10-Q 1 a10-qfqe4x30x2020.htm 10-Q FQE 4-30-2020 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, 2020
 
 
 
OR
 
 
o
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
 
 
For the transition period from               to               .
 
 
 
COMMISSION FILE NUMBER 000-53588
 
HIGHWATER ETHANOL, LLC
(Exact name of registrant as specified in its charter)
 
Minnesota
 
20-4798531
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
24500 US Highway 14, Lamberton, MN 56152
(Address of principal executive offices)
 
(507) 752-6160
(Registrant's telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act: None
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
 
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes     o No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
x Yes     o No

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

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:  As of June 12, 2020 there were 4,800 membership units outstanding.

1


INDEX



2




PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

HIGHWATER ETHANOL, LLC
Condensed Balance Sheets
 ASSETS
April 30, 2020
 
October 31, 2019

(Unaudited)
 

Current Assets

 

Cash and cash equivalents
$
640,056

 
$
1,639,114

Derivative instruments
338,198

 
469,740

Accounts receivable
1,632,007

 
2,961,977

Inventories
8,632,642

 
7,367,356

Prepaids and other
233,703

 
166,243

Total current assets
11,476,606

 
12,604,430



 

Property and Equipment

 

Land and land improvements
12,836,332

 
12,836,332

Buildings
38,818,532

 
38,818,532

Office equipment
1,151,330

 
1,151,330

Plant and process equipment
78,744,660

 
78,050,785

Vehicles
123,779

 
123,779

Construction in progress
246,067

 
278,333


131,920,700

 
131,259,091

Less accumulated depreciation
(77,305,062
)
 
(72,784,587
)
Net property and equipment
54,615,638

 
58,474,504



 

Other Assets

 

Investments
3,084,692

 
2,752,266

  Right of use asset - operating leases
626,095

 

  Right of use asset - finance leases
1,304,292

 

Deposits
409,283

 
191,457

Total other assets
5,424,362

 
2,943,723



 

Total Assets
$
71,516,606

 
$
74,022,657


3




LIABILITIES AND MEMBERS' EQUITY
April 30, 2020
 
October 31, 2019

(Unaudited)
 

Current Liabilities

 

Accounts payable
$
3,833,528

 
$
6,908,305

Accrued expenses
1,134,366

 
1,156,038

Current maturities of long-term debt
1,987,540

 
2,729,739

  Current portion of operating lease liability
137,476

 

  Current portion of finance lease liability
108,879

 

Total Current Liabilities
7,201,789

 
10,794,082

 
 
 
 
 
 
 
 
Long-Term Liabilities
 
 
 
  Term Debt
13,211,200

 
7,244,124

  Operating lease liability
488,619

 

  Finance lease liability
1,211,820

 

Total Long-Term Liabilities
14,911,639

 
7,244,124

 
 
 
 
Commitments and Contingencies

 

 
 
 
 
Members' Equity

 

Members' equity, 4,805 and 4,807 units outstanding
49,403,178

 
55,984,451

 
 
 
 
Total Liabilities and Members’ Equity
$
71,516,606

 
$
74,022,657


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

4


HIGHWATER ETHANOL, LLC
Condensed Unaudited Statements of Operations


Three Months Ended
 
Six Months Ended

April 30, 2020
 
April 30, 2019
 
April 30, 2020
 
April 30, 2019


 

 
 
 
 
Revenues
$
20,257,229

 
$
22,939,711

 
$
47,441,253

 
$
45,628,121



 

 
 
 
 
Cost of Goods Sold
23,074,815

 
24,556,335

 
$
51,734,163

 
$
49,043,632



 

 
 
 
 
Gross Loss
(2,817,586
)
 
(1,616,624
)
 
$
(4,292,910
)
 
$
(3,415,511
)


 

 
 
 
 
Operating Expenses
1,065,807

 
811,557

 
$
2,086,328

 
$
1,572,888



 

 
 
 
 
Operating Loss
(3,883,393
)
 
(2,428,181
)
 
$
(6,379,238
)
 
$
(4,988,399
)


 

 
 
 
 
Other Income (Expense)

 

 
 
 
 
Interest income
825

 
2,539

 
$
3,237

 
$
3,281

Other income
85,607

 
46,019

 
$
101,143

 
$
52,917

Interest expense
(197,535
)
 
(213,570
)
 
$
(358,778
)
 
$
(416,164
)
Income from equity method investments
42,906

 
13,692

 
$
65,363

 
$
49,152

Total other income (expense), net
(68,197
)
 
(151,320
)
 
$
(189,035
)
 
$
(310,814
)

 
 
 
 
 
 
 
Net Loss
$
(3,951,590
)
 
$
(2,579,501
)
 
$
(6,568,273
)
 
$
(5,299,213
)
 
 
 
 
 
 
 
 
Weighted Average Units Outstanding
4,806

 
4,810

 
4,807

 
4,811

Net Loss Per Unit, Basic and Diluted
$
(822.22
)
 
$
(536.28
)
 
(1,366.40
)
 
$
(1,101.48
)
Distributions Per Unit
$

 
$

 
$

 
$


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

5


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

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

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

 
 
Net loss for the three-month period ended April 30, 2019
(2,579,501
)
 
 
Member unit repurchase, 4 units
(32,000
)
 
 
Balance - April 30, 2019
$
58,966,674


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

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

 
 
Net loss for the three-month period ended April 30, 2020
(3,951,590
)
 
 
Member unit repurchase, 2 units
(13,000
)
 
 
Balance - April 30, 2020
$
49,403,178


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

6


HIGHWATER ETHANOL, LLC
Condensed Unaudited Statements of Cash Flows

Six Months Ended

April 30, 2020
 
April 30, 2019
Cash Flows from Operating Activities

 

Net Loss
$
(6,568,273
)
 
$
(5,299,213
)
Adjustments to reconcile net loss to net cash used in operating activities
 
 
 
Depreciation and amortization
4,601,799

 
4,443,543

Distributions in excess of earnings from equity method investments
78,683

 
270,532

Non-cash patronage income
(411,111
)
 
(224,464
)
Changes in assets and liabilities

 

Accounts receivable
1,329,970

 
(1,237,882
)
Inventories
(1,265,286
)
 
783,469

Derivative instruments
131,543

 
429,082

Prepaids and other
(285,286
)
 
(128,033
)
Accounts payable
(3,080,046
)
 
(609,930
)
Accrued expenses
(21,672
)
 
752,336

Net cash used in operating activities
(5,489,679
)
 
(820,560
)


 

Cash Flows from Investing Activities

 

Capital expenditures
(656,339
)
 
(810,754
)
   Net cash used in investing activities
(656,339
)
 
(810,754
)


 

Cash Flows from Financing Activities

 

Payments on long-term debt
(4,500,000
)
 
(1,500,000
)
Proceeds from long-term debt
9,712,200

 
4,000,000

Member unit repurchase
(13,000
)
 
(32,000
)
Payment on finance lease liability
(52,240
)
 

Net cash provided by financing activities
5,146,960

 
2,468,000



 

Net (Decrease) Increase in Cash and Cash Equivalents
(999,058
)
 
836,686



 

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

 
430,702



 

Cash and Cash equivalents – End of Period
$
640,056

 
$
1,267,388

 
 
 
 
Supplemental Cash Flow Information

 

Cash paid for interest
$
298,090

 
$
356,260



 

Supplemental Disclosure of Noncash Financing and Investing Activities

 

Capital expenditures included in accounts payable
$
18,485

 
$
27,559

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

 
$


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

7

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2020


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations.  The accompanying balance sheet and related notes as of October 31, 2019 are derived from the audited financial statements as of that date. These condensed financial statements and related notes should be read in conjunction with the financial statements and notes thereto included in the Company’s audited financial statements for the year ended October 31, 2019, contained in the Company’s Form 10-K.
 
In the opinion of management, the interim condensed financial statements reflect all adjustments, consisting of only normal recurring adjustments, considered necessary for fair presentation of the Company's financial position as of April 30, 2020 and the results of operations and cash flows for all periods presented.

Nature of Business

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

Accounting Estimates

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

Revenue Recognition

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

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

8

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2020


Disaggregation of revenue:

All revenue recognized in the income statement is considered to be revenue from contracts with customers. The following table depicts the disaggregation of revenue according to product line for the three and six months ended April 30, 2020 and 2019:
 
Three Months Ended April 30, 2020
 
Three Months Ended April 30, 2019
 
Six Months Ended April 30, 2020
 
Six Months Ended April 30, 2019
Revenue Sources
Amount (Unaudited)
 
Amount (Unaudited)
 
Amount
(Unaudited)
 
Amount
(Unaudited)
 
 
 
 
 
 
 
 
Ethanol Sales
$
14,780,030

 
$
17,333,479

 
$
36,136,005

 
$
34,282,684

Modified Distillers Grains Sales
1,161,460

 
953,103

 
2,454,805

 
2,110,556

Dried Distillers Grains Sales
3,526,267

 
4,000,185

 
7,209,629

 
7,850,551

Corn Oil Sales
789,472

 
652,944

 
1,640,814

 
1,384,330

Total Revenues
$
20,257,229

 
$
22,939,711

 
$
47,441,253

 
$
45,628,121


Contract assets and contract liabilities:

The Company has short term contract liabilities from contracts with customers of $6,230 at April 30, 2020 and $4,947 at October 31, 2019.

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

Shipping Costs

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

Operating Segment

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

Derivative Instruments

Derivatives are recognized in the balance sheets and the measurement of these instruments are at fair value. In order for a derivative to qualify as a hedge, specific criteria must be met and appropriate documentation maintained. Gains and losses from derivatives that do not qualify as hedges, or are undesignated, must be recognized immediately in earnings. If the derivative does qualify as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will be either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings.

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

9

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2020


purchases or sales are documented as normal and exempted from accounting as derivatives, therefore, are not marked to market in our financial statements.

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

Carrying Value of 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. If circumstances require a long-lived asset group be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset group to the carrying value of the asset group. If the carrying value of the long-lived asset group 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 discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.

In accordance with the Company’s policy for evaluating impairment of long-lived assets described above, when a triggering event occurs management evaluates the recoverability of the facilities based on projected future cash flows from operations over the facilities’ estimated useful lives. In determining the projected future undiscounted cash flows, the Company makes significant assumptions concerning the future viability of the ethanol industry, the future price of corn in relation to the future price of ethanol and the overall demand in relation to production and supply capacity. The Company has not recorded any impairment as of April 30, 2020 and 2019.

Fair Value of Financial Instruments

The carrying value of accounts receivable, accounts payable, and other financial instrument working capital items approximate fair value at April 30, 2020 due to the short maturity nature of these instruments (Level 2).

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

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

Investments

The Company has a 5.55% investment interest in an unlisted company, Renewable Products Marketing Group, LLC (RPMG), who markets the Company’s ethanol. The Company also has a 7% ownership interest in Lawrenceville Tank, LLC (LT), which owns and operates a trans load/tank facility near Atlanta, Georgia. These investments are flow-through entities and are being accounted for by the equity method of accounting under which the Company’s share of net income is recognized as income in the Company’s statements of operations and added to the investment account. Distributions or dividends received from the investment are treated as a reduction of the investment account. The Company consistently follows the practice of recognizing the net income from equity method investments based on the most recent reliable data. Therefore, the net income which is reported in the Company's statement of operations for the period ended April 30, 2020 is based on the investee’s results of operations for the period ended March 31, 2020.

Recently Issued or Adopted Accounting Pronouncements

Accounting for Leases (Adopted):

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU requires lessees to recognize a lease liability and a right of use asset for all leases with a lease term greater than twelve months on its balance sheet. Leases are classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The Company

10

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2020


has elected the practical expedient to not record a right of use asset or lease liability for leases with a term of 12 months or less. See Note 7 for further information.

2. UNCERTAINTIES

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

The ethanol industry experienced adverse conditions throughout most of 2018 and 2019 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels. These adverse conditions continued into 2020 and were compounded by the COVID-19 pandemic. As a result, the Company has experienced negative operating margins, lower cash flow from operations and net operating losses. In response, the Company has reduced its ethanol production levels by up to 25%.  The Company continues to monitor COVID-19 developments and the effect on demand for its products in order to make adjustments to production levels as warranted.

3. INVENTORIES

Inventories consisted of the following at:
 
 
April 30, 2020
 
October 31, 2019
 
 
 
 
 
Raw materials
 
$
2,964,116

 
$
2,801,255

Spare parts and supplies
 
3,835,817

 
3,384,360

Work in process
 
879,922

 
743,850

Finished goods
 
952,787

 
437,891

 Total
 
$
8,632,642

 
$
7,367,356


The Company recorded a lower of cost or net realizable value write-down on corn inventory of approximately $230,000 and ethanol inventory of approximately $31,000 at April 30, 2020. The Company recorded a lower of cost or net realizable value write-down on distillers grains inventory of approximately $21,000 at October 31, 2019.

4. DERIVATIVE INSTRUMENTS

As of April 30, 2020, the Company had entered into corn and ethanol derivative instruments, which are required to be recorded as either assets or liabilities at fair value in the balance sheet. The Company uses these instruments to manage risks from changes in market rates and prices. Derivatives qualify for treatment as hedges when there is a high correlation between the change in fair value of the derivative instrument and the related change in value of the underlying hedged item. The Company may designate the hedging instruments based upon the exposure being hedged as a fair value hedge or a cash flow hedge. The derivative instruments outstanding at April 30, 2020 are not designated as hedges for accounting purposes.


11

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2020


Commodity Contracts

Management expects all open futures positions outstanding as of April 30, 2020 to be realized within the next twelve months.

The following tables provide details regarding the Company's derivative instruments at April 30, 2020 and October 31, 2019:
          Instrument
Balance Sheet location
 
April 30, 2020
October 31, 2019
 
 
 
 
 
Corn, natural gas and ethanol contracts
 
 




In gain position
 
 
$
9,188

$
124,069

In loss position
 
 
(431,622
)
(775,887
)
Deposits with broker
 
 
760,632

1,121,558

 
Current assets
 
$
338,198

$
469,740


The following tables provide details regarding the gains (losses) from the Company's derivative instruments in the statements of operations, none of which are designated as hedging instruments:
 
 
Statement of
 
Three Months Ended April 30,
 
 
Operations location
 
2020
2019
Ethanol contracts
 
Revenues
 
(13,350
)
$
40,738

Corn contracts
 
Cost of goods sold
 
(462,728
)
(767,484
)
Natural gas contracts
 
Cost of goods sold
 
4,919



 
 
Statement of
 
Six Months Ended April 30,
 
 
Operations location
 
2020
2019
Ethanol contracts
 
Revenues
 
$
47,921

$
(95,059
)
Corn contracts
 
Cost of goods sold
 
(424,373
)
(92,119
)
Natural gas contracts
 
Cost of goods sold
 
11,240

19,806


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, 2020
 
Level 1
 
Level 2
 
Level 3
Derivative instruments - commodities
 


 


 


 


     In gain position
 
$
9,188

 
$
9,188

 
$

 
$

     In loss position
 
(431,622
)
 
(12,450
)
 
(419,172
)
 


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


 


 


 


     In gain position
 
$
124,069

 
$
4,538

 
$
119,531

 
$

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


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


12

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2020


6. DEBT FINANCING

Long-term debt consists of the following at:
 
April 30, 2020
 
October 31, 2019
Term Loan
$
2,000,000

 
$
3,500,000

 
 
 
 
Term Revolving Loan
12,499,000

 
6,499,000

 
 
 
 
PPP Loan
712,200

 

 
 
 
 
Total
15,211,200

 
9,999,000

 
 
 
 
Less Debt Issuance Costs
(12,460
)
 
(25,137
)
 
 
 
 
Less amounts due within one year
(1,987,540
)
 
(2,729,739
)
 
 
 
 
Net long-term debt
$
13,211,200

 
$
7,244,124


Bank Financing

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

The Term Loan had an original balance of $15,000,000 with a variable interest rate based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at April 30, 2020 was 3.97%. Monthly principal payments are due on the Term Loan of approximately $250,000 plus accrued interest. Payments of all amounts outstanding are due on January 22, 2021. The outstanding balance on this note was $2,000,000 at April 30, 2020. 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 is for $20,000,000 with a variable interest rate based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at April 30, 2020 was 3.97%. The Term Revolving Loan may be advanced, repaid and re-borrowed during the term. Monthly interest payments are due on the Term Revolving Loan. Payment of all amounts outstanding are due on January 22, 2023. The outstanding balance on this note was $12,499,000 at April 30, 2020. The Company pays interest at a rate of 1.50% on amounts outstanding for letters of credit which also reduce the amount available under the Term Revolving Loan. The Company has no letters of credit outstanding at April 30, 2020. The Company is also required to pay unused commitment fees for the Term Revolving Loan as defined in the Second Amended and Restated Credit Agreement.


13

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2020


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

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

In March 2020, Congress passed a stimulus bill called the CARES Act to provide economic relief related to the COVID-19 pandemic. One of the programs established by the Cares Act is the Paycheck Protection Program ("PPP"), authorizing loans to small business for use in paying employees that continue to work throughout the COVID-19 pandemic and for rent, utilities and interest on mortgages. Loans obtained through the PPP are administered by the Small Business Administration and eligible to be forgiven as long as the proceeds are used for qualifying purposes and other conditions are met. On April 14, 2020, the Company was awarded a PPP loan in the amount of $712,200. The entire loan is expected to be used to pay employees and for other qualifying costs and be substantially forgiven.  To the extent it is not forgiven, the Company would be required to repay that portion at an interest rate of 1% over twelve months beginning on May 1, 2021.

The estimated maturities of the long-term debt at April 30, 2020 are as follows:
 
Principal
 
Debt Issuance Costs
 
Total
April 2021
2,000,000

 
(12,460
)
 
1,987,540

April 2022
356,100

 

 
356,100

April 2023
12,855,100

 

 
12,855,100

     Long-term debt
$
15,211,200

 
$
(12,460
)
 
$
15,198,740


7.  LEASES

Adoption of ASC 842

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

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

The Company has a contract for use of a natural gas pipeline which transports natural gas from the Northern Natural Gas pipeline to the Company’s facility. This natural gas line has no alternate use and is specifically for the benefit of the Company. The contract

14

HIGHWATER ETHANOL, LLC
Notes to Condensed Unaudited Financial Statements
April 30, 2020


has minimum volume requirements as well as a fixed monthly fee. This contract meets the definition of a lease and is classified as a finance lease. Right of use assets and lease liabilities are recognized at commencement date based on the present value of lease payments over the lease term.
 
The discount rate used in determining the lease liability for each individual lease is the Company's estimated incremental borrowing rate. An incremental borrowing rate of 5.50% was utilized for each of the Company's leases.
 The Company determines if an arrangement is a lease or contains a lease at inception. The Company’s operating and finance leases have remaining lease terms of approximately 5 years and 10 years, respectively. These leases include options to extend the lease when it is reasonably certain the Company will exercise those options. The Company does not have lease arrangements with residual value guarantees, sale leaseback terms or material restrictive covenants.

The following table summarizes the remaining maturities of the Company’s operating and finance lease liabilities as of April 30, 2020:
For the Period Ending April 30,
 
Operating Leases
 
Finance Leases
2021
 
$
168,480

 
$
178,800

2022
 
168,480

 
178,800

2023
 
168,480

 
178,800

2024
 
168,480

 
178,800

2025
 
28,080

 
178,800

Thereafter
 

 
804,600

Totals
 
702,000

 
1,698,600

Amount representing interest
 
(75,905
)
 
(377,901
)
Lease liability
 
$
626,095

 
$
1,320,699


Lease Cost
 
Three Months ended April 30, 2020
Six Months ended
April 30, 2020
 
 
 
 
Operating lease cost
 
$
42,120

$
84,240

Finance lease cost
 
 
 
Amortization of leased assets
 
34,323

68,646

Interest on lease liabilities
 
18,401

37,160

 
 
 
 
Net lease cost
 
$
94,844

$
190,046


8. COMMITMENTS AND CONTINGENCIES

Marketing Agreements

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

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

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

Regulatory Agencies

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

Forward Contracts

In the ordinary course of business, we enter into forward contracts for our commodity purchases and sales. The Company recorded a lower of cost or net realizable value write-down on the forward fixed price contracts of approximately $12,000 at April 30, 2020. Forward contracts are as follows at April 30, 2020:


 
Quantity
Average Price
Delivery Date
 
 
 
 
Purchase of corn (in bushels):
 
 
 
    Basis Contracts
1,862,452

 
By 3/31/21
    Priced Contracts
1,037,875

$
3.35

By 7/31/21
        Total
2,900,327

 
 
 
 
 
 
Purchase of natural gas (in dekatherms):
 
 
 
    Index contracts

 
 
    Priced contracts
2,771,000

$
2.45

By 3/31/23
        Total
2,771,000

 
 
 
 
 
 
Purchase of denaturant (in gallons):
 
 
 
    Index contracts

 
 
    Priced contracts
956,800

$
1.25

By 12/31/20
        Total
956,800

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

 
 
    Priced contracts
4,382

$
161.53

By 6/30/20
        Total
4,382

 
 
 
 
 
 
Sales of modified distillers grains (in tons)
 
 
 
    Index contracts

 
 
    Priced contracts
8,200

$
74.71

By 8/31/20
        Total
8,200

 
 
 
 
 
 
Sales of corn oil (in pounds)
 
 
 
    Index contracts

 
 
    Priced contracts
745,296

$
0.28

By 9/30/20
        Total
745,296

 
 


15


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, 2020, 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, 2019.

Forward-Looking Statements

This report contains forward-looking statements that involve future events, our future performance and our expected future operations and actions.  In some cases you can identify forward-looking statements by the use of words such as “will,” “may,” “should,” “anticipate,” “believe,” “expect,” “plan,” “future,” “intend,” “could,” “estimate,” “predict,” “hope,” “potential,” “continue,” or the negative of these terms or other similar expressions. These forward-looking statements are only our predictions and involve numerous assumptions, risks and uncertainties. Many factors could cause actual results to differ materially from those projected in forward-looking statements. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include, but are not limited to:
Ÿ
Changes in the availability and price of corn and natural gas;
Ÿ
Reduction or elimination of the Renewable Fuel Standard;
Ÿ
Volatile commodity and financial markets;
Ÿ
Changes in legislation benefiting renewable fuels;
Ÿ
Our ability to comply with the financial covenants contained in our credit agreements with our lenders;
Ÿ
Our ability to profitably operate the ethanol plant and maintain a positive spread between the selling price of our products and our raw material costs;
Ÿ
Results of our hedging activities and other risk management strategies;
Ÿ
Ethanol and distillers grains supply exceeding demand and corresponding price reductions;
Ÿ
Our ability to generate cash flow to invest in our business and service our debt;
Ÿ
Changes in the environmental regulations that apply to our plant operations and changes in our ability to comply with such regulations;
Ÿ
Changes in our business strategy, capital improvements or development plans;
Ÿ
Changes in plant production capacity or technical difficulties in operating the plant;
Ÿ
Changes in general economic conditions or the occurrence of certain events causing an economic impact in the agriculture, oil or automobile industries;
Ÿ
Lack of transportation, storage and blending infrastructure preventing ethanol from reaching high demand markets;
Ÿ
Changes in federal and/or state laws or policies impacting the ethanol industry;
Ÿ
Changes and advances in ethanol production technology and the development of alternative fuels and energy sources and advanced biofuels;
Ÿ
Competition from alternative fuel additives;
Ÿ
Changes in interest rates and lending conditions;
Ÿ
Decreases in the price we receive for our ethanol and distillers grains;
Ÿ
Our inability to secure credit or obtain additional equity financing we may require in the future;
Ÿ
Our ability to retain key employees and maintain labor relations;
Ÿ
Changes in the price of oil and gasoline;
Ÿ
Competition from clean power systems using fuel cells, plug-in hybrids and electric cars;
Ÿ
International trade disputes and the imposition of tariffs by foreign governments on our products;
Ÿ
Use by the EPA of small refinery exemptions; and
Ÿ
A slowdown in global and regional economic activity, reduced demand for our products and the potential for labor shortages and shipping disruptions resulting from the COVID-19 pandemic.


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

16


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 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 an ethanol plant near Lamberton, Minnesota. Since August 2009, we have been engaged in the production of ethanol and distillers grains at the plant.

The ethanol industry experienced industry-wide record low ethanol prices throughout most of 2018 and 2019 due to reduced demand and high industry inventory levels. This continued into 2020 and the situation was compounded by the impact of the COVID-19 pandemic. In response to unfavorable operating conditions, we have reduced our ethanol production levels by up to 25%. We continue to monitor the impact of COVID-19 in order to make adjustments to production levels as needed. The plant was operating at an average ethanol production rate of approximately 67 million gallons annually prior to making the decision to curtail production. 

We received a loan in the amount of $712,200 through the Payroll Protection Program which offers loans to small businesses impacted by the COVID-19 pandemic. These loans are forgiven to the extent proceeds are spent on certain qualifying costs and other conditions are met. Management anticipates that the loan will be substantially forgiven. To the extent it is not forgiven, we would be required to repay that portion at an interest rate of 1% over twelve months beginning on May 1, 2020.

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, 2020 and 2019
 
The following table shows the results of our operations and the approximate percentage of revenues, cost of goods sold, operating expenses and other items to total revenues in our unaudited statements of operations for the three months ended April 30, 2020 and 2019:
 
2020
 
2019
Statements of Operations Data
Amount
(unaudited)
 
%
 
Amount
(unaudited)
 
%
 
 
 
 
 
 
 
 
Revenues
$
20,257,229

 
100.00
 %
 
$
22,939,711

 
100.00
 %
Cost of Goods Sold
23,074,815

 
113.91
 %
 
24,556,335

 
107.05
 %
Gross Loss
(2,817,586
)
 
(13.91
)%
 
(1,616,624
)
 
(7.05
)%
Operating Expenses
1,065,807

 
5.26
 %
 
811,557

 
3.54
 %
Operating Loss
(3,883,393
)
 
(19.17
)%
 
(2,428,181
)
 
(10.59
)%
Other Income (Expense), net
(68,197
)
 
(0.34
)%
 
(151,320
)
 
(0.66
)%
Net Loss
$
(3,951,590
)
 
(19.51
)%
 
$
(2,579,501
)
 
(11.24
)%

The following table shows the sources of our revenue for the three months ended April 30, 2020 and 2019:

17


 
2020
 
 
 
2019
 
 
Revenue Sources
Amount
(Unaudited)
 
%
 
Amount
(Unaudited)
 
%
 
 
 
 
 
 
 
 
Ethanol Sales
$
14,780,030

 
72.96
%
 
$
17,333,479

 
75.56
%
Modified Distillers Grains Sales
1,161,460

 
5.73
%
 
953,103

 
4.15
%
Dried Distillers Grains Sales
3,526,267

 
17.41
%
 
4,000,185

 
17.44
%
Corn Oil Sales
789,472

 
3.90
%
 
652,944

 
2.85
%
Total Revenues
$
20,257,229

 
100.00
%
 
$
22,939,711

 
100.00
%

Revenue

Ethanol
Our ethanol revenues were lower for the three months ended April 30, 2020, as compared to the three months ended April 30, 2019. Revenue from ethanol sales decreased by approximately 14.7% during the three months ended April 30, 2020, as compared to the three months ended April 30, 2019, due primarily to decreases in the average price per gallon of ethanol and number of gallons of ethanol sold. The average price per gallon of ethanol sold for the three months ended April 30, 2020 was approximately 11.6% lower than the average price we received for the three months ended April 30, 2019. Ethanol prices have been negatively affected for an extended period by lower domestic demand resulting in part from the use by the Environmental Protection Agency ("EPA") of the small refinery exemption and a decline in ethanol exports due to trade disputes with foreign governments and the institution of a tariff by China on ethanol produced in the United States. Ethanol prices further decreased due to a collapse in both domestic and foreign demand as a result of restrictions put in place in response to the COVID-19 pandemic. Some plants have reduced ethanol production levels in response to unfavorable operating conditions which had positive impact on ethanol prices towards the end of the period.
Ethanol prices will likely remain low until current restrictions in response to the COVID-19 pandemic are released and fuel demand returns. It is uncertain when this may occur. If crude oil and gasoline prices remain low, that could have a significant negative impact on the market price of ethanol and our profitability. However, a decrease in ethanol production resulting from some ethanol plants reducing or shutting down production could have a positive impact on ethanol prices. Trade agreements between the United States and China and other foreign governments could also lead to an increase in ethanol export demand and higher ethanol prices. Other factors likely to affect ethanol prices in the coming fiscal year include the EPA's use of the the small refinery exemption, approval of the year-round sale of E15 and changes in domestic corn prices.
The number of gallons of ethanol sold decreased by approximately 3.2% during the three months ended April 30, 2020, as compared to the three months ended April 30, 2019 resulting primarily from decreased ethanol production rates for the period. We have reduced our ethanol production levels by up to 25%.

We had losses related to ethanol based derivative instruments of $13,350 for the three months ended April 30, 2020. We had gains related to ethanol based derivative instruments of $40,738 for the three months ended April 30, 2019.

Distillers Grains

Revenue from distillers grains sales decreased by approximately 5.1% during the three months ended April 30, 2020, as compared to the three months ended April 30, 2019. The tons of dried distillers grains sold during the three months ended April 30, 2020, decreased by approximately 21.3% as compared to the three months ended April 30, 2019. However, the tons of modified distillers grains sold during the three months ended April 30, 2020, increased by approximately 9.5% as compared to the three months ended April 30, 2019. The overall tons of distillers grains produced decreased due primarily to lower ethanol production levels and higher corn oil production levels for the period which resulted in decreased distillers grains production.

For the three months ended April 30, 2020, the average price per ton of dried distillers grains sold was approximately 12.0% higher than the average price we received during the three months ended April 30, 2019, due to a decrease in supply resulting from some ethanol plants reducing or shutting down production. For the three months ended April 30, 2020, the average price per ton of modified distillers grains sold was approximately 11.3% higher than during the three months ended April 30, 2019, due to increased demand and reduced production in our local area.


18


Management anticipates that both domestic and foreign demand for distillers grains may be negatively affected by the COVID-19 pandemic. However, a decrease in production could continue to have a positive impact on prices. Other factors likely to affect distillers grains prices include domestic corn prices and availability of corn, the imposition by China of anti-dumping and anti-subsidy duties on distillers grains produced in the U.S. and other trade actions by the United States and foreign governments.

Corn Oil

Revenue from corn oil sales increased by approximately 20.9% during the three months ended April 30, 2020, as compared to the three months ended April 30, 2019. This is primarily the result of increases in the average price per pound of corn oil sold and the amount of corn oil sold during the three months ended April 30, 2020. The pounds of corn oil sold during the three months ended April 30, 2020, increased by approximately 13.5% as compared to the the three months ended April 30, 2019. The amount of corn oil sold increased due to improved efficiencies.

The average price per pound of corn oil sold increased during the three months ended April 30, 2020, as compared to the three months ended April 30, 2019. For the three months ended April 30, 2020, the average price per pound of corn oil we received was approximately 8.3% higher than the three months ended April 30, 2019, due to a decrease in corn oil supply resulting from some ethanol plants reducing or shutting down ethanol production in response to poor economic conditions. In addition, corn oil prices were positively affected by the renewal of the biodiesel blenders' tax credit in December 2019 which is expected to increase demand.

Cost of Goods Sold

Our two largest costs of production are corn (68.9% of cost of goods sold for the three months ended April 30, 2020) and natural gas (6.1% of cost of goods sold for the three months ended April 30, 2020). Our total cost of goods sold was approximately 6.3% less during the three months ended April 30, 2020, as compared to the three months ended April 30, 2019, due to decreased bushels of corn ground.

Corn

Our average price per bushel of corn for the three months ended April 30, 2020 increased by approximately 0.9% per bushel, as compared to the three months ended April 30, 2019, due to a smaller corn crop in places near our local area which has led to a higher market value for corn as end users from those areas encroach on our local market. However, corn prices declined towards the end of the period due to decreased demand related to the COVID-19 pandemic.

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

We used approximately 8.8% less bushels of corn in the three months ended April 30, 2020, as compared to the three months ended April 30, 2019, due to improved efficiencies combined with a decrease in ethanol production for the period.

At April 30, 2020, we have 1,862,452 bushels of forward fixed basis corn purchase contracts and 1,037,875 bushels of forward fixed price corn contracts valued at approximately $3,474,000 for various delivery periods through July 2021. We had losses related to corn derivative instruments of $462,728 and $767,484 for the three months ended April 30, 2020 and 2019, respectively.

Natural Gas

Our average price per MMBTU of natural gas was approximately 17.2% higher for the three months ended April 30, 2020, as compared to the three months ended April 30, 2019. Natural gas prices were higher due to new interim tariff rates levied by Northern Natural Gas effective January 1, 2020. Management anticipates that natural gas prices will continue at current levels unless the natural gas industry experiences production problems or if there are large increases in natural gas demand.

For the three months ended April 30, 2020, we purchased approximately 11.5% less natural gas as compared to the three months ended April 30, 2019. This decrease in natural gas usage is primarily due to a decrease in dried distillers grains production.

At April 30, 2020, we have 2,771,000 MMBTUs of forward natural gas sales contracts valued at approximately $6,781,000 for various delivery periods through March 2023. We had gains related to natural gas derivative instruments of $4,919 and $0 for the three months ended April 30, 2020 and 2019, respectively.

19


Operating Expense

We had operating expenses for the three months ended April 30, 2020 of $1,065,807, as compared to operating expenses of $811,557 for the three months ended April 30, 2019. Management attributes this increase in operating expenses primarily to an increase in consulting fees and insurance costs for the three months ended April 30, 2020, as compared to the three months ended April 30, 2019. Management continues to pursue strategies to optimize efficiencies and maximize production. These efforts may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses do not vary with the level of production at the plant, we expect our operating expenses to remain relatively steady.

Operating Loss

We had a loss from operations for the three months ended April 30, 2020 of $3,883,393, which is approximately (19.17%) of our revenues, compared to a loss of $2,428,181, which was approximately (10.59)% of our revenues, for the three months ended April 30, 2019. This increase in operating loss is primarily due to a decrease in the price received for our ethanol relative to the price we paid for corn.

Other Expense

We had total other expense for the three months ended April 30, 2020 of $68,197, as compared to total other expense of $151,320 for the three months ended April 30, 2019. Our other expense for the three months ended April 30, 2020, consisted primarily of interest expense offset by income from investments. This decrease in other expense is primarily due to an increase in income from investments partially offset by an increase in interest expense.

Results of Operations for the Six Months Ended April 30, 2020 and 2019
 
The following table shows the results of our operations and the approximate percentage of revenues, cost of goods sold, operating expenses and other items to total revenues in our unaudited statements of operations for the six months ended April 30, 2020 and 2019:
 
2020
 
2019
Statements of Operations Data
Amount
(unaudited)
 
%
 
Amount
(unaudited)
 
%
 
 
 
 
 
 
 
 
Revenues
$
47,441,253

 
100.00
 %
 
$
45,628,121

 
100.00
 %
Cost of Goods Sold
$
51,734,163

 
109.05
 %
 
$
49,043,632

 
107.49
 %
Gross Loss
$
(4,292,910
)
 
(9.05
)%
 
$
(3,415,511
)
 
(7.49
)%
Operating Expenses
$
2,086,328

 
4.40
 %
 
$
1,572,888

 
3.45
 %
Operating Loss
$
(6,379,238
)
 
(13.45
)%
 
$
(4,988,399
)
 
(10.93
)%
Other Income (Expense), net
$
(189,035
)
 
(0.40
)%
 
$
(310,814
)
 
(0.68
)%
Net Loss
$
(6,568,273
)
 
(13.85
)%
 
$
(5,299,213
)
 
(11.61
)%

The following table shows the sources of our revenue for the six months ended April 30, 2020 and 2019:
 
2020
 
 
 
2019
 
 
Revenue Sources
Amount
(Unaudited)
 
%
 
Amount
(Unaudited)
 
%
 
 
 
 
 
 
 
 
Ethanol Sales
$
36,136,005

 
76.17
%
 
$
34,282,684

 
75.13
%
Modified Distillers Grains Sales
2,454,805

 
5.17
%
 
2,110,556

 
4.63
%
Dried Distillers Grains Sales
7,209,629

 
15.20
%
 
7,850,551

 
17.21
%
Corn Oil Sales
1,640,814

 
3.46
%
 
1,384,330

 
3.03
%
Total Revenues
$
47,441,253

 
100.00
%
 
$
45,628,121

 
100.00
%


20


Revenue

Ethanol

Our ethanol revenues were greater for the six months ended April 30, 2020, as compared to the six months ended April 30, 2019. Revenue from ethanol sales increased by approximately 5.4% during the six months ended April 30, 2020, as compared to the six months ended April 30, 2019, due primarily to an increase in the average price per gallon of ethanol and number of gallons of ethanol sold. The average price per gallon of ethanol sold for the six months ended April 30, 2020 was approximately 1.72% higher than the average price we received for the six months ended April 30, 2019. The average price we received for the six months ended April 30, 2020 was higher when compare to the same period in 2019 primarily due to some plants reducing ethanol production levels in response to unfavorable operating conditions. Overall, ethanol prices have been negatively affected for an extended period by lower domestic demand resulting in part from the EPA's use of the small refinery exemption and a decline in ethanol exports due to trade disputes with foreign governments and the institution of a tariff by China on ethanol produced in the United States. Ethanol prices further decreased due to a collapse in both domestic and foreign demand as a result of restrictions put in place in response to the COVID-19 pandemic.     
Ethanol prices will likely remain low until current restrictions in response to the COVID-19 pandemic are released and fuel demand returns. It is uncertain when this may occur. If crude oil and gasoline prices remain low, that could have a significant negative impact on the market price of ethanol and our profitability. However, a decrease in ethanol production resulting from some ethanol plants reducing or shutting down production could have a positive impact on ethanol prices. Trade agreements between the United States and China and other foreign governments could also lead to an increase in ethanol export demand and higher ethanol prices. Other factors likely to affect ethanol prices in the coming fiscal year include the EPA's use of the the small refinery exemption, approval of the year-round sale of E15 and changes in domestic corn prices.
The number of gallons of ethanol sold increased by approximately 3.2% during the six months ended April 30, 2020, as compared to the six months ended April 30, 2019 due to our receipt of our updated air permit in October 2019 which allows us to increase ethanol gallons produced. However, this increase in our ethanol production rate for the period was partially offset by our reduction of ethanol production levels by up to 25% in March and April due to unfavorable operating conditions in the ethanol industry and the COVID-19 pandemic.

We had gains related to ethanol based derivative instruments of $47,921 for the six months ended April 30, 2020. We had losses related to ethanol based derivative instruments of $95,059 for the six months ended April 30, 2019.

Distillers Grains

Revenue from distillers grains sales decreased by approximately 3.0% during the six months ended April 30, 2020, as compared to the six months ended April 30, 2019. The tons of dried distillers grains sold decreased by approximately 10.50% during the six months ended April 30, 2020, as compared to the six months ended April 30, 2019. However, the tons of modified distillers grains sold during the six months ended April 30, 2020, increased by approximately 6.37% as compared to the six months ended April 30, 2019. The overall tons of distillers grains produced decreased due primarily to higher corn oil production levels for the period which resulted in decreased distillers grains production.

For the six months ended April 30, 2020, the average price per ton of dried distillers grains sold was approximately 2.62% higher than the average price we received during the six months ended April 30, 2019, due to a decrease in supply resulting from some ethanol plants reducing or shutting down production. For the six months ended April 30, 2020, the average price per ton of modified distillers grains sold was approximately 9.34% higher than during the six months ended April 30, 2019, due to increased demand and reduced production in our local area.

Management anticipates that both domestic and foreign demand for distillers grains may continue to be negatively affected by the COVID-19 pandemic. However, a decrease in production could continue to have a positive impact on prices. Other factors likely to affect distillers grains prices include domestic corn prices and availability of corn, the imposition by China of anti-dumping and anti-subsidy duties on distillers grains produced in the U.S. and other trade actions by the United States and foreign governments.
    
Corn Oil

Revenue from corn oil sales increased by approximately 18.5% during the six months ended April 30, 2020, as compared to the six months ended April 30, 2019. This is primarily the result of an increase in corn oil sold during the six months ended

21


April 30, 2020. The pounds of corn oil sold during the six months ended April 30, 2020, increased by approximately 22.87% as compared to the the six months ended April 30, 2019 due to increased ethanol production levels and improved efficiencies.

For the six months ended April 30, 2020, the average price per pound of corn oil we received was comparable to the six months ended April 30, 2019. Factors affecting corn oil prices for the period include the status of the biodiesel blenders' tax credit and changes in supply resulting from some ethanol plants reducing or shutting down ethanol production in response to poor economic conditions.

Cost of Goods Sold

Our two largest costs of production are corn (70.0% of cost of goods sold for the six months ended April 30, 2020) and natural gas (5.7% of cost of goods sold for the six months ended April 30, 2020). Our total cost of goods sold was approximately 5.3% more during the six months ended April 30, 2020, as compared to the six months ended April 30, 2019, due to increased corn costs and bushels ground.

Corn

Our average price per bushel of corn for the six months ended April 30, 2020 increased by approximately 12.3% per bushel, as compared to the six months ended April 30, 2019, due to a smaller corn crop in places near our local area which has led to a higher market value for corn as end users from those areas encroach on our local market. However, corn prices declined towards the end of the period due to reduced demand related to the COVID-19 pandemic.

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

We used approximately 1.5% more bushels of corn in the six months ended April 30, 2020, as compared to the six months ended April 30, 2019, due to an increase in ethanol production for the period.

At April 30, 2020, we have 1,862,452 bushels of forward fixed basis corn purchase contracts and 1,037,875 bushels of forward fixed price corn contracts valued at approximately $3,474,000 for various delivery periods through July 2021. We had losses related to corn derivative instruments of $424,373 and $92,119 for the six months ended April 30, 2020 and 2019, respectively.

Natural Gas

Our average price per MMBTU of natural gas was approximately 7.65% higher for the six months ended April 30, 2020, as compared to the six months ended April 30, 2019. Natural gas prices were higher due to new interim tariff rates levied by Northern Natural Gas effective January 1, 2020. Management anticipates that natural gas prices will continue at current levels unless the natural gas industry experiences production problems or if there are large increases in natural gas demand.

For the six months ended April 30, 2020, we purchased approximately 2.8% less natural gas as compared to the six months ended April 30, 2019. This decrease in natural gas usage is primarily due to a decrease in dried distillers grains production.

At April 30, 2020, we have 2,771,000 MMBTUs of forward natural gas sales contracts valued at approximately $6,781,000 for various delivery periods through March 2023. We had gains related to natural gas derivative instruments of $11,240 and $19,806 the six months ended April 30, 2020 and 2019, respectively.

Operating Expense

We had operating expenses for the six months ended April 30, 2020 of $2,086,328, as compared to operating expenses of $1,572,888 for the six months ended April 30, 2019. Management attributes this increase in operating expenses primarily to an increase in consulting fees and insurance costs for the six months ended April 30, 2020, as compared to the six months ended April 30, 2019. Management continues to pursue strategies to optimize efficiencies and maximize production. These efforts may result in a decrease in our operating expenses on a per gallon basis. However, because these expenses do not vary with the level of production at the plant, we expect our operating expenses to remain relatively steady.


22


Operating Loss

We had a loss from operations for the six months ended April 30, 2020 of $6,379,238, which is approximately (13.45%) of our revenues, compared to a loss of $4,988,399, which was approximately (10.93%) of our revenues, for the six months ended April 30, 2019. This increase in operating loss is primarily due to a an increase 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 six months ended April 30, 2020 of $189,035, as compared to total other expense of $310,814 for the six months ended April 30, 2019. Our other expense for the six months ended April 30, 2020, consisted primarily of interest expense offset by income from investments. This decrease in other expense is primarily due to an increase in other income and income from investments.

Changes in Financial Condition for the Six Months Ended April 30, 2020

The following table highlights the changes in our financial condition as of April 30, 2020 from our previous fiscal year ended October 31, 2019:

 
April 30, 2020
 
October 31, 2019
Current Assets
$
11,476,606

 
$
12,604,430

Current Liabilities
7,201,789

 
10,794,082

Long-Term Liabilities
14,911,639

 
7,244,124

    
Current Assets

The decrease in current assets is primarily the result of decreases in cash and cash equivalents, derivative instruments and accounts receivable, which were offset partially by an increase in inventories at April 30, 2020, as compared to October 31, 2019.
    
Current Liabilities

The decrease in current liabilities is due primarily to a decrease in accounts payable and current maturities of long-term debt at April 30, 2020, as compared to October 31, 2019.

Long-Term Liabilities

Long-term liabilities increased at April 30, 2020, as compared to October 31, 2019, primarily due to increased borrowings on the Term Revolving Loan, obtaining a PPP loan and adoption of ASC 842 which resulted in recording lease liabilities.

Liquidity and Capital Resources

The ethanol industry experienced adverse conditions throughout most of 2018 and 2019 as a result of industry-wide record low ethanol prices due to reduced demand and high industry inventory levels. These adverse conditions continued into 2020 and were compounded by the COVID-19 pandemic. As a result of these factors, we have experienced negative operating margins, lower cash flow from operations and net operating losses. In response, we have reduced our ethanol production levels by up to 25%. We continue to monitor COVID-19 developments and the effect on demand for our products to make adjustments to production levels as warranted. 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 for the next 12 months. We do not currently anticipate seeking additional equity or debt financing in the near term. However, if market conditions worsen, we could be forced to make further reductions in ethanol production levels or even temporarily shut down ethanol production.

    

23


The following table shows cash flows for the six months ended April 30, 2020 and 2019:
 
2020
2019
 
(unaudited)
(unaudited)
Net cash used in operating activities
$
(5,489,679
)
$
(820,560
)
Net cash used in investing activities
(656,339
)
(810,754
)
Net cash provided by financing activities
5,146,960

2,468,000


Cash Flow From Operations

We used more cash in operating activities for the six months ended April 30, 2020, as compared to the same period in 2019. This increase was primarily due to an increase in net loss and changes in accounts payable, inventories and accrued expenses for the six months ended April 30, 2020, as compared to the same period in 2019.

Cash Flow From Investing Activities

We used less cash in investing activities for the six months period ended April 30, 2020, as compared to the same period in 2019. This change was primarily due to a decrease in capital expenditures during the six months ended April 30, 2020.

Cash Flow From Financing Activities

We had more cash provided by financing activities during the six months ended April 30, 2020, as compared to the same period in 2019. This increase in cash provided was primarily the result of increased net borrowings on long-term debt during the six months ended April 30, 2020, as compared to the same period in 2019.

Short-Term and Long-Term Debt Sources

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

Term Loan
    
The Term Loan had an original balance of $15,000,000 with a variable interest rate based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at April 30, 2020 was 3.97%. Monthly principal payments are due on the Term Loan of approximately $250,000 plus accrued interest. Payments of all amounts outstanding are due on January 22, 2021. The outstanding balance on this note was $2,000,000 at April 30, 2020. We may convert the Term Loan to a fixed rate loan, subject to certain conditions as described in the Second Amended and Restated Credit Agreement and with the consent of Compeer.

Term Revolving Loan

The Term Revolving Loan is for up to $20,000,000 with a variable interest rate based on the 30-day LIBOR rate plus 325 basis points with no minimum interest rate. The applicable interest rate at April 30, 2020 was 3.97%. The Term Revolving Loan may be advanced, repaid and re-borrowed during the term. Monthly interest payments are due on the Term Revolving Loan with payment of all amounts outstanding due on January 22, 2023. The outstanding balance on this note was $12,499,000 at April 30, 2020. We pay interest at a rate of 1.50% on amounts outstanding for letters of credit which also reduce the amount available under the Term Revolving Loan. We had no letters of credit outstanding at April 30, 2020. We are also required to pay unused commitment fees for the Term Revolving Loan as defined in the Second Amended and Restated Credit Agreement.


24


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

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

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

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

PPP Loan

In March 2020, Congress passed a stimulus bill called the CARES Act to provide economic relief related to the COVID-19 pandemic. One of the programs established by the Cares Act is the Paycheck Protection Program ("PPP"), authorizing loans to small business for use in paying employees that continue to work throughout the COVID-19 pandemic and for rent, utilities and interest on mortgages. Loans obtained through the PPP are administered by the Small Business Administration and eligible to be forgiven as long as the proceeds are used for qualifying purposes and other conditions are met. On April 14, 2020, we were awarded a PPP loan in the amount of $712,200. Management expects that the entire loan will be used for to pay employees and for other qualifying costs and will be substantially forgiven.  To the extent it is not forgiven, we would be required to repay that portion at an interest rate of 1% over twelve months beginning on May 1, 2021.

Capital Expenditures    

We do not currently anticipate making significant capital expenditures during the remainder of our 2020 fiscal year.

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

Long-Lived Assets
         
We review long-lived assets for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable.  Impairment testing for assets requires various estimates and assumptions, including an allocation of cash flows to those assets and, if required, an estimate of the fair value of those assets.  Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management's

25


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

As of April 30, 2020, the fair values of our commodity-based derivative instruments are a net liability of approximately $422,000. As the prices of the hedged commodity moves in reaction to market trends and information, our statement of operations will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to protect the Company over the term of the contracts for the hedged amounts.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.     

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

Interest Rate Risk

We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from our Term Loan and our Term Revolving Loan, each bearing a variable interest rate.  As of April 30, 2020, we had $2,000,000 outstanding on the Term Loan and $12,499,000 outstanding on the Term Revolving Loan. Interest will accrue at the 30-day LIBOR rate plus 325 basis points. The applicable interest rate on these loans at April 30, 2020 was 3.97%. If we were to experience a 10% adverse change in the applicable interest rate, the annual effect such change would have on our income statement, based on the amount we had outstanding on our Term Loan and Term Revolving Loan at April 30, 2020, would be approximately $58,000.

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.”


26




Commodity Price Risk

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

In the ordinary course of business, we enter into forward contracts for our commodity purchases. At April 30, 2020, we have 1,862,452 bushels of forward fixed basis corn purchase contracts and 1,037,875 bushels of forward fixed price corn purchase contracts valued at approximately $3,474,000. These purchase contracts are for various delivery periods through July 2021. At April 30, 2020, we have 2,771,000 MMBTUs of forward natural gas fixed price purchase contracts valued at approximately $6,781,000 for delivery periods through March 2023. In addition, at April 30, 2020, we have 956,800 gallons of forward fixed price denaturant purchase contracts valued at approximately $1,198,000 for delivery periods through December 2020.

In the ordinary course of business, we enter into forward contracts for our commodity sales. At April 30, 2020, we have 4,382 tons of forward fixed price dried distillers grains sales contracts valued at approximately $708,000 for delivery periods through June 2020. At April 30, 2020, we have 8,200 tons of forward fixed price modified distillers grains sales contracts valued at approximately $613,000 for delivery periods through August 2020. In addition, at April 30, 2020, we have 745,296 pounds of forward fixed price corn oil sales contracts valued at approximately $212,000 for delivery periods through September 2020.
These derivatives have not been designated as effective hedges for accounting purposes and are forecasted to settle within the next twelve months. We had losses related to corn derivative instruments of $462,728 and $767,484 for the three months ended April 30, 2020 and 2019, respectively. We had losses related to ethanol based derivative instruments of $13,350 for the three months ended April 30, 2020. We had gains related to ethanol based derivative instruments of $40,738 for the three months ended April 30, 2019. We had gains related to natural gas derivative instruments of $4,919 and $0 for the three months ended April 30, 2020 and 2019, respectively.
    
As commodity prices move in reaction to market trends and information, our income statement will be affected depending on the impact such market movements have on the value of our derivative instruments. Depending on market movements, crop prospects and weather, these price protection positions may cause immediate adverse effects, but are expected to produce long-term positive growth for us.

A sensitivity analysis has been prepared to estimate our exposure to ethanol, distillers grains, corn and natural gas price risk. Market risk related to these factors is estimated as the potential change in income resulting from a hypothetical 10% adverse change in the average cost of our corn and natural gas prices and average ethanol and distillers grains prices as of April 30, 2020 net of the forward and future contracts used to hedge our market risk for corn and natural gas usage requirements. The volumes are based on our expected use and sale of these commodities for a one year period from April 30, 2020. The results of this analysis, which may differ from actual results, are approximately as follows:
 
Estimated Volume Requirements for the next 12 months (net of forward and futures contracts)
Unit of Measure
Hypothetical Adverse Change in Price as of
April 30, 2020
Approximate Adverse Change to Income
Natural Gas
1,541,000

MMBTU
10
%
 
$
300,500

Ethanol
67,000,000

Gallons
10
%
 
$
5,829,000

Corn
22,558,922

Bushels
10
%
 
$
6,384,000

DDGs
157,912

Tons
10
%
 
$
2,558,000


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

27




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, 2020.  Based on this review and evaluation, these officers have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the forms and rules of the Securities and Exchange Commission; and to ensure that the information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the three months ended April 30, 2020, which were identified in connection with management’s evaluation required by paragraph (d) of rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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

We are subject to global and regional economic downturns and related risks and the effects of COVID-19 may materially and adversely affect demand and the market price for our products.

The level of demand for our products is affected by global and regional demographic and macroeconomic conditions. A significant downturn in global economic growth, or recessionary conditions in major geographic regions for prolonged periods, may lead to reduced demand for our products, which could have a negative effect on the market price of our products.  In December 2019, a novel coronavirus surfaced in Wuhan, China (“COVID-19”).  The spread of COVID-19 worldwide has resulted in businesses suspending or substantially curtailing global operations and travel, quarantines, and an overall substantial slowdown of economic activity impacting consumer and business confidence. Transportation fuels in particular, including ethanol, have experienced significant price declines and reduced demand. The effects of COVID-19 have and may continue to materially and adversely affect the market price for our products, our business, results of operations and liquidity.

The COVID-19 pandemic may negatively impact our ability to operate our business which could decrease or eliminate the value of our units.

COVID-19 has resulted in significant uncertainty in many areas of our business.  We do not know how long these conditions will last.  This uncertainty is expected to negatively impact our operations.  We may experience labor shortages if our employees are unable or unwilling to come to work.  If our suppliers cannot deliver the supplies we need to operate our business or if we are unable to ship our products due to trucking or rail shipping disruptions, we may be forced to suspend operations or reduce production.  If we are unable to operate the ethanol plant at capacity, it may result in unfavorable operating results.  Any shut down of operations or reduction in production, especially for an extended period of time, could reduce or eliminate the value of our units. 



28




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

ISSUER PURCHASES OF EQUITY SECURITIES
Period
Total Number of Units Purchased
Average Price Paid per Unit $
Total Number of Units Purchased as Part of Publicly Announced Plans or Programs
Maximum Number of Units that May Yet Be Purchased Under the Plans or Programs
February 1, 2020 - February 28, 2020




March 1, 2020 - March 31, 2020




April 1, 2020 - April 30, 2020
2

6,500



Total
2

13,000



    
Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Item 6. Exhibits.

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

 
Certificate Pursuant to 17 CFR 240.13a-14(a)*

 
Certificate Pursuant to 17 CFR 240.13a-14(a)*

 
Certificate Pursuant to 18 U.S.C. Section 1350*

 
Certificate Pursuant to 18 U.S.C. Section 1350*
101

 
The following financial information from Highwater Ethanol, LLC's Quarterly Report on Form 10-Q for the quarter ended April 30, 2020, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Balance Sheets as of April 30, 2020 and October 31, 2019, (ii) Condensed Statements of Operations for the three and six months ended April 30, 2020 and 2019, (iii) Statements of Cash Flows for the three and six months ended April 30, 2020 and 2019, (iv) the Notes to Condensed Financial Statements and (v) Condensed Statements of Changes in Members' Equity for the three and six months ended April 30, 2020 and 2019.**
(+) Confidential Treatment Requested.
* Filed herewith.
** Furnished herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
HIGHWATER ETHANOL, LLC
 
 
 
 
Date:
June 12, 2020
 
/s/ Brian Kletscher
 
 
 
Brian Kletscher
 
 
 
Chief Executive Officer
 
 
 
(Principal Executive Officer)
 
 
 
 
Date:
June 12, 2020
 
/s/ Lucas Schneider
 
 
 
Lucas Schneider
 
 
 
Chief Financial Officer
 
 
 
(Principal Financial and Accounting Officer)
 
 
 
 


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