Granite Falls Energy, LLC - Quarter Report: 2016 July (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

☒Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

For the quarterly period ended July 31, 2016

 

OR

 

☐Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

For the transition period from               to               .

 

COMMISSION FILE NUMBER 000-51277

 

GRANITE FALLS ENERGY, LLC

(Exact name of registrant as specified in its charter)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

☒Yes    ☐No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

☒Yes    ☐No

 

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

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

☐Yes    ☒No

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

As of September 14, 2016 there were 30,606 membership units outstanding.

 

INDEX

 

 

 

PART IFINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

GRANITE FALLS ENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

 

 

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

 

GRANITE FALLS ENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

 

 

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

 

 

GRANITE FALLS ENERGY, LLC AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

 

 

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

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation and Principles of Consolidation

 

The accompanying condensed consolidated unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations. These financial statements and related notes should be read in conjunction with the financial statements and notes thereto included in the Company’s audited consolidated financial statements for the year ended October 31, 2015, contained in the Company’s annual report on Form 10-K.

 

In the opinion of management, the condensed consolidated unaudited financial statements reflect all adjustments consisting of normal recurring accruals that we consider necessary to present fairly the Company’s results of operations, financial position and cash flows. The results reported in these condensed consolidated unaudited financial statements should not be regarded as necessarily indicative of results that may be expected for any other fiscal period or for the fiscal year.

 

Nature of Business

 

Granite Falls Energy, LLC (“GFE” or the “Company”) is a Minnesota limited liability company currently producing fuel-grade ethanol, distillers' grains, and crude corn oil near Granite Falls, Minnesota and sells these products, pursuant to marketing agreements, throughout the continental United States and on the international market. GFE's plant has an approximate annual production capacity of 60 million gallons, but is currently permitted to produce up to 70 million gallons of undenatured ethanol on a twelve month rolling sum basis.

 

Heron Lake BioEnergy, LLC (“HLBE”) is a Minnesota limited liability company currently producing fuel-grade ethanol, distillers' grains, and crude corn oil near Heron Lake, Minnesota and sells these products, pursuant to marketing agreements, throughout the continental United States. HLBE's plant has an approximate annual production capacity of 60 million gallons, but is permitted to produce approximately 72.3 million gallons of undenatured ethanol on a twelve month rolling sum basis. Additionally, HLBE, through a majority owned subsidiary, operates a natural gas pipeline that provides natural gas to HLBE's ethanol production facility and other customers.

 

Principles of Consolidation

 

The accompanying condensed consolidated unaudited financial statements consolidate the operating results and financial position of GFE, and its 50.6% owned subsidiary, HLBE (through GFE's 100% ownership of Project Viking, LLC). Given the Company’s control over the operations of HLBE and its majority voting interest, the Company consolidates the condensed consolidated unaudited financial statements of HLBE with GFE's condensed consolidated unaudited financial statements. The remaining 49.4% ownership of HLBE is included in the condensed consolidated unaudited financial statements as a non-controlling interest. HLBE, through its wholly owned subsidiary, HLBE Pipeline Company, LLC, owns 73% of Agrinatural Gas, LLC (“Agrinatural”). Given HLBE’s control over the operations of Agrinatural and its majority voting interest, HLBE consolidates the financial statements of Agrinatural with its consolidated unaudited financial statements, with the equity and earnings attributed to the remaining 27% noncontrolling interest. All intercompany balances and transactions are eliminated in consolidation.

 

Segment Reporting

 

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker or decision making group in deciding how to allocate resources and in assessing performance. The Company has determined that it has one reportable business segment, the manufacture and marketing of fuel-grade ethanol and the co-products of the ethanol production process. Although the Company also realizes relatively immaterial revenue from natural gas pipeline operations at Agrinatural, the Company's chief operating decision maker reviews financial information of the Company as a whole for purposes of assessing financial performance and making operating decisions and does not separately review Agrinatural's operating performance information. Accordingly, the Company considers itself to be operating in a single industry segment.

Accounting Estimates

 

Management uses estimates and assumptions in preparing these condensed consolidated unaudited financial statements in accordance with generally accepted accounting principles in the United States of America. 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 the following significant matters, among others: economic lives of property, plant, and equipment, valuation of commodity derivatives, inventory, and inventory purchase and sale commitments, and the assumptions used in the impairment analysis of long-lived assets and goodwill. Actual results may differ from previously estimated amounts, and such differences may be material to our condensed consolidated unaudited financial statements. The Company periodically reviews estimates and assumptions, and the effects of revisions are reflected in the period in which the revision is made.

 

Revenue Recognition

 

The Company generally sells ethanol and related products pursuant to marketing agreements. Revenues from the production of ethanol and the related products are recorded when the customer has taken title and assumed the risks and rewards of ownership, prices are fixed or determinable and collectability is reasonably assured. Ethanol and related products are generally shipped free on board (FOB) shipping point. The Company believes there are no ethanol sales, during any given month, which should be considered contingent and recorded as deferred revenue.

 

In accordance with the Company's agreements for the marketing and sale of ethanol and related products, marketing fees and commissions due to the marketers are deducted from the gross sales price as earned. These fees and commissions are recorded net of revenues, as they do not provide an identifiable benefit that is sufficiently separable from the sale of ethanol and related products. Shipping costs paid by the Company to the marketer in the sale of ethanol are not specifically identifiable and, as a result, are recorded based on the net selling price reported to the Company from the marketer. Shipping costs incurred by the Company in the sale of distillers' grains and corn oil are included in cost of goods sold.

 

Inventory

 

Inventory is stated at the lower of cost or net realizable value in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2015-11 issued in July 2015. Cost for all inventories is determined using the first in first out method (“FIFO”).  Net realizable value is the estimated selling prices in the ordinary course of business less reasonably predictable costs of completion, disposal, and transportation.  Inventory consists of raw materials, work in process, finished goods, and spare parts.  Corn is the primary raw material along with other raw materials.  Finished goods consist of ethanol, distillers' grains, and corn oil.

 

Derivative Instruments

 

From time to time the Company enters into derivative transactions to hedge its exposures to commodity price fluctuations. The Company is required to record these derivatives on the balance sheets at fair value.

 

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

 

Additionally, the Company is required to evaluate its contracts to determine whether the contracts are derivatives. Certain contracts that literally meet the definition of a derivative may be exempted as “normal purchases or normal sales”.  Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business. Contracts that meet the requirements of normal purchases or sales are documented as normal and exempted from accounting and reporting requirements, and therefore, are not marked to market in our condensed consolidated unaudited financial statements.

 

In order to reduce the risks caused by market fluctuations, the Company occasionally hedges its anticipated corn, natural gas, and denaturant purchases and ethanol sales by entering into options and futures contracts. These contracts are used with the intention to fix the purchase price of anticipated requirements for corn in the Company's ethanol production activities and the related sales price of ethanol. The fair value of these contracts is based on quoted prices in active exchange-traded or over-the-counter market conditions. Although the Company believes its commodity derivative positions are economic hedges, none have been formally designated as a hedge for accounting purposes and derivative positions are recorded on the balance sheet at their fair market value, with changes in fair value recognized in current period earnings or losses. The Company does not enter into financial instruments for trading or speculative purposes.

 

The Company has adopted authoritative guidance related to “Derivatives and Hedging,” and has included the required enhanced quantitative and qualitative disclosure about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses from derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. See further discussion in Note 4.

 

Correction Of An Immaterial Error

 

The Company revised the condensed consolidated unaudited statement of cash flows for the nine months ended July 31, 2015, to correct for a non-cash acquisition of property and equipment resulting in an increase in cash provided by operating activities of $3,359,225 and a corresponding decrease in net cash provided by investing activities. 

 

2.   RISKS AND UNCERTAINTIES

 

The Company has certain risks and uncertainties that it experiences during volatile market conditions. These volatilities can have a severe impact on operations.  The Company's revenues are derived from the sale and distribution of ethanol, distillers' grains, corn oil, and natural gas to customers primarily located in the United States. Corn for the production process is supplied to our plant primarily from local agricultural producers and from purchases on the open market.  Ethanol sales typically average 75 - 85% of total revenues and corn costs typically average 65 - 85% of cost of goods sold.

 

The Company's operating and financial performance is largely driven by the prices at which they sell ethanol and the net expense of corn. The price of ethanol is influenced by factors such as supply and demand, the weather, government policies and programs, and unleaded gasoline prices and the petroleum markets as a whole. Excess ethanol supply in the market, in particular, puts downward pressure on the price of ethanol. Our largest cost of production is corn.  The cost of corn is generally impacted by factors such as supply and demand, the weather, government policies and programs, and our risk management program used to protect against the price volatility of these commodities.

 

 

3.   INVENTORY

 

Inventories consist of the following:

 

 

The Company performs a lower of cost or net realizable value analysis on inventory to determine if the market values of certain inventories are less than their carrying value, which is attributable primarily to decreases in market prices of corn and ethanol. Based on the lower of cost or net realizable value analysis, the Company recorded a loss on ethanol inventories, as a component of cost of goods sold, of approximately $108,000 and $0 for the nine month periods ended July 31, 2016 and 2015, respectively.

 

4.   DERIVATIVE INSTRUMENTS

 

As of July 31, 2016, the total notional amount of the Company's outstanding corn derivative instruments was approximately 6,525,000 bushels, comprised of 2,650,000 and 3,875,000 bushel equivalent positions held by GFE and HLBE, respectively, that were entered into to hedge forecasted corn purchases through July 2017. There may be offsetting positions that are not shown on a net basis that could lower the notional amount of positions outstanding as disclosed above. 

 

As of July 31, 2016, the total notional amount of the Company’s outstanding ethanol derivative instruments was approximately 840,000 gallons, comprised of approximately 420,000 gallons of equivalent positions held by each of GFE and HLBE that were entered into to hedge forecasted ethanol sales through September 2016.

 

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

 

 

In addition, at July 31, 2016, the Company maintained approximately $1,801,000 of restricted cash, comprised of approximately $1,738,000 held by GFE and approximately $63,000 held by HLBE related to margin requirements for the Company’s commodity derivative instrument positions.

 

The following tables provide details regarding the Company's derivative instruments at October 31, 2015, none of which were designated as hedging instruments:

 

 

At October 31, 2015, the Company did not have any cash collateral (restricted cash) related to commodity derivatives held by a broker.

 

The following tables provide details regarding the gains and losses from Company's derivative instruments in statements of operations, none of which are designated as hedging instruments:

 

 

 

 

5.   FAIR VALUE

 

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

 

 

The following table provides information on those derivative instruments measured at fair value on a recurring basis at October 31, 2015:

 

 

The Company determines the fair value of commodity derivative instruments by obtaining fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes and live trading levels from the Chicago Board of Trade market and New York Mercantile Exchange.

 

 

6.   DEBT FACILITIES

 

Debt financing consists of the following:

 

 

Granite Falls Energy:

 

GFE has a revolving term loan facility, under which GFE could initially borrow, repay, and re-borrow in an amount up to $18,000,000.   Under the terms of this revolving term loan facility, the revolving term loan principal commitment for borrowing under this facility reduces by $2,000,000 semi-annually, beginning September 1, 2014, with

final payment due March 1, 2018. GFE had no outstanding balance on the revolving term loan at July 31, 2016, and October 31, 2015. Therefore, the aggregate principal amount available for borrowing under this revolving term loan facility at July 31, 2016 and at October 31, 2015 was $10,000,000 and $12,000,000, respectively. The interest rate is based on the bank's "One Month LIBOR Index Rate," plus 3.05%.

 

The credit facility also requires GFE to comply with certain financial covenants at various times calculated monthly, quarterly or annually, including restriction of the payment of dividends and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility. Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges or penalties. As of July 31, 2016 and October 31, 2015, GFE was in compliance with these financial covenants and expects to be in compliance throughout fiscal 2016. 

 

The credit facility is secured by substantially all assets of the Company. There are no savings account balance collateral requirements as part of this credit facility.

 

Heron Lake BioEnergy:

 

HLBE has a revolving term loan with a lender initially totaling $28,000,000.  Amounts borrowed by HLBE under the revolving term loan and repaid or prepaid may be re-borrowed at any time prior to the March 1, 2022 maturity date. Under the terms of the credit facility, the revolving term loan principal commitment is scheduled to decline by $3,500,000 annually, starting March 1, 2015 and continues each anniversary thereafter until maturity.  Therefore, the aggregate  principal commitment under this facility at July 31, 2016 was $21,000,000. After accounting for amounts outstanding under this facility at July 31, 2016, the aggregate principal amount available to HLBE for borrowing was approximately $15,877,000.  The outstanding balance on the revolving term loan totaled approximately $5,123,000 and $4,823,000 at July 31, 2016, and October 31, 2015, respectively.

 

Interest on the revolving term loan accrues at a variable rate equal to 3.25% above the One-Month London Interbank Offered Rate ("LIBOR") Index rate. HLBE may elect to enter into a fixed interest rate on this loan at various times throughout the term of the loan as provided in the loan agreements. The interest rate on the revolving term loan was 3.75% and 3.45% at July 31, 2016, and October 31, 2015, respectively.

 

HLBE also agreed to pay an unused commitment fee on the unused portion of the revolving term loan commitment at the rate of 0.50% per annum. The revolving term loan is subject to a prepayment fee for any prepayment on the term loan prior to July 1, 2016 due to refinancing. The loan is secured by substantially all of HLBE's assets including a subsidiary guarantee. 

 

During the term of the revolving term loan, HLBE is subject to certain financial covenants at various times calculated monthly, quarterly or annually, including restriction of the payment of dividends and loans and advances to Agrinatural and maintenance of certain financial ratios including minimum working capital, minimum net worth and a debt service coverage ratio as defined by the credit facility. Failure to comply with the protective loan covenants or maintain the required financial ratios may cause acceleration of the outstanding principal balances on the revolving term loan and/or the imposition of fees, charges or penalties. As of July 31, 2016 and October 31, 2015, HLBE was in compliance with these financial covenants and expects to be in compliance throughout fiscal 2016.

 

As part of the credit facility closing, HLBE entered into an Administrative Agency Agreement with CoBank, ACP (“CoBank”).  CoBank purchased a participation interest in the AgStar loans and was appointed the administrative agent for the purpose of servicing the loans.  As a result, CoBank will act as the agent for AgStar with respect to the credit facility.

 

In October 2003, HLBE entered into an industrial water supply development and distribution agreement with the City of Heron Lake, Jackson County, and Minnesota Soybean Processors. In consideration of this agreement, HLBE and Minnesota Soybean Processors are allocated equally the debt service on $735,000 in water revenue bonds that were issued by the City to support this project that mature in February 2019. The parties have agreed that, prior to the scheduled expiration of the agreement, they will negotiate in good faith to replace the agreement with a further agreement regarding the wells and related facilities.

 

In May 2006, HLBE entered into an industrial water supply treatment agreement with the City of Heron Lake and Jackson County. Under this agreement, HLBE pays monthly installments over 24 months starting January 1, 2007 equal to one years' debt service on approximately $3.6 million in water revenue bonds, which will be returned to HLBE if any funds remain after final payment in full on the bonds and assuming HLBE complies with all payment obligations under the agreement.

 

As of July 31, 2016 and October 31, 2015, there were a total of approximately $1,780,000 and $1,963,000, respectively, in outstanding water revenue bonds. HLBE classifies its obligations under these bonds as assessments payable. The interest rates on the bonds range from 0.50% to 8.73%.

 

Estimated annual maturities of debt at July 31, 2016, are as follows based on the most recent debt agreements:

 

 

 

7.   LEASES

 

GFE leases equipment, primarily rail cars, under operating leases through 2025. Rent expense for these leases was approximately $804,000 and $596,000 for the three months ended ended July 31, 2016 and 2015, respectively, and approximately $2,510,000 and $1,800,000 for the nine months ended July 31, 2016, and 2015, respectively.

 

HLBE leases equipment, primarily rail cars, under operating leases through 2017.  Rent expense for these leases was approximately $686,000 and $525,000 for the three months ended July 31, 2016 and 2015, respectively,  and approximately $1,931,000 and $1,572,000 for the nine months ended July 31, 2016 and 2015, respectively.

 

 

8.   MEMBERS' EQUITY

 

GFE has one class of membership units.   The units have no par value and have identical rights, obligations and privileges.  Income and losses are allocated to all members based upon their respective percentage of units held. As of July 31, 2016 and October 31, 2015, GFE had 30,606 membership units authorized, issued, and outstanding.

 

In December 2014, the Board of Governors of GFE declared a cash distribution of $1,050 per unit or approximately $32,136,000, for unit holders of record as of December 18, 2014.  The distribution was paid in January 2015.

 

In December 2015, the Board of Governors of GFE declared a cash distribution of $315 per unit, or approximately $9,641,000,  for unit holders of record as of December 17, 2015. The distribution was paid in January 2016.

 

In December 2014, the Board of Governors of HLBE declared a cash distribution of $0.12 per unit or approximately $9,352,000 for unit holders of record as of December 18, 2014, of which approximately $4,621,000 was made to the non-controlling interest members of HLBE.  The distribution was paid in January 2015.

 

In December 2015, the Board of Governors of HLBE declared a cash distribution of $0.05 per unit, or approximately $3,897,000,  for unit holders of record as of December 17, 2015, of which approximately $2,007,000 was made to the noncontrolling interest members of HLBE. The distribution was paid in January 2016.

 

9.   COMMITMENTS AND CONTINGENCIES

 

Corn Contracts

 

At July 31, 2016, GFE had no forward corn contracts.

 

At July 31, 2016, HBLE had cash and basis contracts for forward corn purchase commitments for approximately 3,826,000 bushels for deliveries through July 2017, which approximates 18% of its anticipated corn needs during this period.

 

Ethanol Contracts

 

At July 31, 2016, GFE had forward contracts (both fixed and basis) to sell approximately $16,030,000 of ethanol for various delivery periods through December 2016 which approximates 41% of its anticipated ethanol sales during this period.

 

During the third fiscal quarter, GFE amended its ethanol marketing agreement with Eco-Energy. As amended, the term of the marketing agreement shall continue through December 31, 2019. Additionally, the amended agreement also provides for certain negotiated changes to the marketing fees payable to Eco-Energy and payment terms based on prevailing market-rate conditions for comparable ethanol marketed services.

 

At July 31, 2016, HLBE had forward contracts (both fixed and basis) to sell approximately $17,100,000 of ethanol for various delivery periods through December 2016, which approximates 44% of its anticipated ethanol sales during this period.

 

During the third fiscal quarter, HLBE amended its ethanol marketing agreement with Eco-Energy. As amended, the term of the marketing agreement shall continue through December 31, 2019. Additionally, the amended agreement also provides for certain negotiated changes to the marketing fees payable to Eco-Energy and payment terms based on prevailing market-rate conditions for comparable ethanol marketed services.

 

Distillers' Grain Contracts

 

At July 31, 2016, GFE had forward contracts to sell approximately $333,000 of distillers' grain for deliveries through September 2016, which approximates 11% of its anticipated distillers’ grains sales during this period.

 

At July 31, 2016, HLBE had forward contracts to sell approximately $1,393,000 of distillers' grains for delivery through December 2016, which approximates 16% of its anticipated distillers’ grains sales during this period.

 

Corn Oil

 

At July 31, 2016, GFE had forward contracts to sell approximately $582,000 of corn oil for delivery through December 2016, which approximates 28% of its anticipated corn oil sales during this period.

 

At July 31, 2016, HLBE had forward contracts to sell approximately $621,000 of corn oil for delivery through December 2016, which approximates 30% of its anticipated distillers’ grains sales during this period.

 

 

 

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 nine months ended July 31, 2016, compared to the same periods of the prior fiscal year. This discussion should be read in conjunction with the condensed consolidated unaudited financial statements and related notes in Item 1 of this report and the information contained in the Company's annual report on Form 10-K for the fiscal year ended October 31, 2015.

 

Disclosure Regarding Forward-Looking Statements

 

The SEC encourages companies to disclose forward-looking information so investors can better understand future prospects and make informed investment decisions. As such, we have historical information, as well as forward-looking statements regarding our business, financial condition, results of operations, performance and prospects in this report.  All statements that are not historical or current facts are forward-looking statements. In some cases,  you can identify forward-looking statements by terms such as “anticipates”, “believes”, “could”, “estimates”, “expects”, “intends”, “may”, “plans”, “potential”, “predicts”, “projects”, “should”, “will”, “would”, and similar expressions. 

 

Forward-looking statements are subject to a number of known and unknown risks, uncertainties and other factors, many of which may be beyond our control, and may cause actual results, performance or achievements to differ materially from those projected in, expressed or implied by forward-looking statements. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us are described more particularly in the “Risk Factors” section of our annual report on Form 10-K for the year ended October 31, 2015 and of this report on Form 10-Q. These risks and uncertainties include, but are not limited to, the following:

 

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

 

Available Information

 

Our website address is www.granitefallsenergy.com.  Our annual report on Form 10-K, periodic reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are available, free of charge, on our website under the link “SEC 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 report on Form 10-Q.

 

Industry and Market Data

 

Much of the information in this report regarding the ethanol industry, including government regulation relevant to the industry is from information published by the Renewable Fuels Association (“RFA”), a national trade association for the United States (“U.S.”) ethanol industry, and information about the market for our products and competition is derived from publicly available information from governmental agencies or publications and other published independent sources.  Although we believe our third-party sources are reliable, we have not independently verified the information.

 

Overview

 

Granite Falls Energy, LLC is a Minnesota limited liability company.  References to “we”,  “us”,  “our”,  “Granite Falls Energy”,  “GFE”, and the “Company” refer to Granite Falls Energy, LLC. Our business consists primarily of the production and sale of ethanol and its co-products (wet, modified wet and dried distillers’ grains, corn oil and corn syrup) locally, and throughout the continental U.S.    

 

Our production operations are carried out at our ethanol plant located in Granite Falls, Minnesota and at the ethanol plant operated by our majority owned subsidiary, Heron Lake BioEnergy, LLC (“Heron Lake BioEnergy” or “HLBE”), near Heron Lake, Minnesota.  As of July 31, 2016, we control approximately 50.6% of HLBE's outstanding membership units through our wholly owned subsidiary, Project Viking, L.L.C.  

 

The GFE ethanol plant has an approximate annual production capacity of 60 million gallons of denatured ethanol, but is currently permitted to produce up to 70 million gallons of undenatured ethanol on a twelve month rolling sum basis. The HLBE plant has an approximate annual production capacity of 60 million gallons of denatured ethanol, but is currently permitted to produce up to 72 million gallons of undenatured ethanol on a twelve month rolling sum basis.  We intend to continue working toward increasing production at both the GFE and HLBE plants to take advantage of the additional production allowed pursuant to our permits so long as we believe it is profitable to do so.

 

We market and sell the products produced at the GFE and HLBE plants primarily using third party marketers. The markets in which our products are sold may be local, regional, national, and international and depend primarily upon the efforts of third party marketers. We have contracted with Eco-Energy, LLC to market all of the ethanol produced at our ethanol plants.  We also independently market a small portion of the ethanol production at the GFE plant as E-85 to local retailers.  We have contracted with Renewable Products Marketing Group, LLC (“RPMG”) to market the distillers’ grains produced at the GFE plant and with Gavilon Ingredients, LLC to market distillers’ grains produced at the HLBE plant. We have contracted with RPMG to market all of corn oil produced at our ethanol plants. HLBE also occasionally independently markets and sells excess corn syrup from the distillation process at the Heron Lake plant to local livestock feeders.

 

On July 22, 2016, we executed Amendment No. 4 (the “Fourth Amendment”) to our ethanol marketing agreement dated December 24, 2008, as previously amended by Amendments 1 trhough 3 (the “GFE Marketing Agreement”), with Eco-Energy, LLC (“Eco-Energy”). Additionally, on July 22, 2016, HLBE executed Amendment No. 1 (the “First Amendment”) to its ethanol marketing agreement dated September 17, 2013 (the “HLBE Marketing Agreement”) with Eco-Energy. Under the terms of the Marketing Agreements with Eco-Energy, Eco-Energy purchases the entire ethanol output of the GFE ethanol plant and HLBE plant and each of HLBE and GFE pay Eco-Energy marketing fee in consideration of Eco-Energy's services.  These Marketing Agreements were set to expire on December 31, 2016.  However, both the Fourth Amendment to the GFE Marketing Agreement and the First Amendment to the HLBE Marketing Agreement provide for an extension of the term of the Marketing Agreements through December 31, 2019, with automatic renewals for additional consecutive terms of three years unless either party provides written notice to the other at least 90 days prior to the end of the term or the renewal term. Additionally, the Amendments provide for certain negotiated changes to the marketing fees payable to Eco-Energy and  the timing of payments by Eco-Energy to each of HLBE and GFE for the ethanol Eco-Energy purchases from our plants. The Amendments are effective as of January 1, 2017.

 

Our cost of goods sold consists primarily of costs relating to the corn and natural gas supplies necessary to produce ethanol and distillers' grains for sale at our ethanol plants. Farmers Cooperative Elevator (“FCE”) is the exclusive supplier of corn to the GFE plant.  HLBE generally does not have long-term, fixed price contracts for the purchase of corn. Typically, HLBE purchases its corn directly from grain elevators, farmers, and local dealers within approximately 80 miles of Heron Lake, Minnesota.

 

At the GFE plant, we pay Center Point Energy/Minnegasco a per unit fee to move the natural gas through the pipeline, and we have guaranteed to move a minimum of 1,500,000 MMBTUs annually through December 31, 2025, which is the ending date of the agreement.  We also have an agreement with U.S. Energy Services, Inc. to procure contracts with various natural gas vendors on our behalf to supply the natural gas necessary to operate the Granite Falls plant.

 

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

 

We have entered into a management services agreement with HLBE pursuant to which our chief executive officer, chief financial officer, and commodity risk manager also hold those same offices with HLBE.  The initial term of the management services agreement expired in July 2016.  However, the management services agreement automatically renewed for an one-year term and will continue to automatically renew for successive one-year terms unless either HLBE or GFE gives the other party written notice of termination prior to expiration of the then current term. The management services agreement may also be terminated by either party for cause under certain circumstances.

 

HLBE also owns a controlling 73% interest in Agrinatural Gas, LLC (“Agrinatural”), which is a natural gas distribution and sales company located in Heron Lake, Minnesota that owns approximately 187 miles of natural gas pipeline and provides natural gas to HLBE’s ethanol plant and other commercial, agricultural and residential customers through a connection with the natural gas pipeline facilities of Northern Border Pipeline Company.  Agrinatural's revenues are generated through natural gas distribution fees and sales.

 

Reportable Operating Segments

 

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Our revenues from operations come from three primary sources: sales of fuel ethanol, sales of distillers' grains and sales of corn oil at GFE's ethanol plant and HLBE's ethanol plant.  Therefore, we have determined that based on the nature of the products and production process and the expected financial results, the Company’s operations at its ethanol plant and HLBE's plant, including the production and sale of ethanol and its co-products, are aggregated into one reporting segment.

 

Additionally, we also realize relatively immaterial revenue from natural gas pipeline operations at Agrinatural, HLBE's majority owned subsidiary.  The intercompany transactions between HLBE and Agrinatural resulting from the firm natural gas transportation agreement between the two companies are eliminated in consolidation. After intercompany eliminations, revenues from Agrinatural represent less than less than 1% of our consolidated revenues and have little to no impact on the overall performance of the Company.  Therefore, our management does not separately review Agrinatural's operating performance information.  Rather, management reviews Agrinatural's natural gas pipeline financial data on a consolidated basis with our ethanol production operations segment. Additionally, management believes that the presentation of separate operating performance information for Agrinatural's natural gas pipeline operations would not provide meaningful information to a reader of the Company’s condensed consolidated unaudited financial statements.

 

We currently do not have or anticipate that we will have any other lines of business or other significant sources of revenue other than the sale of ethanol and its co-products, which include distillers' grains and non-edible corn oil.

 

Plan of Operations for the Next Twelve Months

 

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

 

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

 

At the GFE plant, we constructed an additional grain bin, which expands the GFE plant’s grain storage by approximately 750,000 bushels. The grain storage expansion project was commended in August 2015 and was completed during the three months ended July 31, 2016. 

 

Several upscaling projects will be required to increase the HLBE plant's current production capacity and take full advantage of the additional production allowed under its amended air permit. One such project includes replacing HLBE's existing regenerative thermal oxidizer (“RTO”). During the three months ended July 31, 2016, we completed installation of the RTO and completed emissions testing. With installation complete, management expects the new RTO will improve emissions control and allow us to continue to maintain regulatory compliance under our amended air permit.

 

GFE’s corn storage expansion project and HLBE’s RTO replacement project were funded from current earnings from operations.  In addition, we anticipate continuing to conduct routine maintenance and repair activities at the GFE and HLBE ethanol plants. We anticipate using cash we generate from our operations and, as needed, our credit facilities to finance these plant upgrade projects.

 

Trends and Uncertainties Impacting Our Operations

 

The principal factors affecting our results of operations and financial conditions are the market prices for corn, ethanol, distillers’ grains and natural gas, as well as governmental programs designed to create incentives for the use of corn-based ethanol.  Other factors that may affect our future results of operation include those risks discussed below and in “PART II - Item 1A. Risk Factors” of this report and “PART I - Item 1. Business” and “PART I - Item 1A. Risk Factors” of our annual report on Form 10-K for the fiscal year ended October 31, 2015.

 

Our operations are highly dependent on commodity prices, especially prices for corn, ethanol, distillers’ grains and natural gas. As a result, our operating results can fluctuate substantially due to volatility in these commodity markets. The price and availability of corn is subject to significant fluctuations depending upon a number of factors that affect commodity prices in general, including crop conditions, yields, domestic and global stocks, weather, federal policy and foreign trade.

 

Natural gas prices are influenced by severe weather in the summer and winter and hurricanes in the spring, summer and fall. Other factors include North American exploration and production, and the amount of natural gas in underground storage during injection and withdrawal seasons.

 

Ethanol prices are sensitive to world crude oil supply and demand, domestic gasoline supply and demand, the price of crude oil, gasoline and corn, the price of substitute fuels and octane enhancers, refining capacity and utilization, government regulation and incentives and consumer demand for alternative fuels. Distillers’ grains prices are impacted by livestock numbers on feed, prices for feed alternatives and supply, which is associated with ethanol plant production. 

 

We expect our ethanol plants to produce approximately 2.8 gallons of denatured ethanol for each bushel of grain processed in the production cycle. Because the market price of ethanol is not always directly related to corn, at times ethanol prices may lag price movements in corn prices and corn-ethanol price spread (the difference between the price per gallon of ethanol and the price per bushel of grain divided by 2.8) may be tightly compressed or negative. If the corn-ethanol price spread is compressed or negative for sustained period, it is possible that our operating margins will decline or become negative and our ethanol plants may not generate adequate cash flow for operations. In such cases, we may reduce or cease production at our ethanol plants in order to minimize our variable costs and optimize cash flow. Any such determinations to reduce or cease production will be made independently for each plant.

 

Our operating margins for the three months ended July 31, 2016, were impacted by volatility in the commodity markets. As a result of the lower gasoline prices and the traditional summer driving season, gasoline demand increased for the three months ended July 31 2016, which in turn increased the demand for ethanol.  The increased ethanol demand was countered by increased domestic ethanol production, which resulted in slight increases in ethanol prices through June 2016.  However, in July 2016, favorable weather conditions during the growing season led to higher than expected production projections for the current year corn crop, which resulted in declining corn prices. Following corn prices, ethanol prices also decreased. Despite commodity market volatility, ethanol traded at a premium to wholesale gasoline for much of the three months ended July 31, 2016.

 

Management believes distillers’ grains has also been negatively impacted by the Chinese government initiating an anti-dumping and countervailing duty investigation in January 2016. On July 8, 2016, China’s Ministry of Commerce issued an official notice concerning the hearing in the anti-dumping and countervailing investigations against distillers grains originating in the U.S. The hearing was held August 2, 2016, in Beijing. China is not expected to make a decision on whether to impose antidumping duties on U.S. dried distillers’ grain imports until after the scheduled visit of President Barack Obama to China in early September. If China were to impose a high tariff on distillers’ grains exports from the U.S., it could negatively impact the market price of distillers’ grains in the U.S. which could negatively impact our financial performance.

 

The Renewable Fuels Standard

 

The RFS has been, and we expect will continue to be, a significant factor impacting ethanol usage. In the Environmental Protection Agency’s (“EPA”) November 2015 final rule, the RFS required blending volume obligations (“RVOs”) for corn-based ethanol for 2014, 2015 and 2016 were reduced from the statutorily mandated levels. As set in the November 2015 rule, the required blending volume for corn-based ethanol blending for 2016 is 14.5 billion gallons, compared to 15 billion gallons as originally set by statute. Additionally, on May 18, 2016, the EPA released its preliminary rulemaking for 2017, setting the RVO for corn-based ethanol at 14.8 billion gallons, an increase over the 2016 requirement but still below the statutory mandate of 15 billion gallons. The proposal modestly increases the minimum volume requirements of ethanol to 14.8 billion gallons for the coming year. This proposal is expected to be finalized by November of 2016.

 

The EPA’s departure from the RFS statutory requirements in both the final rule and proposed 2017 volumes are expected to limit demand for ethanol and may have a negative impact on ethanol prices and demand unless additional demand is created by discretionary blending. Beyond the federal mandates, there are limited markets for ethanol. Further, due to the lower price of gasoline, management does not anticipate that renewable fuels blenders will use more ethanol than is required by the RFS which may result in a significant decrease in ethanol demand. A reduction in ethanol demand could have a material adverse effect on our results of operations, cash flows and financial condition, unless additional demand from exports or discretionary or E85 blending develops.

 

Environmental and Other Regulations

 

Our business subjects us to various federal, state, and local environmental laws and regulations.  These laws and regulations require us to obtain and comply with numerous permits to construct and operate our ethanol plant, including water, air and other environmental permits. Although we have been successful in obtaining all of the permits currently required, any retroactive change in environmental regulations, either at the federal or state level, could require us to obtain additional or new permits or spend considerable resources in complying with such regulations. Additionally, any changes that are made to the ethanol plant or its operations must be reviewed to determine if amended permits need to be obtained in order to implement these changes.

 

In connection with HLBE’s RTO replacement project, HLBE has filed an application for a major amendment of its air emissions permit with the Minnesota Pollution Control Agency (“MPCA”) to allow for the replacement under its current permit. However, due to backlog in the permit approval process, on April 27, 2016, HLBE entered into a compliance agreement with the MPCA. Under the compliance agreement, the MPCA will allow HLBE to proceed with replacement of its RTO prior to receiving approval of its major amendment application provided HLBE operates the new RTO in compliance with its existing air emissions permit and completes certain green initiatives at its facility, including constructing a butterfly and bee garden, installing LED lighting throughout the facility, and installing variable frequency drives on its evaporator pumps. As of July 31, 2016, HLBE had completed construction of the butterfly and bee garden and installation of LED lighting throughout the facility. Installation of the variable frequency drives is expected to be completed this fall during HLBE’s regular semi-annual maintenance shutdown.  Although HLBE expects to comply with all of the requirements of the compliance agreement, its failure to do so could result in penalties and fines as well as additional compliance and/or remediation obligations.

 

Results of Operations for the Three Months Ended July 31, 2016 and 2015

 

The following table shows summary information from the results of our operations and the approximate percentage of revenues, costs of goods sold, operating expenses and other items to total revenues in our unaudited condensed consolidated statements of operations for the three months ended July 31, 2016 and 2015 (amounts in thousands).  

 

 

Revenues

 

Our consolidated revenue is derived principally from sales of our three primary products: ethanol, distillers’ grains and corn oil. Revenues from these products represented approximately 99.6%  and 99.7% of our total revenues for the three months ended July 31, 2016 and 2015, respectively.  The remaining approximately 0.4% and 0.3% attributable to miscellaneous other revenue for the three months ended July 31, 2016 and 2015 is made up of incidental sales of corn syrup at HLBE's plant and revenues from natural gas pipeline operations at Agrinatural, net of intercompany eliminations for distribution fees paid by HLBE to Agrinatural for natural gas transportation services.  

 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our unaudited condensed consolidated statements of operations for the three months ended July 31, 2016:

 

 

The following table shows the sources of our consolidated revenue and the approximate percentage of revenues from those sources to total revenues in our condensed consolidated unaudited statements of operations for the three months ended July 31, 2015:

 

 

Our total consolidated revenues decreased by approximately 1.1% for the three months ended July 31, 2016, as compared to the three months ended July  31, 2015 due primarily to decreases in the average price received for our ethanol.  The following table reflects quantities of our three primary products sold and the average net prices received for the three months ended July 31, 2016 and 2015: 

 

 

Ethanol

 

Total revenues from sales of ethanol increased by approximately 1.4% for the three months ended July 31, 2016 compared to the three months ended July 31, 2015 due to an increase of approximately 3.3% in the volumes sold, offset by an approximately 1.8%  decrease in the average price per gallon we received for our ethanol. This increase in the number of gallons sold during the 2016 period is attributable to an approximately 5.6% increase in the number of gallons sold at the HLBE plant during the three months ended July 31, 2016 as compared to the three months ended July 31, 2015.  The number of gallons of ethanol sold at the GFE plant was only marginally higher, increasing by approximately 0.9% from period to period.   The increase in the number of gallons sold during three months ended July 31, 2016 as compared to the same period of 2015, was largely due to the timing of ethanol shipments and an increase in ethanol production at the HLBE plant.    Ethanol production at the HLBE plant was higher compared to prior year due to capital improvements HLBE is making to increase ethanol production under its amended higher permited capacity.