UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
⌧ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended October 31, 2020.
Or
◻ 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 ◻ No ⌧
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 ◻ No ⌧
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 126-2 of the Act) Yes ◻ No ⌧
As of April 30, 2020, the aggregate market value of the 32,199,012 Class A units held by non-affiliates (computed by reference to the most recent offering price of Class A membership units) was approximately $9,659,704. 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 governors, 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.
As of April 30, 2020, 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 February 16, 2021, there were 62,932,107 Class A units and 15,000,000 Class B units outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the registrant’s definitive Proxy Statement for the registrant’s 2021 Annual Meeting of Members are incorporated by reference into Part III.
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; |
| ● | Ethanol may trade at a premium to gasoline at times, causing a disincentive for discretionary blending of ethanol beyond the requirements of the federal Renewable Fuels Standard (“RFS”) and resulting in a negative impact on ethanol prices and demand; |
| ● | 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 impairment of the transportation, storage and blending infrastructure that prevents ethanol from reaching markets; |
| ● | Changes in fuel consumption due to decreased vehicle travel as a result of the COVID-19 or other factors. |
| ● | Challenges created by the COVID-19 pandemic, including increased production costs, market barriers, and decreased demand for fuel. |
| ● | Any effect on prices of distillers’ grains resulting from actions in international markets; |
| ● | 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; |
| ● | Alternative fuel additives may be developed that are superior to, or cheaper than ethanol; |
| ● | 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; |
| ● | 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 delays in shipping our products by rail and corresponding decreases in our sales or production as a result of shipping delay and ethanol storage constraints; |
| ● | 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 U.S. 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 SEC 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.
When we use the terms “Heron Lake BioEnergy,” “Heron Lake,” or “HLBE” or similar words, unless the context otherwise requires, we are referring to Heron Lake BioEnergy, LLC and our operations at our ethanol production facility located near Heron Lake, Minnesota. When we use the terms the “Company,” “we,” “us,” “our” or similar words in this Annual Report on Form 10-K, unless the context otherwise requires, we are referring to Heron Lake BioEnergy and its wholly owned subsidiary, HLBE Pipeline Company, LLC, through which HLBE holds a 100% interest in Agrinatural Gas, LLC (“Agrinatural”).
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.
Overview
Heron Lake BioEnergy, LLC was 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 February 16, 2021, GFE owns approximately 31.4% of our outstanding Class A membership units and 100.0% of our outstanding Class B Units, for total ownership of approximately 50.7%. 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. 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. Our plant was originally constructed as a coal fired plant but was converted to natural gas in November 2011.
Our ethanol plant has a nameplate capacity of 50 million gallons per year. On July 10, 2015, the Minnesota Pollution Control Agency approved a major amendment to our air emission permit which increased our permitted production capacity from 59.9 million gallons to approximately 72.3 million gallons of undenatured fuel-grade ethanol on a twelve-month rolling sum basis. We are currently operating above our stated nameplate capacity at an annual rate of approximately 65 million gallons and intend to continue to take advantage of the additional production allowed pursuant to our permit as long as we believe it is profitable to do so.
In fiscal years 2020 and 2019, we sold approximately 48.2 million gallons and 65.5 million gallons of ethanol, respectively.
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Our wholly owned subsidiary, HLBE Pipeline Company, LLC, is the sole owner 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.
The Company, and the ethanol industry as a whole, experienced significant adverse conditions throughout 2019 and 2020 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels. These conditions were exacerbated by the COVID-19 pandemic and its ramifications. Due to the market risks and uncertainties related to the COVID-19 pandemic, the Company extended its regularly scheduled idle of ethanol production operations to cover the period beginning on or about March 30, 2020 through approximately May 31, 2020. In July 2020, the Company experienced major issues with its boiler, which negatively impacted production. The Company ordered a temporary boiler, which allowed operations to continue in August 2020 until January 2021, when the Company’s new boiler was placed in service. Market conditions, coupled with the idle of our plant, resulted in lower production, negative operating margins, significantly lower cash flow from operations and substantial net losses. As a result of these losses, we have realized two adverse consequences. First, as corn prices increased in January 2021, we received margin calls on our corn futures positions on the Chicago Board of Trade. Because we did not have the cash to pay those margin calls, we exited those futures positions, realized losses, and have become unprotected against future price increases. Second, as we incurred significant losses, our cash balance has decreased, our available working capital has decreased. We have fallen out of compliance with our working capital and local net worth covenants. As a result of these loan covenant violations and forecasted future instances of noncompliance with debt covenants within the next twelve months, the long-term portion of our bank term debt is reclassified as a current liability, further worsening our working capital challenges. If we continue to experience unfavorable operating conditions in the future, we will have to secure additional debt or equity sources for working capital and other purposes or further idle ethanol production altogether. Similarly, there is a risk that CoBank, as the administrative agent for our lender Compeer, may seek to enforce its security interests and take control of our assets. If that were to happen, we may be faced with the prospects of either ceasing operations or seeking Chapter 11 “reorganization” bankruptcy protection.
Reportable Operating Segments
Accounting Standards Codification (“ASC”) 280, “Segment Reporting,” establishes the standards for reporting information about segments in financial statements. Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Based on the related business nature and expected financial results criteria set forth in ASC 280, the Company has two reportable operating segments for financial reporting purposes.
| ● | Ethanol Production. Based on the nature of the products and production process and the expected financial results, the Company’s operations at its ethanol plant, including the production and sale of ethanol and its co-products, are aggregated into one financial reporting segment. |
| ● | Natural Gas Pipeline. The Company has majority ownership in Agrinatural, through its wholly owned subsidiary, HLBE Pipeline, LLC, and operations of Agrinatural’s natural gas pipeline are aggregated into another financial reporting segment. |
Before intercompany eliminations, revenues from our natural gas pipeline segment represented 3.2% and 3.0%, of our total consolidated revenues in the years ended October 31, 2020 and 2019, respectively. After accounting for intercompany eliminations for fees paid by the Company to Agrinatural for natural gas transportation services pursuant to our natural gas transportation agreement, Agrinatural’s revenues represented 1.9% and 1.3% of our consolidated revenues for the fiscal years ended October 31, 2020 and 2019, 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 16, “Business Segments,” of the notes to audited consolidated financial statements for financial information about our financial reporting segments.
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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 98.1% and 98.7% of our revenues in the years ended October 31, 2020 and 2019, 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, 2020.
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 2020 |
| Fiscal Year 2019 |
|
Ethanol |
| 76.7% | | 77.3% | |
Distillers' Grains |
| 16.7% | | 17.1% | |
Corn Oil |
| 3.8% | | 3.3% | |
Misc. Syrup Sales |
| 0.9% | | 1.0% | |
Ethanol
Ethanol is a type of alcohol produced in the U.S. principally from corn. Ethanol is ethyl alcohol, a fuel component made primarily from corn in the U.S. 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 U.S. 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 U.S. 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. Additionally, ethanol is available as E15 (15% ethanol and 85% gasoline), which is approved by the EPA for use in model year 2001 and newer cars, light-duty trucks, medium-duty passenger vehicles, and all flex-fuel vehicles.
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 and beef industries. 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 and modified/wet distillers’ grains. Modified/wet distillers’ grains are processed corn mash that has been dried to approximately 50% moisture and has a shelf life of approximately 7 days. Modified/wet distillers’ grains are often sold to nearby markets. Dried distillers’ grains with solubles are corn mash that has been dried to approximately 10% to 12% 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.
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Corn Oil
We also extract a portion of the crude corn oil contained in our distillers’ grains which we market separately from our distillers’ grains. The corn oil that we produce is not food grade corn oil and therefore cannot be used for human consumption. Corn oil is used primarily as a biodiesel feedstock and as a supplement for animal feed.
Corn Syrup
We also occasionally sell excess corn syrup in liquid syrup form to livestock feeders. The excess syrup results from a plant upset, or when the amount of syrup produced during the drying process exceeds our distillers’ grains’ dryer capacity. Corn syrup is used primarily 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, distillers’ grains and corn oil through professional third party marketers. Our marketers make all decisions with regard to where our products are marketed and we have little control over the marketing decisions they make.
Our ethanol, distillers’ grains and corn oil are primarily sold in the domestic market; however, as markets allow, our products can be, and have been, sold in the export markets. We expect our marketers to explore all markets for our products, including export markets. We believe that there is some potential for increased international sales of our products. Nevertheless, 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.
Ethanol Markets
The success of our sales efforts in the ethanol markets will depend primarily upon the efforts of Eco-Energy, Inc. (“Eco-Energy”), which buys and markets our ethanol. There are local, regional, national, and international markets for ethanol. The principal markets for our ethanol are petroleum terminals in the continental U.S. The principal purchasers of ethanol are generally wholesale gasoline distributors or blenders.
We believe that local markets will be limited and must typically be evaluated on a case-by-case basis. Although local markets may 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.
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 U.S. and the east and west coast regions.
We expect a majority of our ethanol to continue to be marketed and sold domestically. Over our past fiscal year, exports of ethanol have increased slightly, with Canada receiving the largest percentage of ethanol produced in the United States and Brazil in second place. India, Korea, Netherlands, Colombia, Mexico, and Philippines were also top destinations. Ethanol export demand is more unpredictable than domestic demand and tends to fluctuate over time as it is subject to monetary and political forces in other nations. For example, a strong U.S. dollar is a force that may negatively impact ethanol exports from the United States. Additionally, the imposition of tariffs and duties on ethanol imported from the United States, as well as increased production of ethanol and similar fuels in other countries, can also negatively impact domestic export demand.
Due to the ongoing COVID-19 pandemic demand for transportation fuels including the fuel ethanol we manufacture substantially decreased in 2020. Lockdowns, closures, and other social distancing measures imposed in response to the pandemic caused many individuals to work from home, forego travel, and otherwise reduce fuel consumption. Between March and November 2020, the ethanol industry experienced an estimated production decline of 2 billion gallons. Economists estimated the ethanol industry suffered $8 billion in losses in 2020 due, in large part, to the
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effects of the pandemic. We were not immune from these conditions and experienced decrease demand and high inventory levels of ethanol. In 2020, we experienced a 26.4% decrease in the volume of ethanol sold, year-over-year. We expect ethanol demand to increase in 2021, however there is no guarantee this will occur
Exports to China have been negligible during fiscal years 2020 and 2019. This is due to China’s increase of the tariff on ethanol imported from the U.S. to 45% as of April 2, 2018, compared to the previous 30% tariff imposed in 2017, and the subsequent increase of the 45% tariff to 70% as of July 6, 2018. It is unclear whether the tariffs will be reduced, if ever, and therefore, this tariff is likely to continue to have a negative impact on the export market demand and prices for ethanol produced in the United States.
On January 15, 2020, President Trump signed a “phase one” trade agreement with China. The agreement includes a commitment by China to purchase agricultural products over course of two years, including ethanol. While this agreement appeared positive for the industry, exports to China remained negligible during fiscal year 2020. There is no guarantee that the agreement will be fully implemented, nor is there a guarantee that exports to China return to pre-tariff levels. Joe Biden became the President on January 20, 2021. He is believed to be evaluating whether and how to continue various tariffs including those levied against certain Chinese imports to the United States. Although U.S. trade policy towards China may change, we cannot now predict whether or how China may consider changing its tariffs against our products.
In December 2020, Brazil’s import quota on imported ethanol expired. As a result, imports of U.S. ethanol are subject to a 20% tariff. Under the original, expired import quota, the 20% tariff on U.S. ethanol imports was levied only after the import level exceeded 150 million liters, or 39.6 million gallons per quarter. The import quota was initially set to expire in September 2019. In September 2019, Brazil raised the import quota to 187.5 million liters, or 49.5 million gallons, per quarter, before the imports become subject to the 20% tariff. U.S. exports to Brazil have decreased from our 2019 fiscal year to our 2020 fiscal year. The tariff has had and likely will continue to have a negative impact on the export market demand and prices for ethanol produced in the United States.
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.
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 U.S. ethanol industry exports a significant amount of dried distillers’ grains, which may increase as worldwide acceptance grows. According to the U.S. Grains Council, total U.S. distiller’s grains exports through October 2020 increased compared to distiller’s grains exports for the same period last year. Top export markets include Mexico, Vietnam, Korea, Indonesia, Turkey, Thailand, and the European Union and United Kingdom.
Historically, the United States ethanol industry exported a significant amount of distillers’ grains to China and Vietnam. However, during 2016, China began an anti-dumping and countervailing duty investigation related to distillers’ grains imported from the U.S. which contributed to a decline in distillers’ grains shipped to China during 2016. In January 2017, China issued final tariffs on U.S. distillers’ grains. The Chinese distillers’ grains anti-dumping tariffs range from 42.2% to 53.7% and the anti-subsidy tariffs range from 11.2% to 12%. The imposition of these duties resulted in a significant decline in demand from this top importer, requiring U.S. producers to seek out alternative markets. While exports to China increased during fiscal year 2020 compared to fiscal year 2019, exports to China remain substantially below the pre-tariff export levels. There is no guarantee that distillers’ grains exports to China will return to pre-tariff levels.
On January 15, 2020, President Trump signed a “phase one” trade agreement with China, which is to take effect within 30 days of its signing. The agreement includes a commitment by China to purchase agricultural products over the next two years, including distillers’ grains. The agreement will also provide U.S. manufacturers of DDGS with a streamlined process for registration and licensing in order to facilitate U.S. exports to China. While this agreement appears positive for the industry, there is no guarantee that the agreement will be fully implemented, nor is there a guarantee that exports to China return to pre-tariff levels.
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Additionally, exports of U.S. distillers’ grains to Vietnam had halted completely due to Vietnam’s imposition of stricter regulations in December 2016. In a statement issued September 1, 2017, the U.S. Grains Council announced that Vietnam is lifting its suspension of U.S. distillers’ grains imports and easing fumigation requirements. While exports to Vietnam have resumed, they remain substantially below the pre-2016 levels. There is no guarantee that distillers’ grains exports to Vietnam will return to such levels.
We also sell modified wet distillers’ grains, which typically have a shelf life of a maximum of 7 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’ grains, 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.
Ethanol Distribution
Eco-Energy is our ethanol marketer. Pursuant to our marketing agreement with Eco-Energy, it has agreed to purchase and market the entire ethanol output of our ethanol plant. Additionally, Eco-Energy arranges for the transportation of our ethanol. We pay Eco-Energy a marketing fee based on a percentage of the applicable sales price per gallon of ethanol sold, as well as a fixed lease fee for rail cars leased from Eco-Energy. The marketing fee was negotiated based on prevailing market-rate conditions for comparable ethanol marketing services.
The term of our agreement with Eco-Energy originally expired on December 31, 2020. The term of our agreement with Eco-Energy was automatically extended for one year, pursuant to a provision in the agreement which provides for automatic renewals for additional consecutive terms of one year unless either party provides written notice to the other at least 90 days prior to the end of the then-current term.
Distillers’ Grains Distribution
Gavilon Ingredients, LLC (“Gavilon”) 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. The contract commenced on November 1, 2013 with an initial term of six months, and will continue to remain in effect until terminated by either party at its unqualified option, by providing written notice of not less than 60 days to the other party.
Corn Oil Distribution
RPMG, Inc. (“RPMG”) 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.
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We independently market and sell the excess corn syrup occasionally produced from the distillation process at our plant to local livestock feeders.
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. Trends in ethanol prices and corn prices are subject to a number of factors and are difficult to predict.
The price and availability of corn is subject to significant fluctuations depending upon a number of factors that affect commodity prices in general, including crop conditions, yields, domestic and global stocks, weather, federal policy and foreign trade. With the volatility of the weather and commodity markets, we cannot predict the future price of corn. Historically, ethanol prices have tended to correlate with corn prices, as well as 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.
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. Corn prices have trended higher during December 2020 and January 2021, in part due to large purchases by China in the world and U.S. marketplaces. Because the market price of ethanol is not directly related to corn prices, we, like most ethanol producers, are not able to compensate for increases in the cost of corn through adjustments in our prices for our ethanol, although we do tend to see increases in the prices of our distillers’ grains during times of higher corn prices. Given that ethanol sales comprise a majority of our revenues, our inability to adjust our ethanol prices can result in a negative impact on our profitability during periods of high corn prices.
Ethanol prices were lower during fiscal year 2020 compared to fiscal year 2019. Ethanol prices were lower during the fiscal year ended October 31, 2020 due primarily to effects of the COVID-19 pandemic, which resulted in reduced demand and high inventory levels. Management expects additional volatility for the price of ethanol in 2021. According to EIA forecasts, ethanol production is projected to increase slightly in 2021, and demand is also expected to increase slightly. However, there is no guarantee that either of these forecasts will occur. While exports improved slightly in 2020, tariffs and international competition continued to adversely affect the export market, and there is no guarantee that the export market will improve in 2021. U.S. gas demand decreased significantly year over year in 2020, due primarily to the COVID-19 pandemic. Ethanol consumption is projected to increase slightly in 2021; however, there is no guarantee that this projection will be accurate. A continued or further decrease in demand for either gasoline or ethanol blends would adversely impact the price of ethanol, which could result in a material adverse effect on our business, results of operations and financial condition.
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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
Ethanol production requires substantial amounts of corn. The cost of corn represented approximately 71.2% and 74.0% of our cost of sales for the years ended October 31, 2020 and 2019, respectively. At our current production rate of approximately 65 million gallons of ethanol per year, we need to consume approximately 22.5 million bushels of corn per year for our dry mill ethanol process. We believe our facility has sufficient corn storage capacity, with the capability to store approximately 19 days of corn supply.
We generally purchase corn through spot cash, fixed-price forward, basis only, and futures only contracts. 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 (“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. We may also purchase a portion of our corn on a spot basis. For our spot purchases, we post daily corn bids so that corn producers can sell to us on a spot basis.
Typically, we purchase our corn directly from grain elevators, farmers, and local dealers within approximately 80 miles of Heron Lake, Minnesota. We compete with ethanol producers in close proximity for the supplies of corn we will require to operate our plant. There are 8 ethanol plants within an approximate 50 mile radius of 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. We also 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.
Since corn is the primary raw material we use to produce our products, the availability and cost of corn can have a significant impact on the profitability of our operations. Corn prices were slightly higher during our 2020 fiscal year due primarily to strong export demand during the 2020 period compared to the 2019 period. If we or the industry experience unfavorable conditions during our 2021 fiscal year, the price we pay for corn and the availability of corn near our plant could be negatively impacted. If we experience a localized shortage of corn, we may be forced to purchase corn from producers who are farther away from our ethanol plant which can increase our transportation costs. However, our currently limited supply of working capital has raised substantial doubt about our ability to purchase enough corn, hedge our corn price risk, profitably operate our ethanol plant, and remain a going concern. See Notes to Consolidated Financial Statements, Note 2, Going Concern.
Natural Gas Procurement
The primary source of energy in our manufacturing process is natural gas. The cost of natural gas represented approximately 5.7% and 6.3% of our cost of sales for the years ended October 31, 2020 and 2019, respectively.
We do not anticipate any problems securing the natural gas we require to continue to operate our plant at capacity during our 2021 fiscal year or beyond. We have a facilities agreement with Northern Border Pipeline Company, which allows us to access an existing interstate natural gas pipeline located approximately 16 miles north from our plant. We also have entered into a firm natural gas transportation agreement with our indirectly wholly owned subsidiary, Agrinatural. 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 a term which ended on October 31, 2020, but which was automatically renewed to extend the term an additional five years.
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 March 31, 2022.
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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 an agreement in place to supply electricity to our plant. Our plant obtains its electricity from Federal Rural Electric. We generally do not anticipate any problems securing the electricity that we require to continue to operate our plant at capacity during our 2021 fiscal year or beyond.
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. We generally do not anticipate any problems securing the water that we require to continue to operate our plant at capacity during our 2021 fiscal year or beyond.
Risk Management and Hedging
The profitability of our operations is highly dependent on the impact of market fluctuations associated with commodity prices. We use various derivative instruments as part of an overall strategy to manage market risk and to reduce the risk that our ethanol production will become unprofitable when market prices among our principal commodities and products do not correlate.
In order to mitigate our commodity and product price risks, we enter into hedging transactions, including forward corn, ethanol, distillers’ grains and natural gas contracts, in an attempt to partially offset the effects of price volatility for corn and ethanol. 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. We also enter into over-the-counter and exchange-traded futures, swaps and option contracts for corn, ethanol and distillers’ grains, designed to limit our exposure to increases in the price of corn and manage ethanol price fluctuations. Because of our reduced amount of working capital, we terminated our corn price risk hedging contracts in January 2021. We presently have no significant hedging contracts or price risk protection in place to protect us against material changes in corn prices.
Although we believe that our hedging strategies can reduce the risk of price fluctuations, the financial statement impact of these activities depends upon, among other things, the prices involved and our ability to physically receive or deliver the commodities involved. Our hedging activities could 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 corn and ethanol 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.
Hedging arrangements expose us to the risk of financial loss in situations where the counterparty to the hedging contract defaults or, in the case of exchange-traded contracts, where there is a change in the expected differential between the price of the commodity underlying the hedging agreement and the actual prices paid or received by us for the physical commodity bought or sold. There are also situations where the hedging transactions themselves may result in losses, as when a position is purchased in a declining market or a position is sold in a rising market. Hedging losses may be offset by a decreased cash price for corn and natural gas and an increased cash price for ethanol and distillers’ grains.
We have established a risk management committee which assists the board and our risk management manager to, among other things, establish appropriate policies and strategies for hedging and enterprise risk. We continually monitor and manage our commodity risk exposure and our hedging transactions as part of our overall risk management policy. As a result, we may vary the amount of hedging or other risk mitigation strategies we undertake, and we may choose not to engage in hedging transactions. Our ability to hedge is always subject to our liquidity and available capital. However, our currently limited supply of working capital has raised substantial doubt about our ability to hedge against our various
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commodities price risks, profitably operate our ethanol plant, and remain a going concern. See Notes to Consolidated Financial Statements, Note 2, Going Concern.
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, Inc. 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
Ethanol Competition
We sell our ethanol in a highly competitive market. Ethanol is a commodity product where competition in the industry is predominantly based on price. On a national scale, we are in direct competition with numerous other ethanol producers. According to the Renewable Fuels Association (the “RFA”), there are approximately 210 biorefineries with a total nameplate capacity of approximately 17.6 billion gallons of ethanol per year, with an additional plant under expansion or construction with capacity to produce an additional 16 million gallons.
The following table identifies the top five largest ethanol producers in the U.S. along with their production capacities.
|
| Nameplate Capacity |
|
Company | | (mmgy) | |
POET Biorefining | | 1,794 | |
Valero Renewable Fuels |
| 1,730 | |
Archer Daniels Midland |
| 1,716 | |
Green Plains, Inc. |
| 1,128 | |
Flint Hills Resources LP |
| 840 | |
Source: Renewable Fuels Association | | | |
| | | |
Each of the large ethanol producers above are capable of producing significantly more ethanol than we produce. These producers and other large 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. This could put us at a competitive disadvantage to other ethanol producers.
Larger ethanol producers may have an advantage over us from economies of scale and stronger negotiating positions with purchasers. Large producers own multiple ethanol plants and may have flexibility to run certain facilities while shutting or slowing down production at their other facilities. This added flexibility may allow these producers to compete more effectively, especially during periods when operating margins are unfavorable in the ethanol industry. Additionally, our currently limited supply of working capital has raised substantial doubt about our ability to purchase the various inputs we require to operate our ethanol plant, which could decrease our competitiveness.
Some large producers own ethanol plants in geographically diverse areas of the U.S. and as result, may be able to more effectively spread the risk they encounter related to feedstock prices. Some of our competitors are owned subsidiaries of larger oil companies, such as Valero Renewable Fuels and Flint Hills Resources. Because their parent oil companies are required to blend a certain amount of ethanol each year, these competitors may be able to operate their ethanol production facilities at times when it is unprofitable for us to operate our 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.
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A majority of the U.S. 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. According to the RFA, Minnesota is one of the top producers of ethanol in the U.S. with 19 ethanol plants producing an aggregate of approximately 1.4 billion gallons of ethanol per year. Therefore, we face increased regional and local competition because of the location of our ethanol plant.
Eco-Energy markets our ethanol primarily on a regional and national basis. 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 domestic producers of ethanol, we have faced increased competition from ethanol produced in foreign countries. Depending on feedstock prices, ethanol imported from foreign countries may be less expensive than domestically-produced ethanol. However, foreign demand, transportation costs and infrastructure constraints may temper the market impact on the United States. Ethanol imports have been lower in recent years. However, if demand for imported ethanol were to increase again, demand for domestic ethanol may be reduced, which could lead to lower domestic prices and lower operating margins. Large international companies with much greater resources than ours have developed, or are developing, increased foreign ethanol production capacities. Many international suppliers produce ethanol primarily from inputs other than corn, such as sugar cane, and have cost structures that may be substantially lower than U.S. based ethanol producers including us. Many of these international suppliers are companies with much greater resources than us with greater production capacities.
Competition from Alternative Fuels and Other Fuel Additives
Alternative fuels and alternative ethanol production methods are continually under development. New ethanol products or methods of ethanol production developed by larger and better-financed competitors could provide them competitive advantages over us and harm our business.
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 researchers have commenced pilot projects to study the feasibility of commercially producing cellulosic ethanol. Additionally, a few companies have begun construction or completed commercial scale cellulosic ethanol 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. 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.
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. The major oil companies have significantly greater resources than we have to develop alternative products and to influence legislation and public perception of ethanol. 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). 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 using fuel cells, plug-in hybrids, electric cars or clean burning gaseous fuels. Electric car technology has recently grown in popularity, especially in urban areas. While there are currently a limited number of vehicle recharging stations, there has been increased focus on developing these recharging stations to make electric car technology more feasible and widely available in the future. Additional competition from these other sources of alternative energy, particularly in the automobile market, could reduce the demand for ethanol, which would negatively impact our profitability.
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Distillers’ Grains Competition
The amount of distillers’ grains produced annually in North America has increased significantly as the number of ethanol plants has 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. These competitors may be more likely to sell to the same markets that we target for our distillers’ grains.
Distillers’ grains are primarily used as an animal feed, competing with other feed formulations using corn and soybean meal. As a result, we believe that distillers’ grains prices are positively impacted by increases in corn and soybean prices. In fiscal year 2020, the U.S. ethanol industry increased exports of distillers’ grains. However, exports of distillers’ grains fell in 2019 as compared to 2018, and the 2020 export levels remain below pre-2018 levels. The decline in exports increases the domestic supply of distillers’ grains, which has a corresponding negative impact on the price of distillers’ grains as compared to a comparable volume of corn. Continued decreases in distillers’ grains exports could result in increased competition among ethanol producers for sales of distillers’ grains and could negatively impact distillers’ grains prices in the U.S.
Corn Oil Competition
We compete with many ethanol producers for the sale of corn oil. Many ethanol producers have installed the equipment necessary to separate corn oil from the distillers’ grains they produce which has increased competition for corn oil sales and has resulted in lower market corn oil prices.
Government Ethanol Supports
The ethanol industry is dependent on several economic incentives to produce ethanol, the most significant of which 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 has been, and we expect will continue to be, a significant factor impacting ethanol usage.
Under the RFS, the EPA is required to pass an annual rule that establishes the number of gallons of different types of renewable fuels that must be used in the U.S. by refineries, blenders, distributors and importers, which are known as renewable volume obligations (“RVOs”). The EPA has the authority to waive the mandates in whole or in part if one of two conditions have been met: 1) there is inadequate domestic renewable fuel supply, or 2) implementation of the mandate requirement would severely harm the economy or environment of a state, region or the United States.
The RFS sets the statutory RVO for corn-based ethanol at 15 billion gallons beginning in 2016 and each year thereafter through 2022. In May 2020, the EPA delivered its proposed rule to the White House Office of Management and Budget (“OMB”) to set 2021 RVOs. OMB is required to review the proposed rule before releasing it for public comment. The proposed 2021 RVOs are still undergoing OMB review, and therefore, the proposed rule has neither been released for public comment or finalized. As a result, the statutory November 30 deadline was not met. The EPA Administrator has stated that the COVID-19 pandemic resulted in significant delays and that the EPA is analyzing various factors in setting 2021 RVOs in light of the pandemic.
On December 19, 2019, the EPA announced the final 2020 RVOs, setting the RVOs for conventional ethanol at 15.0 billion gallons, advanced biofuels at 5.09 billion gallons and cellulosic ethanol at 0.59 billion gallons, for overall RVOs of 20.09 billion gallons for 2020. Although this final rule achieves the statutory RVO for conventional corn-based ethanol, it reduces the overall RVOs below the overall statutory level of 30 billion gallons.
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The following chart illustrates the potential U.S. ethanol demand based on the schedule of minimum usage established by the RFS program through the year 2022 (in billions of gallons):
| | | | | | | | | | | | Maximum Amount of Corn-based |
| | | | Total Renewable | | Cellulosic | | Biodiesel | | Advanced Biofuel | | Ethanol That Can Be Used to |
Year |
| RVO Source |
| Fuel RVO |
| Ethanol RVO | | RVO |
| RVO |
| Satisfy Total Renewable Fuel RVO |
2017 |
| RFS Statute |
| 24.00 |
| 5.50 | | - |
| 9.00 |
| 15.00 |
|
| EPA Final Rule(1) |
| 19.28 |
| 0.31 | | 2.00 |
| 4.28 |
| 15.00 |
2018 |
| RFS Statute |
| 26.00 |
| 7.00 | | - |
| 11.00 |
| 15.00 |
| | EPA Final Rule(2) | | 19.29 | | 0.29 | | 2.10 | | 4.29 | | 15.00 |
2019 |
| RFS Statute |
| 28.00 |
| 8.50 | | - |
| 13.00 |
| 15.00 |
| | EPA Final Rule(3) | | 19.92 | | 0.42 | | 2.10 | | 4.92 | | 15.00 |
2020 | | RFS Statute | | 30.00 | | 10.50 | | - | | 15.00 | | 15.00 |
| | EPA Final Rule(4) | | 20.09 | | 0.59 | | 2.43 | | 5.09 | | 15.00 |
2021 | | RFS Statute | | 33.00 | | 13.50 | | - | | 18.00 | | 15.00 |
2022 | | RFS Statute | | 36.00 | | 16.00 | | - | | 21.00 | | 15.00 |
(1)Final EPA RFS RVOs for 2017 issued November 2016.
(2)Final EPA RFS RVOs for 2018 issued November 2017.
(3)Final EPA RFS RVOs for 2019 issued November 2018.
(4)Final EPA RFS RVOs for 2020 issued December 2019.
Ethanol production capacity exceeded the EPA’s 2018, 2019 and 2020 RVOs that could be satisfied by corn-based ethanol. Under the RFS, if mandatory renewable fuel volumes are reduced by at least 20% for two consecutive years, the EPA is required to modify, or reset, statutory volumes through 2022. In October 2018, the Office of Management and Budget announced that the 20% thresholds “have been met or are expected to be met in the near future.” In May 2019, the EPA delivered a proposed RFS “reset” rule to the Office of Management and Budget. The “reset” remains on the OMB agenda. If the statutory RVOs are reduced as a result of such reset, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.
Beginning in January 2016, various ethanol and agricultural industry groups petitioned a federal appeals court to hear a legal challenge to of the EPA’s decision to reduce the total renewable fuel volume requirements for 2014-2016 through use of its “inadequate domestic supply” waiver authority. On July 28, 2017, the U.S. Court of Appeals for the D.C. Circuit ruled in favor of the petitioners, concluding that the EPA erred in its exercise of “inadequate domestic supply” waiver authority by considering demand-side constraints. As a result, the Court vacated the EPA’s decision to reduce the total renewable fuel volume requirements for 2016, and remanded to the EPA to address the 2016 total renewable fuels volume requirements. In December 2019, the EPA announced that it is deferring action on this issue. While management believes the decision should benefit the ethanol industry overall by clarifying the EPA's waiver analysis is limited to consideration of supply-side factors only, no direct impact on the Company is expected from the decision.
Management anticipates that there will be further legal challenges to the EPA's reduction in the volume requirements, including the final rules for 2019 and 2020. However, if the EPA's decision to reduce the volume requirements under the RFS is allowed to stand, or if the volume requirements are further reduced, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.
Beyond the federal mandates, there are limited domestic markets for ethanol. Further, opponents of ethanol such as large oil companies will likely continue their efforts to repeal or reduce the RFS through lawsuits or lobbying of Congress. If such efforts are successful in further reducing or repealing the blending requirements of the RFS, a significant decrease in ethanol demand may result and could have a material adverse effect on our results of operations, cash flows and financial condition, unless additional demand from exports or discretionary or E85 blending develops.
Most ethanol that is used in the U.S. is sold in a blend called E10. E10 is a blend of 10% ethanol and 90% gasoline. E10 is approved for use in all standard vehicles. Estimates indicate that gasoline demand in the U.S. is approximately 143 billion gallons per year. Assuming that all gasoline in the U.S. is blended at a rate of 10% ethanol and 90% gasoline, the maximum demand for ethanol is 14.3 billion gallons per year. 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
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gasoline that is being used in the U.S. and it discounts the possibility of additional ethanol used in higher percentage blends such as E15 and E85. These higher percentage blends may lead to additional ethanol demand if they become more widely available and accepted by the market.
There is growing availability of E85 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 approved its use in vehicles model year 2001 and newer. However, widespread adoption of E15 has been hampered by regulatory and infrastructure hurdles in many states, as well as consumer acceptance. 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 have been required at certain times of the year in order to use E15 due to federal regulations related to fuel evaporative emissions. This prevented E15 from being used during certain times of the year in various states. However, on May 30, 2019, the EPA issued a final rule which allows E15 to be sold year-round. In June 2019, the American Fuel and Petrochemical Manufacturers association filed a lawsuit in the U.S. Court of Appeals for the District of Columbia challenging the final rule. Additionally, in August 2019, the Small Retailers Coalition filed a lawsuit in the U.S. Court of Appeals for the District of Columbia seeking review of the final rule. These legal challenges remain pending, and there is no guarantee that the final rule will be upheld. Legal challenges could create uncertainty for retailers desiring to implement or expand sales of E15. Additionally, although the year-round E15 rule is now final, there is no guarantee that retailers will implement the sale of year-round E15, nor is there a guarantee that the rule will result in an increase of ethanol sales.
Obligated parties use renewable identification numbers (“RINs”) to show compliance with RFS-mandated volumes. RINs are attached to renewable fuels by producers and detached when the renewable fuel is blended with transportation fuel or traded in the open market. The market price of detached RINs affects the price of ethanol in certain markets and influences the purchasing decisions by obligated parties. Under the RFS, small refineries may petition for and be granted temporary exemptions from the RVOs if they can demonstrate that compliance with the RVOs would cause disproportionate economic hardship. On December 17, 2020, the EPA released data on the number of waivers filed, which indicated that, as of December 17, 2020, 14 petitions for waivers for the 2020 compliance year have been received. For the 2019 compliance year, 32 petitions have been received. To date, all of the petitions received for both compliance years 2020 and 2019 remain pending. Further, some petitions remain pending from previous compliance years. Additionally, 44 petitions have been received by the EPA for the 2018 compliance year. To date, 31 petitions have been approved, which have exempted approximately 1.43 billion RINs, which is approximately 13.42 billion gallons of gasoline and diesel, from meeting the RFS blending targets. It is expected that additional petitions for waivers for the 2020 compliance year will be received by the EPA. It is also expected that the EPA will approve a significant number of these waiver petitions, thereby exempting a substantial number of gallons of gasoline and diesel from meeting the RFS blending targets. These exemptions decrease demand for our products, which negatively impacts ethanol prices and our profitability.
On May 29, 2018, the National Corn Growers Association, National Farmers Union, and the RFA filed a petition with the U.S. Court of Appeals for the 10th Circuit challenging the EPA’s grant of waivers to three specific refineries. The petitioners are asking the U.S. Court of Appeals for the 10th Circuit to reject the waivers granted to three refineries located in Wynnewood, Oklahoma, Cheyenne, Wyoming, and Woods Cross, Utah as an abuse of EPA authority. These waived gallons are not redistributed to obligated parties, and in effect, reduce the aggregate RVOs under the RFS. In January 2020, the court struck down the exemptions as improperly issued by the EPA. The court interpreted the RFS statute to provide that refineries are only eligible for relief if they have received uninterrupted, continuous extensions of the exemptions. Consistent with the ruling, the EPA denied certain small refinery exemption petitions filed by oil refineries in 2020 seeking retroactive relief from their ethanol use requirements for prior years. However, HollyFrontier and Wynnewood Refining filed a petition in the U.S. Supreme Court in September 2020 seeking review of the January 2020 ruling. In January 2021, the Supreme Court agreed to hear the appeal. Oral arguments are expected to be scheduled in spring of 2021. The Supreme Court’s decision could result in the overturning of the EPA’s denial of certain small refinery exemption petitions. Such a decision could have sweeping negative effects on the ethanol industry and our profitability.
An EPA final rule released in December 2019 provides that EPA will project exempt volumes based on a three-year average of the relief recommended by the Department of Energy (“DOE”) for years 2016-2018, rather than based on actual exemptions granted. For the 2016 compliance year, the EPA said the DOE’s recommended relief was approximately 440 million RINs. The EPA, however, actually granted waivers for approximately 790 million RINs.
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Similarly, the DOE’s 2017 compliance year recommendation was 1.02 billion RINs, as compared to the approximately 1.82 billion RINs granted waivers by the EPA. For the 2018 compliance year, the DOE recommended the EPA approve waivers for 840 million RINs, as compared to the approximately 1.43 billion RINs granted waivers by the EPA. The EPA’s final rule also announced its general policy approach with respect to small refinery waivers on a go-forward basis as consistent with DOE’s recommendations, where appropriate. This final rule fell short of the relief that was urged by ethanol producers. As a result, management expects that small refinery exemptions will continue to have a negative effect on demand for our products, ethanol prices, and our profitability.
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. Additionally, 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.
Our air permit requires certain on-going performance testing to be completed periodically to ensure compliance with minor source emission limits. On May 12, 2017, we submitted a letter to the Minnesota Pollution Control Agency (“MPCA”) regarding the certain non-compliant results from on-going performance testing required under our air permit. Since reporting to MPCA, the Company cooperated with MPCA’s review of the non-compliant tests and maintained open communication with MPCA staff to resolve the matter. On October 17, 2017, we entered into a stipulation agreement with MPCA relating to the non-compliant test results. Under the stipulation agreement, we agreed to pay a civil penalty of $63,500, which was paid in October 2017.
For the fiscal year ended October 31, 2018, we incurred costs and expenses of approximately $133,000 complying with environmental laws. 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. For the fiscal year ended October 31, 2019, we incurred costs and expenses of approximately $88,000 complying with environmental laws. For the fiscal year ended October 31, 2020, we incurred costs and expenses of approximately $156,000 complying with environmental laws.
On January 13, 2015, we submitted an efficient producer petition to the EPA which was approved by the EPA on March 12, 2015. In the approval determination, the EPA’s analysis indicated that we achieved at least a 20.1% reduction in greenhouse gas (“GHG”) emissions for their non-grandfathered volumes compared to the baseline lifecycle GHG emissions. Pursuant to the award approval, we are only authorized to generate RINs for our plant’s non-grandfathered volumes if we can demonstrate that all ethanol produced at the plant during an averaging period (defined as the prior 365 days or the number of days since the date of the EPA efficient producer pathway approval) meets the 20% GHG reduction requirement. To make this demonstration, we must comply with the compliance plan we developed and keep certain records as specified in the EPA’s approval. Additionally, we must register with the EPA as a renewable fuel producer for the non-grandfathered volumes. Although we believe we will be able to maintain continuous compliance with the 20% reduction in GHG emissions requirement, there is no guarantee that we will do so. If we do not maintain continuous compliance with the 20% reduction in GHG emissions requirement, we will not be able issue RINs for the non-grandfathered volumes of ethanol produced at our plant. As a result, we may be forced to rely on export sales for these non-grandfathered volumes of ethanol, which could adversely affect our operating margins, which, in turn could adversely affect our results of operations, cash flows and financial condition.
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 federal appellate court reversed the
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federal district court finding the LCFS constitutional and remanding the case back to federal district court to determine whether the LCFS imposes a burden on interstate commerce that is excessive in light of the local benefits. On June 30, 2014, the U.S. Supreme Court declined to hear the appeal of the federal appellate court ruling and CARB recently re-adopted the LCFS with some slight modifications. The LCFS could have a negative impact on demand for corn-based ethanol and result in decreased ethanol prices affecting our ability to operate profitably.
Exports to China have been negligible since the imposition of a 70% tariff in July 2018. It is unclear when the tariffs will be reduced, if ever, and therefore, this tariff is likely to continue to have a negative impact on the export market demand and prices for ethanol produced in the United States. Additionally, in December 2020, Brazil’s import quota exempting certain volumes of U.S. ethanol imports from a 20% tariff expired, which resulted in all imports of U.S. ethanol becoming subject to the 20% tariff. The import quota had already resulted in decreases of ethanol exported to Brazil, and the expiration of the import quota will likely result in further decreases. The tariff and/or import quota has had and likely will continue to have a negative impact on the export market demand and prices for ethanol produced in the United States.
Employees
We compete with ethanol producers in close proximity of our facility 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.
As of the date of this report, we have 40 full time employees, of which 7 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.
We have entered into a management services agreement with Granite Falls Energy. Pursuant to the management services agreement, GFE provides its chief executive officer, chief financial officer, and commodity risk manager to act in those positions as part-time officers and managers of the Company. 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.
The initial term of the management services agreement automatically renews for successive one-year terms until either party gives the other party written notice of termination prior to expiration of the then current term. The management services agreement may also be terminated by either party for cause under certain circumstances.
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. Under the terms of the management services agreement, the Company pays GFE 50% of the estimated total salary, bonuses and other expenses and costs (including all benefits and tax contributions) incurred by GFE for the three management positions on a monthly basis with a “true-up” following the close of GFE’s fiscal year.
Our currently limited supply of working capital has raised substantial doubt about our ability to attract and retain qualified and experienced personnel, profitably operate our ethanol plant, and remain a going concern. See Notes to Consolidated Financial Statements, Note 2, Going Concern.
Natural Gas Pipeline Segment
Through our wholly owned subsidiary, HLBE Pipeline Company, we indirectly own 100% of Agrinatural Gas, LLC, a Delaware limited liability company (“Agrinatural”). On October 18, 2019, HLBE Pipeline Company entered into an agreement to purchase RES’s 27% non-controlling interest in Agrinatural, which became effective on December 11, 2019. Prior to December 11, 2019, Rural Energy Solutions, LLC (“RES”) owned a 27% non-controlling interest in Agrinatural.
Agrinatural is governed by a 3-member board of managers. As the sole member of the sole member of Agrinatural, we have the right to appoint all of the managers of Agrinatural.
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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 190 miles of pipeline, including 164 miles of distribution mains and 26 miles of service lines. 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, Storden, and Okabena, Minnesota.
Prior to July 1, 2019, Agrinatural had a management and operating agreement with Swan Engineering, Inc. (“SEI”), an affiliate of RES, whereby SEI provided Agrinatural with day-to-day management and operation of Agrinatural’s pipeline distribution business. In exchange for these services, Agrinatural paid SEI an aggregate management fee equal to the fixed monthly base fee plus the variable customer management fee based on the number of customers served on the pipeline less the agreed monthly fee reduction of $4,500. For the fiscal year ended October 31, 2019, the Company paid SEI approximately $28,000 of monthly base fees and approximately $111,000 of variable customer management fees. The management and operating agreement with SEI expired July 1, 2019. Agrinatural entered into a new five-year management and operating agreement with a third party effective July 1, 2019.
Prior to July 1, 2019, Agrinatural also had a project management agreement with SEI, whereby SEI supervised all of Agrinatural’s pipeline construction projects. These projects are constructed by unrelated third-party pipeline construction companies. Under the project management agreement, Agrinatural paid SEI a total of 10% of the actual capital expenditures for construction projects approved by Agrinatural’s board of managers, excluding capitalized marketing costs. For the fiscal year ended October 31, 2019, the Company paid SEI approximately $45,000 for project management and capital work fees. The project management agreement with SEI expired June 30, 2019. Agrinatural entered into a new five-year management and operating agreement with a third party effective July 1, 2019.
The Company has two intercompany credit facilities with Agrinatural: a July 2014 credit facility (the “Original Credit Facility”) and a March 2015 credit facility (the “Additional Credit Facility”). Under the Original Credit Facility, the Company made a five-year term loan in the principal amount of $3.05 million and pursuant to the Additional Credit Facility, made a four-year term loan in the principal amount of $3.5 million to Agrinatural. Subsequent to the closing of the Company’s indirect acquisition of Agrinatural’s non-controlling interest in December 2019, the parties agreed to forgive the debt related to the Original Agrinatural Credit Facility.
On May 19, 2016, the Company amended the Additional Credit Facility, entering into an amendment to the loan agreement dated March 30, 2015 and an allonge to the negotiable promissory note dated March 30, 2015 issued by Agrinatural to the Company. Under the terms of the amendment and allonge, the Company agreed to increase the amount of the capital expenditures allowed by Agrinatural during the term of the facility and defer a portion of the principal payments required for 2016 and capitalize the deferred principal to the balloon payment due at maturity. Subsequent to the closing of the Company’s indirect acquisition of Agrinatural’s non-controlling interest in December 2019, the parties agreed to forgive the debt related to the Additional Agrinatural Credit Facility.
Details of the Agrinatural credit facilities are provided below in the section below entitled “PART II - ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Credit Arrangements”.
Assets from our natural gas pipeline segment have represented approximately 21.3% and 22.1% of our consolidated total assets in the years ended October 31, 2020 and 2019, 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 3.8% and 3.0% of our total consolidated revenues in the years ended October 31, 2020 and 2019, respectively. After accounting for intercompany eliminations for fees from the Company for natural gas transportation services, Agrinatural’s revenues represented 1.9% and 1.3% of our consolidated revenues for the fiscal years ended October 31, 2020 and 2019, 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 U.S., including those of Agrinatural, our majority owned subsidiary. All of the products sold to our customers for the fiscal years ended October 31, 2020 and 2019 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.
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
Management has determined there is substantial doubt that we will be able to continue in business over the next year.
The Company has suffered recurring operating and cash flow losses related to difficult market conditions and operating performance. The Company was out of compliance with certain debt covenants on October 31, 2020, for which a waiver was obtained from the lender. Subsequent to October 31, 2020, the Company had further instances of noncompliance with debt covenants and has forecasted that it is probable that there will be future instances of noncompliance with debt covenants within the next twelve months. These conditions result in the classification of all debt with the lender as current as of October 31, 2020. The Company has insufficient cash on hand and additional borrowing capacity, and current forecasts indicate insufficient cash flows from operations, to repay the debt if it were to come due as a result of covenant noncompliance. These factors raise substantial doubt about the Company's ability to continue as a going concern.
If we are unable to continue as a going concern, we might have to liquidate our assets and the values we receive for our assets in liquidation or dissolution could be significantly lower than the values reflected in our financial statements. In addition, the existence of substantial doubt about our ability to continue as a going concern and our inability to meet certain debt obligations may materially adversely affect our unit price and our ability to raise new capital or to enter into critical contractual relations with third parties. There is no assurance that we will be able to adequately fund our operations in the future.
We have debts that may come due as a result of our failure to comply with certain loan covenants, and because we lack sufficient funds to pay such debts, there is substantial doubt regarding our ability to continue as a going concern.
Our debt obligations create substantial doubt as to our ability to continue operating as a going concern. Difficult market conditions, partially due to the impact of the COVID-19 pandemic, have caused substantial operating losses, reduced cash flows and liquidity, and violations of certain of our debt covenants. As of October 31, 2020, we were out of compliance with a debt covenant that required us to maintain a minimum amount of working capital. Our lender issued a temporary waiver for that violation, but we have subsequently committed further violations of the debt covenants by failing to maintain adequate working capital. Unless we receive additional equity, or perhaps refinance our debt, we expect to continue to violate our working capital covenants. As a result of our violation of this debt covenant, our lender may have the ability to require our immediate repayment of the debt.
Additionally, in January 2021 we borrowed $5 million from our majority owner Granite Falls Energy, LLC, pursuant to the terms of a modified promissory note. The note generally requires repayment of the principal amount in
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March 2023. However, if we violate our primary lender covenants, including the working capital covenant described above, we will be considered in default of the Granite Falls Energy, LLC, promissory note. Because there is a substantial risk we will violate our debt covenants with Cobank as the administrative agent with our lender Compeer, we may be found in default of our promissory note to Granite Falls Energy, LLC, and the $5 million debt may become due before we have adequate funds to repay the debt. In such event, our creditors would have a superior interest in the value of our assets than would our members, and their interest in the value in our assets would be superior to those of our members in the event we are forced to liquidate.
Because we are primarily dependent upon one product of our ethanol production segment, our business is not significantly 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. Changes in the 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 U.S. 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.
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.
Volatility in oil and gas prices may materially affect ethanol pricing and demand.
Ethanol has historically traded at a discount to gasoline. When ethanol trades at a discount to gasoline it encourages discretionary blending, thereby increasing the demand for ethanol beyond required blending rates. Conversely, when ethanol trades at a premium to gasoline, there is a disincentive for discretionary blending and ethanol demand is negatively impacted. Consequently, ethanol pricing and demand may also be volatile, which makes it
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difficult to manage profit margins and which could result in a material adverse effect on our business, results of operations and financial condition.
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.
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.
Management expects additional volatility for the price of ethanol in 2021. Ethanol production and demand are expected to increase slightly in 2021, but there is no guarantee that either projection will be accurate. While exports rose slightly in 2020, due to tariffs and international competition, exports have fallen overall in recent years, and it appears unlikely that the export market will significantly improve in 2021. U.S. gas demand decreased substantially year over year in 2020, due primarily to the COVID-19 pandemic. A continued or further decrease in demand for either gasoline or ethanol blends would adversely impact the price of ethanol, which could result in 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.
Historically, sales prices for distillers’ grains have been correlated with prices of corn. However, recently, the price increase for this co-product has lagged behind increases in corn prices. In addition, our distillers’ grains co-product competes with products made from other feedstocks, the cost of which may not have risen as corn prices have risen. Consequently, the price we may receive for distillers grains may not rise as corn prices rise, thereby lowering our cost recovery percentage relative to corn.
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 U.S. and negatively affect our profitability.
Our industry has become increasingly dependent on export markets. The U.S. ethanol industry was bolstered during our 2020 fiscal year with exports of ethanol which increased demand for our ethanol. However, export levels still remain lower than previous years’ levels, and there is no guarantee that export levels will improve or remain steady. If producers and exporters of ethanol and distillers’ grains are subjected to trade barriers when selling products to foreign customers, such as the tariffs and quotas currently in effect, there may be a reduction in the price of these products in the
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U.S. 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.
If U.S. producers cannot satisfy import requirements imposed by countries importing distillers’ grains, export demand 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 U.S. 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.
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, POET Biorefining, Cargill, Inc., Valero Energy Corporation, and Green Plains, Inc. have substantially greater financial, operational, procurement, marketing, distribution and technical resources than we have. 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 affect our financial performance.
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 U.S., we face increased competition because of the location of our ethanol plants. 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.
Until recently, oil companies, petrochemical refiners and gasoline retailers have not been engaged in ethanol production to a large extent. These companies, however, form the primary distribution networks for marketing ethanol through blended gasoline. During the past few years, several large oil companies have begun to penetrate the ethanol production market. If these companies increase their ethanol plant ownership or other oil companies seek to engage in direct ethanol production, such as Valero Renewable Fuels and Flint Hills Resources which are subsidiaries of larger oil companies, there may be a decrease in the demand for ethanol from smaller independent ethanol producers like us which could result in an adverse effect on our operations, cash flows and financial condition.
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.
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 could harm our business.
We are exposed to market risk from changes in commodity prices. Exposure to commodity price risk results from our dependence on corn and natural gas in the ethanol production process. We seek to minimize the risks from fluctuations in the prices of corn, natural gas and ethanol through the use of hedging instruments. The effectiveness of our hedging strategies is dependent on the price of corn, natural gas and ethanol and our ability to sell sufficient products to use all of the corn and natural gas for which we have futures contracts. Our hedging activities may not successfully reduce the risk caused by price fluctuation which may leave us vulnerable to high corn and natural gas prices, as well as low ethanol prices.
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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.
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 our 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.
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Rail logistical problems may result in delays in shipments of our products which could negatively impact our financial performance.
There has been an increase in rail traffic congestion throughout the U.S. primarily due to the increase in cargo trains carrying shale oil. From time to time, periodic high demand and unusually adverse weather conditions may cause rail congestion resulting in rail delays and rail logistical problems. Although we have not been materially affected by prior rail congestion period, future periods of congestion may affect our ability to operate our plant at full capacity due to ethanol storage capacity constraints, which in turn could have a negative effect on our financial performance.
Our business, and our industry as a whole, could be adversely affected by an outbreak of disease, epidemic or pandemic, such as the global COVID-19 pandemic, or similar public threat, or fear of such an event.
The global outbreak of the COVID-19 pandemic has had a negative impact on our revenues and operating results, which could worsen and/or continue for a significant period of time. This outbreak has resulted in disruptions and damage to our business, caused by the negative impact to our ability to obtain cost effective raw materials, supplies and component parts necessary to operate our ethanol, distillers’ grains, corn oil, or natural gas business, the negative impact on our ability to operate our facility should COVID-19 spread more broadly within Minnesota or the Midwest, thereby creating an increased risk of exposure to our workforce which cannot operate our facility remotely, and the negative impact to our ability to market and sell our products to markets which have slowed or shut down altogether. It is likely that effect such as these will continue to negatively impact our revenues, operating results, and business as a whole. Mitigation efforts have not and will not completely prevent our business from being adversely affected, and the longer the pandemic impacts supply and demand and the more broadly the pandemic spreads, it is more likely that the impact on our business, revenues and operating results will become increasingly negative.
We depend on our management and key employees, and the loss of these relationships could negatively impact our ability to operate profitably.
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 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.
Failures of our information technology infrastructure could have a material adverse effect on operations.
We utilize various software applications and other information technology that are critically important to our business operations. We rely on information technology networks and systems, including the Internet, to process, transmit and store electronic and financial information, to manage a variety of business processes and activities, including production, manufacturing, financial, logistics, sales, marketing and administrative functions. We depend on our information technology infrastructure to communicate internally and externally with employees, customers, suppliers and others. We also use information technology networks and systems to comply with regulatory, legal and tax requirements. These information technology systems, some of which are managed by third parties, may be susceptible to
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damage, disruptions or shutdowns due to failures during the process of upgrading or replacing software, databases or components thereof, power outages, hardware failures, computer viruses, attacks by computer hackers or other cybersecurity risks, telecommunication failures, user errors, natural disasters, terrorist attacks or other catastrophic events. If any of our significant information technology systems suffer severe damage, disruption or shutdown, and our disaster recovery and business continuity plans do not effectively resolve the issues in a timely manner, our product sales, financial condition and results of operations may be materially and adversely affected.
A cyber-attack or other information security breach could have a material adverse effect on our operations and result in financial losses.
We are regularly the target of attempted cyber and other security threats and must continuously monitor and develop our information technology networks and infrastructure to prevent, detect, address and mitigate the risk of unauthorized access, misuse, computer viruses and other events that could have a security impact. If we are unable to prevent cyber-attacks and other information security breaches, we may encounter significant disruptions in our operations which could adversely impact our business, financial condition and results of operations or result in the unauthorized disclosure of confidential information. Such breaches may also harm our reputation, result in financial losses or subject us to litigation or other costs or penalties.
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.
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 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 breach their contracts or do not have the ability, for financial or other reasons, to market all of the ethanol we produce or to market the co-products produced at our plant, we may not have any readily available alternative means to sell our products. Our lack of a sales force and reliance on these third parties to sell and market most of our products may place us at a competitive disadvantage. Our failure to sell all of our ethanol and co-products may result in lower revenues and reduced profitability.
We are exposed to credit risk resulting from non-payment by significant customers.
We have a concentration of credit risk because we sell our primary product, ethanol, and its co-products, distillers’ grains and corn oil to three customers. Although we typically receive payments timely and within the terms of our marketing agreements with these customers, we continually monitor this credit risk exposure. These customers accounted for approximately 96.4% and 97.5% of revenue for the years ended October 31, 2020 and 2019, respectively, and
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approximately 81.2% and 98.1% of the outstanding accounts receivable balance at October 31, 2020 and 2019, respectively. The inability of a third party to pay our accounts receivable may cause us to experience losses and may adversely affect our liquidity and our ability to make our payments when due.
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 widespread 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.
Risks Related to Regulation and Government Action
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.
Our air permit requires certain on-going performance testing to be completed periodically to ensure compliance with minor source emission limits. On May 12, 2017, we submitted a letter to the MPCA regarding the results of certain non-compliant tests. On October 17, 2017, we entered into a stipulation agreement with the MPCA relating to these non-compliant tests. Under the stipulation agreement, we agreed to pay a civil penalty of $63,500, which was paid in October 2017.
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. The MPCA’s approval of our amendment, as well as 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. Further, regulations of the EPA and the MPCA 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.
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. We believe the most important of these is the RFS, which sets minimum national volume standards for use of cellulosic, biomass-based diesel and total advanced renewable fuels. The RFS helps support a market for ethanol that might disappear without this incentive. In the case of the RFS, 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 RFS may also reduce demand for ethanol in favor of the renewable fuels for which specific categories exist.
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By statute, the RFS requires that 16.55 billion gallons be sold or dispensed in 2013, increasing to 36.0 billion gallons by 2022, but caps the amount of corn-based ethanol that can be used to meet the renewable fuels blending requirements at 15.0 billion gallons for 2015 and thereafter. The final 2021 RVOs have not yet been released. On December 19, 2019, the EPA announced final RVO requirements for the RFS for calendar year 2020. The corn-based biofuel requirement was set at 15.0 billion gallons, equating to the statutory requirement level as originally set by Congress when the RFS was enacted. However, the overall RVOs were set at 20.09 billion gallons for 2020, more than 20% below the overall statutory level of 30 billion gallons, due to decreases in the RVOs for cellulosic ethanol and advanced biofuels. The 2019 and 2018 standards were also more than 20% below the overall statutory level.
According to the RFS, if mandatory renewable fuel volumes are reduced by at least 20% for two consecutive years, the EPA is required to modify, or reset, statutory volumes through 2022. In October 2018, the Office of Management and Budget announced that the 20% thresholds “have been met or are expected to be met in the near future.” In May 2019, the EPA delivered a proposed RFS “reset” rule to the Office of Management and Budget. If the statutory RVOs are reduced as a result of reset, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance. Current ethanol production capacity exceeds the 2020 RVO standard which can be satisfied by corn-based ethanol. Reduction of blending requirements could reduce the demand for and price of ethanol. If demand for ethanol decreases, it could materially adversely affect our business, results of operations and financial condition.
Additionally, opponents of ethanol such as large oil companies will likely continue their efforts to repeal or reduce the RFS through lawsuits or lobbying of Congress. Successful reduction or repeal of the blending requirements of the RFS could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.
Under the RFS, small refineries may petition for and be granted temporary exemptions from the RVOs if they can demonstrate that compliance with the RVOs would cause disproportionate economic hardship. On December 17, 2020, the EPA released data on the number of waivers filed, which indicated that, as of December 17, 2020, 14 petitions for waivers for the 2020 compliance year have been received. For the 2019 compliance year, 32 petitions have been received. To date, all of the petitions received for both compliance years 2020 and 2019 remain pending. Further, some petitions remain pending from previous compliance years. Additionally, 44 petitions have been received by the EPA for the 2018 compliance year. To date, 31 petitions have been approved, which have exempted approximately 1.43 billion RINs, which is approximately 13.42 billion gallons of gasoline and diesel, from meeting the RFS blending targets. It is expected that additional petitions for waivers for the 2020 compliance year will be received by the EPA. It is also expected that the EPA will approve a significant number of these waiver petitions, thereby exempting a substantial number of gallons of gasoline and diesel from meeting the RFS blending targets. These exemptions decrease demand for our products, which negatively impacts ethanol prices and our profitability.
On May 29, 2018, the National Corn Growers Association, National Farmers Union, and the RFA filed a petition with the U.S. Court of Appeals for the 10th Circuit challenging the EPA’s grant of waivers to three specific refineries. The petitioners are asking the U.S. Court of Appeals for the 10th Circuit to reject the waivers granted to three refineries located in Wynnewood, Oklahoma, Cheyenne, Wyoming, and Woods Cross, Utah as an abuse of EPA authority. These waived gallons are not redistributed to obligated parties, and in effect, reduce the aggregate RVOs under the RFS. In January 2020, the court struck down the exemptions as improperly issued by the EPA. The court interpreted the RFS statute to provide that refineries are only eligible for relief if they have received uninterrupted, continuous extensions of the exemptions. Consistent with the ruling, the EPA denied certain small refinery exemption petitions filed by oil refineries in 2020 seeking retroactive relief from their ethanol use requirements for prior years. However, HollyFrontier and Wynnewood Refining filed a petition in the U.S. Supreme Court in September 2020 seeking review of the January 2020 ruling. In January 2021, the Supreme Court agreed to hear the appeal. Oral arguments are expected to be scheduled in spring of 2021. The Supreme Court’s decision could result in the overturning of the EPA’s denial of certain small refinery exemption petitions. Such a decision could have sweeping negative effects on the ethanol industry and our profitability.
An EPA final rule released in December 2019 provides that EPA will project exempt volumes based on a three-year average of the relief recommended by the Department of Energy (“DOE”) for years 2016-2018, rather than based on actual exemptions granted. For the 2016 compliance year, the EPA said the DOE’s recommended relief was approximately 440 million RINs. The EPA, however, actually granted waivers for approximately 790 million RINs.
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Similarly, the DOE’s 2017 compliance year recommendation was 1.02 billion RINs, as compared to the approximately 1.82 billion RINs granted waivers by the EPA. For the 2018 compliance year, the DOE recommended the EPA approve waivers for 840 million RINs, as compared to the approximately 1.43 billion RINs granted waivers by the EPA. The EPA’s final rule also announced its general policy approach with respect to small refinery waivers on a go-forward basis as consistent with DOE’s recommendations, where appropriate. This final rule fell short of the relief that was urged by ethanol producers. As a result, management expects that small refinery exemptions will continue to have a negative effect on demand for our products, ethanol prices, and our profitability.
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, 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.
In addition, different gasoline blendstocks may have been required at certain times of the year in order to use E15 due to federal regulations related to fuel evaporative emissions. This prevented E15 from being used during certain times of the year in various states. However, on May 30, 2019, the EPA issued a final rule which allows E15 to be sold year-round. In June 2019, the American Fuel and Petrochemical Manufacturers association filed a lawsuit in the U.S. Court of Appeals for the District of Columbia challenging the final rule. Additionally, in August 2019, the Small Retailers Coalition filed a lawsuit in the U.S. Court of Appeals for the District of Columbia seeking review of the final rule. There is no guarantee that the final rule will be upheld. Legal challenges could create uncertainty for retailers desiring to implement or expand sales of E15. Additionally, although the year-round E15 rule is now final, there is no guarantee that retailers will implement the sale of year-round E15, nor is there a guarantee that the rule will result in an increase of ethanol sales.
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.
Meeting the requirements of evolving environmental, health and safety laws and regulations, and in particular those related to climate change, could adversely affect our financial performance.
When the EPA released its final regulations on RFS, these regulations grandfathered our plant at its current production capacity for the generation of RINs for compliance with RFS. Any expansion of our plant beyond the grandfathered volumes must meet a threshold of a 20% reduction in GHG emissions from a 2005 baseline measurement for the ethanol to be eligible to generate RINS for compliance with the RFS II mandate.
In 2015, our plant was awarded “efficient producer” status under the pathway petition program for the non-grandfathered volumes of ethanol produced at our plant. Pursuant to the award approval, we are only authorized to generate RINs for our non-grandfathered volume if we can demonstrate that all ethanol produced at the plant during an
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averaging period (defined as the prior 365 days or the number of days since the date EPA efficient producer pathway approval) meets the 20% GHG reduction requirement.
Although we believe our plant will be able to maintain continuous compliance with the 20% reduction in GHG emissions requirement as presently operated, there is no guarantee that we will not have to install carbon dioxide mitigation equipment or take other steps unknown to us at this time in order to comply with the efficient producer requirements or other future law or regulation. Continued compliance with the efficient producer GHG reduction requirements or compliance with future law or regulation of carbon dioxide, could be costly and may prevent us from operating our plant as profitably, which may have an adverse impact on our operations, cash flows and financial position.
If we fail to comply with the 20% reduction in GHG emissions requirement, we will not be able to generate RINs for our non-grandfathered volumes of ethanol, which could adversely affect our operating margins.
We expect that nearly all of the anticipated demand for our ethanol production will be by customers obligated to comply with the RFS. The EPA’s approval of our efficient producer petitions requires that the plant demonstrates continuous compliance with the 20% reduction in GHG emissions for all volumes of ethanol produced, not just non-grandfathered volumes of ethanol. If we cannot show continuous compliance with the requirement for all volumes of ethanol, we will not be able issue RINs for the non-grandfathered volumes of ethanol produced. If our ethanol production does not meet the requirements for RIN generation as administered by the EPA, we may be required to sell those gallons of ethanol without RINs at lower prices in the domestic market to compensate for the lack of RINs or sell these gallons of ethanol in the export market where RINs are not required, which could adversely affect our results of operations, cash flows and financial condition.
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
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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.
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 allows it to control or heavily influence matters requiring member approval, and has additional board rights under our member control agreement.
As of February 16, 2021, Granite Falls Energy, LLC, through its wholly owned subsidiary, Project Viking, L.L.C., owns approximately 50.7% 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, 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. We have established a Unit Trading Bulletin Board through FNC Ag Stock, LLC, in order to facilitate trading among our members. The Unit Trading Bulletin Board is a private online matching service that 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.
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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.
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 Compeer Financial, formerly known as AgStar Financial Services, FCLA (“Compeer”) under our credit facility. Our credit facility with Compeer 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 distributions that were paid to members in January 2016 and 2018, 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.
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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.
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
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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 (21% beginning after December 31, 2017). 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.
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.
Although we expect that a number of our members may qualify for the Qualified Business Income Deduction (“QBID”), you may not qualify for the QBID.
Your ownership of our units may qualify you for the QBID. Pursuant to the Tax Cuts and Jobs Act of 2017, the QBID allows for a deduction of up to 20% of the qualified business income (“QBI”) of an owner of a pass-through entity. QBI generally includes the net amount of qualified income, gain, deduction, and loss from a domestic trade or business in which the taxpayer is an owner. The calculation of the QBID depends on a variety of factors, with the most significant factor being the taxpayer’s taxable income. For married persons filing jointly with taxable income equal to or
34
less than the threshold amount, which is subject to adjustment for inflation, of $315,000 ($157,500 for taxpayers filing single), a taxpayer’s QBID is the lesser of: (1) 20% of the taxpayer’s QBI, or (2) 20% of the taxpayer’s taxable income less their net capital gains. For married persons filing jointly with taxable income exceeding the above-referenced threshold amounts, the QBID is subject to further limitations, such as limitations based on the amount of W-2 wages paid with respect to that entity or business, the unadjusted basis of qualified property in the business, and the type of trade or business. Because the impact of this deduction is dependent upon your particular tax situation, you should consult your own tax advisor as to your eligibility for the QBID. There is no guarantee that you will qualify for the QBID.
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 U.S. 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.
We own approximately 216 acres of land located near Heron Lake, Minnesota on which we have constructed and operate 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 Compeer as security for loan obligations.
Our indirectly wholly owned subsidiary’s, Agrinatural, property consists of 190 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 21.3% and 22.1% of our consolidated total assets in the years ended October 31, 2020 and 2019, respectively. All of Agrinatural’s real property and assets are subject to mortgages in favor of HLBE as security for loan obligations.
Our and Agrinatural’s credit facilities are discussed in more detail under “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Credit Arrangements.”
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.
35
ITEM 4. MINE SAFETY DISCLOSURES
None.
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, we have 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 two fiscal years regarding the actual unit transactions that were completed by our unit-holders during the periods specified. 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 |
| ||
2019 1st |
| $ | 0.80 | | $ | 0.80 | | 16,250 | |
2019 2nd |
| $ | 0.80 | | $ | 0.80 | | 11,000 | |
2019 3rd |
| $ | 0.50 | | $ | 0.60 | | 55,000 | |
2019 4th |
| $ | 0.70 | | $ | 0.75 | | 22,000 | |
2020 1st |
| $ | 0.60 | | $ | 0.60 | | 21,500 | |
2020 2nd |
| | N/A | | | N/A | | — | |
2020 3rd |
| | N/A | | | N/A | | — | |
2020 4th |
| | N/A | | | N/A | | — | |
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
36
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 year 2020.
Holders of Record
As of February 16, 2021, there were 62,932,107 Class A units outstanding held of record by 1,187 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 February 16, 2021, Granite Falls Energy, LLC owns an approximately 50.7% controlling interest in the Company through its wholly owned subsidiary, Project Viking, L.L.C. GFE is a related party by virtue of its ownership interest in us. 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, 2020, and February 16, 2021, 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 Compeer. 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.
No additional distributions were either declared or paid in 2019 or 2020.
Our board of directors has complete discretion over the timing and amount of distributions to our members. 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.”
Unregistered Sales of Equity Securities
The Company had no unregistered sales of securities in fiscal year 2020.
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.
ITEM 6. SELECTED FINANCIAL DATA
Not applicable.
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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, 2020. 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 U.S. and in the sale and distribution of our distillers’ grains (DGS) locally, and throughout the continental U.S.
Based on the criteria set forth in ASC 280, the Company has two reportable operating segments for financial reporting purposes: (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.
Before intercompany eliminations, revenues from our natural gas pipeline segment represented 3.8% and 3.0% of our total consolidated revenues in the years ended October 31, 2020 and 2019, 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 1.9% and 1.3% of our consolidated revenues for the fiscal years ended October 31, 2020 and 2019, respectively, and have little to no impact on the overall performance of the Company.
Plan of Operations For the Next Twelve Months
The Company, and the ethanol industry as a whole, experienced significant adverse conditions throughout most of 2019 and 2020 as a result of industry-wide record low ethanol prices due to reduced demand, high industry inventory levels and other effects of the COVID-19 pandemic. These factors resulted in prolonged negative operating margins, significantly lower cash flow from operations and substantial net losses. As a result of these losses, we have realized two adverse consequences. First, as corn prices increased in January 2021, we received margin calls on our corn futures positions on the Chicago Board of Trade. Because we did not have the cash to pay those margin calls, we exited those futures positions and have become unprotected against future price increases. Second, our available working capital and net worth have decreased. As such, we have fallen out of compliance with our loan covenants which requires us to maintain a minimum level of working capital and local net worth. As a result of this loan covenant violation we have reclassified the long-term portion of our bank term debt as a current liability since the bank would retain the right to take adverse action as a result of those violations. If we continue to experience unfavorable operating conditions in the future, we may either have to secure additional debt or equity sources from other sources or idle ethanol production altogether. If CoBank, as the administrative agent for our lender Compeer, seeks to enforce its security interests we may be faced with the prospects of either ceasing operations or seeking Chapter 11 “reorganization” bankruptcy protection.
If we can satisfy our creditors and remain operating, then over the next twelve months we will continue our focus on operational improvements at our plant. These operational improvements include exploring methods to improve ethanol yield per bushel and increasing production output at our plant, continued emphasis on safety and environmental regulation, reducing our operating costs, and optimizing our margin opportunities through prudent risk-management policies.
In addition, we expect to continue to conduct routine maintenance and repair activities at the ethanol plant to maintain current plant infrastructure, as well as small capital projects, to improve operating efficiency.
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Trends and Uncertainties Impacting Our Operations
The principal factors affecting our results of operations and financial conditions are the market prices for corn, ethanol, distillers’ grains and natural gas, as well as governmental programs designed to create incentives for the use of corn-based ethanol. Other factors that may affect our future results of operation include those risks and factors discussed in this report at “PART I - ITEM 1. BUSINESS” and “PART I - ITEM 1A. RISK FACTORS”.
Our operations are highly dependent on commodity prices, especially prices for corn, ethanol, distillers’ grains and natural gas. As a result, our operating results can fluctuate substantially due to volatility in these commodity markets. The price and availability of corn is subject to significant fluctuations depending upon a number of factors that affect commodity prices in general, including crop conditions, yields, domestic and global stocks, weather, federal policy and foreign trade. Natural gas prices are influenced by severe weather in the summer and winter and hurricanes in the spring, summer and fall. Other factors include North American exploration and production, and the amount of natural gas in underground storage during injection and withdrawal seasons. Ethanol prices are sensitive to world crude oil supply and demand, domestic gasoline supply and demand, the price of crude oil, gasoline and corn, the price of substitute fuels and octane enhancers, refining capacity and utilization, government regulation and incentives and consumer demand for alternative fuels. Distillers’ grains prices are impacted by livestock numbers on feed, prices for feed alternatives and supply, which is associated with ethanol plant production.
We expect our ethanol plant to produce approximately 2.8 gallons of denatured ethanol for each bushel of grain processed in the production cycle. Because the market price of ethanol is not always directly related to corn, at times ethanol prices may lag price movements in corn prices and corn-ethanol price spread (the difference between the price per gallon of ethanol and the price per bushel of grain divided by 2.8) may be tightly compressed or negative. If the corn-ethanol spread is compressed or negative for sustained period, it is possible that our operating margins will decline or become negative and our ethanol plant may not generate adequate cash flow for operations. In such cases, we may reduce or cease production at our ethanol plant in order to minimize our variable costs and optimize cash flow.
For the fiscal year ended October 31, 2020 compared to fiscal year ended October 31, 2019, our average price per gallon of ethanol sold decreased approximately 4.0%. Ethanol prices were lower during the fiscal year ended October 31, 2020 due primarily to effects of the COVID-19 pandemic, which resulted in reduced demand and high inventory levels. Additionally, the increase in approved economic hardship exemptions has effectively lowered the RVOs by a significant number of gallons of domestic demand. If this trend continues, it may continue to negatively impact the U.S. ethanol market. Management believes that the ethanol outlook moving into fiscal year 2021 will remain relatively flat and our margins will remain tight due to higher corn prices and depressed gasoline demand.
In recent years, including fiscal year 2020 over fiscal year 2019, exports of ethanol have increased. Export demand for ethanol is less consistent compared to domestic demand which can lead to ethanol price volatility. During 2017, Brazil and China adopted import quotas and/or tariffs on the importation of ethanol, which are expected to continue to negatively impact U.S. exports. China, the number three importer of U.S. ethanol in 2016, has imported negligible volumes since imposing a 70% tariff in 2018 until January 2021. On September 1, 2017, Brazil’s Chamber of Foreign Trade imposed a 20% tariff on U.S. ethanol imports in excess of 150 million liters, or 39.6 million gallons, per quarter. The tariff was renewed in September 2019, but the import quota was raised to 187.5 million liters, or 49.5 million gallons, per quarter. In December 2020, the import quota expired, thereby subjecting all Brazilian imports of U.S. ethanol to a 20% tariff. These tariffs have had and will likely continue to have a negative impact on the export market demand and prices for ethanol produced in the United States. Any decrease in U.S. ethanol exports could adversely impact the market price of ethanol unless domestic demand increases or additional foreign markets are developed.
Corn prices were slightly higher during our 2020 fiscal year compared to our 2019 fiscal year, due primarily to strong export demand during the 2020 period compared to the 2019 period. The latest estimates of supply and demand provided by the U.S. Department of Agriculture (“USDA”) estimate the 2019-2020 ending corn stocks at approximately 1.9 billion bushels, and project the 2020-2021 corn supply at approximately 16.5 billion bushels, which is more than the 2019-2020 supply, with corn consumption for ethanol and co-products slightly higher at approximately 5.1 billion bushels, suggesting higher corn prices into fiscal 2021. Beginning in December 2020, and carrying through January and into February 2021, China substantially increased its purchase of U.S. corn reducing U.S. inventories and increasing prices. Weather, world supply and demand, current and anticipated stocks, agricultural policy and other factors can
39
contribute to volatility in corn prices. If corn prices rise, it will have a negative effect on our operating margins unless the price of ethanol and distillers’ grains outpaces rising corn prices.
Distillers’ grains prices decreased in 2020 over 2019 due to decreased supply as a result of decreased production. Top export markets include Mexico, Vietnam, Korea, Indonesia, Turkey, Thailand, and the European Union and United Kingdom. Of note, however, is that export demand from China, historically one of the largest importers of U.S. produced distillers grains, has significantly declined. In 2017, China imposed significant anti-dumping and anti-subsidy tariffs on distillers’ grains imported from the U.S., which resulted in significant declines in exports of U.S. distillers’ grains to China. The anti-dumping tariffs range from 42.2% to 53.7% and the anti-subsidy tariffs range from 11.2% to 12%. The imposition of these duties has resulted in a significant decline in demand from this top importer requiring U.S. producers to seek out alternative markets. While exports to China increased during fiscal year 2020 compared to fiscal year 2019, exports to China remain substantially below the pre-tariff export levels. There is no guarantee that distillers’ grains exports to China will return to pre-tariff levels.
On January 15, 2020, President Trump signed a “phase one” trade agreement with China. The agreement includes a commitment by China to purchase agricultural products over the next two years, including distillers’ grains. The agreement will also provide U.S. manufacturers of DDGS with a streamlined process for registration and licensing in order to facilitate U.S. exports to China. While this agreement appears positive for the industry, there is no guarantee that the agreement will be fully implemented, nor is there a guarantee that exports to China return to pre-tariff levels.
Additionally, exports of U.S. distillers’ grains to Vietnam had halted completely due to Vietnam’s imposition of stricter regulations in December 2016. In a statement issued September 1, 2017, the U.S. Grains Council announced that Vietnam is lifting its suspension of U.S. distillers’ grains imports and easing fumigation requirements. While exports to Vietnam have resumed, they remain substantially below the pre-2016 levels. There is no guarantee that distillers’ grains exports to Vietnam will return to such levels.
Management anticipates distillers’ grains prices will remain steady during our 2021 fiscal year, unless additional domestic demand, increased corn prices or other foreign markets develop. Domestic demand for distillers’ grains could be negatively affected if corn prices decline and end-users switch to lower priced alternatives.
Corn oil prices as a whole have been adversely impacted during the last few years by oversupply of corn oil due to the substantial increase in corn oil production. Additionally, corn oil prices have been impacted by the oversupply of soybeans and the resulting lower price of soybean oil which competes with corn oil for biodiesel production. In December 2019, legislation was signed extending the $1.00 per-gallon biodiesel blender tax credit retroactively to January 1, 2018, and through December 31, 2022.
Given the inherent volatility in ethanol, distillers’ grains, non-food grade corn oil, grain and natural gas prices, we cannot predict the likelihood that the spread between ethanol, distillers’ grains, non-food grade corn oil and grain prices in future periods will be consistent compared to historical periods.
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Results of Operations for the Fiscal Years Ended October 31, 2020 and 2019
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 audited consolidated statements of operations for the fiscal years ended October 31, 2020 and 2019 (amounts in thousands):
| | 2020 | | 2019 | ||||||||
Statement of Operations Data |
| |
| % |
| |
| % | ||||
Revenues | | $ | 76,030 |
| 100.0 | % | | $ | 106,827 |
| 100.0 | % |
Cost of Goods Sold | |
| 84,998 |
| 111.8 | % | |
| 108,812 |
| 101.9 | % |
Gross Loss | |
| (8,968) |
| (11.8) | % | |
| (1,985) |
| (1.9) | % |
Operating Expenses | |
| (5,402) |
| (7.1) | % | |
| (3,398) |
| (3.2) | % |
Operating Loss | |
| (14,370) |
| (18.9) | % | |
| (5,383) |
| (5.1) | % |
Other Income, net | |
| 119 |
| 0.2 | % | |
| 205 |
| 0.2 | % |
Net Loss | |
| (14,251) |
| (18.7) | % | |
| (5,178) |
| (4.9) | % |
Less: Net Income Attributable to Non-controlling Interest | |
| (68) |
| (0.1) | % | |
| (278) |
| (0.3) | % |
Net Loss Attributable to Heron Lake BioEnergy, LLC | | $ | (14,319) |
| (18.8) | % | | $ | (5,456) |
| (5.2) | % |
Revenues
Our consolidated revenue is derived principally from revenues from our ethanol production segment, which consists of sales of our three primary products: ethanol, distillers’ grains and corn oil. Our remaining consolidated revenues are attributable to incidental sales of corn syrup and Agrinatural revenues, net of eliminations for distribution fees paid by the Company to Agrinatural for natural gas transportation services.
The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our audited consolidated statements of operations for the fiscal year ended October 31, 2020:
| | Year Ended October 31, 2020 | ||||
|
| Sales Revenue |
| % of Total Revenues | ||
|
| (in thousands) | | | | |
Ethanol sales | | $ | 58,326 |
| 76.7 | % |
Distillers' grains sales | |
| 12,693 |
| 16.7 | % |
Corn oil sales | |
| 2,926 |
| 3.8 | % |
Corn syrup sales | | | 678 | | 0.9 | % |
Agrinatural revenues (net of intercompany eliminations) | | | 1,407 | | 1.9 | % |
Total Revenues | | $ | 76,030 |
| 100.0 | % |
The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our consolidated statements of operations for the fiscal year ended October 31, 2019:
| | Year Ended October 31, 2019 | ||||
|
| Sales Revenue |
| % of Total Revenues | ||
|
| (in thousands) | | | | |
Ethanol sales | | $ | 82,544 |
| 77.3 | % |
Distillers' grains sales | |
| 18,214 |
| 17.1 | % |
Corn oil sales | |
| 3,514 |
| 3.3 | % |
Corn syrup sales | | | 1,123 | | 1.0 | % |
Agrinatural revenues (net of intercompany eliminations) | | | 1,432 | | 1.3 | % |
Total Revenues | | $ | 106,827 |
| 100.0 | % |
Our total consolidated revenues decreased by approximately 28.8% for the fiscal year ended October 31, 2020, as compared to the fiscal year 2019 due to decreases in quantities sold of our ethanol, distillers’ grains and corn oil, in addition to decreases in the average net prices received for our ethanol, distillers’ grains and corn oil. The following
41
table reflects quantities of our three primary products sold and the average net prices received for the fiscal years ended October 31, 2020 and 2019:
| | Year Ended October 31, 2020 | | Year Ended October 31, 2019 | ||||||
| | Quantity Sold | | Avg. Selling Price | | Quantity Sold | | Avg. Selling Price | ||
Product |
| (in thousands) |
| | |
| (in thousands) |
| | |
Ethanol (gallons) | | 48,239 | | $ | 1.21 | | 65,512 | | $ | 1.26 |
Distillers' grains (tons) | | 111 | | $ | 113.99 | | 143 | | $ | 127.32 |
Corn oil (pounds) | | 12,178 | | $ | 0.24 | | 14,251 | | $ | 0.25 |
Ethanol
Total revenues from sales of ethanol decreased by approximately 29.3% for fiscal year 2020 compared to the fiscal year 2019 due primarily to an approximately 26.4% decrease in the volumes sold from period to period, coupled with an approximately 4.0% decrease in the average price per gallon we received for our ethanol. The decrease in price is primarily due to a decrease in demand for ethanol and significantly lower gasoline prices. The decrease in volume sold is primarily due to a decrease in volume produced during the 2020 period, which included the plant being idled from March 2020 through May 2020 due to effects of the COVID-19 pandemic and experiencing operational issues with our boiler after production resumed. Management anticipates higher ethanol production and sales during our 2021 fiscal year, as compared to our 2020 fiscal year.
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. At October 31, 2020, we had fixed and basis contracts for forward ethanol sales for various delivery periods through December 2020 valued at approximately $12.4 million. Separately, ethanol derivative instruments resulted in a loss of approximately $131,000 for the fiscal year ended October 31, 2020, as compared to a gain of approximately $25,000 for the fiscal year ended October 31, 2019.
Distillers’ Grains
Total revenues from sales of distillers’ grains for our 2020 fiscal year decreased approximately 30.3% compared to fiscal year 2019. The decrease in distillers’ grains revenues is primarily attributable to an approximately 22.4% decrease in the tons of distillers’ grains sold from period to period, coupled with an approximately 10.5% decrease in the average price per ton we received for our distillers’ grains sold during fiscal year 2020 compared to fiscal year 2019.
The decrease in the market price of distillers’ grains is primarily due to decreased demand. Management anticipates that distillers’ grains prices will remain steady during our 2021 fiscal year unless export markets continue to shrink or production increases.
We produced and sold fewer tons of distillers’ grains during fiscal year 2020 as compared to 2019 due primarily to decreased ethanol production at the plant in the 2020 period, which included the plant being idled from March 2020 through May 2020 due to effects of the COVID-19 pandemic and experiencing operational issues with our boiler after production resumed. Management anticipates higher distillers’ grains production during our 2021 fiscal year, as compared to our 2020 fiscal year.
At October 31, 2020, we had forward contracts to sell approximately $5.4 million of distillers’ grains for delivery through March 2021.
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. Total revenues from sales of corn oil decreased by approximately 16.7% for fiscal year 2020 compared to the fiscal year 2019. This decrease is attributable to an approximately 14.5% decrease in the number of pounds of corn oil sold from period to period, coupled with an approximately 4.0% decrease in the average price we received per pound of corn oil sold during fiscal year 2020 compared to fiscal year 2019.
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Management attributes the decrease in corn oil sales during fiscal year 2020 as compared to 2019 primarily to decreased production at the plant in the 2020 period, which included the plant being idled from March 2020 through May 2020 due to effects of the COVID-19 pandemic and experiencing operational issues with our boiler after production resumed. Management anticipates higher corn oil production during our 2021 fiscal year, as compared to our 2020 fiscal year.
Although management believes that corn oil prices will remain relatively steady, prices may decrease if there is an oversupply of corn oil production resulting from increased production rates at ethanol plants or if biodiesel producers begin to utilize lower-priced alternatives such as soybean oil or if the biodiesel blenders’ tax credit is not renewed and biodiesel production declines.
At October 31, 2020, we had forward corn oil sales contracts to sell approximately $633,000 for delivery through December 2020.
Cost of Goods Sold
Our cost of goods sold decreased by approximately 21.9% for the fiscal year ended October 31, 2020, as compared to the fiscal year ended October 31, 2019. However, cost of goods sold, as a percentage of revenues, increased to approximately 111.8% for the fiscal year ended October 31, 2020, as compared to approximately 101.9% for the 2019 fiscal year due to the negative margin between the price of ethanol and the price of corn from period to period. Approximately 90% of our total costs of goods sold is attributable to ethanol production. As a result, the cost of goods sold per gallon of ethanol produced for the fiscal year ended October 31, 2020 was approximately $1.59 per gallon of ethanol sold compared to approximately $1.49 per gallon of ethanol produced for the fiscal year ended October 31, 2019.
The following table shows the costs of corn and natural gas (our two largest single components of costs of goods sold), as well as all other components of cost of goods sold, which includes processing ingredients, depreciation expense, electricity, and wages, salaries and benefits of production personnel, and the approximate percentage of costs of those components to total costs of goods sold in our audited consolidated statements of operations for the fiscal year ended October 31, 2020:
| | Year Ended October 31, 2020 | ||||
|
| Amount |
| % of | ||
| | (in thousands) | | Cost of Goods Sold | ||
Corn costs |
| $ | 60,497 |
| 71.2 | % |
Natural gas costs | |
| 4,826 |
| 5.7 | % |
All other components of costs of goods sold | |
| 19,675 |
| 23.1 | % |
Total Cost of Goods Sold |
| $ | 84,998 |
| 100.0 | % |
The following table shows the costs of corn, natural gas and all other components of cost of goods sold and the approximate percentage of costs of those components to total costs of goods sold in our audited consolidated statements of operations for the fiscal year ended October 31, 2019:
| | Year Ended October 31, 2019 | ||||
|
| Amount |
| % of | ||
| | (in thousands) | | Cost of Goods Sold | ||
Corn costs |
| $ | 80,504 |
| 74.0 | % |
Natural gas costs | |
| 6,818 |
| 6.3 | % |
All other components of costs of goods sold | |
| 21,490 |
| 19.7 | % |
Total Cost of Goods Sold |
| $ | 108,812 |
| 100.0 | % |
Corn Costs
Our cost of goods sold related to corn decreased approximately 24.9% for our 2020 fiscal year compared to our 2019 fiscal year, due to an approximately 25.5% decrease in the number of bushels of corn processed from period to period, which was partially offset by an approximately 0.8% increase in the average price per bushel paid for corn from period to period. The corn-ethanol price spread (the difference between the price per gallon of ethanol and the price per
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bushel of grain divided by 2.8) for our 2020 fiscal year was approximately $0.06 less than the corn-ethanol price spread we experienced for fiscal year 2019.
For our fiscal years ended October 31, 2020 and 2019, we processed approximately 16.3 million and 21.9 million bushels of corn, respectively. This decrease is due largely to the plant being idled from March 2020 through May 2020 due to effects of the COVID-19 pandemic and experiencing operational issues with our boiler after production resumed. Our corn conversion efficiency decreased slightly during our 2020 fiscal year compared to 2019. Management anticipates a slight increase in corn consumption during our 2021 fiscal year provided that we can achieve operating margins that allow us to continue to operate the ethanol plant at similar levels.
The increase in our cost per bushel of corn was due primarily to strong export demand during the 2020 period compared to the 2019 period. Due to projected increased corn stocks and projected slightly increased demand, management anticipates that corn prices will remain higher during our 2021 fiscal year.
From time to time we enter into forward purchase contracts for our corn purchases. At October 31, 2020, we had forward corn purchase contracts for approximately 2,462,000 bushels for deliveries through July 2022. Comparatively, at October 31, 2019, we had forward corn purchase contracts for approximately 740,000 bushels for deliveries through December 2021.
Our corn derivative positions resulted in a loss of approximately $1.1 million for the fiscal year ended October 31, 2020, which increased cost of goods sold, and a gain of approximately $351,000 for the fiscal year ended October 31, 2019, which decreased cost of goods sold. We recognize the gains or losses that result from the changes in the value of our derivative instruments from 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. In January 2021, we sold out of all of derivative instruments which had helped hedge our future price risk in corn due to our limited working capital resulting from operating and investment losses accruing in 2020.
Natural Gas Costs
For our 2020 fiscal year, we experienced a decrease of approximately 29.2% in our overall natural gas costs compared to our 2019 fiscal year. This decrease is due largely to the plant being idled from March 2020 through May 2020 due to effects of the COVID-19 pandemic and experiencing operational issues with our boiler after production resumed. In recent years, there has been an increase in cost of natural gas, primarily as a result of an increase in the average price per MMBTU of natural gas due to increased domestic and export demand. Management also anticipates higher natural gas prices as we move through the winter months due to the typical seasonal natural gas cost increases experienced during the winter months.
Operating Expense
Operating expenses include wages, salaries and benefits of administrative employees at the plant, insurance, professional fees, property taxes and similar costs. Operating expenses as a percentage of revenues rose to 7.1% of revenues for our fiscal year ended October 31, 2020, compared to 3.2% of revenues for our fiscal year ended October 31, 2019. This increase is due primarily to lower revenues and the recognition of an approximately $1.8 million loss on the disposal of assets in the 2020 period.
Our efforts to optimize efficiencies and maximize production may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses generally do not vary with the level of production at the plant, we expect our operating expenses to remain steady into and throughout our 2021 fiscal year.
Operating Loss
For our fiscal year ended October 31, 2020, we reported operating loss of approximately $14.4 million, compared to operating loss of approximately $5.4 million for our fiscal year ended October 31, 2019. This increase in operating loss resulted largely from increased prices for corn relative to the price of ethanol and negative operating margin, largely due to losses on disposal of assets of approximately $1.8 million and change in fair value of commodity
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derivative instruments of approximately $1.2 million, and losses resulting from the plant being idled from March 2020 through May 2020 due to effects of the COVID-19 pandemic and experiencing operational issues with our boiler after production resumed.
Other Income, Net
We had net other income of approximately $119,000 during fiscal year 2020, compared to net other income of approximately $205,000 for fiscal year 2019. We had less other income during fiscal year 2020 compared to fiscal year 2019 primarily due to increased interest expense.
Changes in Financial Condition at October 31, 2020 and 2019
The following table highlights the changes in our financial condition from our audited consolidated balance sheet for the periods presented (amounts in thousands):
|
| October 31, 2020 |
| October 31, 2019 |
| ||
Current Assets | | $ | 13,268 | | $ | 16,266 | |
Total Assets | | $ | 63,080 | | $ | 56,596 | |
Current Liabilities | | $ | 21,116 | | $ | 6,144 | |
Long-Term Debt, less current portion | | $ | 296 | | $ | 300 | |
Operating Leases, long-term liabilities | | $ | 7,947 | | | — | |
Other Long-Term Liabilities | | $ | 597 | | $ | 551 | |
Members' Equity attributable to Heron Lake BioEnergy, LLC | | $ | 33,125 | | $ | 47,599 | |
Non-Controlling Interest | | $ | — | | $ | 2,002 | |
The approximate $6.5 million increase in total assets was primarily driven by the recognition of operating lease right of use asset of approximately $9.3 million and an increase in property and equipment of approximately $780,000, which was partially offset by the decrease of current assets of approximately $3.0 million and other long-term assets of approximately $589,000. The decrease in current assets was primarily driven by a decrease in our cash of approximately $1.3 million and accounts receivable of approximately $3.3 million, partially offset by an increase in restricted cash of approximately $461,000 and inventory of approximately $788,000.
Current liabilities at October 31, 2020 increased by approximately $15.0 million compared to October 31, 2019. This increase includes increases of current maturities of long-term debt by approximately $11.2 million, checks drawn in excess of bank balance by approximately $693,000, accounts payable by approximately $1.5 million, and the recognition of short-term operating lease liabilities of approximately $1.3 million at October 31, 2020 compared to October 31, 2019. The increase in current maturities was primarily due to the aforementioned reclassification as further described in Note 2 of our financial statements.
Our other long-term liabilities increased by approximately $46,000 at October 31, 2020 compared to October 31, 2019. The increase is due to rail car rehabilitation costs recorded for fiscal year 2020.
Members’ equity attributable to Heron Lake BioEnergy, LLC decreased approximately $14.5 million at October 31, 2020 compared to October 31, 2019. This decrease was due primarily to approximately $14.3 million in net loss attributable to HLBE. Non-controlling interest decreased approximately $2.0 million due to acquisition of the non-controlling interest in fiscal year 2020, which was directly related to recognition of the then-27.0% non-controlling interest in Agrinatural, LLC.
Liquidity and Capital Resources
Our working capital is significantly impaired. Losses arising in fiscal 2020 and continuing into fiscal 2021 have reduced our available cash and utilized much of our available operating credit. Our principal sources of liquidity consist of cash provided by operations, cash on hand, and available borrowings under our credit facility with Compeer. Our principal uses of cash are to pay operating expenses of the plant, to make debt service payments on our long-term debt, and to make distribution payments to our members. Ordinarily, we would expect to use cash generated by continuing operations, our revolving term loan, and our loan with GFE to fund our operations for the next twelve
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months. However, to remain an operating company, we will have to secure additional debt or equity sources to meet our loan covenants or idle ethanol production altogether. There is a risk that CoBank, as the administrative agent for our lender Compeer, may seek to enforce its security interests and take control of our assets. If that were to happen, then we may be faced with the prospects of either ceasing operations or seeking Chapter 11 “reorganization” bankruptcy protection.
We do not currently anticipate any significant purchases of property and equipment that would require us to secure additional capital in the next twelve months. For our 2021 fiscal year, we anticipate completion of several small capital projects and to maintain current plant infrastructure and improve operating efficiency.
Management continues to evaluate conditions in the ethanol industry and explore opportunities to improve the efficiency and profitability of our operations which may require additional capital to supplement cash generated from operations and available for borrowing under our revolving term loan.
Year Ended October 31, 2020 Compared to Year Ended October 31, 2019
The following table summarizes cash flows for the fiscal years presented (amounts in thousands):
| | Fiscal Year Ended October 31, |
| ||||
| | 2020 | | 2019 | | ||
Net cash used in operating activities |
| $ | (4,824) |
| $ | (420) | |
Net cash used in investing activities | | $ | (5,826) | | $ | (432) | |
Net cash provided by (used in) financing activities | | $ | 9,846 | | $ | (550) | |
Net decrease in cash and restricted cash | | $ | (803) | | $ | (1,402) | |
Operating Cash Flows
During the fiscal year ended October 31, 2020, net cash used in operating activities increased by approximately $4.4 million compared to the fiscal year ended October 31, 2019. The increase resulted largely from an approximately $9.1 million increase in our net loss in the current year, offset by non-cash charge in fiscal year 2020 for loss on disposal of assets of approximately $1.8 million, and mitigated by increases of approximately $1.3 million from period to period in various working capital items. Net loss increased for fiscal year 2020 due to decreased revenues and higher costs of goods sold as a percentage of revenues.
Investing Cash Flows
During the fiscal year ended October 31, 2020, net cash used in investing activities increased by approximately $5.4 million due primarily to increased capital expenditures for grain storage of approximately $3.0 million and the new boiler of approximately $2.8 million compared to the fiscal year ended October 31, 2019. In addition, approximately $2.1 million of accounts payable at October 31, 2020 includes payables for capital expenditures incurred during the fiscal year ended October 31, 2020.
Financing Cash Flows
Our financing activities provided us with approximately $9.8 million for the fiscal year ended October 31, 2020, compared to the approximately $550,000 we used for financing activities for the fiscal year ended October 31, 2019. During the fiscal year ended October 31, 2020, we had net proceeds from long-term debt of approximately $10.3 million. These increases were offset by the $2.0 million we used to acquire non-controlling interest in fiscal year 2020. For the same period of 2019, we used cash to make payments of approximately $325,000 on our long-term debt and $225,000 to acquire non-controlling interest. Additionally, in fiscal year 2020, we received proceeds from our Paycheck Protection Program loan of approximately $596,000.
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Credit Arrangements
Revolving Term Note
We had a revolving term note payable to Compeer Financial, formerly known as AgStar Financial Services, FCLA (“Compeer”) under which we could borrow, repay, and re-borrow in an amount up to the original aggregate principal commitment at any time prior to maturity at March 1, 2022. The original aggregate principal commitment was $28,000,000, which reduced by $3,500,000 annually, starting March 1, 2015 and continuing each anniversary thereafter until maturity. In December 2017, the Company and its lender orally agreed to reduce the aggregate principal commitment of the revolving term loan to $8,000,000. On April 6, 2018, the Company finalized loan agreements with an effective date of March 29, 2018 for an amended credit facility with Compeer (the “2018 Credit Facility”). On January 7, 2020, the Company finalized loan agreements for an amended credit facility with its lender (the “2020 Credit Facility”).
2018 Credit Facility with Compeer
We had a comprehensive credit facility with Compeer for which CoBank, ACP (“CoBank”) served as the administrative agent. This credit facility originally consisted of a revolving term loan with a maturity date of March 1, 2022. However, on April 6, 2018, we entered into an amended credit facility with Compeer (the “2018 Credit Facility”). The 2018 Credit Facility includes an amended and restated revolving term loan with a $4.0 million principal commitment and a revolving seasonal line of credit with a $4.0 million principal commitment. CoBank will continue to act as Compeer's administrative agent with respect to our 2018 Credit Facility and has a participation interest in the loans. The Company agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.
Under the terms of the amended revolving term loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4.0 million. Final payment of amounts borrowed under our amended revolving term loan was due December 1, 2021. Interest on the amended revolving term loan accrues at a variable weekly rate equal to 3.10% above the One-Month London Interbank Offered Rate (“LIBOR”) Index rate, which was 3.24% at October 31, 2020.
We agreed to pay an unused commitment fee on the unused available portion of the amended revolving term loan commitment at the rate of 0.500% per annum, payable monthly in arrears.
The aggregate principal amount available to the Company for borrowing under the revolving term loan at October 31, 2019 was $4.0 million.
Under the terms of the seasonal revolving loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $4.0 million until its maturing. Amounts borrowed under the seasonal revolving loan bear interest at a variable weekly rate equal to 2.85% above the LIBOR Index rate, which was 2.99% at October 31, 2020.
The Company also agreed to pay an unused commitment fee on the unused portion of the seasonal revolving loan commitment at the rate of 0.250% per annum.
The aggregate principal amount available to the Company for borrowing under the seasonal revolving loan at October 31, 2019 was $4.0 million.
The 2018 Credit Facility is secured by substantially all of our assets, including a subsidiary guarantee.
Under the 2018 Credit Facility, the Company is subject to certain financial and non-financial covenants that limit the Company’s distributions and debt and require minimum working capital, minimum local net worth, and debt service coverage ratio. We agreed to a debt service coverage ratio of 1.15 to 1.0, to maintain minimum working capital $8.0 million through September 30, 2018 and $10.0 million thereafter, and to maintain net worth of $32.0 million. We are permitted to pay distributions to our members up to 75% of our net income for the year in which the distributions are paid provided that immediately prior to the distribution and after giving effect to the distribution, no default exists and we are in compliance with all of our loan covenants. Further, we agreed not to make loans or advances to Agrinatural that exceed an aggregate principal amount of approximately $6.6 million without the consent of Compeer.
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In October 2019, the Company had an event of non-compliance related to the debt service coverage ratio as defined in the 2018 Credit Facility. In December 2019, the Company received a waiver from its lender waiving this event of noncompliance. Subsequent to October 31, 2020, HLBE had further events of non-compliance and has forecasted that it is probable that there will be future instances of noncompliance with debt covenants within the next 12 months.
2020 Credit Facility with Compeer
The 2020 Credit Facility includes an amended and restated revolving term loan with an $8,000,000 principal commitment, which was increased to a $13,000,000 principal commitment in June 2020. The loans are secured by substantially all of the Company’s assets, including a subsidiary guarantee. The 2020 Credit Facility contains customary covenants, including restrictions on the payment of dividends and loans and advances to Agrinatural, and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility. During the second fiscal quarter of 2020, the 2020 Credit Facility was amended to reduce the working capital covenant to $8 million, from the original $10 million working capital covenant, for the period of April 30, 2020 through December 31, 2020, and increasing to $10 million beginning January 1, 2021. Additionally, the current portion of leases are excluded from the calculation of current liabilities. Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges, or penalties. In May 2020, HLBE had an event of non-compliance related to the minimum working capital requirement as defined in the 2020 Credit Facility. The Company has obtained a waiver from its lender for this event of non-compliance. As of and for the fiscal year ended October 31, 2020, HLBE had events of non-compliance with respect to our working capital covenant our debt service coverage ratio. HLBE has obtained a waiver from its lender for the non-compliance events. Subsequent to October 31, 2020, HLBE had further events of non-compliance and has forecasted that it is probable that there will be future instances of noncompliance with debt covenants within the next 12 months.
As part of the 2020 Credit Facility closing, the Company entered into an amended administrative agency agreement with CoBank. As a result, CoBank will continue act as the agent for the lender with respect to the 2020 Credit Facility. The Company agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.
Under the terms of the amended and restated revolving term loan, the Company may borrow, repay, and reborrow up to the aggregate principal commitment amount of $13,000,000. Final payment of amounts borrowed under amended revolving term loan is due December 1, 2022. Interest on the amended and restated revolving term loan accrues at a variable weekly rate equal to 3.35% above the higher of 0.00% or the One-Month LIBOR Index rate, which was 3.51% at October 31, 2020. We agreed to pay an unused commitment fee on the unused available portion of the amended revolving term loan commitment at the rate of 0.500% per annum, payable monthly in arrears.
The aggregate principal amount available to the Company for borrowing under the revolving term loan at October 31, 2020 was $5.1 million.
Single Advance Term Note
In June 2020, we entered into a single advance term note with a $3,000,000 principal commitment, with the purpose to finance the construction of a new grain bin and provide principal reduction on the revolving term note. The interest rate is fixed at 3.80%. Principal with interest is to be paid in 10 consecutive, semi-annual installments, with the first installment due on December 20, 2020 and the last installment due on June 20, 2025. The note is secured as provided in the 2020 Credit Facility.
Short Term Revolving Promissory Note
In February 2021, HLBE entered into a revolving promissory note with its lender in order to finance the operating needs of HLBE. Under the terms, HLBE may borrow, repay and reborrow up to the aggregate principal commitment amount of $5,000,000. Final payment of amounts borrowed under the revolving promissory note is June 1, 2021. Interest of the loan accrues at a variable weekly rate equal to 3.35% above the higher of 0.00% or the One-Month London Interbank Offered Rate (“LIBOR”) Index rate and is payable monthly in arrears. In addition, HLBE agreed to
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pay an unused commitment fee on the unused available portion of the loan at the rate of 0.50% per annum payable monthly in arrears. The revolving promissory note is subject to the 2020 Credit Facility.
SBA Paycheck Protection Program Loan
In March 2020, Congress passed the Paycheck Protection Program, authorizing loans to small businesses for use in paying employees that they continue to employ throughout the COVID-19 pandemic and for rent, utilities and interest on mortgages. Loans obtained through the Paycheck Protection Program are eligible to be forgiven as long as the proceeds are used for qualifying purposes and certain other conditions are met. On April 18, 2020, HLBE received a loan in the amount of $595,693 through the Paycheck Protection Program. Management expects that the entire loan will be used for payroll, utilities and interest; therefore, management anticipates that the loan will be substantially forgiven. To the extent it is not forgiven, HLBE would be required to repay that portion at an interest rate of 1% over a period of two years, with principal repayment installments in May 2021 with a final installment in May 2022.
Negotiable Promissory Note
In December 2020, we entered into a negotiable promissory note with GFE with a $5,000,000 principal commitment. Interest on the loan accrues at a variable weekly rate equal to the higher of 1.00% or the One-Month LIBOR Index rate, plus 3.35%. The note is due on demand, and accrued interest must be paid in full the first business day of each month. The note is unsecured and may be prepaid at any time without penalty.
In January 2021, we borrowed the $5,000,000 on the promissory note. In February 2021, GFE agreed to modify the promissory note to remove the due on demand feature, instead agreeing that GFE will not require any principal repayment on the loan until March 2023. However, should there be future violations of the Compeer loan covenants, those violations would also be considered a default on this promissory note.
Other Credit Arrangements
In addition to our primary credit arrangement with Compeer, 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 were 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. On September 30, 2019, we finalized a new industrial water supply development and distribution agreement with the City of Heron Lake, effective as of February 1, 2019. Under this agreement, we pay flow charges and fixed monthly charges to the City of Heron Lake, in addition to certain excess maintenance costs. The term of this agreement expires February 1, 2029.
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, 2020 and 2019, there was a total of approximately $301,000 and $634,000 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%. Final payment on the water revenue bonds is due October 2021.
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Loans to Agrinatural
Original Agrinatural Credit Facility
On July 29, 2014, HLBE entered into an intercompany loan agreement and related loan documents with Agrinatural (the “Original Agrinatural Credit Facility”). Under the Original Agrinatural Credit Facility, HLBE 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. The Original Agrinatural Credit Facility contains customary financial and non-financial affirmative covenants and negative covenants for loans of this type and size.
On March 30, 2015, HLBE entered into an allonge (the “Allonge”) to the July 29, 2014 note with Agrinatural. Under the terms of the Allonge, HLBE and Agrinatural agreed to increase the principal amount of the Original Agrinatural Credit Facility to approximately $3.06 million, defer commencement of repayment of principal until May 1, 2015, decrease the monthly principal payment to $36,000 per month and shorten maturity of the Original Agrinatural Credit Facility to May 1, 2019.
Interest on the Original Agrinatural Credit Facility was not amended and 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. Accrued interest is due and payable on a monthly basis. Except as otherwise provided in the Allonge, all of the terms and conditions contained in the Original Agrinatural Credit Facility remain in full force and effect.
In exchange for the Loan Agreement, the Agrinatural executed a security agreement granting HLBE a first lien security interest in all of Agrinatural’s equipment and assets and a collateral assignment assigning HLBE all of Agrinatural’s interests in its contracts, leases, easements and other agreements. In addition, RES, the former minority owner of Agrinatural, executed a guarantee under which RES guaranteed full payment and performance of 27% of Agrinatural’s obligations to HLBE.
Upon the passage of the May 1, 2019 maturity date, Agrinatural went into default on the Original Agrinatural Credit Facility. As noted, we have a security interest in all of Agrinatural’s assets. No interruption in the service of natural gas to our ethanol production facility occurred as a result of the default. The balance of this loan was approximately $1.1 million at October 31, 2019. Subsequent to the closing of HLBE’s indirect acquisition of Agrinatural’s non-controlling interest in December 2019, the parties agreed to forgive the debt related to the Original Agrinatural Credit Facility.
Additional Agrinatural Credit Facility
On March 30, 2015, HLBE entered into a second intercompany loan agreement and related loan documents (the “Additional Agrinatural Credit Facility”) with Agrinatural. Under the Additional Agrinatural Credit Facility, HLBE agreed to make a four-year term loan in the principal amount of $3.5 million to Agrinatural for use by Agrinatural to repay its outstanding trade debt and provide working capital. The Additional Agrinatural Credit Facility contains customary financial and non-financial affirmative covenants and negative covenants for loans of this type and size.
Interest on the additional 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. Prior to May 1, 2015, Agrinatural is required to pay only monthly interest on the term loan. Commencing May 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 was due and payable in full on May 1, 2019.
On May 19, 2016, HLBE and Agrinatural amended the Additional Agrinatural Credit Facility, entering into amendment to the loan agreement dated March 30, 2015 (the “Amendment”). Additionally, HLBE and Agrinatural entered into an allonge to the negotiable promissory note dated March 30, 2015 issued by Agrinatural to HLBE (the “Additional Allonge”) to increase the amount of the capital expenditures allowed by Agrinatural during the term of the facility and deferred a portion of the principal payments required for 2016.
The Amendment provides that the portion of principal payments deferred in calendar year 2016 to continue to accrue interest at the rate set forth in the Note and become a part of the balloon payment due at maturity. Additionally,
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for calendar years, 2017, 2018 and 2019, the Amendment provides that Agrinatural may, without consent of HLBE, proceed with and pay for capital expenditures in an amount up to $100,000 plus the amount of contributions in aid of construction received by Agrinatural from customers for capital improvements (“CIAC”), less a reserve for distribution to the Agrinatural members to cover the income or other taxes imposed as a result of receipt of CIAC in an amount equal to 40% of CIAC. Prior to the Amendment, Agrinatural’s capital expenditures were restricted to $100,000 per year.
In exchange for the Additional Agrinatural Credit Facility, Agrinatural executed a security agreement granting HLBE a first lien security interest in all of Agrinatural’s equipment and assets and a collateral assignment assigning HLBE all of Agrinatural’s interests in its contracts, leases, easements and other agreements. In addition, RES executed a guarantee under which RES guaranteed full payment and performance of 27% of Agrinatural’s obligations to HLBE under the Additional Agrinatural Credit Facility.
Upon the passage of the May 1, 2019 maturity date, Agrinatural went into default on the Additional Agrinatural Credit Facility. As noted, we have a security interest in all of Agrinatural’s assets. No interruption in the service of natural gas to our ethanol production facility occurred as a result of the default. The balance of this loan was approximately $1.5 million at October 31, 2019. Subsequent to the closing of HLBE’s indirect acquisition of Agrinatural’s non-controlling interest in December 2019, the parties agreed to forgive the debt related to the Additional Agrinatural Credit Facility.
Off Balance-Sheet Arrangements
We have no off balance-sheet arrangements.
Critical Accounting Estimates
Note 1 to our consolidated financial statements contains a summary of our significant accounting policies, many of which require management to use estimates and assumptions. Accounting estimates are an integral part of the preparation of financial statements and are based upon management’s current judgment. We use our knowledge and experience about past events and certain future assumptions to make estimates and judgments involving matters that are inherently uncertain and that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. We believe that of our significant accounting policies, the following are most noteworthy because changes in these estimates or assumptions could materially affect our financial position and results of operations:
Revenue Recognition
Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. Our contracts primarily consist of agreements with marketing companies and other customers as described below. Our performance obligations consist of the delivery of ethanol, distillers' grains, and corn oil to our customers. Our customers primarily consist of three distinct marketing companies as discussed below. The consideration we receive for these products is fixed or determinable based on current observable market prices at the Chicago Mercantile Exchange, generally, and adjusted for local market differentials. Our contracts have specific delivery modes, rail or truck, and dates. Revenue is recognized when the Company delivers the products to the mode of transportation specified in the contract, at the transaction price established in the contract, net of commissions, fees, and freight.
Agrinatural generates revenue from the transportation of natural gas to residential and commercial customers. Revenue is recognized at the point when natural gas is delivered at the transaction price established in the contract.
Derivative Instruments
From time to time, the Company enters into derivative transactions to hedge its exposures to commodity price fluctuations. The Company is required to record these derivatives in the balance sheets at fair value.
In order for a derivative to qualify as a hedge, specific criteria must be met and appropriate documentation maintained. Gains and losses from derivatives that do not qualify as hedges, or are undesignated, must be recognized immediately in earnings. If the derivative does qualify as a hedge, depending on the nature of the hedge, changes in the
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fair value of the derivative will be either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. Changes in the fair value of undesignated derivatives are recorded in earnings.
Additionally, the Company is required to evaluate its contracts to determine whether the contracts are derivatives. Certain contracts that literally meet the definition of a derivative may be exempted as “normal purchases or normal sales”. Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business.
Contracts that meet the requirements of normal purchases or sales are documented as normal and exempted from accounting and reporting requirements, and therefore, are not marked to market in our consolidated financial statements.
In order to reduce the risks caused by market fluctuations, the Company occasionally hedges its anticipated corn, natural gas, and denaturant purchases and ethanol sales by entering into options and futures contracts. These contracts are used with the intention to fix the purchase price of anticipated requirements for corn in the Company’s ethanol production activities and the related sales price of ethanol. The fair value of these contracts is based on quoted prices in active exchange-traded or over-the-counter market conditions. Although the Company believes its commodity derivative positions are economic hedges, none have been formally designated as a hedge for accounting purposes and derivative positions are recorded on the balance sheet at their fair market value, with changes in fair value recognized in current period earnings or losses. The Company does not enter into financial instruments for trading or speculative purposes.
The Company has adopted authoritative guidance related to “Derivatives and Hedging,” and has included the required enhanced quantitative and qualitative disclosure about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses from derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. See further discussion in Note 7 to our consolidated financial statements.
Inventory
We value our inventory at the lower of cost or net realizable value using the first in first out method or net realized value. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management’s assumptions which do not reflect unanticipated events and circumstances that may occur. In our analysis, we consider 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 net realized value on inventory to be a critical accounting estimate.
Property and Equipment
Management’s estimate of the depreciable lives of property 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. The Company tests for impairment at the asset group level, which is the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities.
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.
52
Rail Car Rehabilitation Costs
The Company leases 50 hopper rail cars under a multi-year agreement which ends in May 2027. Under the agreement, the Company is required to pay to rehabilitate each car for “damage” that is considered to be other than normal wear and tear upon turn in of the car(s) at the termination of the lease. Prior to the year ending October 31, 2019, the Company believed ongoing repairs resulted in an insignificant future rehabilitation expense. During the year ending October 31, 2019, based on new information, we re-evaluated our assumptions and believe that it is probable that we may be assessed for damages incurred. Company management has estimated total costs to rehabilitate the cars at October 31, 2020 and 2019 to be approximately $597,000 and $551,000, respectively. During the years ended October 31, 2020 and 2019, the Company has recorded an expense in cost of goods totaling approximately $85,000 and $551,000, respectively. The Company accrues the estimated cost of railcar damages over the term of the lease as the damages are incurred.
53
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Governors and Members of
Heron Lake BioEnergy, LLC and Subsidiaries
Heron Lake, Minnesota
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Heron Lake BioEnergy, LLC and Subsidiaries (the Company) as of October 31, 2020 and 2019, and the related consolidated statements of operations, changes in members’ equity, and cash flows for each of the years in the two-year period ended October 31, 2020, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of October 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the two-year period ended October 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
Going Concern Uncertainty
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring operating and cash flow losses and has certain debt agreements which require compliance with financial covenants. Difficult market conditions, partially due to the impact of the COVID 19 pandemic, are expected to continue to have a material adverse effect on the Company’s operating results, cash flows and liquidity, including compliance with future debt covenants. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans regarding those matters are also described in Note 2 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, 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.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also
54
included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Boulay PLLP
We have served as the Company’s auditor since 2005.
Minneapolis, Minnesota
February 16, 2021
55
HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Consolidated Balance Sheets
|
| October 31, 2020 |
| October 31, 2019 |
| ||
ASSETS | | | | | | | |
Current Assets | | | | | | | |
Cash | | $ | 3,276,301 | | $ | 4,541,295 | |
Restricted cash | | | 514,050 | | | 52,516 | |
Accounts receivable | |
| 1,616,489 | |
| 4,891,249 | |
Inventory | |
| 7,063,675 | |
| 6,276,258 | |
Commodity derivative instruments | |
| 15,150 | |
| 95,823 | |
Prepaid expenses and other current assets | |
| 782,280 | |
| 408,325 | |
Total current assets | |
| 13,267,945 | |
| 16,265,466 | |
| | | | | | | |
Property and Equipment, net | |
| 40,187,733 | |
| 39,408,195 | |
| | | | | | | |
Operating lease right of use assets | | | 9,291,249 | | | — | |
| | | | | | | |
Other assets | |
| 333,254 | |
| 922,254 | |
| | | | | | | |
Total Assets | | $ | 63,080,181 | | $ | 56,595,915 | |
| | | | | | | |
LIABILITIES AND MEMBERS' EQUITY | | | | | | | |
| | | | | | | |
Current Liabilities | | | | | | | |
Current maturities of long-term debt | | $ | 11,492,059 | | $ | 333,977 | |
Checks drawn in excess of bank balances | |
| 692,984 | |
| — | |
Accounts payable | |
| 6,916,045 | |
| 5,386,618 | |
Commodity derivative instruments | | | 173,928 | | | — | |
Accrued expenses | |
| 496,513 | |
| 423,266 | |
Operating lease, current liabilities | | | 1,344,258 | | | — | |
Total current liabilities | |
| 21,115,787 | |
| 6,143,861 | |
| | | | | | | |
Long-Term Debt, less current portion | |
| 295,611 | |
| 300,203 | |
| | | | | | | |
Operating Lease, long-term liabilities | | | 7,946,991 | | | — | |
| | | | | | | |
Other Long-Term Liabilities | | | 596,924 | | | 551,000 | |
| | | | | | | |
Commitments and Contingencies | | | | | | | |
| | | | | | | |
Members' Equity | | | | | | | |
Members' equity attributable to Heron Lake BioEnergy, LLC consists of 77,932,107 units issued and outstanding at October 31, 2020 and October 31, 2019 | |
| 33,124,868 | |
| 47,599,276 | |
Non-controlling interest | |
| — | |
| 2,001,575 | |
Total members' equity | |
| 33,124,868 | |
| 49,600,851 | |
| | | | | | | |
Total Liabilities and Members' Equity | | $ | 63,080,181 | | $ | 56,595,915 | |
Notes to Consolidated Financial Statements are an integral part of this Statement.
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Consolidated Statements of Operations
| | | | | | |
| | Fiscal Year Ended October 31, | ||||
|
| 2020 |
| 2019 | ||
Revenues | | $ | 76,029,841 | | $ | 106,827,445 |
| | | | | | |
Cost of Goods Sold | |
| 84,998,010 | |
| 108,812,379 |
| | | | | | |
Gross Loss | |
| (8,968,169) | |
| (1,984,934) |
| | | | | | |
Operating Expenses | |
| (5,401,600) | |
| (3,397,611) |
| | | | | | |
Operating Loss | |
| (14,369,769) | |
| (5,382,545) |
| | | | | | |
Other Income (Expense): | | | | | | |
Interest income | |
| 13,947 | |
| 77,654 |
Interest expense | |
| (253,639) | |
| (98,815) |
Other income, net | |
| 358,478 | |
| 225,872 |
Total other income, net | |
| 118,786 | |
| 204,711 |
| | | | | | |
Net Loss | |
| (14,250,983) | |
| (5,177,834) |
| | | | | | |
Less: Net Income Attributable to Non-controlling Interest | |
| (67,827) | |
| (277,736) |
| | | | | | |
Net Loss Attributable to Heron Lake BioEnergy, LLC | | $ | (14,318,810) | | $ | (5,455,570) |
| | | | | | |
Weighted Average Units Outstanding—Basic and Diluted (Class A and B) | |
| 77,932,107 | |
| 77,932,107 |
| | | | | | |
Net Loss Per Unit Attributable to Heron Lake BioEnergy, LLC—Basic and Diluted (Class A and B) | | $ | (0.18) | | $ | (0.07) |
| | | | | | |
Notes to Consolidated Financial Statements are an integral part of this Statement.
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Consolidated Statements of Changes in Members’ Equity
|
| |
| |
| Members' |
| | |
| | |
| |
| | | | | | Equity | | | | | | |
| |
| | | | | | attributable to | | | | | | |
| |
| | | | | | Heron Lake | | Non- | | Total |
| |||
| | | | | | BioEnergy, | | controlling | | Members' |
| |||
| | Class A Units | | Class B Units | | LLC | | Interest | | Equity |
| |||
| | | | | | | | | | | | | | |
Balance—October 31, 2018 |
| 62,932,107 |
| 15,000,000 | | $ | 53,054,846 | | $ | 1,723,839 | | $ | 54,778,685 | |
| | | | | | | | | | | | | | |
Net income attributable to non-controlling interest |
| — |
| — | | | — | | | 277,736 | | | 277,736 | |
Net loss attributable to Heron Lake BioEnergy, LLC |
| — |
| — | | | (5,455,570) | | | — | | | (5,455,570) | |
| | | | | | | | | | | | | | |
Balance—October 31, 2019 |
| 62,932,107 |
| 15,000,000 | | | 47,599,276 | | | 2,001,575 | | | 49,600,851 | |
| | | | | | | | | | | | | | |
Acquisition of non-controlling interest |
| — |
| — | | | (155,598) | |
| (2,069,402) | |
| (2,225,000) | |
Net income attributable to non-controlling interest |
| — |
| — | | | — | |
| 67,827 | |
| 67,827 | |
Net loss attributable to Heron Lake BioEnergy, LLC |
| — |
| — | |
| (14,318,810) | |
| — | |
| (14,318,810) | |
| | | | | | | | | | | | | | |
Balance—October 31, 2020 |
| 62,932,107 |
| 15,000,000 | | $ | 33,124,868 | | $ | — | | $ | 33,124,868 | |
Notes to Consolidated Financial Statements are an integral part of this Statement.
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Consolidated Statements of Cash Flows
|
| Fiscal Year Ended October 31, | | ||||
| | 2020 | | 2019 | | ||
Cash Flow From Operating Activities: | | | | | | | |
Net loss | | $ | (14,250,983) | | $ | (5,177,834) | |
Adjustments to reconcile net loss to net cash used in operations: | | | | | | | |
Depreciation and amortization | |
| 5,228,078 | |
| 5,253,479 | |
Loss on disposal of assets | |
| 1,833,928 | |
| 4,864 | |
Change in fair value of commodity derivative instruments | |
| 1,200,066 | |
| (375,216) | |
Change in operating assets and liabilities: | | | | | | | |
Accounts receivable | |
| 3,274,760 | |
| (938,562) | |
Inventory | |
| (787,417) | |
| 122,428 | |
Commodity derivative instruments | |
| (945,465) | |
| 679,851 | |
Prepaid expenses and other current assets | |
| (9,955) | |
| (15,345) | |
Accounts payable | |
| (486,012) | |
| (103,915) | |
Accrued expenses | |
| 73,247 | |
| (420,609) | |
Accrued railcar rehabilitation costs | | | 45,924 | | | 551,000 | |
Net cash used in operating activities | |
| (4,823,829) | |
| (419,859) | |
| | | | | | | |
Cash Flows from Investing Activities: | | | | | | | |
Capital expenditures | |
| (5,826,105) | |
| (432,291) | |
Net cash used in investing activities | |
| (5,826,105) | |
| (432,291) | |
| | | | | | | |
Cash Flows from Financing Activities: | | | | | | | |
Proceeds from long-term debt | | | 66,305,585 | | | — | |
Payments on long-term debt | |
| (55,747,788) | |
| (325,021) | |
Checks drawn in excess of bank balance | |
| 692,984 | |
| — | |
Proceeds from Paycheck Protection Program loan | | | 595,693 | | | — | |
Acquisition of non-controlling interest | | | (2,000,000) | | | (225,000) | |
Net cash provided by (used in) financing activities | |
| 9,846,474 | |
| (550,021) | |
| | | | | | | |
Net decrease in Cash and Restricted Cash | |
| (803,460) | |
| (1,402,171) | |
| | | | | | | |
Cash and Restricted Cash—Beginning of Period | |
| 4,593,811 | |
| 5,995,982 | |
| | | | | | | |
Cash and Restricted Cash—End of Period | | $ | 3,790,351 | | $ | 4,593,811 | |
| | | | | | | |
Reconciliation of Cash and Restricted Cash | | | | | | | |
Cash - Balance Sheet | | $ | 3,276,301 | | $ | 4,541,295 | |
Restricted Cash - Balance Sheet | | | 514,050 | | | 52,516 | |
Cash and Restricted Cash | | $ | 3,790,351 | | $ | 4,593,811 | |
| | | | | | | |
Supplemental Disclosure of Cash Flow Information | | | | | | | |
Cash paid during the period for: | | | | | | | |
Interest expense | | $ | 181,849 | | $ | 98,815 | |
| | | | | | | |
Supplemental Disclosure of Non-Cash Investing and Financing Activities | | | | | | | |
Capital expenditures included in accounts payable | | $ | 2,140,625 | | $ | 125,186 | |
Notes to Consolidated Financial Statements are an integral part of this Statement.
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Heron Lake BioEnergy, LLC owns and operates an ethanol plant near Heron Lake, Minnesota with a permitted capacity of approximately 72.3 million gallons per year of undenatured ethanol on a twelve-month rolling sum basis. In addition, Heron Lake BioEnergy, LLC produces and sells distillers’ grains with solubles and corn oil as co-products of ethanol production.
Heron Lake BioEnergy, LLC’s wholly owned subsidiary, HLBE Pipeline Company, LLC (“HLBE Pipeline Company”), is the sole owner of Agrinatural Gas, LLC (“Agrinatural”). Agrinatural operates a natural gas pipeline that provides natural gas to Heron Lake BioEnergy, LLC’s ethanol production facility and other customers through a connection with natural gas pipeline facilities of Northern Border Pipeline Company in Cottonwood County, Minnesota. Beginning as of December 11, 2019, HLBE holds a 100% interest in Agrinatural. At October 31, 2019, HLBE held a 73% interest in Agrinatural.
Principles of Consolidation
The consolidated financial statements include the accounts of Heron Lake BioEnergy, LLC and its wholly owned subsidiary, HLBE Pipeline Company (collectively, “the Company”). Given the Company’s control over the operations of Agrinatural and its majority voting interest, the Company consolidates the financial statements of Agrinatural with its consolidated financial statements, with the equity and earnings attributed to the remaining 27% non-controlling interest identified separately in the accompanying consolidated balance sheets and statements of operations through December 11, 2019 when the remaining non-controlling interest was acquired. All significant intercompany balances and transactions are eliminated in consolidation.
Fiscal Reporting Period
The Company’s fiscal year end for reporting financial operations is October 31.
Accounting Estimates
Management uses estimates and assumptions in preparing these consolidated financial statements in accordance with U.S. generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. The Company uses estimates and assumptions in accounting for significant matters including, among others, the economic lives of property and equipment, valuation of commodity derivative instruments and inventory, evaluation of rail car rehabilitation costs, the assumptions used in the impairment analysis of long-lived assets, and inventory purchase and sale commitments. The Company periodically reviews estimates and assumptions, and the effects of revisions are reflected in the period in which the revision is made. Actual results could differ from those estimates.
Non-controlling Interest
Amounts recorded as non-controlling interest on the October 31, 2019 consolidated balance sheet relates to the net investment by an unrelated party in Agrinatural through December 11, 2019 when the remaining non-controlling interest was acquired.
Revenue Recognition
Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. Our contracts primarily consist of agreements with marketing companies and other customers as described below. Our performance obligations consist of the delivery of ethanol, distillers’ grains, and corn oil to our customers. Our customers primarily consist of three distinct marketing companies as discussed below. The consideration we receive for these products reflects an amount that the company expects to be entitled to in exchange for those products, based on current observable market prices at the Chicago Mercantile Exchange, generally, and adjusted for local market differentials. Our contracts have specific delivery modes, rail or truck, and dates. Revenue is recognized when the Company delivers the products to the mode of
60
HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
transportation specified in the contract, at the transaction price established in the contract, net of commissions, fees, and freight. We sell each of the products via different marketing channels as described below.
| ● | Ethanol. The Company sells its ethanol via a marketing agreement with Eco-Energy, Inc. Eco-Energy sells one hundred percent of the Company’s ethanol production based on agreements with end users at prices agreed upon mutually among the end user, Eco-Energy and the Company. Our performance obligations consist of our obligation to deliver ethanol to our customers. Our customer contracts consist of orders received from the customer pursuant to a marketing agreement. The marketing agreement calls for control and title to pass to Eco-Energy once a rail car is released to the railroad or a truck is released from the Company’s scales. Revenue is recognized then at the price in the agreement with the end user, net of commissions, freight, and fees. |
| ● | Distillers grains. The Company engages another third-party marketing company, Gavilon, Inc, to sell one hundred percent of the distillers grains it produces at the plant. Gavilon takes title and control once a rail car is released to the railroad or a truck is released from the Company’s scales. Prices are agreed upon between Gavilon and the Company. Our performance obligations consist of our obligation to deliver distillers grains to our customers. Our customer contracts consist of orders received from the customer pursuant to a marketing agreement. Revenue is recognized net of commissions, freight and fees. |
| ● | Distillers corn oil (corn oil). The Company sells one hundred percent of its corn oil production to RPMG, Inc. The process for selling corn oil is the same as our distillers’ grains. RPMG takes title and control once a rail car is released to the railroad or a truck is released from the Company's scales. Prices are agreed upon between RPMG and the Company. Our performance obligations consist of our obligation to deliver corn oil to our customers. Our customer contracts consist of orders received from the customer pursuant to a marketing agreement. Revenue is recognized net of commissions, freight and fees. |
| ● | Agrinatural generates revenue from the transportation of natural gas to residential and commercial customers. Revenue is recognized at the point when natural gas is delivered at the transaction price established in the contract. |
Cost of Goods Sold
The primary components of cost of goods sold for the production of ethanol and related co-products are corn, energy, raw materials, overhead, depreciation, railcar rehabilitation costs, and direct labor.
Operating Expenses
The primary components of operating expenses are salaries and expenses for administrative employees, professional fees, board of governor expenses, loss on disposal of assets and property taxes.
Cash
The Company maintains its accounts at multiple financial institutions. At times throughout the year, the Company’s cash balances may exceed amounts insured by the Federal Deposit Insurance Corporation and the Securities Investor Protection Corporation. The Company does not believe it is exposed to any significant credit risk on its cash balances.
Restricted Cash
The Company is periodically required to maintain cash balances at its broker related to derivative instrument positions as discussed in Note 7.
Accounts Receivable
Credit terms are extended to customers in the normal course of business. The Company performs ongoing credit evaluations of its customers’ financial condition and, generally, requires no collateral.
Accounts receivable are recorded at their estimated net realizable value. Accounts are considered past due if payment is not made on a timely basis in accordance with the Company’s credit terms. Accounts considered uncollectible are
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
written off. The Company follows a policy of providing an allowance for doubtful accounts; however, based on historical experience, and its evaluation of the current status of receivables, the Company is of the belief that such accounts will be collectible in all material respects and thus an allowance was not necessary at October 31, 2020 or 2019. It is at least possible this estimate will change in the future.
Inventory
Inventory is stated at the lower of cost or net realizable value. Cost for all inventories is determined using the first in first out method (FIFO). Net realizable value is the estimated selling prices in the ordinary course of business less reasonably predictable costs of completion, disposal, and transportation. Inventory consists of raw materials, work in process, finished goods, and supplies. Corn is the primary raw material along with other raw materials. Finished goods consist of ethanol, distillers’ grains, and corn oil.
Derivative Instruments
From time to time, the Company enters into derivative transactions to hedge its exposures to commodity price fluctuations. The Company is required to record these derivatives in the balance sheets at fair value.
In order for a derivative to qualify as a hedge, specific criteria must be met and appropriate documentation maintained. Gains and losses from derivatives that do not qualify as hedges, or are undesignated, must be recognized immediately in earnings. If the derivative does qualify as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will be either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. Changes in the fair value of undesignated derivatives are recorded in earnings.
Additionally, the Company is required to evaluate its contracts to determine whether the contracts are derivatives. Certain contracts that literally meet the definition of a derivative may be exempted as “normal purchases or normal sales”. Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business.
Contracts that meet the requirements of normal purchases or sales are documented as normal and exempted from accounting and reporting requirements, and therefore, are not marked to market in our consolidated financial statements.
In order to reduce the risks caused by market fluctuations, the Company occasionally hedges its anticipated corn, natural gas, and denaturant purchases and ethanol sales by entering into options and futures contracts. These contracts are used with the intention to fix the purchase price of anticipated requirements for corn in the Company’s ethanol production activities and the related sales price of ethanol. The fair value of these contracts is based on quoted prices in active exchange-traded or over-the-counter market conditions. Although the Company believes its commodity derivative positions are economic hedges, none have been formally designated as a hedge for accounting purposes and derivative positions are recorded on the balance sheet at their fair market value, with changes in fair value recognized in current period earnings or losses. The Company does not enter into financial instruments for trading or speculative purposes.
The Company has adopted authoritative guidance related to “Derivatives and Hedging,” and has included the required enhanced quantitative and qualitative disclosure about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses from derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. See further discussion in Note 7.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is provided over an estimated useful life by use of the straight-line deprecation method. Maintenance and repairs are expensed as incurred; major improvements and betterments are capitalized. Construction in progress expenditures will be depreciated using the straight-line method over their estimated useful lives once the assets are placed into service.
62
HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Depreciable useful lives are as follows:
| | | |
Land improvements |
| 15 Years | |
Plant building and equipment |
| 7-40 Years | |
Vehicles and other equipment |
| 5-7 Years | |
Office buildings and equipment |
| 3-40 Years | |
Long-Lived Assets
Long-lived assets, such as property and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When determining impairment losses, a long lived asset should be grouped with other assets or liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets or liabilities. If circumstances require a long-lived asset to be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset to the carrying value of the asset. If the carrying value of the long-lived asset is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including, but not limited to, discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. No impairment expense was recorded during fiscal 2020 or 2019.
Fair Value of Financial Instruments
The Company follows guidance for accounting for fair value measurements of financial assets and liabilities and for fair value measurements of nonfinancial items that are recognized or disclosed at fair value in the consolidated financial statements on a recurring and nonrecurring basis. The guidance establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level 3 measurements).
The three levels of the fair value hierarchy are as follows:
| ● | Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. |
| ● | Level 2 inputs include: |
| 1. | Quoted prices in active markets for similar assets or liabilities. |
| 2. | Quoted prices in markets that are observable for the asset or liability either directly or indirectly, for substantially the full term of the asset or liability. |
| 3. | Inputs that derived primarily from or corroborated by observable market date by correlation or other means. |
| ● | Level 3 inputs are unobservable inputs for the asset or liability. |
The level in the fair value hierarchy within which a fair measurement in its entirety falls is based on the lowest level input that is significant to the fair value measurement in its entirety.
Except for those assets and liabilities which are required by authoritative accounting guidance to be recorded at fair value, the Company has elected not to record any other assets or liabilities at fair value. No events occurred during the fiscal years ended October 31, 2020 or 2019 that required adjustment to the recognized balances of assets or liabilities, which are recorded at fair value on a nonrecurring basis.
The carrying value of cash, accounts receivable, accounts payable and accrued liabilities approximates fair value due to the short maturity of these instruments. The fair value of debt has been estimated using discounted cash flow analysis based upon the Company’s current incremental borrowing rates for similar types of financing arrangements. The fair value of outstanding debt will fluctuate with changes in applicable interest rates. Fair value will exceed carrying value when the current market interest rate is lower than the interest rate at which the debt was originally issued. The Company believes the carrying amount of its debt facilities approximates the fair value.
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Notes to Consolidated Financial Statements
Income Taxes
The Company is treated as a partnership for federal and state income tax purposes and generally does not incur income taxes. Instead, its earnings and losses are included in the income tax returns of the members. Therefore, no provision or liability for federal or state income taxes has been included in these financial statements. Differences between financial statement basis of assets and tax basis of assets is related to capitalization and amortization of organization and start-up costs for tax purposes, whereas these costs are expensed for financial statement purposes. In addition, the Company uses the alternative depreciation system (ADS) for tax depreciation instead of the straight-line method that is used for book depreciation, which also causes temporary differences. The Company’s tax year end is December 31.
The Company had no significant uncertain tax positions as of October 31, 2020 or 2019 that would require disclosure, primarily due to the partnership tax status. The Company recognizes and measures tax benefits when realization of the benefits is uncertain under a two-step approach. The first step is to determine whether the benefit meets the more-likely-than-not condition for recognition and the second step is to determine the amount to be recognized based on the cumulative probability that exceeds 50%. Primarily due to the Company’s tax status as a partnership, the adoption of this guidance had no material impact on the Company’s financial condition or results of operations.
The Company files income tax returns in the U.S. federal and Minnesota state jurisdictions. The Company is no longer subject to U.S. federal and state income tax examinations by tax authorities for years before 2017.
Net Income (Loss) per Unit
Basic net income (loss) per unit is computed by dividing net income by the weighted average number of members’ units outstanding during the period. Diluted net income or loss per unit is computed by dividing net income by the weighted average number of members’ units and members’ unit equivalents outstanding during the period.
Environmental Liabilities
The Company’s operations are subject to environmental laws and regulations adopted by various governmental entities in the jurisdiction in which it operates. These laws require the Company to investigate and remediate the effects of the release or disposal of materials at its location. Accordingly, the Company has adopted policies, practices, and procedures in the areas of pollution control, occupational health, and the production, handling, storage and use of hazardous materials to prevent material environmental or other damage, and to limit the financial liability, which could result from such events. Environmental liabilities are recorded when the liability is probable and the costs can be reasonably estimated.
Reportable Operating Segments
Accounting Standards Codification (“ASC”) 280, “Segment Reporting,” establishes the standards for reporting information about segments in financial statements. Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Based on the related business nature and expected financial results criteria set forth in ASC 280, the Company has two reportable operating segments for financial reporting purposes.
| ● | Ethanol Production. Based on the nature of the products and production process and the expected financial results, the Company’s operations at its ethanol plant, including the production and sale of ethanol and its co-products, are aggregated into one financial reporting segment. |
| ● | Natural Gas Pipeline. The Company has majority ownership in Agrinatural, through its wholly owned subsidiary, HLBE Pipeline, LLC, and operations of Agrinatural’s natural gas pipeline are aggregated into another financial reporting segment. |
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Recently Adopted Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board (FASB) issued new guidance on accounting for leases under Accounting Standards Codification 842 (ASC 842). Under the new guidance, lessees are required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted cash flow basis; and (2) a “right of use” asset, which is an asset that represents the lessee’s right to use the specified asset for the lease term. Lease expense under the new guidance is substantially the same as prior to the adoption. See Note 11 for further information.
2. GOING CONCERN
The financial statements have been prepared on a going-concern basis, which contemplates the recoverability of assets and the satisfaction of liabilities in the normal course of business. The Company has suffered recurring operating and cash flow losses related to difficult market conditions and operating performance. The Company was out of compliance with certain debt covenants on October 31, 2020, for which a waiver was obtained from the lender. Subsequent to October 31, 2020, the Company had further instances of noncompliance with debt covenants and has forecasted that it is probable that there will be future instances of noncompliance with debt covenants within the next twelve months. These conditions result in the classification of all debt with the lender as current as of October 31, 2020. The Company has insufficient cash on hand and additional borrowing capacity, and current forecasts indicate insufficient cash flows from operations, to repay the debt if it were to come due as a result of covenant noncompliance. These factors raise substantial doubt about the Company's ability to continue as a going concern.
While the Company believes the replacement of the boiler has improved the operating performance of the plant, and led to lower operating costs, market conditions have resulted in losses. The Company intends to source other capital sources, which may include re-negotiating their debt agreements and terms. At this time, there are no commitments to do so and we may not be successful in doing so.
3. RISKS AND UNCERTAINTIES
The Company has certain risks and uncertainties that it experienced during volatile market conditions. These volatilities can have a severe impact on operations. The Company’s revenues are primarily derived from the sale and distribution of ethanol, distillers’ grains and corn oil to customers primarily located in the U.S. Corn for the production process is supplied to the plant primarily from local agricultural producers. Ethanol sales average 75%-85% of total revenues and corn costs average 70%-90% of cost of goods sold.
The Company’s operating and financial performance is largely driven by the prices at which it sells ethanol, distillers’ grains and corn oil, and the related costs of corn. The price of ethanol is influenced by factors such as supply and demand, the weather, government policies and programs, unleaded gasoline prices and the petroleum markets as a whole. Excess ethanol supply in the market, in particular, puts downward pressure on the price of ethanol. The largest cost of production is corn. The cost of corn is generally impacted by factors such as supply and demand, the weather, government policies and programs, and a risk management program used to protect against the price volatility of these commodities. Market fluctuations in the price of and demand for these products may have a significant adverse effect on the Company’s operations, profitability and the availability and adequacy of cash flow to meet the Company’s working capital requirements. The Company’s risk management program is used to protect against the price volatility of these commodities.
The Company, and the ethanol industry as a whole, experienced significant adverse conditions throughout most of 2019 and 2020 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels. These factors, which are compounded by the recent impact of the novel coronavirus (“COVID-19”), resulted in and continue to result in negative operating margins, significantly lower cash flow from operations and substantial net losses. In response to the low margin environment, the Company idled its ethanol production from on or about March 30, 2020 through approximately May 31, 2020 and continues to monitor COVID-19 developments in order to determine whether further adjustments to production are warranted.
Additionally, supply and demand for ethanol are impacted by federal and state legislation and regulation, most significantly the Renewable Fuels Standard (“RFS”), and any changes in legislation or regulation could cause the demand for ethanol to decline or its supply to increase, which could have a material adverse effect on our business,
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
results of operations and financial condition, and the ability to operate at a profit. In May 2020, the EPA delivered its proposed rule to the White House Office of Management and Budget (“OMB”) to set 2021 RVOs. OMB is required to review the proposed rule before releasing it for public comment. The proposed 2021 RVOs are still undergoing OMB review, and therefore, the proposed rule has neither been released for public comment or finalized. As a result, the statutory November 30 deadline was not met. The EPA Administrator has stated that the COVID-19 pandemic resulted in significant delays and that the EPA is analyzing various factors in setting 2021 RVOs in light of the pandemic.
On December 19, 2019, the EPA announced the final 2020 renewable volume requirements (“RVOs”), setting the RVOs for conventional ethanol at 15.0 billion gallons, advanced biofuels at 5.09 billion gallons and cellulosic ethanol at 0.59 billion gallons, for overall RVOs of 20.09 billion gallons for 2020. Although this final rule achieves the statutory RVO for conventional corn-based ethanol originally set by Congress when the RFS was enacted, it reduces the overall RVOs below the overall statutory level of 30 billion gallons.
Current ethanol production capacity exceeds the EPA’s 2019 and 2020 RVOs that can be satisfied by corn-based ethanol. According to the RFS, if mandatory renewable fuel volumes are reduced by at least 20% for two consecutive years, the EPA is required to modify, or reset, statutory volumes through 2022. In October 2018, the Office of Management and Budget announced that the 20% thresholds “have been met or are expected to be met in the near future In May 2019, the EPA delivered a proposed RFS “reset” rule to the Office of Management and Budget. The “reset” remains on the OMB agenda. If the statutory RVOs are reduced as a result of such reset, it could have an adverse effect on the market price and demand for ethanol which would negatively impact our financial performance.
Additionally, opponents of ethanol such as large oil companies will likely continue their efforts to repeal or reduce the RFS through lawsuits or lobbying of Congress. Successful reduction or repeal of the blending requirements of the RFS could result in a significant decrease in ethanol demand.
4. REVENUE
Revenue by Source
All revenues from contracts with customers under ASC Topic 606 are recognized at a point in time. The following table disaggregates revenue by major source for the fiscal year ended October 31, 2020:
| Ethanol Production |
| Natural Gas Pipeline |
| Total | |||
Ethanol | $ | 58,326,265 | | $ | — | | $ | 58,326,265 |
Distillers’ Grains | | 12,692,196 | | | — | | | 12,692,196 |
Corn Oil | | 2,925,808 | | | — | | | 2,925,808 |
Other | | 678,226 | | | — | | | 678,226 |
Natural Gas | | — | | | 1,407,346 | | | 1,407,346 |
Total Revenues | $ | 74,622,495 | | $ | 1,407,346 | | $ | 76,029,841 |
| | | | | | | | |
| Ethanol Production |
| Natural Gas Pipeline |
| Total | |||
Ethanol | $ | 82,544,145 | | $ | — | | $ | 82,544,145 |
Distillers’ Grains | | 18,214,512 | | | — | | | 18,214,512 |
Corn Oil | | 3,513,679 | | | — | | | 3,513,679 |
Other | | 1,123,217 | | | — | | | 1,123,217 |
Natural Gas | | — | | | 1,431,892 | | | 1,431,892 |
Total Revenues | $ | 105,395,553 | | $ | 1,431,892 | | $ | 106,827,445 |
| | | | | | | | |
Payment Terms
The Company has contractual payment terms with each respective marketer that sells ethanol, distillers’ grains and corn oil. These terms are 10 calendar days after the transfer of control date. The Company has contractual payment terms with the natural gas customers of 20 days.
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Notes to Consolidated Financial Statements
Shipping and Handling Costs
Shipping and handling costs related to contracts with customers for sale of goods are accounted for as a fulfillment activity and are included in cost of goods sold. Accordingly, amounts billed to customers for such costs are included as a component of revenue.
5. FAIR VALUE MEASUREMENTS
The Company follows accounting guidance related to fair value disclosures. For the Company, this guidance applies to certain derivative investments. The authoritative guidance also clarifies the definition of fair value for financial reporting, establishes a framework for measuring fair value and requires additional disclosures about the use of fair measurements.
The following table sets forth, by level, the Company assets that were accounted for at fair value on a recurring basis at October 31, 2020:
| | | | | | | | Fair Value Measurement Using |
| |||||||
| | Carrying Amount in | | | | | Quoted Prices | | Significant Other | | Significant |
| ||||
| | Consolidated Balance Sheet | | | | | Active Markets | | Observable Inputs | | Unobservable inputs |
| ||||
Financial Assets: |
| |
| Fair Value |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| |||||
Commodity Derivative instruments - Ethanol | | $ | 15,150 | | $ | 15,150 | | $ | 15,150 | | $ | — | | $ | — | |
| | | | | | | | | | | | | | | | |
Financial Liabilities: | | | | | | | | | | | | | | | | |
Commodity Derivative instruments - Corn | | $ | 173,928 | | $ | 173,928 | | $ | 173,928 | | $ | — | | $ | — | |
Accounts payable (1) | | $ | 553,248 | | $ | 553,248 | | | — | | $ | 553,248 | | | — | |
The following table sets forth, by level, the Company assets that were accounted for at fair value on a recurring basis at October 31, 2019:
| | | | | | | | | | | | | | | | |
| | | | | | | | Fair Value Measurement Using |
| |||||||
| | Carrying Amount in | | | | | Quoted Prices in | | Significant Other | | Significant | | ||||
| | Consolidated | | | | | Active Markets | | Observable Inputs | | Unobservable Inputs |
| ||||
Financial Assets: |
| Balance Sheet |
| Fair Value |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| |||||
Commodity Derivative instruments - Corn | | $ | 20,060 | | $ | 20,060 | | $ | 20,060 | | $ | — | | $ | — | |
Commodity Derivative instruments - Ethanol | | $ | 75,763 | | $ | 75,763 | | $ | 75,763 | | $ | — | | $ | — | |
(1) | Accounts payable is generally stated at historical amounts with the exception of amounts in this table related to certain delivered inventory for which the payable fluctuates based on the changes in commodity prices. These payables are hybrid financial instruments for which the company has elected the fair value option. |
We determine the fair value of commodity derivative instruments by obtaining fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes and live trading levels from the Chicago Board of Trade market and New York Mercantile Exchange. We determine the fair value of level 2 accounts payable based on nearby futures values, plus or minus nearby basis.
6. CONCENTRATIONS
The Company sold all of the ethanol, distillers’ grains, and corn oil produced at its plant to three customers under marketing agreements during the fiscal years ended October 31, 2020 and 2019.
The percentage of total revenues attributable to each of the Company’s three major customers for the fiscal years ended October 31, 2020 and 2019 were as follows:
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
| | | | | | |
| | October 31, 2020 | | October 31, 2019 | | |
Eco-Energy, Inc. - Ethanol | | 76.7% | | 77.3% | | |
Gavilon Ingredients, LLC - Distillers' Grains | | 15.9% | | 16.9% | | |
RPMG, Inc. - Corn Oil | | 3.8% | | 3.3% | | |
The percentage of total accounts receivable attributable to each of the Company’s three major customers at October 31, 2020 and 2019 were as follows:
| | October 31, 2020 | | October 31, 2019 | |
Eco-Energy, Inc. - Ethanol | | 54.8% | | 80.0% | |
Gavilon Ingredients, LLC - Distillers' Grains | | 20.0% | | 15.3% | |
RPMG, Inc. - Corn Oil | | 6.4% | | 2.8% | |
7. INVENTORY
Inventory consists of the following at October 31:
| | | | | | | |
| | 2020 | | 2019 | | ||
Raw materials | | $ | 2,440,997 | | $ | 932,503 | |
Work in process | |
| 713,037 | |
| 732,243 | |
Finished goods | |
| 2,677,095 | |
| 3,157,429 | |
Supplies | |
| 1,232,546 | |
| 1,454,083 | |
Totals | | $ | 7,063,675 | | $ | 6,276,258 | |
The Company performs a lower cost or net realizable value analysis on inventory to determine if the market values of certain inventories are less than their carrying value, which is attributable primarily to decreases in market prices of corn and ethanol. Based on the lower of cost or net realizable value analysis, the Company recorded a loss on ethanol inventories, as a component of cost of goods sold, of approximately $204,000 for the fiscal year ended October 31, 2020. The Company recorded a loss on ethanol and corn inventories, as a component of cost of goods sold, of approximately $537,000 and $47,000 for the fiscal year ended October 31, 2019, respectively.
8. DERIVATIVE INSTRUMENTS
The Company enters into corn, ethanol, and natural gas derivatives in order to protect cash flows from fluctuations caused by volatility in commodity prices for periods up to 24 months. These derivatives are put in place to protect gross profit margins from potentially adverse effects of market and price volatility on ethanol sales and corn purchase commitments where the prices are set at a future date. Although these derivative instruments serve the Company’s purpose as an economic hedge, they are not designated as effective hedges for accounting purposes. For derivative instruments that are not accounted for as hedges, or for the ineffective portions of qualifying hedges, the change in fair value is recorded through earnings in the period of change.
As of October 31, 2020, the total notional amount of the Company’s outstanding corn derivative instruments was approximately 2,095,000 bushels, comprised of long corn futures positions on 325,000 bushels that were entered into to hedge forecasted ethanol sales through March 2021, and short corn futures positions on 1,770,000 bushels that were entered into to hedge forecasted corn purchases through July 2022 and are directly related to corn forward contracts. Additionally, there are corn options positions of 1,380,000 bushels through March 2021. There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding.
As of October 31, 2020, the Company had approximately $514,000 in cash collateral (restricted cash) related to derivates held by a broker.
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Notes to Consolidated Financial Statements
The following table provides detail regarding the Company’s derivative financial instruments at October 31, 2020, none of which were designated as hedging instruments:
|
| Consolidated Balance Sheet Location |
| Assets |
| Liabilities |
| ||
Corn contracts | | Commodity derivative instruments | | $ | — | | $ | 173,928 | |
Ethanol contracts | | Commodity derivative instruments | | | 15,150 | | | — | |
Totals | | | | $ | 15,150 | | $ | 173,928 | |
As of October 31, 2019, the total notional amount of the Company’s outstanding corn derivative instruments was approximately 5,398,000 bushels, comprised of long corn futures positions on 2,131,000 bushels that were entered into to hedge forecasted ethanol sales through July 2020, and short corn futures positions on 3,267,000 bushels that were entered into to hedge forecasted corn purchases through December 2021. Additionally, there are corn options positions of 4,000,000 bushels through March 2020. There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding.
As of October 31, 2019, the Company had approximately $52,000 in cash collateral (restricted cash) related to derivatives held by a broker.
The following table provides detail regarding the Company’s derivative financial instruments at October 31, 2019, none of which were designated as hedging instruments:
|
| Consolidated Balance Sheet Location |
| Assets |
| Liabilities |
| ||
Corn contracts | | Commodity derivative instruments | | $ | 20,060 | | $ | — | |
Ethanol contracts | | Commodity derivative instruments | | | 75,763 | | | — | |
Totals | | | | $ | 95,823 | | $ | — | |
The following table provides details regarding the gains (losses) from the Company’s derivative instruments in its consolidated statements of operations, none of which are designated as hedging instruments:
|
| Consolidated Statement of |
| | | | | | |
|
| Operations Location |
| 2020 |
| 2019 |
| ||
Corn contracts |
| Cost of goods sold | | $ | (1,069,393) | | $ | 350,624 | |
Ethanol contracts | | Revenues | | | (130,673) | | | 24,592 | |
Total gain (loss) | | | | $ | (1,200,066) | | $ | 375,216 | |
9. PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows:
| | | | | | | |
|
| October 31, 2020 |
| October 31, 2019 |
| ||
Land and improvements | | $ | 9,111,838 | | $ | 9,111,838 | |
Plant buildings and equipment | |
| 88,879,395 | |
| 88,708,522 | |
Vehicles | |
| 700,959 | |
| 700,959 | |
Office buildings | |
| 735,864 | |
| 735,864 | |
Construction in progress | |
| 4,680,716 | |
| 58,319 | |
| |
| 104,108,772 | |
| 99,315,502 | |
Less: accumulated depreciation | |
| (63,921,039) | |
| (59,907,307) | |
Net property and equipment | | $ | 40,187,733 | | $ | 39,408,195 | |
Depreciation expense totaled approximately $5,228,000 and $5,246,000 during the fiscal years ended October 31, 2020 and 2019, respectively.
In July 2020, the Company experienced major issues with its boiler, which negatively impacted production. The Company operated with temporary boilers from August 2020 through part of January 2021. The Company determined that the purchase and installation of a new boiler would be more economical and efficient than attempted repairs to the failing boiler. On September 2, 2020, the Company received notice of approval of the new boiler from the Minnesota Pollution Control Agency. As a result, the Company abandoned the failing boiler at that time. The Company recorded the loss on
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
disposal as a component of operating expenses during the fourth fiscal quarter of the fiscal year ended October 31, 2020 of approximately $1.8 million. The new boiler was placed in service in January 2021 at an estimated cost of approximately $5.2 million.
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Notes to Consolidated Financial Statements
10. DEBT FACILITIES
Long-term debt consists of the following:
| | October 31, 2020 | | October 31, 2019 | | ||
Amended revolving term note payable to lending institution, see terms below. | | $ | 7,891,426 | | $ | — | |
Single advance term note payable to lending institution, see terms below. | | | 3,000,000 | | | — | |
Assessment payable as part of water treatment agreement, due in semi-annual installments of $189,393 with interest at 6.55%, enforceable by statutory lien, with the final payment due in October 2021. The Company made deposits for one years' worth of debt service payments of approximately $364,000, which is included with other assets that are held on deposit to be applied with the final payments of the assessment. | |
| 300,551 | | | 634,180 | |
SBA Paycheck Protection Program Loan | |
| 595,693 | | | — | |
Totals | |
| 11,787,670 | |
| 634,180 | |
Less amounts due within one year | |
| 11,492,059 | |
| 333,977 | |
Net long-term debt | | $ | 295,611 | | $ | 300,203 | |
Revolving Term Note
The 2020 Credit Facility includes an amended and restated revolving term loan with an $8,000,000 principal commitment, which was increased to a $13,000,000 principal commitment in June 2020. This loan replaces the amended revolving term note and seasonal revolving loan made under the 2018 Credit Facility. The loan is secured by substantially all of HLBE’s assets, including a subsidiary guarantee. The 2020 Credit Facility contains customary covenants, including restrictions on the payment of dividends and loans and advances to Agrinatural, and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility. During the second fiscal quarter of 2020, the 2020 Credit Facility was amended to reduce the working capital covenant to $8 million, from the original $10 million working capital covenant, for the period of April 30, 2020 through December 31, 2020, and increasing to $10 million beginning January 1, 2021. Additionally, the amendment excludes current portion of leases from the calculation of current liabilities. Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges, or penalties. In May 2020, HLBE had an event of non-compliance related to the minimum working capital requirement as defined in the 2020 Credit Facility. The Company has obtained a waiver from its lender for this event of non-compliance. For the fiscal year ended October 31, 2020, HLBE had events of non-compliance related to the working capital covenant and the debt service coverage ratio. HLBE has obtained a waiver from its lender for the non-compliance events.
Subsequent to October 31, 2020, HLBE had further events of non-compliance and has forecasted that it is probable that there will be future instances of non-compliance with debt covenants within the next twelve months. As a result, approximately $10,300,000 of long term debt has been reclassified as current maturities.
As part of the 2020 Credit Facility closing, the Company entered into an amended administrative agency agreement with CoBank, ACP (“CoBank”). As a result, CoBank will continue act as the agent for the lender with respect to the 2020 Credit Facility. The Company agreed to pay CoBank an annual fee of $2,500 for its services as administrative agent.
Under the terms of the amended revolving term loan, HLBE may borrow, repay, and reborrow up to the aggregate principal commitment amount of $13,000,000. Final payment of amounts borrowed under the amended revolving term loan is due December 1, 2022. Interest on the amended revolving term loan accrues at a variable weekly rate equal to 3.35% above the higher of 0.00% or the One-Month London Interbank Offered Rate (“LIBOR”) Index rate, which totaled 3.51% at October 31, 2020.
HLBE also agreed to pay an unused commitment fee on the unused available portion of the amended revolving term loan commitment at the rate of 0.500% per annum, payable monthly in arrears.
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Notes to Consolidated Financial Statements
Single Advance Term Note
In June 2020, HLBE entered into a single advance term note with a $3,000,000 principal commitment, with the purpose to finance the construction of a new grain bin and provide principal reduction on the Revolving Term Note. The interest rate is fixed at 3.80%. Principal with interest is to be paid in 10 consecutive, semi-annual installments, with the first installment due on December 20, 2020 and the last installment due on June 20, 2025. The note is secured as provided in the 2020 Credit Facility.
SBA Paycheck Protection Program Loan
In March 2020, Congress passed the Paycheck Protection Program, authorizing loans to small businesses for use in paying employees that they continue to employ throughout the COVID-19 pandemic and for rent, utilities and interest on mortgages. Loans obtained through the Paycheck Protection Program are eligible to be forgiven as long as the proceeds are used for qualifying purposes and certain other conditions are met. On April 18, 2020, HLBE received a loan in the amount of $595,693 through the Paycheck Protection Program. Management expects that the entire loan will be used for payroll, utilities and interest; therefore, management anticipates that the loan will be substantially forgiven. To the extent it is not forgiven, HLBE would be required to repay that portion at an interest rate of 1% over a period of two years, with principal repayment installments in May 2021 with a final installment in May 2022.
Negotiable Promissory Note
In December 2020, we entered into a negotiable promissory note with GFE with a $5,000,000 principal commitment. Interest on the loan accrues at a variable weekly rate equal to the higher of 1.00% or the One-Month LIBOR Index rate, plus 3.35%. The note was due on demand, and accrued interest must be paid in full the first business day of each month. The note is unsecured and may be prepaid at any time without penalty. In January 2021, we borrowed the $5,000,000 on the promissory note. In February 2021, GFE agreed to modify the promissory note to remove the due on demand feature, instead agreeing that GFE will not require any principal repayment on the loan until March 2023. However, should there be future violations of the Compeer loan covenants, those violations would also be considered a default on this promissory note.
Short Term Revolving Promissory Note
In February 2021, HLBE entered into a revolving promissory note with its lender in order to finance the operating needs of HLBE. The revolving promissory note is subject to the 2020 Credit Facility. Under the terms, HLBE may borrow, repay and reborrow up to the aggregate principal commitment amount of $5,000,000. Final payment of amounts borrowed under the revolving promissory note is June 1, 2021. Interest of the loan accrues at a variable weekly rate equal to 3.35% above the higher of 0.00% or the One-Month London Interbank Offered Rate (“LIBOR”) Index rate and is payable monthly in arrears. In addition, HLBE agreed to pay an unused commitment fee on the unused available portion of the loan at the rate of 0.50% per annum payable monthly in arrears.
Estimated annual maturities of long-term debt at October 31, 2020 are as follows based on the most recent debt agreements:
2021 |
| $ | 11,492,059 |
|
2022 | |
| 295,611 | |
Total debt | | $ | 11,787,670 | |
11. MEMBERS’ EQUITY
The Company is authorized to issue 80,000,000 capital units, of which 65,000,000 have been designated Class A units and 15,000,000 have been designated as Class B units. Members of the Company are holders of units who have been admitted as members and who hold at least 2,500 units. Any holder of units who is not a member will not have voting rights. Transferees of units must be approved by our board of governors to become members. Members are entitled to one vote for each unit held. Subject to the Member Control Agreement, all units share equally in the profits and losses and distributions of assets on a per unit basis.
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Notes to Consolidated Financial Statements
12. LEASES
As discussed in Note 1, on November 1, 2019, the Company adopted the provisions of ASC 842 using the modified retrospective approach, which applies the provisions of ASC 842 upon adoption, with no change to prior periods. This adoption resulted in the Company recognizing initial right of use assets and lease liabilities of approximately $10.9 million at November 1, 2019. The adoption did not have a significant impact on the Company’s statement of operations.
Upon the initial adoption of ASC 842, the Company elected the following practical expedients allowable under the guidance: not to reassess whether any expired or existing contracts are or contain leases; not to reassess the lease classification for any expired or existing leases; not to reassess initial direct costs for any existing leases. Additionally, the Company elected the short-term lease exemption policy, applying the requirements of ASC 842 to only long-term (greater than one year) leases.
The Company leases rail cars for its facility to transport ethanol and dried distillers’ grains to its end customers. Operating lease right of use assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. The Company uses its estimated incremental borrowing rate, unless an implicit rate is readily determinable, as the discount rate for each lease in determining the present value of lease payments. For the twelve months ended October 31, 2020, the Company’s weighted average discount rate was 4.87%. Operating lease expense is recognized on a straight-line basis over the lease term.
The Company determines if an arrangement is a lease or contains a lease at inception. The Company’s leases have remaining terms of approximately one to seven years. For the fiscal year ended October 31, 2020, the weighted average remaining lease term was four years.
The Company elected to use a portfolio approach for lease classification, which allows for an entity to group together leases with similar characteristics provided that its application does not create a material difference when compared to accounting for the leases at a contract level. For railcar leases, the Company elected to combine the railcars within each rider and account for each rider as an individual lease.
The following table summarizes the remaining maturities of the Company’s operating lease liabilities as of October 31, 2020:
Twelve Months Ended October 31, | | | | |
2021 | | $ | 1,767,000 | |
2022 | | | 1,767,000 | |
2023 | | | 1,767,000 | |
2024 | | | 1,669,500 | |
2025 | | | 1,650,000 | |
Thereafter | | | 2,162,500 | |
Totals | | | 10,783,000 | |
Less: Amount representing interest | | | 1,491,751 | |
Lease liabilities | | $ | 9,291,249 | |
Lease expense for the Company’s leases was approximately $2,331,000 and $2,374,000 for the fiscal years ended October 31, 2020 and 2019, respectively.
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
13. INCOME TAXES
The differences between consolidated financial statement basis and tax basis of assets and liabilities are estimated as follows at October 31:
|
| 2020 |
| 2019 | ||
Consolidated financial statement basis of assets | | $ | 63,080,181 | | $ | 56,595,915 |
Plus: Organization and start-up costs capitalized for tax purposes, net | |
| 355,152 | |
| 502,566 |
Less: Unrealized gains on commodity derivative instruments | |
| (15,150) | |
| (95,823) |
Less: Accumulated tax depreciation and amortization greater than financial statement basis | |
| (56,055,250) | |
| (56,386,730) |
Book to tax operating lease right of use assets | | | (9,291,249) | | | — |
Plus: Impairment charge | |
| 27,844,579 | |
| 27,844,579 |
Income tax basis of assets | | $ | 25,918,263 | | $ | 28,460,507 |
|
| |
| | ||
Financial Statement basis of liabilities | | $ | 29,955,313 | | $ | 6,995,064 |
Accrued rail car maintenance | |
| (596,924) | |
| (551,000) |
Book to tax operating lease liabilities | | | (9,291,249) | | | — |
Other Accruals | |
| (176,828) | |
| (183,891) |
Income tax basis of liabilities | | $ | 19,890,312 | | $ | 6,260,173 |
14. EMPLOYEE BENEFIT PLANS
The Company has a defined contribution plan available to all of its qualified employees. The Company contributes a match of 50% of the participant’s salary deferral up to a maximum of 4% of the employee’s salary. The Company contributions totaled approximately $89,000 and $92,000 for the fiscal years ended October 31, 2020 and 2019, respectively.
15. RELATED PARTY TRANSACTIONS
Granite Falls Energy, LLC
The Company has a management services agreement with Granite Falls Energy, LLC (“GFE”), a related party. Under the terms of the agreement, GFE supplies its own personnel to act as part-time officers and managers of the Company for the positions of Chief Executive Officer, Chief Financial Officer, and Commodity Risk Manager and the Company pays GFE 50% of the total salary, bonuses and other expenses and costs for the three management positions. The management services agreement automatically renews for successive one-year terms unless the Company or GFE gives the other party 90-day written notice of termination prior to expiration of the then-current term. The management services agreement may also be terminated by either party for cause under certain circumstances.
Total expenses under this agreement were $510,000 for the fiscal year ended October 31, 2020, of which approximately $63,000 is included in accounts payable at October 31, 2020, and $438,000 for the fiscal year ended October 31, 2019, of which approximately $39,000 is included in accounts payable at October 31, 2019.
In February 2020, Agrinatural entered into a natural gas local distribution company management agreement with GFE for, among other purposes, the purpose of sharing certain management employees. The agreement automatically renews for successive one-year terms unless and until Agrinatural or GFE gives the other party 30 days’ written notice of termination prior to expiration of the initial term or the start of a renewal term. The agreement may also be terminated by either party for cause under certain circumstances. Under the agreement, GFE supplies its personnel to act as part-time officers of Agrinatural for the positions of chief executive officer and chief financial officer. In return, Agrinatural pays GFE $9,000 per month, excluding fees for third-party services. GFE responsible for and agreed to directly pay salary, wages, and/or benefits to the persons providing management services under the agreement. Total expenses under this agreement were $81,000 for the fiscal year ended October 31, 2020.
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
In December 2020, HLBE entered into a negotiable promissory note with GFE with a $5,000,000 principal commitment. Interest on the loan accrues at a variable weekly rate equal to the higher of 1.00% or the One-Month LIBOR Index rate, plus 3.35%. The note was due on demand, and accrued interest must be paid in full the first business day of each month. The note is unsecured and may be prepaid at any time without penalty. In January 2021, we borrowed the $5,000,000 on the promissory note. In February 2021, GFE agreed to modify the promissory note to remove the due on demand feature, instead agreeing that GFE will not require any principal repayment on the loan until March 2023. However, should there be future violations of the Compeer loan covenants, those violations would also be considered a default on this promissory note.
Corn Purchase - Members
The Company purchased corn from members of its Board of Governors of approximately $12,545,000 in fiscal year 2020, of which approximately $171,000 is included in accounts payable at October 31, 2020 and $11,478,000 in fiscal year 2019, of which approximately $470,000 is included in accounts payable at October 31, 2019.
16. COMMITMENTS AND CONTINGENCIES
Water Agreements
In September 2019, the Company entered into an industrial water supply development and distribution agreement, effective as of February 1, 2019, with the City of Heron Lake for 10 years. The Company has the exclusive rights to the first 600 gallons per minute of capacity that is available from the well. In consideration, the Company will pay flow charges at a rate of $0.60 cents per thousand gallons of water, in addition to a fixed monthly charge of $1,500 per month. The flow charges are placed into a dedicated fund for operation and maintenance of the well, and are capped at $300,000 at the end of each year. The Company is also responsible for paying 55% of operation and maintenance costs in excess of the $300,000 cap, in the first two years of the agreement. Thereafter, the percentage payable by the Company is determined based on a two-year average of the Company’s usage compared to the total amount of industrial water supplied to the Company and a third-party customer of the City of Heron Lake.
Under the previous industrial water supply development and distribution agreement with the City of Heron Lake, the Company paid one half of the City of Heron Lake’s water well bond payments of $735,000, plus a 5% administrative fee, totaling approximately $594,000, and operating costs, relative to the Company’s water usage, plus a 10% profit. The Company recorded an assessment of approximately $367,000 with long-term debt as described in Note 9. The Company paid operating and administrative expenses of approximately $12,000 per year.
In May 2006, the Company entered into a water treatment agreement with the City of Heron Lake and Jackson County for 30 years. The Company will pay for operating and maintenance costs of the plant in exchange for receiving treated water. In addition, the Company agreed to an assessment for a portion of the capital costs of the water treatment plant.
The Company recorded assessments with long-term debt of $500,000 and $3,550,000 in fiscal 2007 and 2006, respectively, as described in Note 9. The Company paid operating and maintenance expenses of approximately $77,000 and $52,000 in fiscal 2020 and 2019, respectively.
Ethanol Marketing Agreement
The Company has a marketing agreement (“Eco Agreement”) with Eco-Energy, Inc., an unrelated party (“Eco-Energy”) for the sale of ethanol. Under this ethanol agreement, Eco-Energy purchases, markets and resells 100% of the ethanol produced at the Company’s ethanol production facility and arranges for the transportation of ethanol. The Company pays Eco-Energy a marketing fee per gallon of ethanol sold in consideration of Eco-Energy’s services, as well as a fixed lease fee for rail cars leased from Eco-Energy to the Company. The marketing fee was negotiated based on prevailing market-rate conditions for comparable ethanol marketing services.
The initial term of Eco Agreement continued through December 31, 2016, with automatic renewals for additional three terms of three year periods unless terminated by either party by providing written notice to the other party at least 3 months prior to the end of the then current term. During the third fiscal quarter of 2016, the Company amended the Eco Agreement. In October 2019, the Company amended the Eco Agreement, which provides an extension of the term of the agreement through December 31, 2020, with automatic renewals for additional consecutive terms of one year unless
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
either party provides written notice to the other at least 90 days prior to the end of the then-current term. Additionally, the amended Eco Agreement provides for certain negotiated changes to the marketing fees payable to Eco-Energy and payment terms based on prevailing market-rate conditions for comparable ethanol marketed services.
Ethanol marketing fees and commissions totaled approximately $265,000 and $635,000 for the fiscal years ended October 31, 2020 and 2019, respectively.
Ethanol Forward Contracts
At October 31, 2020, the Company had fixed and basis contracts to sell approximately $12,350,000 of ethanol for various delivery periods through December 2020, which approximates 88% of its anticipated ethanol sales for that period.
Distillers’ Grains Marketing Agreement
Gavilon Ingredients, LLC, an unrelated party (“Gavilon”), 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. The contract commenced on November 1, 2013 with an initial term of six months, and will continue to remain in effect until terminated by either party at its unqualified option, by providing written notice of not less than 60 days to the other party.
Distillers’ grains commissions totaled approximately $187,000 and $287,000 for the fiscal years ended October 31, 2020 and 2019, respectively.
Distillers’ Grains Forward Contracts
At October 31, 2020, the Company had forward contracts to sell approximately $5,356,000 of distillers’ grains for delivery through March 2021, which approximates 45% of its anticipated distillers’ grains sales during that period.
Corn Oil Marketing Agreement
RPMG, Inc., an unrelated party, 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. The contract commenced on November 1, 2013 with an initial term of one year and will continue to remain in effect until terminated by either party at its unqualified option, by providing written notice of not less than 90 days to the other party.
Corn oil commissions totaled approximately $61,000 and $71,000 for the fiscal years ended October 31, 2020 and 2019, respectively.
Corn Oil Forward Contracts
At October 31, 2020, the Company had forward contracts to sell approximately $633,000 of corn oil for delivery through December 2020, which approximates 80% of its anticipated corn oil sales for that period.
Contract for Natural Gas Pipeline to Plant
The Company has 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 the plant. Agrinatural was formed to own and operate the pipeline and transports gas to the Company pursuant to a transportation agreement.
The Company also has a base agreement for the sale and purchase of natural gas with Constellation NewEnergy-Gas Division, LLC (“Constellation”), pursuant to which it buys all of its natural gas from Constellation. This agreement runs until March 31, 2022.
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HERON LAKE BIOENERGY, LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Corn Forward Contracts
At October 31, 2020, the Company had cash and basis contracts for forward corn purchase commitments for approximately 2,462,000 bushels for deliveries through July 2022.
Given the uncertainty of future ethanol and corn prices, the Company could incur a loss on the outstanding corn purchase contracts in future periods. Management has evaluated these forward contracts and its inventories using the lower of cost or net realizable value evaluation, similar to the method used on its inventory, and has determined that an impairment loss existed of approximately $47,000 at October 31, 2020. The impairment expense is recorded as a component of cost of goods sold. No impairment loss existed at October 31, 2019.
Rail Car Rehabilitation Costs
The Company leases 50 hopper rail cars under a multi-year agreement which ends in May 2027. Under the agreement, the Company is required to pay to rehabilitate each car for “damage” that is considered to be other than normal wear and tear upon turn in of the car(s) at the termination of the lease. Prior to the year ending October 31, 2019, the Company believed ongoing repairs resulted in an insignificant future rehabilitation expense. During the year ending October 31, 2019, based on new information, we re-evaluated our assumptions and believe that it is probable that we may be assessed for damages incurred. Company management has estimated total costs to rehabilitate the cars at October 31, 2020 and 2019 to be approximately $597,000 and $551,000, respectively. During the years ended October 31, 2020 and 2019, the Company has recorded an expense in cost of goods totaling $85,000 and $551,000, respectively. The Company accrues the estimated cost of railcar damages over the term of the lease as the damages are incurred.
17. BUSINESS SEGMENTS
The Company groups its operations into the following two business segments:
| | |
Ethanol Production: |
| Ethanol and co-product production and sales |
Natural gas pipeline: | | Ownership and operations of natural gas pipeline |
Segment reporting is intended to give financial statement users a better view of how the Company manages and evaluates its businesses. The accounting policies for each segment are the same as those described in the summary of significant accounting policies in Note 1. Segment income or loss does not include any allocation of shared-service costs. Segment assets are those that are directly used in or identified with segment operations. Inter-segment balances and transactions have been eliminated.
The following tables summarize financial information by segment and provide a reconciliation of segment revenue, contribution to operating income and total assets for the fiscal years ended October 31:
| | | | | | | | |
Revenue: | | 2020 | | 2019 | | | ||
Ethanol production | | $ | 74,622,495 | | $ | 105,395,553 | | |
Natural gas pipeline | | | 2,924,684 | | | 3,182,958 | | |
Eliminations | | | (1,517,338) | | | (1,751,066) | | |
Total Revenue | | $ | 76,029,841 | | $ | 106,827,445 | | |
Operating Income (Loss): | | 2020 | | 2019 | | | ||
Ethanol production |
| $ | (15,330,752) |
| $ | (6,594,653) |
| |
Natural gas pipeline | |
| 1,459,545 | |
| 1,878,935 | | |
Eliminations | |
| (498,562) | |
| (666,827) | | |
Operating Loss | | $ | (14,369,769) | | $ | (5,382,545) | | |
Assets: | | 2020 | | 2019 | | ||
Ethanol production | | $ | 49,613,394 | | $ | 44,097,379 | |
Natural gas pipeline | |
| 13,466,787 | |
| 12,498,536 | |
Total Assets | | $ | 63,080,181 | | $ | 56,595,915 | |
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit pursuant to the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosures.
Our management, including our Chief Executive Officer and General Manager (the principal executive officer), Steve Christensen, along with our Chief Financial Officer (the principal financial officer), Stacie Schuler, have reviewed and evaluated the effectiveness of our disclosure controls and procedures as of October 31, 2020. Based upon this review and evaluation, these officers have concluded that our consolidated disclosure controls and procedures are effective as of October 31, 2020.
(b) Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a15-(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and governors of the Company; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision of our Chief Executive Officer and our Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management has concluded that the Company’s internal control over financial reporting was effective as of October 31, 2020.
An attestation report from our accounting firm on our internal control over financial reporting is not included in this annual report because an attestation report is only required under the regulations of the Securities and Exchange Commission for accelerated filers and large accelerated filers.
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(c) Changes in Internal Controls Over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the fourth fiscal quarter ended October 31, 2020 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
None.
Pursuant to General Instruction G(3), we omit Part III, Items 10, 11, 12, 13 and 14 and incorporate such items by reference to an amendment to this Annual Report on Form 10-K or to a definitive proxy statement (the “2021 Proxy Statement”) to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year (October 31, 2020) covered by this Annual Report.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The Information required by this Item is incorporated by reference to the 2021 Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The Information required by this Item is incorporated by reference to the 2021 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The Information required by this Item is incorporated by reference to the 2021 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The Information required by this Item is incorporated by reference to the 2021 Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The Information required by this Item is incorporated by reference to the 2021 Proxy Statement.
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ITEM 15. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES
The following exhibits and financial statements are filed as part of, or are incorporated by reference into, this report:
(a) | Financial Statements |
The consolidated financial statements appear beginning at page 54 of this report.
(b) | Financial Statement Schedules |
All supplemental schedules are omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.
(c) | Exhibits |
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81
82
* Indicates compensatory agreement.
† Certain portions of this exhibit have been redacted and filed on a confidential basis with the Commission pursuant to a request for confidential treatment under Rule 24b-2 of under the Exchange Act. Spaces corresponding to the deleted portions are represented by brackets with asterisks [* * *].
ɷ Certain portions of this exhibit have been redacted pursuant to Item 601(b)(10)(iv) as they are both not material and would likely cause competitive harm to the Company if publicly disclosed. Spaces corresponding to the deleted portions are represented by brackets with [* * *].
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | |
| | HERON LAKE BIOENERGY, LLC |
| | |
Date: | February 16, 2021 | /s/ Steve Christensen |
| | Steve Christensen |
| | Chief Executive Officer |
| | |
Date: | February 16, 2021 | /s/ Stacie Schuler |
| | Stacie Schuler |
| | Chief Financial Officer |
| | |
84
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| | | |
Date: | February 16, 2021 | | /s/ Steve Christensen |
| | | Steve Christensen, Chief Executive Officer and General Manager |
| | | (Principal Executive Officer) |
| | | |
Date: | February 16, 2021 | | /s/ Stacie Schuler |
| | | Stacie Schuler, Chief Financial Officer |
| | | (Principal Financial and Accounting Officer) |
| | | |
Date: | February 16, 2021 | | /s/ Paul Enstad |
| | | Paul Enstad, Governor and Chairman |
| | | |
Date: | February 16, 2021 | | /s/ Rodney R. Wilkison |
| | | Rodney R. Wilkison, Governor and Vice Chairman |
| | | |
Date: | February 16, 2021 | | /s/ Michael Kunerth |
| | | Michael Kunerth, Governor and Secretary |
| | | |
Date: | February 16, 2021 | | /s/ Dean Buesing |
| | | Dean Buesing, Governor |
| | | |
Date: | February 16, 2021 | | /s/ Robert Ferguson |
| | | Robert Ferguson, Governor |
| | | |
Date: | February 16, 2021 | | /s/ Marten Goulet |
| | | Marten Goulet, Governor |
| | | |
Date: | February 16, 2021 | | /s/ Kenton Johnson |
| | | Kenton Johnson, Governor |
| | | |
Date: | February 16, 2021 | | /s/ Doug Schmitz |
| | | Doug Schmitz, Governor |
| | | |
Date: | February 16, 2021 | | /s/ David Woestehoff |
| | | David Woestehoff, Governor |
| | | |
Date: | February 16, 2021 | | /s/ Jeremy Janssen |
| | | Jeremy Janssen, Alternate Governor |
| | | |
Date: | February 16, 2021 | | /s/ Martin Seifert |
| | | Martin Seifert, Alternate Governor |
| | | |
Date: | February 16, 2021 | | /s/ Robin Spaude |
| | | Robin Spaude, Alternate Governor |
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