10-Q 1 a10-qfqe4x30x18.htm HIGHWATER ETHANOL 10-Q FQE 4-30-2018 Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
 
 
For the quarterly period ended April 30, 2018
 
 
 
OR
 
 
o
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
 
 
For the transition period from               to               .
 
 
 
COMMISSION FILE NUMBER 000-53588
 
HIGHWATER ETHANOL, LLC
(Exact name of registrant as specified in its charter)
 
Minnesota
 
20-4798531
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
24500 US Highway 14, Lamberton, MN 56152
(Address of principal executive offices)
 
(507) 752-6160
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes     o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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).
x Yes     o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act:
Large Accelerated Filer o
Accelerated Filer  o
Non-Accelerated Filer x
Smaller Reporting Company o
 
Emerging Growth Company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:  As of June 7, 2018 there were 4,813.50 membership units outstanding.

1


INDEX



2




PART I    FINANCIAL INFORMATION

Item 1. Financial Statements

HIGHWATER ETHANOL, LLC
Condensed Balance Sheets
 ASSETS
April 30, 2018
 
October 31, 2017

(Unaudited)
 

Current Assets

 

Cash and cash equivalents
$
2,080,103

 
$
738,209

Derivative instruments
742,855

 
800,199

Accounts receivable
3,113,798

 
2,838,154

Inventories
7,299,739

 
7,380,706

Prepaids and other
116,275

 
90,133

Total current assets
13,352,770

 
11,847,401



 

Property and Equipment

 

Land and land improvements
12,647,512

 
12,647,512

Buildings
38,818,532

 
38,811,666

Office equipment
1,151,330

 
1,151,330

Equipment
74,849,056

 
74,364,700

Vehicles
74,094

 
74,094

Construction in progress
354,603

 
256,923


127,895,127

 
127,306,225

Less accumulated depreciation
(59,537,595
)
 
(55,254,778
)
Net property and equipment
68,357,532

 
72,051,447



 

Other Assets

 

Investments
2,405,473

 
2,641,755

Deposits
191,457

 
191,457

Total other assets
2,596,930

 
2,833,212



 

Total Assets
$
84,307,232

 
$
86,732,060


LIABILITIES AND MEMBERS' EQUITY
April 30, 2018
 
October 31, 2017

(Unaudited)
 

Current Liabilities

 

Accounts payable
$
2,165,183

 
$
2,765,060

Accrued expenses
1,115,456

 
1,175,100

Customer deposits
7,566

 

Current maturities of long-term debt
2,708,285

 
2,715,528

Total current liabilities
5,996,490

 
6,655,688



 

Long-Term Debt
7,455,143

 
7,942,403



 

Commitments and Contingencies

 



 

Members' Equity

 

Members' equity, 4,813.50 units issued and outstanding
70,855,599

 
72,133,969

 
 
 
 
Total Liabilities and Members’ Equity
$
84,307,232

 
$
86,732,060


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

3


HIGHWATER ETHANOL, LLC
Condensed Unaudited Statements of Operations


Three Months Ended
 
Six Months Ended

April 30, 2018
 
April 30, 2017
 
April 30, 2018
 
April 30, 2017


 

 
 
 
 
Revenues
$
24,262,577

 
$
23,718,623

 
$
47,242,624

 
$
50,777,236



 

 
 
 
 
Cost of Goods Sold
21,979,252

 
23,127,166

 
45,010,995

 
45,993,969



 

 
 
 
 
Gross Profit
2,283,325

 
591,457

 
2,231,629

 
4,783,267



 

 
 
 
 
Operating Expenses
790,744

 
754,042

 
1,533,693

 
1,478,062



 

 
 
 
 
Operating Profit (Loss)
1,492,581

 
(162,585
)
 
697,936

 
3,305,205



 

 
 
 
 
Other Income (Expense)

 

 
 
 
 
Interest income
369

 
274

 
695

 
776

Other income
14,987

 
1,256

 
25,909

 
3,549

Interest expense
(182,850
)
 
(165,314
)
 
(356,428
)
 
(366,800
)
Income from equity method investments
10,395

 
18,086

 
14,175

 
39,162

Total other income (expense), net
(157,099
)
 
(145,698
)
 
(315,649
)
 
(323,313
)

 
 
 
 
 
 
 
Net Income (Loss)
$
1,335,482

 
$
(308,283
)
 
$
382,287

 
$
2,981,892

 
 
 
 
 
 
 
 
Weighted Average Units Outstanding
4,814

 
4,814

 
4,814

 
4,854

Net Income (Loss) Per Unit, Basic and Diluted
$
277.42

 
$
(64.04
)
 
$
79.41

 
$
614.32

Distributions Per Unit
$

 
$

 
$
345

 
$
345


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

4


HIGHWATER ETHANOL, LLC
Condensed Unaudited Statements of Cash Flows

Six Months Ended

April 30, 2018
 
April 30, 2017
Cash Flows from Operating Activities

 

Net income
$
382,287

 
$
2,981,892

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

 

Depreciation and amortization
4,288,317

 
3,966,282

Distributions in excess of earnings from equity method investments
350,475

 
214,922

Gain on sale of asset

 
(9,093
)
Non-cash patronage income
(114,194
)
 
(81,854
)
Changes in assets and liabilities

 

Accounts receivable
(275,644
)
 
1,975,362

Inventories
80,967

 
(716,211
)
Derivative instruments
57,344

 
140,682

Prepaids and other
(26,142
)
 
(75,521
)
Customer deposits
7,566

 

Accounts payable
(614,400
)
 
(315,434
)
Accrued expenses
(59,644
)
 
(8,254
)
Net cash provided by operating activities
4,076,932

 
8,072,773



 

Cash Flows from Investing Activities

 

Capital expenditures
(574,380
)
 
(1,320,649
)
Proceeds from sale of asset

 
28,777

   Net cash used in investing activities
(574,380
)
 
(1,291,872
)


 

Cash Flows from Financing Activities

 

Payments on long-term debt
(1,500,000
)
 
(4,832,660
)
Proceeds from long-term debt
1,000,000

 

Member unit repurchase, 78.5 units

 
(550,000
)
Member distributions
(1,660,658
)
 
(1,687,740
)
Net cash used in financing activities
(2,160,658
)
 
(7,070,400
)


 

Net Increase (Decrease) in Cash and Cash Equivalents
1,341,894

 
(289,499
)


 

Cash and Cash equivalents – Beginning of Period
738,209

 
2,129,800



 

Cash and Cash equivalents – End of Period
$
2,080,103

 
$
1,840,301

 
 
 
 
Supplemental Cash Flow Information

 

Cash paid for interest
$
289,807

 
$
284,037



 

Supplemental Disclosure of Noncash Financing and Investing Activities

 

Capital expenditures included in accounts payable
$
58,739

 
$
131,062


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

5

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2018


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations.  The accompanying balance sheet and related notes as of October 31, 2017 are derived from the audited financial statements as of that date. These condensed financial statements and related notes should be read in conjunction with the financial statements and notes thereto included in the Company’s audited financial statements for the year ended October 31, 2017, contained in the Company’s Form 10-K.
 
In the opinion of management, the interim condensed financial statements reflect all adjustments, consisting of only normal recurring adjustments, considered necessary for fair presentation of the Company's financial position as of April 30, 2018 and the results of operations and cash flows for all periods presented.

Nature of Business

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

Accounting Estimates

Management uses estimates and assumptions in preparing these financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. The Company uses estimates and assumptions in accounting for significant matters, among others, the carrying value of property and equipment and related impairment testing, inventory valuation, and derivative instruments. Actual results could differ from those estimates and such differences may be material to the financial statements. The Company periodically reviews estimates and assumptions and the effects of revisions are reflected in the period in which the revision is made.

Revenue Recognition

The Company generally sells ethanol and related products pursuant to marketing agreements. The Company’s products are shipped FOB shipping point. Revenues are recognized when the customer has taken title and has assumed the risks and rewards of ownership, prices are fixed or determinable and collectability is reasonably assured. For ethanol sales, title transfers when loaded into the rail car and for distiller’s grains when the loaded rail cars leave the plant facility.

In accordance with the Company’s agreements for the marketing and sale of ethanol and related products, marketing fees and freight due to the marketers are deducted from the gross sales price at the time incurred. Revenue is recorded net of these marketing fees and freight as they do not provide an identifiable benefit that is sufficiently separable from the sale of ethanol and related products.

Derivative Instruments

Derivatives are recognized in the balance sheet and the measurement of these instruments is at fair value. Margin amounts required by the broker are classified as deposits with broker within derivative instruments and any excess is classified as cash equivalents in the balance sheets. 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 recognized currently in earnings.

Contracts are evaluated to determine whether the contracts are derivatives. Certain contracts that meet the definition of a derivative may be exempted as “normal purchases or normal sales”. Normal purchases and normal sales are contracts that provide for the

6

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2018


purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business. Contracts that meet the requirements of normal purchases or sales are documented as normal and exempted from accounting as derivatives, therefore, are not marked to market in our financial statements.

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

Fair Value of Financial Instruments

The carrying value of accounts receivable, accounts payable, and other working capital items approximate fair value at April 30, 2018 due to the short maturity nature of these instruments.

The Company believes the carrying value of the derivative instruments approximates fair value based on quoted market prices or widely accepted valuation techniques including discounted cash flow analysis which includes observable market-based inputs.

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

Equity Method Investments

The Company has a 6% investment interest in an unlisted company, Renewable Products Marketing Group, LLC (RPMG), who markets the Company’s ethanol. The Company also has a 7% ownership interest in Lawrenceville Tank, LLC (LT), which owns and operates a trans load/tank facility near Atlanta, Georgia. These investments are flow-through entities and are being accounted for by the equity method of accounting under which the Company’s share of net income is recognized as income in the Company’s statements of operations and added to the investment account. Distributions or dividends received from the investment are treated as a reduction of the investment account. The Company consistently follows the practice of recognizing the net income from equity method investments based on the most recent reliable data. Therefore, the net income which is reported in the Company's statement of operations for the quarter ended April 30, 2018 is based on the investee’s results of operations for the three month period ended March 31, 2018.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09 (ASU 2014-09), Revenue from Contracts with Customers, which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The new standard requires a company to recognize revenue when it transfers goods or services to customers in an amount that reflects the consideration that the company expects to receive for those goods or services. Additionally, the guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, which is the Company’s first quarter of fiscal year 2019. Early application is permitted one year earlier. The new standard allows for the amendment to be applied either retrospectively to each prior reporting period presented or retrospectively as a cumulative-effect adjustment as of the date of adoption. The Company is evaluating the effect that ASU 2014-09 will have on its financial statements and related disclosures, including which transition method it will adopt. The Company plans to complete its initial evaluation by July 31, 2018, and its final evaluation by October 31, 2018.

In January 2016, the FASB issued ASU No. 2016-01 (ASU2016-01), Financial Instruments-Overall (Subtopic 825-10), which is intended to make financial statement information on recognition, measurement, presentation, and disclosure of financial instrument more useful. ASU 2016-01 is effective for fiscal periods beginning after December 15, 2017. The Company is currently in the process of evaluating the impact that this new guidance will have on the financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842).  This ASU requires lessees to recognize a lease liability and a right-to-use asset for all leases, including operating leases, with a term greater than twelve months on its balance sheet.  This

7

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2018


ASU is effective in annual and interim periods in fiscal years beginning after December 15, 2018, with early adoption permitted, and requires a modified retrospective transition method.  The Company is currently in the process of evaluating the impact that this new guidance will have on the financial statements.

In August 2016, the FASB issued ASU No. 2016-15 (ASU 2016-15), Statement of Cash Flows (Topic 230), which clarifies and provides guidance for specific cash flow issues. ASU 2016-15 is effective for fiscal periods beginning after December 15, 2017. The Company implemented ASU 2016-15 effective November 1, 2017. The effect was reclassifying Distributions from Equity Method Investments from Cash Flows from Investing Activities to Cash Flows from Operating Activities.
2. UNCERTAINTIES

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

3. INVENTORIES

Inventories consisted of the following at:
 
 
April 30, 2018
 
October 31, 2017
 
 
 
 
 
Raw materials
 
$
1,926,513

 
$
2,130,668

Spare parts and supplies
 
3,148,149

 
2,938,262

Work in process
 
772,556

 
729,167

Finished goods
 
1,452,521

 
1,582,609

 Total
 
$
7,299,739

 
$
7,380,706


4. DERIVATIVE INSTRUMENTS

As of April 30, 2018, the Company had entered into corn, ethanol and natural gas derivative instruments, which are required to be recorded as either assets or liabilities at fair value in the balance sheet. The Company uses these instruments to manage risks from changes in market rates and prices. Derivatives qualify for treatment as hedges when there is a high correlation between the change in fair value of the derivative instrument and the related change in value of the underlying hedged item. The Company may designate the hedging instruments based upon the exposure being hedged as a fair value hedge or a cash flow hedge. The derivative instruments outstanding at April 30, 2018 are not designated as effective hedges for accounting purposes.

Commodity Contracts

As of April 30, 2018, the Company has open futures and option positions for 4,100,000 bushels of corn. Management expects all open positions outstanding as of April 30, 2018 to be realized within the next twelve months.

The following tables provide details regarding the Company's derivative instruments at April 30, 2018 and October 31, 2017:

8

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2018


          Instrument
Balance Sheet location
 
April 30, 2018
October 31, 2017
 
 
 
 
 
Corn, natural gas and ethanol futures contracts
 
 




In gain position
 
 
$
1,116,318

$
66,438

In loss position
 
 
(2,036,735
)
(1,668,043
)
Deposits with broker
 
 
1,663,272

2,401,804

 
Current assets
 
$
742,855

$
800,199


The following tables provide details regarding the gains (losses) from the Company's derivative instruments in the statements of operations, none of which are designated as hedging instruments:
 
 
Statement of
 
Three Months Ended April 30,
 
 
Operations location
 
2018
2017
Ethanol contracts
 
Revenues
 
$
61,138

$
196,478

Corn contracts
 
Cost of goods sold
 
1,160,553

300,480

Natural gas contracts
 
Cost of goods sold
 
4,480

14,887

 
 
 
 
 
 
 
 
Statement of
 
Six Months Ended April 30,
 
 
Operations location
 
2018
2017
Ethanol contracts
 
Revenues
 
$
(36,188
)
$
422,210

Corn contracts
 
Cost of goods sold
 
1,658,343

850,816

Natural gas contracts
 
Cost of goods sold
 
35,332

11,747


5. FAIR VALUE MEASUREMENTS

The following table provides information on those assets (liabilities) measured at fair value on a recurring basis.
 
 
Fair Value as of
 
Fair Value Measurement Using
 
 
April 30, 2018
 
Level 1
 
Level 2
 
Level 3
Derivative instruments - commodities
 
$
(920,417
)
 
$
63,689

 
$
(984,106
)
 
$


 
 
Fair Value as of
 
Fair Value Measurement Using
 
 
October 31, 2017
 
Level 1
 
Level 2
 
Level 3
Derivative instruments - commodities
 
$
(1,601,605
)
 
$
(3,750
)
 
$
(1,597,855
)
 
$


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

Long-term debt consists of the following at:

9

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2018


 
April 30, 2018
 
October 31, 2017
Variable Rate Term Loan
$
8,250,000

 
$
9,750,000

 
 
 
 
Term Revolving Loan
2,000,000

 
1,000,000

 
 
 
 
Total
10,250,000

 
10,750,000

 
 
 
 
Less Debt Issuance Costs
(86,572
)
 
(92,069
)
 
 
 
 
Less amounts due within one year
(2,708,285
)
 
(2,715,528
)
 
 
 
 
Net long-term debt
$
7,455,143

 
$
7,942,403


Bank Financing

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

The Term Loan is for $15,000,000 with a variable interest rate based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at April 30, 2018 was 4.99%. Monthly principal payments are due on the Term Loan of approximately $250,000 plus accrued interest. Payments of all amounts outstanding are due on January 22, 2021. The outstanding balance on this note was $8,250,000 at April 30, 2018. The Company may convert the Term Loan to a fixed rate loan, subject to certain conditions as described in the Second Amended and Restated Credit Agreement and with the consent of Compeer.

Term Revolving Loan

The Term Revolving Loan was previously for $15,000,000 with a variable interest rate based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at April 30, 2018 was 4.99%. Effective April 20, 2018, the availability under the Term Revolving Loan was increased to $20,000,000. The Term Revolving Loan may be advanced, repaid and re-borrowed during the term. Monthly interest payments are due on the Term Revolving Loan. Payment of all amounts outstanding are due on January 22, 2023. The outstanding balance on this note was $2,000,000 at April 30, 2018. The Company also has $500,000 in letters of credit outstanding at April 30, 2018 which reduce the amount available under the Term Revolving Loan. The Company pays interest at a rate of 1.50% on amounts outstanding for the letters of credit. The Company is also required to pay unused commitment fees for the Term Revolving Loan as defined in the Second Amended and Restated Credit Agreement.

Debt Issuance Costs

Costs associated with the issuance of debt are recorded as debt issuance costs and are amortized over the term of the related debt by use of the effective interest method.

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

10

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2018


The Company is also subject to various financial and non-financial covenants that limit distributions and debt and require minimum debt service coverage, tangible net worth, and working capital requirements. The debt service coverage ratio is no less than 1.25:1.00 measured annually by comparing adjusted EBITDA to scheduled payments of principal and interest. The minimum working capital is $8,250,000, which is calculated as current assets plus the amount available for drawing under the Term Revolving Loan and undrawn amounts on outstanding letters of credit, less current liabilities, and is measured quarterly.
The Company is limited to annual capital expenditures of $5,000,000 without prior approval, incurring additional debt over certain amounts without prior approval, and making additional investments as described in the Amended and Restated Credit Agreement without prior approval of Compeer. The Company is allowed to make cash distributions to members as frequently as monthly in an amount equal to 75% of net income if working capital is greater than or equal to $8,250,000, or 100% of net income if working capital is greater than or equal to $11,000,000, or an unlimited amount if working capital is greater than or equal to $11,000,000 and the outstanding balance on the Term Loan is $0.
The estimated maturities of the long-term debt at April 30, 2018 are as follows:
 
Principal
 
Debt Issuance Costs
 
Total
April 2019
$
2,750,000

 
$
(41,715
)
 
$
2,708,285

April 2020
3,000,000

 
(30,555
)
 
2,969,445

April 2021
2,500,000

 
(14,302
)
 
2,485,698

April 2022

 

 

April 2023
2,000,000

 

 
2,000,000

     Long-term debt
$
10,250,000

 
$
(86,572
)
 
$
10,163,428


7. COMMITMENTS AND CONTINGENCIES

Marketing Agreements

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

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

The Company has a crude corn oil marketing agreement with a marketer to market all corn oil to be produced at the plant. Under the agreement, the marketer will execute contracts with buyers after giving prior notice of the terms and conditions thereof to the Company and receiving direction from the Company to accept such contracts. The Company receives the actual price received from buyers less a marketing fee, actual freight and transportation costs and certain taxes related to the purchase, delivery or sale. The Company is required to provide corn oil meeting certain specifications as provided in the agreement and the agreement provides for a process for rejection of nonconforming corn oil. The agreement automatically renews for successive one-year terms unless terminated in accordance with the agreement.

Regulatory Agencies

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

Forward Contracts

At April 30, 2018, the Company had purchase commitments of approximately 2,625,000 bushels of forward fixed basis corn contracts and 3,093,000 bushels of forward fixed price corn contracts totaling approximately $10,671,000. These purchase contracts are for various delivery periods through December 2018. At April 30, 2018, the Company had approximately 2,123,000 MMBTUs of forward fixed price natural gas purchase contracts totaling approximately $5,164,000 for various delivery periods through September 2020. In addition, at April 30, 2018, the Company had approximately 9,200 gallons of forward fixed price denaturant purchase contracts totaling approximately $15,000 for various delivery periods through May 2018.

At April 30, 2018, the Company had approximately 3,900 tons of forward fixed price dried distillers grains sales contracts totaling approximately $554,000 for various delivery periods through June 2018. In addition, at April 30, 2018, the Company had approximately 6,500 tons of forward fixed price modified distillers grains sales contracts totaling approximately $377,000 for delivery periods through September 2018. In addition, at April 30, 2018, the Company had approximately 280,000 pounds of forward fixed price corn oil sales contracts totaling approximately $64,000 for delivery periods through May 2018.




11


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

We prepared the following discussion and analysis to help you better understand our financial condition, changes in our financial condition, and results of operations for the three and six month periods ended April 30, 2018, compared to the same periods of the prior fiscal year. This discussion should be read in conjunction with the condensed financial statements and notes and the information contained in the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 2017.

Forward-Looking Statements

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

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

Available Information

Our website address is www.highwaterethanol.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), are available, free of charge, on our website at www.highwaterethanol.com under the link “SEC Compliance,” as soon as reasonably practicable after we electronically file such materials with, or furnish such

12


materials to, the Securities and Exchange Commission. The contents of our website are not incorporated by reference in this Quarterly Report on Form 10-Q.

Overview

Highwater Ethanol, LLC (“we,” “our,” “Highwater Ethanol” or the “Company”) was formed as a Minnesota limited liability company organized on May 2, 2006, for the purpose of constructing, owning, and operating a 50 million gallon per year ethanol plant near Lamberton, Minnesota. Since August 2009, we have been engaged in the production of ethanol and distillers grains at the plant. We have been operating in excess of our nameplate capacity of 50 million gallons per year and anticipate we will continue to do so in the future. We have submitted an application to the Minnesota Pollution Control Agency to increase the emissions limits in our air permit.
    
Our operating results are largely driven by the prices at which we sell our ethanol and distillers grains as well as the costs related to production. The price of ethanol has historically fluctuated with the price of corn. The price of distillers grains has also historically been influenced by the price of corn as a substitute livestock feed. We expect these price relationships to continue for the foreseeable future, although recent volatility in the commodities markets makes historical pricing relationships less reliable. Our largest costs of production are corn, natural gas, depreciation and manufacturing chemicals. The cost of corn is largely impacted by geopolitical supply and demand factors and the outcome of our risk management strategies. Prices for natural gas, manufacturing chemicals and denaturant are tied directly to the overall energy sector, crude oil and unleaded gasoline. We market and sell our products primarily in the continental United States using third party marketers. RPMG, Inc. markets our ethanol. CHS, Inc. markets our dried distillers grains and corn oil and supplies our corn.

Effective April 20, 2018, we executed a First Amendment to Second Amended and Restated Credit Agreement (the "First Amendment") with Compeer Financial, PCA as successor in interest to AgStar Financial Services, PCA and as administrative agent ("Compeer"), which amended the Second and Amended and Restated Credit Agreement originally dated January 22, 2016. In connection therewith, as of the same date, the Company executed a Third Amended and Restated Term Revolving Note and a Third Amended and Restated Mortgage, Security Agreement, Assignment of Leases and Fixture Financing Statement. The First Amendment increased the availability under the Term Revolving Loan to $20,000,000.

We expect to fund our operations during the next 12 months using cash flow from our continuing operations and our current credit facilities. However, should we experience unfavorable operating conditions in the ethanol industry that prevent us
from profitably operating the ethanol plant, we may need to seek additional funding.

Results of Operations for the Three Months Ended April 30, 2018 and 2017
 
The following table shows the results of our operations and the approximate percentage of revenues, cost of goods sold, operating expenses and other items to total revenues in our unaudited statements of operations for the three months ended April 30, 2018 and 2017:
 
2018
 
2017
Statements of Operations Data
Amount
(unaudited)
 
%
 
Amount
(unaudited)
 
%
 
 
 
 
 
 
 
 
Revenues
$
24,262,577

 
100.00
 %
 
$
23,718,623

 
100.00
 %
Cost of Goods Sold
21,979,252

 
90.59
 %
 
23,127,166

 
97.51
 %
Gross Profit
2,283,325

 
9.41
 %
 
591,457

 
2.49
 %
Operating Expenses
790,744

 
3.26
 %
 
754,042

 
3.18
 %
Operating Profit (Loss)
1,492,581

 
6.15
 %
 
(162,585
)
 
(0.69
)%
Other Income (Expense)
(157,099
)
 
(0.65
)%
 
(145,698
)
 
(0.61
)%
Net Income (Loss)
$
1,335,482

 
5.50
 %
 
$
(308,283
)
 
(1.30
)%

The following table shows the sources of our revenue for the three months ended April 30, 2018 and 2017:

13


 
2018
 
 
 
2017
 
 
Revenue Sources
Amount
(Unaudited)
 
%
 
Amount
(Unaudited)
 
%
 
 
 
 
 
 
 
 
Ethanol Sales
$
18,737,309

 
77.23
%
 
$
19,454,609

 
82.02
%
Modified Distillers Grains Sales
1,048,830

 
4.32
%
 
546,003

 
2.30
%
Dried Distillers Grains Sales
3,891,497

 
16.04
%
 
3,067,130

 
12.93
%
Corn Oil Sales
584,941

 
2.41
%
 
650,881

 
2.75
%
Total Revenues
$
24,262,577

 
100.00
%
 
$
23,718,623

 
100.00
%

Revenue
Ethanol
Our total revenues were higher for the three months ended April 30, 2018, as compared to the three months ended April 30, 2017. Revenue from ethanol sales decreased by approximately 3.70% during the three months ended April 30, 2018, as compared to the three months ended April 30, 2017, due primarily to a decrease in the average price per gallon of ethanol sold. The average price per gallon of ethanol sold for the three months ended April 30, 2018 was approximately 3.68% lower than the average price we received for the three months ended April 30, 2017. Ethanol prices were lower for the three months ended April 30, 2018, due to record levels of domestic production.
    Ethanol prices will likely continue to be directionally consistent with changes in corn and energy prices. If corn and gasoline prices decrease, that could have a significant negative impact on the price of ethanol particularly if ethanol stocks were to remain at current high levels. However, an increase in domestic usage due to seasonal driving demand could contribute to an increase in ethanol prices. Strong export demand could also have a positive impact on ethanol prices. However, a recent trade dispute between China and the United States has created additional uncertainty as to future export demand from China.
The number of gallons of ethanol sold during the three months ended April 30, 2018 were approximately the same as the number of gallons of ethanol sold for the three months ended April 30, 2017. Management anticipates that the amount of ethanol produced for the three months ended April 30, 2018, will remain relatively consistent in the future until we receive our updated air permit which we applied for in order to allow an increase in gallons produced to approximately 70.2 million gallons of denatured ethanol per 12-month rolling average.

We had gains related to ethanol based derivative instruments of approximately $61,000 and $196,000 for the three months ended April 30, 2018 and 2017, respectively.

Distillers Grains

Revenue from distillers grains sales increased by approximately 36.70% during the three months ended April 30, 2018, as compared to the three months ended April 30, 2017. This is primarily a result of higher dried and modified distillers grains prices for the three months ended April 30, 2018, as compared to the three months ended April 30, 2017. For the three months ended April 30, 2018, the average price per ton of dried distillers grains sold was approximately 45.16% higher than the average price we received during the three months ended April 30, 2017, due to price increases in the protein market that correlate to the price of soybean meal. For the three months ended April 30, 2018, the average price per ton of modified distillers grains sold was approximately 18.62% higher than during the three months ended April 30, 2017, due to increased demand in our local area.

Distillers grains prices typically change in proportion to corn prices and availability of corn. Domestic demand for distillers grains could decrease due to expansion of production capacity in the ethanol industry or if corn prices decline and end-users switch to lower priced alternatives. Changes in foreign demand also impact distillers grains prices. Historically, China has been a significant consumer of exported distillers grains. However, an anti-dumping investigation by the Chinese government into distillers grains produced in the United States and the imposition by China of anti-dumping and anti-subsidy duties on distillers grains produced in the U.S. has had a negative effect on export demand from China resulting in lower distillers grains prices. In addition, a recent trade dispute between China and the United States has created additional uncertainty as to future export demand from China.

The tons of dried distillers grains sold decreased by approximately 12.60% during the three months ended April 30, 2018, as compared to the three months ended April 30, 2017. The tons of modified distillers grains sold during the three months ended

14


April 30, 2018, increased by approximately 61.93% as compared to the three months ended April 30, 2017. The overall tons of distillers grains produced increased due to the increase in modified distillers grain production which has a higher moisture content. Management anticipates that the overall amount of distillers grains produced for the three months ended April 30, 2018, will remain relatively consistent in the future until we receive our updated air permit which we anticipate will allow us to increase our gallons of ethanol produced and which would also increase our distillers grains production.

At April 30, 2018, we have approximately 3,900 tons of forward dried distiller grains sales contracts valued at $554,000 for various delivery periods through June 2018. In addition, at April 30, 2018, the Company had approximately 6,500 tons of forward fixed price modified distillers grains sales contracts valued at approximately $377,000 for delivery periods through September 2018.
        
Corn Oil

Revenue from corn oil sales decreased by approximately 10.10% during the three months ended April 30, 2018, as compared to the three months ended April 30, 2017. This is primarily a result of lower corn oil prices during the three months ended April 30, 2018, as compared to the three months ended April 30, 2017. For the three months ended April 30, 2018, the average price per pound of corn oil we received was approximately 22.22% lower than during the three months ended April 30, 2017, due to decreased demand from the corn oil feed market. Management anticipates that corn oil prices in the future will be affected by changes in corn and energy prices and the status of the biodiesel blenders' tax credit.

    The pounds of corn oil sold during the three months ended April 30, 2018, increased by approximately 14.46% as compared to the the three months ended April 30, 2017 due to our corn oil extraction equipment running more efficiently. Management anticipates that the amount of corn oil produced will remain relatively consistent in the future with the amounts produced for the three months ended April 30, 2018, until we receive our updated air permit which we anticipate will allow us to increase our gallons of ethanol produced and which would also increase our corn oil production.

At April 30, 2018, we had approximately 280,000 pounds of forward fixed price corn oil sales contracts valued at approximately $64,000 for delivery periods through May 2018.

Cost of Goods Sold

Our two largest costs of production are corn (67.10% of cost of goods sold for the three months ended April 30, 2018) and natural gas (6.30% of cost of goods sold for the three months ended April 30, 2018). Our total cost of goods sold was approximately 5.0% less during the three months ended April 30, 2018, as compared to the three months ended April 30, 2017, due to lower corn costs and improved efficiencies.

Corn

Our average price per bushel of corn for the three months ended April 30, 2018 decreased by approximately 5.03% per bushel, as compared to the three months ended April 30, 2017, due to lower corn prices.

Management expects there to be an adequate corn supply available in our area to operate the ethanol plant and that prices during our 2018 fiscal year may remain low due to the large corn crop which was harvested in the fall of 2017. However, corn prices are likely to remain volatile in the future depending on weather conditions, supply and demand, stocks and other factors and could significantly impact our costs of production.

We used approximately 3.00% less bushels of corn in the three months ended April 30, 2018, as compared to the three months ended April 30, 2017, due to improved corn to ethanol yield.

At April 30, 2018, we have approximately 2,625,000 bushels of forward fixed basis corn purchase contracts and 3,093,000 bushels of forward fixed price corn contracts valued at approximately $10,671,000 for various delivery periods through December 2018. For the three months ended April 30, 2018 and 2017, we had gains related to corn derivative instruments of approximately $1,161,000 and $300,000, respectively.

Natural Gas

Our average price per MMBTU of natural gas was approximately 1.58% lower for the three months ended April 30, 2018, as compared to the three months ended April 30, 2017. Natural gas prices were lower due to decreased natural gas demand due to warmer weather conditions and due to our locking in prices for the majority of our natural gas requirements at favorable prices.

15


Management anticipates that natural gas prices will continue at their current levels unless the natural gas industry experiences production problems or if there are large increases in natural gas demand.

For the three months ended April 30, 2018, we purchased approximately 1.30% less natural gas as compared to the three months ended April 30, 2017. This decrease in natural gas usage is primarily due to a decrease in dried distillers grains production.

At April 30, 2018, we have approximately 2,123,000 MMBTUs of forward natural gas sales contracts valued at approximately $5,164,000 for various delivery periods through September 2020. For the three months ended April 30, 2018 and 2017, we had gains related to natural gas derivative instruments of approximately $4,000 and $15,000, respectively.

Operating Expense

We had operating expenses for the three months ended April 30, 2018 of $790,744, as compared to operating expenses of $754,042 for the three months ended April 30, 2017. Management attributes this increase in operating expenses primarily to an increase in licenses and permits and advertising for the three months ended April 30, 2018, as compared to the three months ended April 30, 2017. Management continues to pursue strategies to optimize efficiencies and maximize production. These efforts may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses do not vary with the level of production at the plant, we expect our operating expenses to remain relatively steady.

Operating Profit (Loss)

We had profit from operations for the three months ended April 30, 2018 of $1,492,581, which is approximately 6.15% of our revenues, compared to a loss of $162,585, which was approximately (0.69)% of our revenues, for the three months ended April 30, 2017. This increase in our operating income is primarily due to a decrease in the price we paid for corn relative to the price received for our ethanol.

Other Income (Expense)

We had total other expense for the three months ended April 30, 2018 of $157,099, as compared to total other expense of $145,698 for the three months ended April 30, 2017. Our other expense for the three months ended April 30, 2018, consisted primarily of interest expense offset by income from investments. This increase in other expense is primarily due to an increase in interest expense.

Results of Operations for the Six Months Ended April 30, 2018 and 2017
 
The following table shows the results of our operations and the approximate percentage of revenues, cost of goods sold, operating expenses and other items to total revenues in our unaudited statements of operations as of six months ended April 30, 2018 and 2017:
 
2018
 
2017
Statements of Operations Data
Amount
(unaudited)
 
%
 
Amount
(unaudited)
 
%
 
 
 
 
 
 
 
 
Revenues
$
47,242,624

 
100.00
 %
 
$
50,777,236

 
100.00
 %
Cost of Goods Sold
45,010,995

 
95.28
 %
 
45,993,969

 
90.58
 %
Gross Profit
2,231,629

 
4.72
 %
 
4,783,267

 
9.42
 %
Operating Expenses
1,533,693

 
3.24
 %
 
1,478,062

 
2.91
 %
Operating Profit
697,936

 
1.48
 %
 
3,305,205

 
6.51
 %
Other Income (Expense)
(315,649
)
 
(0.67
)%
 
(323,313
)
 
(0.64
)%
Net Income
$
382,287

 
0.81
 %
 
$
2,981,892

 
5.87
 %

The following table shows the sources of our revenue for the six months ended April 30, 2018 and 2017:

16


 
2018
 
2017
Revenue Sources
Amount
(Unaudited)
 
%
 
Amount
(Unaudited)
 
%
 
 
 
 
 
 
 
 
Ethanol Sales
$
36,597,367

 
77.47
%
 
$
41,776,092

 
82.28
%
Modified Distillers Grains Sales
1,753,488

 
3.71
%
 
1,113,301

 
2.19
%
Dried Distillers Grains Sales
7,503,579

 
15.88
%
 
6,323,306

 
12.45
%
Corn Oil Sales
1,388,190

 
2.94
%
 
1,564,537

 
3.08
%
Total Revenues
$
47,242,624

 
100.00
%
 
$
50,777,236

 
100.00
%

Revenue

Ethanol
Our total revenues were lower for the six months ended April 30, 2018, as compared to the six months ended April 30, 2017. Revenue from ethanol sales decreased by approximately 12.40% during the six months ended April 30, 2018, as compared to the six months ended April 30, 2017, due primarily to a decrease in the average price per gallon of ethanol sold. The average price per gallon of ethanol sold for the six months ended April 30, 2018 was approximately 12.06% lower than the average price we received for the six months ended April 30, 2017. Ethanol prices were lower for the six months ended April 30, 2018 due to record levels of domestic production.
    The number of gallons of ethanol sold during the six months ended April 30, 2018 were approximately the same as the number of gallons of ethanol sold for the six months ended April 30, 2017. Management anticipates that the amount of ethanol produced for the six months ended April 30, 2018, will remain relatively consistent in the future until we receive our updated air permit which we applied for in order to allow an increase in gallons produced to approximately 70.2 million gallons of denatured ethanol per 12-month rolling average.
Distillers Grains

Revenue from distillers grains sales increased by approximately 24.50% during the six months ended April 30, 2018, as compared to the six months ended April 30, 2017. This is primarily a result of higher dried and modified distillers grains prices for the six months ended April 30, 2018, as compared to the six months ended April 30, 2017. For the six months ended April 30, 2018, the average price per ton of dried distillers grains sold was approximately 31.90% higher than the average price we received during the six months ended April 30, 2017, due to price increases in the protein market that correlate to the price of soybean meal. For the six months ended April 30, 2018, the average price per ton of modified distillers grains sold was approximately 13.69% higher than during the six months ended April 30, 2017, due to increased demand in our local area.

The tons of dried distillers grains sold decreased by approximately 10.04% during the six months ended April 30, 2018, as compared to the six months ended April 30, 2017. The tons of modified distillers grains sold during the six months ended April 30, 2018, increased by approximately 38.54% as compared to the six months ended April 30, 2017. The overall tons of distillers grains produced decreased somewhat due primarily to decreased corn grind which was a result of improved corn to ethanol yield and less gallons of ethanol produced. However, management anticipates that the overall amount of distillers grains produced for the six months ended April 30, 2018, will remain relatively consistent in the future until we receive our updated air permit which we anticipate will allow us to increase our gallons of ethanol produced and which would also increase our distillers grains production.

Corn Oil

Revenue from corn oil sales decreased by approximately 11.09% during the six months ended April 30, 2018, as compared to the six months ended April 30, 2017. This is primarily a result of lower corn oil prices during the six months ended April 30, 2018, as compared to the six months ended April 30, 2017. For the six months ended April 30, 2018, the average price per pound of corn oil we received was approximately 18.52% lower than during the six months ended April 30, 2017, due to decreased demand from the corn oil feed market.

    The pounds of corn oil sold during the six months ended April 30, 2018, increased by approximately 9.18% as compared to the the six months ended April 30, 2017, due to our corn oil extraction equipment running more efficiently. Management anticipates that the amount of corn oil produced for the six months ended April 30, 2018, will remain relatively consistent in the

17


future until we receive our updated air permit which we anticipate will allow us to increase our gallons of ethanol produced and which would also increase our corn oil production.

Cost of Goods Sold

Our two largest costs of production are corn (66.10% of cost of goods sold for the six months ended April 30, 2018) and natural gas (6.70% of cost of goods sold for the six months ended April 30, 2018). Our total cost of goods sold was approximately 2.10% less during the six months ended April 30, 2018, as compared to the six months ended April 30, 2017.

Corn

Our average price per bushel of corn for the six months ended April 30, 2018 decreased by approximately 3.90% per bushel, as compared to the six months ended April 30, 2017, due to lower corn prices.

We used approximately 3.90% less bushels of corn in the six months ended April 30, 2018, as compared to the six months ended April 30, 2017, due primarily to a slight decrease in production of ethanol and an improved corn to ethanol yield which reduces the amount of corn necessary to grind.

Natural Gas

Our average price per MMBTU of natural gas was approximately 1.00% lower for the six months ended April 30, 2018, as compared to the six months ended April 30, 2017. Natural gas prices were lower due primarily to an increase in natural gas production.

For the six months ended April 30, 2018, we purchased approximately 1.10% less natural gas as compared to the six months ended April 30, 2017. This decrease in natural gas usage is primarily due to a decrease in dried distillers grains production.

Operating Expense

We had operating expenses for the six months ended April 30, 2018 of $1,533,693, as compared to operating expenses of $1,478,062 for the six months ended April 30, 2017. Management attributes this increase in operating expenses primarily to an increase in legal fees and advertising for the six months ended April 30, 2018, as compared to the six months April 30, 2017. Management continues to pursue strategies to optimize efficiencies and maximize production. These efforts may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses do not vary with the level of production at the plant, we expect our operating expenses to remain relatively steady.

Operating Profit (Loss)

We had profit from operations for the six months ended April 30, 2018 of $697,936, which is approximately 1.48% of our revenues, compared to a profit of $3,305,205 which was approximately 6.51% of our revenues, for the six months ended April 30, 2017. This decrease in our operating income is primarily due to a decrease in the price we received for our ethanol relative to the price we paid for corn.

Other Income (Expense)

We had total other expense for the six months ended April 30, 2018 of $315,649, as compared to total other expense of $323,313 for the six months ended April 30, 2017. Our other expense for the six months ended April 30, 2018, consisted primarily of interest expense offset by income from investments. This decrease in other expense is primarily due to a decrease in interest expense.

Changes in Financial Condition for the Six Months Ended April 30, 2018

The following table highlights the changes in our financial condition as of April 30, 2018 from our previous fiscal year ended October 31, 2017:


18


 
April 30, 2018
 
October 31, 2017
Current Assets
$
13,352,770

 
$
11,847,401

Current Liabilities
5,996,490

 
6,655,688

Long-Term Debt
7,455,143

 
7,942,403

    
Current Assets

The increase in current assets is primarily the result of increases in cash and cash equivalents and accounts receivable which were offset partially by decreases in derivative instruments and inventories at April 30, 2018, as compared to October 31, 2017.
    
Current Liabilities

The decrease in current liabilities is due primarily to decreases in accounts payable, accrued expenses and current maturities of long-term debt at April 30, 2018, as compared to October 31, 2017.

Long-Term Debt

Long-term debt decreased at April 30, 2018, as compared to October 31, 2017, primarily due to principal repayments on our loans.

Liquidity and Capital Resources

Our primary sources of liquidity are our Term Revolving Loan and cash generated from operations. Based on financial forecasts prepared by our management, we anticipate that we will have sufficient cash on hand, cash from our current credit facilities, and cash from our operations to continue to operate the ethanol plant at capacity for the next 12 months. We do not currently anticipate seeking additional equity or debt financing in the near term. However, changes in corn prices significantly affect our cost of goods sold. If increases in cost of goods sold are not offset by corresponding increases in the prices we receive from the sale of our products, these increases in cost of goods sold can have a significant negative impact on our financial performance. If we experience unfavorable operating conditions in the ethanol industry that prevent us from profitably operating the ethanol plant, we could have difficulty maintaining our liquidity and we may have to secure additional debt or equity financing for working capital or other purposes. We do not currently anticipate that we will need to secure additional capital resources for any other significant purchases of property and equipment in the next 12 months.

The following table shows cash flows for the six months ended April 30, 2018 and 2017:
 
2018
2017
 
(unaudited)
(unaudited)
Net cash provided by operating activities
$
4,076,932

$
8,072,773

Net cash used in investing activities
(574,380
)
(1,291,872
)
Net cash used in financing activities
(2,160,658
)
(7,070,400
)

Cash Flow From Operations

We experienced a decrease in our cash provided by operating activities for the six months ended April 30, 2018, as compared to the same period in 2017. This decrease was primarily due to a decrease in our net income for the six months ended April 30, 2018, as compared to net income for the same period in 2017.

Cash Flow From Investing Activities

We used less cash in investing activities for the six month period ended April 30, 2018, as compared to the same period in 2017. This change was primarily due to a decrease in capital expenditures during the six months ended April 30, 2018.


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Cash Flow From Financing Activities

We used less cash for financing activities during the six months ended April 30, 2018, as compared to the same period in 2017. This decrease was the result of decreased payments and increased borrowings on long-term debt during the six months ended April 30, 2018, as compared to the same period in 2017.

Short-Term and Long-Term Debt Sources
            
On January 22, 2016, we entered into a Second Amended and Restated Credit Agreement with Compeer Financial f/k/a AgStar Financial Services, PCA ("Compeer"). In connection therewith, as of the same date, we executed Second Amended and Restated Term Notes, Second Amended and Restated Term Revolving Notes, an Amended and Restated Security Agreement and a Second Amended and Restated Mortgage, Security Agreement, Assignment of Leases and Fixture Financing Statement. The Second Amended and Restated Credit Agreement decreased the Term Loan to $15,000,000, increased the Term Revolving Loan to $15,000,000 and eliminated the Revolving Line of Credit. Subsequent to the fiscal year end, on November 29, 2017, Compeer waived our violation, at October 31, 2017, of the $5,000,000 limitation on annual capital expenditures as set forth in the Second Amended and Restated Credit Agreement. Effective April 20, 2018, we executed a First Amendment to Second Amended and Restated Credit Agreement with Compeer which increased the availability under the Term Revolving Loan to $20,000,000. In connection therewith, as of the same date, we executed a Third Amended and Restated Term Revolving Note and a Third Amended and Restated Mortgage, Security Agreement, Assignment of Leases and Fixture Financing Statement.
    
Term Loan
    
The Term Loan is for $15,000,000 with a variable interest rate based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at April 30, 2018 was 4.99%. Monthly principal payments are due on the Term Loan of approximately $250,000 plus accrued interest. Payments of all amounts outstanding are due on January 22, 2021. The outstanding balance on this note was $8,250,000 at April 30, 2018. We may convert the Term Loan to a fixed rate loan, subject to certain conditions as described in the Second Amended and Restated Credit Agreement and with the consent of AgStar.

Term Revolving Loan

The Term Revolving Loan is for up to $20,000,000 with a variable interest rate based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at April 30, 2018 was 4.99%. The Term Revolving Loan may be advanced, repaid and re-borrowed during the term. Monthly interest payments are due on the Term Revolving Loan with payment of all amounts outstanding due on January 22, 2023. The outstanding balance on this note was $2,000,000 at April 30, 2018. We also have $500,000 in letters of credit outstanding at April 30, 2018 which reduce the amount available under the Term Revolving Loan. We pay interest at a rate of 1.50% on amounts outstanding for the letters of credit. We are also required to pay unused commitment fees for the Term Revolving Loan as defined in the Second Amended and Restated Credit Agreement.

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

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

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


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

Butamax Letter of Intent
    
In November 2011, we signed a non-binding letter of intent with Butamax Advanced Biofuels, L.L.C. ("Butamax") for the purpose of exploring the possible implementation of biobutanol technology and commercial-scale production of biobutanol at our facility. We completed Phase 1 of the project in April 2014 with the installation of a corn oil separation system at our plant. However, Phase 2 of the project, the implementation of biobutanol technology, is dependent upon completion and execution of separate definitive agreements related to biobutanol production and negotiations related to Phase 2 of the project are currently on hold.  We may never enter into those definitive agreements with Butamax and, therefore, may never convert our ethanol facility to a biobutanol facility.
    
Capital Expenditures    
We do not currently anticipate making significant capital expenditures during our 2018 fiscal year.
Critical Accounting Estimates

Management uses various estimates and assumptions in preparing our financial statements in accordance with generally accepted accounting principles.  These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Accounting estimates that are the most important to the presentation of our results of operations and financial condition, and which require the greatest use of judgment by management, are designated as our critical accounting estimates. We have the following critical accounting estimates:

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

Inventory Valuation

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

Derivatives

We are exposed to market risks from changes in interest rates, corn, natural gas, and ethanol prices. We may seek to minimize these commodity price fluctuation risks through the use of derivative instruments. In the event we utilize derivative instruments, we will attempt to link these instruments to financing plans, sales plans, market developments, and pricing activities. Such instruments in and of themselves can result in additional costs due to unexpected directional price movements.
We have entered into corn commodity-based derivatives, natural gas derivatives and ethanol derivatives in order to protect cash flows from fluctuations caused by volatility in commodity prices. In practice, as markets move, we actively attempt to manage our risk and adjust hedging strategies as appropriate. We do not use hedge accounting which could match the gain or loss on our

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hedge positions to the specific commodity contracts being hedged. Instead, we use fair value accounting for our hedge positions, which means that as the current market price of our hedge position changes, the gains and losses are immediately recognized in our statement of operation. The immediate recognition of hedging gains and losses under fair value accounting can cause net income (loss) to be volatile from quarter to quarter due to the timing of the change in value of the derivative instruments relative to the cost and use of the commodity being hedged.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.     

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

Interest Rate Risk

We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from our Term Loan and our Term Revolving Loan, each bearing a variable interest rate.  As of April 30, 2018, we had $8,250,000 outstanding on the Term Loan and $2,000,000 outstanding on the Term Revolving Loan. Interest will accrue at the greater of the 30-day LIBOR rate plus 325 basis points. The applicable interest rate on these loans at April 30, 2018 was 4.99%. If we were to experience a 10% adverse change in the applicable interest rate, the annual effect such change would have on our income statement, based on the amount we had outstanding on our Term Loan and Term Revolving Loan at April 30, 2018, would be approximately $51,000.

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

Commodity Price Risk

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

As of April 30, 2018, the fair values of our commodity-based derivative instruments are a net liability of approximately $920,000. As the prices of the hedged commodity moves in reaction to market trends and information, our statement of operations will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to protect the Company over the term of the contracts for the hedged amounts.

In the ordinary course of business, we enter into forward contracts for our commodity purchases. At April 30, 2018, we have approximately 2,625,000 bushels of forward fixed basis corn purchase contracts and 3,093,000 bushels of forward fixed price corn purchase contracts valued at approximately $10,671,000. These purchase contracts are for various delivery periods through December 2018. At April 30, 2018, we have approximately 2,123,000 MMBTUs of forward natural gas fixed price purchase contracts valued at approximately $5,164,000 for delivery periods through September 2020. In addition, at April 30, 2018, we have approximately 9,200 gallons of forward fixed price denaturant purchase contracts valued at approximately $15,000 for delivery periods through May 2018.

In the ordinary course of business, we enter into forward contracts for our commodity sales. At April 30, 2018, we have approximately 3,900 tons of forward fixed price dried distillers grains sales contracts valued at approximately $554,000 for delivery periods through June 2018. At April 30, 2018, we have approximately 6,500 tons of forward fixed price modified distillers grains sales contracts valued at approximately $377,000 for delivery periods through September 2018. In addition, at April 30, 2018,

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we have approximately 280,000 pounds of forward fixed price corn oil sales contracts valued at approximately $64,000 for delivery periods through May 2018.
At April 30, 2018, we have open futures positions for the sale of 4,100,000 bushels of corn. These derivatives have not been designated as effective hedges for accounting purposes and are forecasted to settle within the next twelve months. We recorded gains due to changes in the fair value of our outstanding corn derivative positions for the three months ended April 30, 2018 and 2017 of approximately $1,161,000 and $300,000, respectively. For the three months ended April 30, 2018, we recorded gains due to changes in the fair value of our outstanding ethanol derivative positions of approximately $61,000 and $196,000, respectively. For the three months ended April 30, 2018 and 2017, we recorded gains due to the change in fair value of our outstanding natural gas derivative positions of approximately $4,000 and $15,000, respectively.

As commodity prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to produce long-term positive growth for us.

A sensitivity analysis has been prepared to estimate our exposure to ethanol, distillers grains, corn and natural gas price risk. Market risk related to these factors is estimated as the potential change in income resulting from a hypothetical 10% adverse change in the average cost of our corn and natural gas prices and average ethanol and distillers grains prices as of April 30, 2018 net of the forward and future contracts used to hedge our market risk for corn and natural gas usage requirements. The volumes are based on our expected use and sale of these commodities for a one year period from April 30, 2018. The results of this analysis, which may differ from actual results, are approximately as follows:
 
Estimated Volume Requirements for the next 12 months (net of forward and futures contracts)
Unit of Measure
Hypothetical Adverse Change in Price as of
April 30, 2018
Approximate Adverse Change to Income
Natural Gas
1,499,390

MMBTU
10
%
 
$
445,000

Ethanol
59,500,000

Gallons
10
%
 
$
7,676,000

Corn
20,376,712

Bushels
10
%
 
$
7,234,000

DDGs
141,312

Tons
10
%
 
$
2,346,000


Item 4.  Controls and Procedures
 
Disclosure Controls and Procedures

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

Our management, including our Chief Executive Officer (the principal executive officer), Brian Kletscher, along with our Chief Financial Officer (the principal financial officer), Lucas Schneider, have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of April 30, 2018.  Based on this review and evaluation, these officers have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the forms and rules of the Securities and Exchange Commission; and to ensure that the information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the three months ended April 30, 2018, which were identified in connection with management’s evaluation required by paragraph (d) of rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors
    
The risk factors below should be read in conjunction with the risk factors previously discussed in our Form 10-K for the fiscal year ended October 31, 2017. Additional risks and uncertainties, including risks and uncertainties not presently known to us, or that we currently deem immaterial, could also have an adverse effect on our business, financial condition and/or results of operations.

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 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.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
None.
    
Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Item 6. Exhibits.

(a)
The following exhibits are filed as part of this report.

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Exhibit No.
 
Exhibit
3.1

 
31.1

 
31.2

 
32.1

 
32.2

 
101

 
The following financial information from Highwater Ethanol, LLC's Quarterly Report on Form 10-Q for the quarter ended April 30, 2018, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Balance Sheets as of April 30, 2018 and October 31, 2017, (ii) Condensed Statements of Operations for the three and six months ended April 30, 2018 and 2017, (iii) Statements of Cash Flows for the six months ended April 30, 2018 and 2017, and (iv) the Notes to Condensed Financial Statements.**
* Filed herewith.
** Furnished herewith.
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
HIGHWATER ETHANOL, LLC
 
 
 
 
Date:
June 7, 2018
 
/s/ Brian Kletscher
 
 
 
Brian Kletscher
 
 
 
Chief Executive Officer
 
 
 
(Principal Executive Officer)
 
 
 
 
Date:
June 7, 2018
 
/s/ Lucas Schneider
 
 
 
Lucas Schneider
 
 
 
Chief Financial Officer
 
 
 
(Principal Financial and Accounting Officer)
 
 
 
 


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