Revenues
$
163,764,144

 
100.0
%
The following table shows the sources of our revenue for the fiscal year ended October 31, 2012:
Revenue Sources
Amount
 
Percentage of
Total Revenues
Ethanol sales
$
128,238,656

 
76.0
%
Distillers' grains sales
32,599,978

 
19.3
%
Corn oil sales
2,658,853

 
1.6
%
Other/Miscellaneous
5,162,448

 
3.1
%
    Total Revenues
$
168,659,935

 
100.0
%
We experienced a 2.9% decrease in our revenues for our 2013 fiscal year compared to our 2012 fiscal year. Management attributes this decrease in revenues primarily to an decrease in the quantities of products sold in 2013 due to decreased production fiscal year 2013.

39


Ethanol
The average price we received for our ethanol was slightly higher during our 2013 fiscal year compared to our 2012 fiscal year. Our average price per gallon of ethanol sold was $2.27 in 2013 and $2.20 in 2012. However, this increase in price was offset by a 4.9% decrease in the number of gallons sold in our fiscal year ended October 31, 2013 compared to the our fiscal year ended October 31, 2012. Management attributes this increase in ethanol prices with increased commodity prices, particularly during our first three quarters of 2013.
Distillers' Grains
Distillers' grains represent a slightly smaller portion of our revenues during our 2013 fiscal year compared to our 2012 fiscal year as a result of higher prices but smaller quantities of distillers' grains sold. The price we received for our distillers' grains in our 2013 fiscal year was approximately 8.1% higher than the price we received during our 2012 fiscal year. Management believes these higher distillers' grains prices are a result of the high price of other feed products available to livestock producers during much of our 2013 fiscal year. Offsetting this increase was a decrease of approximately 7.5% in the quantity of distillers' grains sold during our 2013 fiscal year compared to our 2012 fiscal year.
Corn Oil
Corn oil separation began in February 2012. Total sales of corn oil during fiscal years 2013 and 2012 was $4,033,942 and $2,658,853, respectively.
Cost of Sales
We experienced an decrease in our cost of goods sold for our 2013 fiscal year compared to our 2012 fiscal year. Our cost of goods sold decreased to approximately $155.5 million for our fiscal year ended October 31, 2013 from approximately $166.5 million in our fiscal year ended October 31, 2012. Our costs of goods sold as a percentage of revenues were 95.0% for our fiscal year ended October 31, 2013 compared to 98.7% for the same period of 2012.
Corn Costs
We experienced an decrease of approximately 7.0% in the total amount we paid for corn for our 2013 fiscal year compared to our 2012 fiscal year. This was the net result of a 5.2% decrease in the quantity of bushels we purchased, coupled with a 1.9% decrease in our per bushel cost. A tight corn supply following the 2012 harvest put upward pressure on corn prices throughout much of our 2012 fiscal year. However, the record 2013 corn harvest eased prices substantially in 2013.
Natural Gas Costs
For our 2013 fiscal year, we experienced an decrease of approximately 11.9% in our overall natural gas costs compared to our 2012 fiscal year.
Hedging and Volatility of Purchases
We did not have any realized and unrealized gains and losses related to our corn derivative instruments for our 2013 fiscal year compared to a gain of approximately $1.1 million which decreased our cost of goods sold for our 2012 fiscal year.  We recognize the gains or losses that result from the changes in the value of our derivative instruments related to corn in cost of goods sold as the changes occur.  As corn prices fluctuate, the value of our derivative instruments are impacted, which affects our financial performance.  We anticipate continued volatility in our cost of goods sold due to the timing of the changes in value of the derivative instruments relative to the cost and use of the commodity being hedged. 
Operating Expense
Operating expenses as a percentage of revenues increased slightly from 1.9% of revenues for our fiscal year ended October 31, 2012 to 2.0% of revenues for our fiscal year ended October 31, 2013.
Operating Income
Our income from operations for our fiscal year ended October 31, 2013 was 3.0% of our revenues compared to loss of 17.6% of our revenues for our fiscal year ended October 31, 2012. For our fiscal year ended October 31, 2013, we reported operating income of approximately $5.0 million and for our fiscal year ended October 31, 2012, we had an operating loss of a approximately $29.8 million due to an impairment charge of approximately $27.8 million and settlement expense of approximately $900,000 during fiscal year 2012.

40


Other Income (Expense), Net
We had total other expense, net for our fiscal year ended October 31, 2013 of approximately $2.7 million compared to total other expense, net of approximately $2.6 million for our fiscal year ended October 31, 2012. We had an increase in interest expense during our fiscal year ended October 31, 2013 compared to the same period of 2012 due to increased borrowings on our credit facilities. Additionally, our other income, net decreased from approximately $17,000 of income for our fiscal year ended October 31, 2012 to approximately $11,000 of expense for our fiscal year ended October 31, 2013.
Changes in Financial Condition for the Fiscal Year Ended October 31, 2013 and 2012
The following table highlights the changes in our financial condition for the fiscal year ended ended October 31, 2013 from our previous fiscal year ended October 31, 2012:
 
October 31, 2013
 
October 31, 2012
Current Assets
$
7,849,244

 
$
7,538,782

Total Assets
$
60,793,917

 
$
66,581,019

Current Liabilities
$
5,061,910

 
$
45,000,237

Long-Term Debt
$
28,181,155

 
$
4,031,335

Members' Equity attributable to Heron Lake BioEnergy, LLC
$
27,142,275

 
$
17,344,433

Noncontrolling Interest
$
408,577

 
$
205,014

Total assets were approximately $60.8 million at October 31, 2013, a decrease of approximately $5.8 million compared to approximately $66.6 million at October 31, 2012.
Current assets totaled approximately $7.8 million at October 31, 2013, which was slightly more than our current assets as of October 31, 2012 which totaled approximately $7.5 million. The increase was primarily due to an increase in cash and prepaid expenses and other current assets, offset slightly by a decrease in accounts receivable.
Total current liabilities decreased to approximately $5.1 million at October 31, 2013 as compared to approximately $45.0 million at October 31, 2012. This decrease was primarily the result reclassification of our debt facilities with AgStar to to long-term debt during fiscal 2013.
Long-term debt totaled approximately $28.2 million at October 31, 2013 which was more than our long-term debt as of October 31, 2012 which totaled approximately $4.0 million due to the reclassification of our debt facilities with AgStar to long-term debt as described above.
Members’ equity attributable to Heron Lake BioEnergy, LLC totaled $27,142,275 at October 31, 2013 as compared to October 31, 2012 which totaled $17,344,433. The increase was related to the net income attributable to Heron Lake BioEnergy, LLC of approximately $1.9 million for the year ended October 31, 2013 and the issuance of 11,190,000 Class A units and 15,000,000 Class B units, resulting in net proceeds of approximately $7.9 million.
Noncontrolling interest totaled $408,577 at October 31, 2013 compared to $205,014 at October 31, 2012.  This increase is directly related to recognition of the 27.0% noncontrolling interest in Agrinatural, LLC.

41



Liquidity and Capital Resources
Year Ended October 31, 2014 Compared to Year Ended October 31, 2013
Our principal uses of cash are to pay operating expenses of the plant and to make debt service payments.
The following table summarizes our sources and uses of cash and equivalents from our consolidated statements of cash flows for the periods presented:
 
Year Ended October 31
 
2014
 
2013
Net cash provided by operating activities
$
28,319,812

 
$
3,957,770

Net cash provided by (used in) investing activities
$
(3,544,389
)
 
$
2,811,649

Net cash used in financing activities
$
(24,656,533
)
 
$
(6,879,542
)
Net increase (decrease) in cash and equivalents
$
118,890

 
$
(110,123
)
Operating Cash Flows
During the fiscal year ended October 31, 2014, we had net cash provided by operating activities of approximately $28.3 million compared to approximately $4.0 million during the fiscal year ended October 31, 2013. This difference is primarily due generating income of $24.3 million during fiscal year 2014 compared to approximately $2.3 million during fiscal year 2013. Currently, our capital needs are being adequately met through cash flows from our operating activities and our currently available credit facilities.
Investing Cash Flows
During the fiscal year ended October 31, 2014, investing activities used approximately $3.5 million for capital expenditures. During the same period of 2013, we received proceeds of $3.7 million primarily attributable to the sale by our subsidiary, Lakefield Farmers Elevator, LLC, of grain facilities at Lakefield and Wilder, Minnesota, which was offset by approximately $0.9 million of capital expenditures.
Financing Cash Flows
During the fiscal year ended October 31, 2014, we used approximately $24.7 million from financing activities consisting primarily of payments on our long term debt and line of credit of approximately $24.4 million and payments on the convertible subordinated debt of $207,000. During the fiscal year ended October 31, 2013, we used approximately $6.9 million for financing activities consisting primarily of payments on our long term debt of approximately $19.5 million. Offsetting cash sources from financing activities for fiscal year 2013 included issuances of member units and convertible subordinated debt.
Year Ended October 31, 2013 Compared to Year Ended October 31, 2012
The following table summarizes our sources and uses of cash and equivalents from our consolidated statements of cash flows for the periods presented :
 
Year Ended October 31
 
2013
 
2012
Net cash provided by operating activities
$
3,957,770

 
$
397,708

Net cash provided by (used in) investing activities
$
2,811,649

 
$
(1,560,616
)
Net cash used in financing activities
$
(6,879,542
)
 
$
(5,324,304
)
Net decrease in cash and equivalents
$
(110,123
)
 
$
(6,487,212
)
During the fiscal year ended October 31, 2013, we received approximately $4.0 million in cash for operating activities. This consists primarily of generating a net income of $2.3 million plus non-cash expenses and charges including depreciation and amortization expense, and net cash uses for changes in other current assets and liabilities. During the fiscal year ended October 31, 2012, we received $0.4 million in cash for operating activities. This consists primarily of generating net loss of $32.4 million plus non-cash expenses including depreciation and amortization of $5.7 million , an impairment charge of $27.8 million, and reductions in inventory and accounts receivable.

42


During the fiscal year ended October 31, 2013, we had proceeds approximately $2.8 million from investing activities primarily attributable to the sale by our subsidiary, Lakefield Farmers Elevator, LLC, of grain facilities at Lakefield and Wilder, Minnesota. During the fiscal year ended October 31, 2012, we used approximately $1.6 million for investing activities, primarily to pay for capital expenditures which included costs for the conversion of our plant from coal to natural gas.
During the fiscal year ended October 31, 2013, we used approximately $6.9 million from financing activities consisting primarily of payments on our long term debt of approximately $19.5 million. Offsetting cash sources from financing activities included approximately $5.1 million of proceeds from the issuance of convertible debt and approximately $6.9 million for the issuance of Class A units. During the fiscal year ended October 31, 2012, we used approximately $5.3 million from financing activities, consisting primarily of payments on our term note of approximately $6.9 million.
Contractual Obligations
The following table provides information regarding the consolidated contractual obligations of the Company as of October 31, 2014:
 
Total
 
Less than
One Year
 
One to
Three Years
 
Four to
Five Years
 
Greater Than
Five Years
Long-term debt obligations(1)
$
3,606,661

 
$
1,001,002

 
$
1,047,364

 
$
818,006

 
$
740,289

Operating lease obligations (2)
5,273,250

 
2,133,300

 
3,139,950

 

 

Purchase obligations (3)
3,317,166

 
3,317,166

 

 

 

Total contractual obligations
$
12,197,077

 
$
6,451,468

 
$
4,187,314

 
$
818,006

 
$
740,289

_______________________________________________________________________________
(1)
Long-term debt obligations include estimated interest and interest on unused debt.
(2)
The operating lease obligations in the table above include our rail car leases.
(3)
Purchase obligations consist of forward contracted corn deliveries and forward contracted natural gas purchases.
Off Balance-Sheet Arrangements
We have no off balance-sheet arrangements.

43



Credit Arrangements
Credit Arrangements with AgStar
On July 29, 2014, we entered into a new comprehensive credit facility with AgStar Financial Services, FCLA (“AgStar”).  The new comprehensive credit facility consists of a $28 million term revolving loan with a maturity date of March 1, 2022.  In exchange for this new comprehensive credit facility, we executed a mortgage in favor of AgStar covering all of our real property and granted AgStar a security interest in all of our equipment and other assets.  Our new credit facility with AgStar is subject to numerous covenants requiring us to maintain various financial ratios. 
At the time we executed the new credit facility with AgStar, we repaid the entire outstanding balance of our prior credit facilities with AgStar.  Our credit facilities with AgStar prior to the payoff included our term note and a revolving term note.  At the loan closing, we paid off the $7.5 million balance of the revolving term note. There was no outstanding balance on the prior AgStar term note at loan closing.  AgStar canceled its prior mortgage and security interest in all of our assets.  We currently have no further obligations under our prior AgStar credit facilities. For additional information related to the repayment of the term note and a revolving term note under our prior AgStar master loan agreement, see Note 7 included herein as part of the Notes to the Consolidated Financial Statements.
Revolving Term Note
We have a total of $28 million available under the new revolving term loan with AgStar.  Interest on this loan accrues at 3.25% above the One-Month London Interbank Offered Rate (LIBOR) Index rate.  The interest rate is subject to weekly adjustment.  We 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 maximum principal amount of this loan decreases by $3.5 million annually starting on March 1, 2015 and continuing thereafter until maturity.  In the event any amount is outstanding on this loan in excess of the new credit limit, we agreed to repay principal on the loan until we reach the new credit limit.  We agreed to pay an annual fee of 0.5% of the unused portion of this loan.  The revolving term loan is subject to a prepayment fee for any prepayment on the Term Loan prior to July 1, 2016 due to refinancing. As of October 31, 2014, we had no balance outstanding on this loan.
For additional information related to the the revolving term note, see Note 7 included herein as part of the Notes to the Consolidated Financial Statements.
Administrative Agency Agreement  
As part of the Credit Facility closing, we entered into an Administrative Agency Agreement with CoBank, ACP (“CoBank”). CoBank purchased a participation interest in the AgStar loan and was appointed the administrative agent for the purpose of servicing the loans.
Subordinated Convertible Debt
On September 18, 2013, we entered into an indenture with U.S. Bank National Association (“U.S. Bank”), as trustee and collateral agent, in connection with the closing of our offering of a maximum of $12 million aggregate principal amount of 7.25% Secured Subordinated Notes due 2018 (the “Notes”). On September 18, 2013, we sold an aggregate principal amount of approximately $2.8 million of the Notes. Additionally, subscribers from our prior interim subordinated notes offering holding an aggregate principal amount of approximately $1.3 million of our interim subordinated notes elected to exchange their notes for Notes under the indenture, per the original terms of the interim subordinated notes, resulting in an aggregate principal amount of approximately $4.1 million in Notes. The Notes were subordinated secured obligations, with interest payable on April 1 and October 1 of each year, beginning April 1, 2014, through the maturity date of October 1, 2018 at a rate of 7.25% per annum. The Notes were secured by a second mortgage and lien position on, among other assets, our property, plant and equipment located in Heron Lake, Minnesota, which mortgage and lien position are junior to and subordinated to our senior debt with AgStar.
On May 2, 2014, we issued a notice to U.S. Bank that we intended to redeem all of the outstanding 7.25% Secured Subordinated Notes due 2018 (the “Notes”) on July 1, 2014. The announced redemption was pursuant to the Company's "optional redemption" right in the indenture governing the notes. A notice of the redemption was mailed to Note holders by the trustee on May 23, 2014. The outstanding principal balance of $4.1 million would be redeemed at a redemption price equal to 100% of the aggregate principal amount plus accrued and unpaid interest to interest to, but excluding, the redemption date. The Company's obligation to pay the redemption price on the redemption date was subject to the right of the holders of the notes to elect to convert the principal amount of their Notes into capital units of the Company at a conversion rate of $0.30 per unit.

44


As of the close of business on June 20, 2014, the last day to elect conversion, note holders holding an aggregate principal amount of approximately $3.9 million of Notes elected to convert their Notes into units of the Company. On July 1, 2014, the Company issued 13,120,000 Class A units of the Company to the holders of the Notes electing conversion and redeemed the remaining $207,000 of the Notes at par value. In addition, on the same day, the Company paid accrued and unpaid interest through July 1, 2014 to all note holders, including those electing conversion, per the terms of the Notes and the Indenture. Following the issuance of the Class A units described above, 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.
Other Credit Arrangements
In addition to our primary credit arrangement with AgStar and our subordinated convertible debt, we have other material credit arrangements and debt obligations.
In October 2003, we entered into an industrial water supply development and distribution agreement with the City of Heron Lake, Jackson County, and Minnesota Soybean Processors, an unrelated company. In consideration of this agreement, we and Minnesota Soybean Processors are allocated equally the debt service on $735,000 in water revenue bonds that were issued by the City to support this project that mature in February 2019. The parties have agreed that prior to the scheduled expiration of the agreement, they will negotiate in good faith to replace the agreement with a further agreement regarding the wells and related facilities. In May 2006, we entered into an industrial water supply treatment agreement with the City of Heron Lake and Jackson County. Under this agreement, we pay monthly installments over 24 months starting January 1, 2007 equal to one years' debt service on approximately $3.6 million in water revenue bonds, which will be returned to us if any funds remain after final payment in full on the bonds and assuming we comply with all payment obligations under the agreement. As of October 31, 2014 and 2013, there was a total of $2,292,913 and $2,604,678 in outstanding water revenue bonds, respectively. We classify our obligations under these bonds as assessments payable. The interest rates on the bonds range from 0.50% to 8.73%.
To fund the purchase of the distribution system and substation for the plant, we entered into a loan agreement with Federated Rural Electric Association pursuant to which we borrowed $600,000 by a secured promissory note. Under the note we are required to make monthly payments to Federated Rural Electric Association of $6,250 consisting of principal and an annual maintenance fee of 1% beginning on October 10, 2009. In exchange for this loan, Federated Rural Electric Association was granted a security interest in the distribution system and substation for the plant. The balances of this loan at October 31, 2014 and 2013 were $218,750 and $293,750, respectively.
We had a note payable in connection with the construction of our pipeline assets. This loan was initially due in December 2011, but was converted in February 2012 to a term loan with a three-year repayment period. The note was paid off in full on July 29, 2014 by Agrinatural using funds loaned to Agrinatural by the Company described below.
We financed our corn oil separation equipment from the equipment vendor. We pay approximately $40,000 per month on this debt, conditioned upon revenue generated from the corn oil separation equipment. The monthly payment includes implicit interest of 5.57% until maturity in May 2015. The note is secured by the corn oil separation equipment. The balance of this loan at October 31, 2014 and 2013 was $146,984 and $640,653, respectively.
We also have a note payable to the minority owner of Agrinatural Gas, LLC in the amount of $300,000 at October 31, 2014 and 2013. Interest on the note is One-Month LIBOR rate plus 4.0% and the note is due on demand.
Loans to Agrinatural
Loan from the Company
On July 29, 2014, the Company entered into an intercompany loan agreement and related loan documents with Agrinatural. Under the loan agreement, the Company agreed to make a five-year term loan in the principal amount of $3.05 million to Agrinatural for use by Agrinatural to repay approximately $1.4 million of its outstanding debt and provide approximately $1.6 million of working capital to Agrinatural. Interest on the term loan accrues at a variable rate equal to the One-Month LIBOR rate plus 4.0%, with the interest rate capped and not to exceed 6.0% per annum.  The interest rate is subject to weekly adjustment.  Prior to January 1, 2015, Agrinatural is required to pay only monthly interest on the term loan.  Commencing January 1, 2015, Agrinatural is required to make monthly installments of principal plus accrued interest. The entire principal balance and accrued and unpaid interest on the term loan is due and payable in full on December 1, 2019. 

45


In exchange for the Loan Agreement, the Agrinatural executed a Security Agreement granting the Company a first lien security interest in all of Agrinatural's equipment and assets and a Collateral Assignment assigning the Company all of Agrinatural's interests in its contracts, leases, easements and other agreements. In addition, Rural Energy Solutions, LLC, the minority owner of Agrinatural, executed a guarantee under which RES guaranteed full payment and performance of 27% of Agrinatural's obligations to the Company.
Loan from Granite Falls Energy
Agrinatural was loaned $500,000 from Granite Falls Energy, LLC, which owns approximately 50.6% of our outstanding membership units, during July 2014. The demand promissory note accrued interest at 5.29% and payment was due in full on or before July 31, 2014. Agrinatural paid the balance full, including accrued interest, on July 29, 2014.
ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to the impact of market fluctuations associated commodity prices as discussed below. We have no exposure to interest rate risk as we had no amount outstanding on our variable interest loan at the end of our 2014 fiscal year and we have no exposure to foreign currency risk as all of our business is conducted in United States Dollars. We use derivative financial instruments as part of an overall strategy to manage market risk. We use cash, futures and option contracts to hedge changes to the commodity prices of corn, ethanol, 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 pursuant to the requirements of FASB ASC 815, Derivatives and Hedging.
Commodity Price Risk
We seek to minimize the risks from fluctuations in the prices of raw material inputs, such as corn and natural gas, and finished products, such as ethanol and distillers' grains, through the use of hedging instruments. In practice, as markets move, we actively manage our risk and adjust hedging strategies as appropriate. Although we believe our hedge positions accomplish an economic hedge against our future purchases and sales, management has chosen not to use hedge accounting, which would match the gain or loss on our hedge positions to the specific commodity purchase being hedged. We are using fair value accounting for our hedge positions, which means as the current market price of our hedge positions changes, the realized or unrealized gains and losses are immediately recognized in our cost of goods sold or as an offset to revenues. The immediate recognition of hedging gains and losses under fair value accounting can cause net income 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 October 31, 2014, we had price protection in place for approximately 20% of our anticipated corn needs, approximately 20% of our natural gas needs and 23% of our ethanol sales for the next 12 months. Through these contracts we hope to minimize risk from future market price fluctuations and basis fluctuations. As input 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, 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 fair value of our corn and natural gas prices and average ethanol price as of October 31, 2014, 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 October 31, 2014. The results of this analysis, which may differ from actual results, are 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
10/31/2014
 
Approximate
Adverse
Change to
Income
Ethanol
44,620,000

 
Gallons
 
10
%
 
$
7,719,000

Corn
16,600,000

 
Bushels
 
10
%
 
$
5,843,000

Natural Gas
1,300,000

 
MMBTU
 
10
%
 
$
659,000


46



ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Audit Committee and Board of Directors
Heron Lake BioEnergy, LLC
Heron Lake, Minnesota

We have audited the accompanying consolidated balance sheets of Heron Lake BioEnergy, LLC as of October 31, 2014 and 2013, and the related consolidated statements of operations, changes in members’ equity, and cash flows for each of the years in the three-year period ended October 31, 2014. Heron Lake BioEnergy, LLC’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Heron Lake BioEnergy, LLC as of October 31, 2014 and 2013, and the results of its operations and its cash flows for each of the years in the three-year period ended October 31, 2014 in conformity with accounting principles generally accepted in the United States of America.



/s/ Boulay PLLP
Certified Public Accountants

Minneapolis, Minnesota
January 28, 2015

47


HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Consolidated Balance Sheets

 
October 31, 2014
 
October 31, 2013
ASSETS
 
 
 
Current Assets
 
 
 
Cash
$
662,128

 
$
543,238

Restricted cash
264,086

 

Accounts receivable
4,055,981

 
749,426

Inventory
5,187,267

 
5,604,309

Commodity derivative instruments
437,500

 

Prepaid expenses and other current assets
289,740

 
952,271

Total current assets
10,896,702

 
7,849,244

 
 
 
 
Property, Plant and Equipment
 
 
 
Land and improvements
9,111,838

 
9,111,838

Plant buildings and equipment
73,080,366

 
71,275,334

Vehicles and other equipment
611,976

 
611,976

Office buildings and equipment
613,407

 
612,151

Construction in progress
6,559,517

 
1,394,191

 
89,977,104

 
83,005,490

Less accumulated depreciation
(35,609,106
)
 
(31,335,218
)
Net property, plant and equipment
54,367,998

 
51,670,272

 
 
 
 
Other Assets
 
 
 
Other intangible assets, net
160,296

 
218,370

Other assets
697,254

 
1,056,031

Total other assets
857,550

 
1,274,401

 
 
 
 
Total Assets
$
66,122,250

 
$
60,793,917

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


48


HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Consolidated Balance Sheets

 
October 31, 2014
 
October 31, 2013
LIABILITIES AND MEMBERS' EQUITY
 
 
 
 
 
 
 
Current Liabilities
 
 
 
Current portion of long-term debt
$
846,235

 
$
3,371,575

Accounts payable
7,047,544

 
1,300,727

Accrued liabilities
215,616

 
389,608

Total current liabilities
8,109,395

 
5,061,910

 
 
 
 
Long-Term Debt, less current portion
2,112,412

 
28,181,155

 
 
 
 
Commitments and Contingencies

 

 
 
 
 
Members' Equity
 
 
 
Members' equity attributable to Heron Lake BioEnergy, LLC consists of:
 
 
 
77,932,107 and 64,812,107 multiple classes of units authorized, issued and outstanding at October 31, 2014 and 2013, respectively
55,047,120

 
27,142,275

Noncontrolling interest
853,323

 
408,577

Total members' equity
55,900,443

 
27,550,852

 
 
 
 
Total Liabilities and Members' Equity
$
66,122,250

 
$
60,793,917


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

49


HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Consolidated Statements of Operations

 
Fiscal Year Ended 
 October 31, 2014
 
Fiscal Year Ended 
 October 31, 2013
 
Fiscal Year Ended 
 October 31, 2012
Revenues
$
149,418,044

 
$
163,764,144

 
$
168,659,935

 
 
 
 
 
 
Cost of Goods Sold
120,569,409

 
155,536,974

 
166,529,283

 
 
 
 
 
 
Gross Profit
28,848,635

 
8,227,170

 
2,130,652

 
 
 
 
 
 
Operating Expenses
2,950,047

 
3,214,036

 
3,171,331

Impairment Charge

 

 
27,844,579

Settlement Expense

 

 
900,000

 
 
 
 
 
 
Operating Income (Loss)
25,898,588

 
5,013,134

 
(29,785,258
)
 
 
 
 
 
 
Other Income (Expense)
 
 
 
 
 
Interest income
658

 
17,335

 
10,773

Interest expense
(1,665,007
)
 
(2,789,373
)
 
(2,625,322
)
Other income
93,279

 
26,764

 
47,164

Total other expense, net
(1,571,070
)
 
(2,745,274
)
 
(2,567,385
)
 
 
 
 
 
 
Net Income (Loss)
24,327,518

 
2,267,860

 
(32,352,643
)
 
 
 
 
 
 
Net Income (Loss) Attributable to Noncontrolling Interest
358,673

 
327,018

 
353,019

 
 
 
 
 
 
Net Income (Loss) Attributable to Heron Lake BioEnergy, LLC
$
23,968,845

 
$
1,940,842

 
$
(32,705,662
)
 
 
 
 
 
 
Weighted Average Units Outstanding—Basic
69,233,367

 
44,868,463

 
38,510,066

 
 
 
 
 
 
Net Income (Loss) Per Unit Attributed to Heron Lake BioEnergy, LLC—Basic (Class A and B)
$
0.35

 
$
0.04

 
$
(0.85
)
 
 
 
 
 
 
Weighted Average Units Outstanding—Diluted
78,389,586

 
48,086,445

 
38,510,066

 
 
 
 
 
 
Net Income (Loss) Per Unit Attributed to Heron Lake BioEnergy, LLC—Diluted (Class A and B)
$
0.31

 
$
0.04

 
$
(0.85
)
 
 
 
 
 
 
Notes to Consolidated Financial Statements are an integral part of this Statement.

50


HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Consolidated Statements of Changes in Members' Equity
 
Class A Units
 
Class B Units
 
Members' Equity attributable to
Heron Lake BioEnergy, LLC
 
Noncontrolling Interest
 
Total Members' Equity
 
 
 
 
 
 
 
 
 
 
Balance—October 31, 2011
37,208,074

 

 
$
49,508,122

 
$
(26,838
)
 
$
49,481,284

Capital issuance, net
1,414,033

 

 
541,973

 

 
541,973

Member distributions

 

 

 
(121,167
)
 
(121,167
)
Net income attributable to noncontrolling interest

 

 

 
353,019

 
353,019

Net income attributable to Heron Lake BioEnergy, LLC

 

 
(32,705,662
)
 

 
(32,705,662
)
 
 
 
 
 
 
 
 
 
 
Balance—October 31, 2012
38,622,107

 

 
17,344,433

 
205,014

 
17,549,447

 
 
 
 
 
 
 
 
 
 
Capital issuance, net
8,075,000

 
15,000,000

 
6,922,500

 

 
6,922,500

Conversion of subordinated convertible debt
3,115,000

 

 
934,500

 

 
934,500

Member distributions

 

 

 
(123,455
)
 
(123,455
)
Net income attributable to noncontrolling interest

 

 

 
327,018

 
327,018

Net income attributable to Heron Lake BioEnergy, LLC

 

 
1,940,842

 

 
1,940,842

 
 
 
 
 
 
 
 
 
 
Balance—October 31, 2013
49,812,107

 
15,000,000

 
27,142,275

 
408,577

 
27,550,852

 
 
 
 
 
 
 
 
 
 
Conversion of subordinated convertible debt
13,120,000

 

 
3,936,000

 

 
3,936,000

Cancellation of accrued distribution to noncontrolling interest

 

 

 
86,073

 
86,073

Net income attributable to noncontrolling interest

 

 

 
358,673

 
358,673

Net income attributable to Heron Lake BioEnergy, LLC

 

 
23,968,845

 

 
23,968,845

 
 
 
 
 
 
 
 
 
 
Balance—October 31, 2014
62,932,107

 
15,000,000

 
$
55,047,120

 
$
853,323

 
$
55,900,443


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

51


HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Consolidated Statements of Cash Flows

 
Fiscal Year Ended 
 October 31, 2014
 
Fiscal Year Ended 
 October 31, 2013
 
Fiscal Year Ended 
 October 31, 2012
Cash Flow From Operating Activities
 
 
 
 
 
Net income (loss)
$
24,327,518

 
$
2,267,860

 
$
(32,352,643
)
Adjustments to reconcile net income (loss) to net cash provided by operations:
 
 
 
 
 
Depreciation and amortization
4,321,961

 
4,282,523

 
5,693,459

Write-off of deferred loan cost included in interest expense
369,699

 

 

Gain on sale of asset
(58,000
)
 

 

Impairment charge

 

 
27,844,579

Change in fair value of commodity derivative instruments
(787,617
)
 

 

Change in operating assets and liabilities:          
 
 
 
 
 
Restricted cash
(264,086
)
 

 
103,697

Accounts receivable
(3,306,555
)
 
1,035,335

 
(406,541
)
Inventory
417,042

 
(2,015,737
)
 
176,044

Commodity derivative instruments
350,117

 

 

Prepaid expenses and other current assets
651,610

 
(155,442
)
 
117,396

Accounts payable
2,387,592

 
(1,390,905
)
 
(727,926
)
Accrued liabilities
(89,469
)
 
(65,864
)
 
(50,357
)
Net cash provided by operating activities
28,319,812

 
3,957,770

 
397,708

 
 
 
 
 
 
Cash Flows from Investing Activities
 
 
 
 
 
Payments for capital expenditures
(3,602,389
)
 
(917,020
)
 
(1,560,616
)
Proceeds from disposal of property and equipment
58,000

 
3,728,669

 

Net cash provided by (used in) investing activities
(3,544,389
)
 
2,811,649

 
(1,560,616
)
 
 
 
 
 
 
Cash Flows from Financing Activities
 
 
 
 
 
Proceeds from (payments on) line of credit

 
(480,000
)
 
480,000

Payments on long-term debt
(24,449,533
)
 
(19,493,936
)
 
(6,922,038
)
Proceeds from note payable

 
820,929

 
262,250

Issuance of (Payments on) convertible subordinated debt
(207,000
)
 
5,077,500

 

Issuance of member units

 
6,922,500

 
707,017

Deferred financing costs

 
(390,858
)
 

Release of restricted cash

 
715,259

 
257,630

Distributions to noncontrolling interest

 
(50,936
)
 
(109,163
)
Net cash used in financing activities
(24,656,533
)
 
(6,879,542
)
 
(5,324,304
)
Net Increase (Decrease) in cash
118,890

 
(110,123
)
 
(6,487,212
)
Cash—Beginning of period
543,238

 
653,361

 
7,140,573

Cash—End of period
$
662,128

 
$
543,238

 
$
653,361


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

52


HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Consolidated Statements of Cash Flows

 
Fiscal Year Ended 
 October 31, 2014
 
Fiscal Year Ended 
 October 31, 2013
 
Fiscal Year Ended 
 October 31, 2012
Supplemental Disclosure of Cash Flow Information
 
 
 
 
 
Cash paid during the period for:
 
 
 
 
 
Interest expense
$
1,340,260

 
$
2,961,259

 
$
2,642,087

 
 
 
 
 
 
Supplemental Disclosure of Non-Cash Investing, Operating and Financing Activities